Donating to charity is a fulfilling experience. The way you donate may allow you to keep more of what you’ve earned, so you can help out your favorite charity or charities even more.
Normally donations are done through cash, check, or credit card. Outside of the norm are two main strategies that have additional tax incentives.
- Qualified Charitable Distribution (QCD)
- Donation of appreciated investments
Let’s break these down into a detailed summary to better understand the why and how behind these two options.
What is a Qualified Charitable Distribution?
Per the Internal Revenue Code, a Qualified Charitable Distribution (QCD) is a distribution made directly from an IRA to a public charity. The distribution directly from your retirement account to your favorite charity is considered tax free. You don’t pay income tax on the money out of your account. Don’t get too excited because you don’t receive a tax deduction on top of that. That would be double dipping.
In order to make a QCD, the IRA owner must be at least 70 1/2 and the check must be written in the name of the qualifying charity. There are a few more stipulations you must follow to take advantage of a QCD such as:
- A QCD is not allowed from an employer retirement plan.
- Your old 401(k), 403(b), or 457(b) is not eligible!
- Your SEP or SIMPLE IRA is not eligible if you’re still active in the plan.
- Make sure the donation is normally and fully deductible.
- You’re ineligible for QCD treatment if you receive a kickback or you receive some benefit.
- This prevents any type of split-interest charitable trust from being an eligible QCD beneficiary.
- Each person is allowed to complete a $100,000 QCD each year
- Married couples can complete up to $200,000 each year
Since you must be 70 1/2 or older it is common that the QCD is completed to use up a portion of a Required Minimum Distribution (RMD). If this is (or one of) your reasons to make a QCD then you need to make sure your QCD is your first IRA distribution for the year.
If you take other IRA distributions before your QCD then the QCD is not eligible for your RMD. Donate before you spend!
When should I make a Qualified Charitable Distribution?
A QCD should be made for one of two reasons:
- Avoid paying tax on money you don’t need to spend from an RMD
- Strategically donate to your favorite charity
Some retirees have sufficient money available to cover living expenses prior to an RMD. Fortunately, the use of a QCD is a way to remove taxable income while fulfilling your charitable goal.
However, many retirees do live on their RMDs (or more). Yet, these retirees may have charitable goals. In the case of these retirees it may make sense to have a few checks sent directly to the charity of their choice.
The benefits of a QCD is magnified when you don’t itemize your deductions. If you don’t itemize then you don’t get a deduction for charitable contributions. Utilizing a QCD is a way to ensure you receive tax savings.
Under recent tax reform the standard deduction might increase to a level where many individuals no longer itemize. Unless a special rule is created for charitable contributions the benefit of utilizing a QCD could be tremendous.
The key rule to keep in mind is the ordering rule. The first distributions from your IRA must be checks written directly to the charity to count towards your RMD. Any distributions after that can be paid to you for your normal living expenses. Here is an example:
Bob, 72, has a Required Minimum Distribution of $12,000 and is in the 25% tax bracket. He chooses to be paid $1,000 per month. He donates $2,000 every year to his favorite charity. In January and February, Bob, would need to have the checks written out directly to the charity. After that each check could be sent to Bob to be spent however he wants. When he files his tax return only $10,000 of the $12,000 distributed would be taxable. This is a tax savings of approximately $500.
If you take more than the RMD in a given year you are still eligible for a QCD. It simply does not fulfill the requirement to cover an RMD.
Keep in mind that if any check is written to you and then in turn is paid to a charity it does not meet eligibility for a QCD. It will be considered a regular cash donation.
When you make a QCD you need to let your tax preparer know. Form 1099-R does not have any special reporting regarding a QCD! If you don’t notify your tax preparer they will have no idea that you completed a QCD meaning you will likely pay tax on money you weren’t responsible to pay.
How are donations of appreciated investments treated for tax purposes?
An alternative gifting strategy is donating appreciated investments.
In general, you are allowed to donate stock (or other investments) that has appreciated in value and held for more than 12 months directly to charity. You are allowed a deduction of the fair market value of the stock, and not responsible for the tax on the appreciation. Here is an example:
Sandra, 57, owns $10,000 of Amazon’s stock that she purchased a few years ago for $3,000. She is in the 25% ordinary tax bracket and 15% capital gains bracket. Sandra has a $10,000 charitable goal, so she donates all of the stock. She will receive a $10,000 itemized deduction. She will also avoid paying tax on the $7,000 of appreciation. Overall her tax savings is $3,550 ($10,000 x 25% + $7,000 x 15%). If she had sold the stock and then donated the money she would have only been able keep $8,950 for herself rather than allow the charity to receive the full $10,000.
If the stock had been at a loss then the tax savings isn’t as favorable because you won’t receive the tax benefit for the loss on the appreciation of stock.
What should I do?
Choosing what donation method is best for you is definitely a personal decision. You need to start with whether or not you itemize your deductions. If you don’t itemize than a cash donation or stock donation loses its favorability. Yet, you must be 70 1/2 or older to take advantage of a QCD.
It seems intuitive that a QCD is more favorable than appreciated stock donations because a QCD avoids ordinary income tax. However, your personal facts and circumstances can definitely push the benefit towards personal stock donations.
Understanding which option allows you to keep more of what you’ve earned also allows you to maximize your charitable giving goals.
Do you want to understand how to make your money work for you and keep more of what you have earned?
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Nate Byers a Madison, WI CPA Financial Advisor, and all rights are reserved. Read the full Disclaimer in the footer below.