A tax break for Seniors

Sometimes Congress actually gets something right! This happens so rarely that I wanted to write a special blog post on it.

Clients who have followed our advice over the years tend to retire with no mortgage debt and few out-of-pocket medical expenses. This leaves their charitable contributions as the main source of itemized deductions to reduce their taxable income. 

The problem with this is that with a standard deduction (for married filing jointly) at $12,600, it can become difficult for clients to reap any tax benefit from their charitable giving. In this case, charitable donations (and any other itemized deductions) would have to exceed the standard deduction amount above to yield any tax benefit.

BUT . . .

What if there were a way to reduce your income by these charitable donations without having to itemize? In that case you would get a tax deduction for both the standard deduction and your charitable contributions!

The Qualified Charitable Distribution (QCD),contained in the “Protecting Americans from Tax Hikes Act of 2015” (passed by Congress on December 15, 2015) makes this strategy possible. This law has been around for several years, but expired each December 31 and was renewed for another year. Now that the law has been made a permanent part of the tax code, it’s a tax move that can be safely incorporated into each year’s tax planning for retirees who have begun Required Minimum Distributions (RMDs) from their IRA accounts.

A QCD allows IRA owners age 70½ and older to directly transfer up to $100,000 (or less) from an IRA account to a qualified charity, tax-free, as part (or all) of their Required Minimum Distribution (RMD) for the year.

So here’s how it would work:

John & Mary typically give $3,500 each year to their church. Let’s assume that their RMD is $5,000.  Because they are forced to use the standard deduction, no tax benefit is achieved for the donation. By giving to their church from their IRA, with the gift designed as a QCD, they reduce gross and taxable income by $3,500 and are considered to have taken 3,500 of their Required Minimum Distribution amount. They later take the additional $1,500 IRA withdrawal and have satisfied the RMD requirement of $5,000 but with only report $1,500 of income!

Any portion of an RMD that represents a QCD is not included in gross taxable income reported on your federal tax return!  

You will receive a Form 1099-R from the IRA trustee for the full amount of the distribution, which you report on Line 15a of your Form 1040.  But you will enter as “taxable amount” on Line 15b the net amount you received “in hand” after making the QCD, and write “QCD” next to Line 15b.  If the entire amount of the distribution was a QCD, you would enter “0” on Line 15b.

The main tax benefit of the QCD is that it turns a normally “below-the-line” deduction into an “above-the-line” deduction, reducing your Adjusted Gross Income (AGI).  There are a multitude of credits, deductions, and exclusions that are phased out or eliminated based on your AGI.

Just a few of these favorable side effects from a QCD are:

• Less gross income (AGI) to trigger the taxability of social security received,
• The reduced adjusted gross income may result in less AMT (Alternative Minimum Tax) if applicable,
• If, in addition to the QCD, you do itemize your deductions, then deductions (such as medical expenses) that are limited by a higher AGI may become available,
• If you’re in the highest brackets you may reduce the amounts of phase-outs on total itemized deductions and personal exemptions.

Bear in mind there is no double-dip on this. You are not allowed to claim a charitable deduction for the amount of the QCD on Schedule A – the “deduction” has already been claimed by reducing the taxable portion of your RMD.

QCDs should only be made from a “traditional” IRA.  Qualified distributions from a ROTH IRA are totally tax-free, so there is no tax benefit in a direct transfer of funds from a ROTH account.   The direct tax-free transfer to a charity is also not available from a SEP or SIMPLE IRA, or a 401(k), 403(b), 457, or other employer plan. However, you can first rollover monies from a self-employment retirement account or an employer plan to a traditional IRA tax free, and then make a QCD from the IRA account.

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