Paying from your IRA
Paying Pledges from your IRA using a Qualified Charitable Distribution (QCD)
If you are 70-1/2 or older, it may be beneficial to pay charitable donations directly from your IRA. This is known as a Qualified Charitable Distribution (QCD). It has the following advantages:
- The amount withdrawn from the IRA does not count as earned income. This means that it does not increase your Adjusted Gross Income (AGI). AGI is your raw taxable income, and it affects various aspects of your taxes, most importantly how much of a surcharge that you may have to pay for Medicare coverage, so minimizing it is beneficial. If you take an IRA distribution yourself and then send a check to the charity and deduct it as an itemized donation, your AGI increases by the amount of the donation. This can push you into a higher Medicare bracket. Making a QCD avoids that hit to your AGI. AGI affects other things, such as a surcharge on capital gains tax, but this does not affect most taxpayers (but it may affect you).
- The amount withdrawn counts toward the Required Minimum Distribution (RMD) that you must take from your IRA each year if you are at least 72 years old. Normally IRA distributions are taxed at the full regular rate. Because the amount paid as a QCD is not considered income, you don’t pay taxes on it. You don’t get an itemized deduction for it either, but it reduces your AGI (see previous point), so it works like a deduction while minimizing AGI. If you have other sources of income, such as selling stocks, they might be taxable at a lower rate, which usually lowers your taxes compared to withdrawing money from an IRA, so you want to offset as much of the RMD as you can.
- You do not deduct the donations made as QCDs as itemized deductions, but they reduce your taxable income (AGI), so you get the full benefit from them. Because your itemized deductions are less, you may be able to take the standard deduction (in 2020, $24,880 for married filing jointly, and $12,400 for single filing). If your other deductions (such as mortgage payments and state taxes) are less than that amount, you come out ahead using the standard deduction: you get the full benefit from your donations (by reducing taxable income), and the standard deduction is larger than your other itemized deductions would be. That difference represents a “bonus” deduction compared to itemizing everything including donations. Plus taking the standard deduction means that you don’t need to fuss with all the other deductions when preparing your taxes.
- Since state tax deductions are now capped at $10,000, many people will not reach the standard deduction threshold unless their mortgage interest payments are high. If you have owned your house for a number of years, most of your mortgage payment may be going to principal, not interest. Many people with IRAs who are 72 or above will find that the standard deduction is better, once donations are paid from their IRAs.
- You should try to pay all of your donations using QCDs. You get the full tax benefit of the donations while preserving as much of the standard deduction as possible.
- There is a $100,000 limit on QCDs per year. Few people have this problem.
- You may not use a QCD to make a contribution to a personal charitable foundation. The donation must go directly to a qualified charity.
- You must be 70-1/2 on the date that you make the Qualified Charitable Distribution (not just at the end of the year!). You are subject to the Required Minimum Distribution if you are 72 by the end of the year, so such a distribution would count toward the required distribution but would not be taxable.
If you have a complicated tax situation, if you are in a very high tax bracket, or if your donations exceed 50% of your income, you should seek professional tax advice. At least read a good tax guide. I use J.K. Lasser’s Your Income Tax(updated every year, you want the current copy), but there are others.
The procedure for making a Qualified Charitable Distribution is as follows:
- Ask your IRA broker to make a Qualified Charitable Distribution in an amount that you choose. The check must be made out to the charity, in our case “First Unitarian Church of San Jose”. Some brokers, such as Fidelity, allow you to submit your request online. It usually takes 2-3 weeks to process.
- If they provide the option, make sure your name is on the check as a note or in the memo line, so we know who the donor is.
- Have them mail the check to you, not directly to the charity. It must be payable to the charity, not to yourself. Then can make sure your name is in the memo line and also write the purpose of the donation on the check, such as “2022-23 Operating Year Pledge” or “Capital Campaign”. That way the bookkeeper will credit it to you under the proper account. Then mail the check to the church office or drop it in the collection plate (once we are back in the church). If you are renewing a membership with a charity that sends you a preprinted donation form, you can include that form with the check, so they credit it to your account. Third-party checks that arrive in the church office frequently lack identification about the donor, therefore it is better that you receive the check, make sure it is correct, and write your information on it, before sending it to us or another charity.
- The check must be received by us and deposited by the end of the year. Please do not send a check in the last two weeks of December and expect us to process it on time. It also takes some time for your IRA broker to process your request. Please start before Halloween to be sure everything arrives on time.
You should receive a receipt from the charity. In our case, it will be included in the charitable contribution summary that you receive at the end of the calendar year. Even though you will not claim an itemized deduction, you need the receipt in case the IRS questions you about the donation which you have excluded from income.
At the end of the year, you will receive a 1099-R form for your IRA distributions. The amount of your QCD will be included in this amount, which you will enter on your tax form under “IRA distributions”. Then you subtract the amount of your QCDs from the total and enter the difference as the “Taxable Amount” for the IRA distributions. You really don’t want to be doing this by hand! Buy TurboTax or one of the other tax preparation products if you don’t use a tax preparer. They know how to handle it correctly.
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