How to Reduce Your Taxes and AGI By Giving to Charity
Required minimum distributions (RMDs) from individual retirement accounts (IRAs) can be a blessing. After all, you worked hard during your life to earn a regular form of income during your retirement. You can begin taking RMDs from your traditional IRA start when you turn 72. This is non-negotiable and is a requirement of the account.
The distributions taken are then taxed at ordinary income tax rates. As such, they can also be a burden because they can boost your annual income—sometimes into a higher tax bracket. But there's a way you can put these distributions to good use, which can ultimately reduce your bottom line. Given the impact RMDs can have on your tax bill, it’s worth creating long-term planning strategies around this rule.
The qualified charitable distribution rule allows traditional IRA owners to deduct their required minimum distributions on their tax returns if they give the money to a charity.
The rule can effectively reduce your income taxes by lowering your adjusted gross income.
These distributions are capped at $100,000 annually per person.
They must be made directly to an approved charity.
If you donate a portion of your RMD, you must take the remaining distribution amount yourself.
Who Can Use the Qualified Charitable Distribution (QCD) Rule?
Congress made the qualified charitable distribution (QCD) a permanent rule in 2015. It allows owners of a traditional IRA to exclude RMDs from their adjusted gross income (AGI) if they give the money to approved charities, also known as qualified charitable organizations.
The QCD rule allows you to deduct the amount you donate from your IRA. The QCD counts as part of your annual RMD amount, and you must pay the distribution directly from your IRA to the qualified charity. Thus, if you are at least 72 years old, you can use the QCD rule to exempt your RMDs from taxation.
You can choose to make full or partial RMD distributions to charities. For example, if your RMD amount is $5,000 a year, you can make a $3,000 charitable distribution and take the remaining $2,000 yourself. You can also give the full $5,000 to charity if you choose to do so.
Here's how it works. Once you decide to make a QCD, choose a charity and make sure it qualifies as a charitable organization under Internal Revenue Service (IRS) rules. You must let your IRA custodian know of your intentions and the amount as they are the ones who will cut the check to the charity on your behalf. The investment firm then sends the check to the organization or to you, which you then send to the charity.
QCDs must be made directly from your IRA. A distribution that is paid to you and is then passed on to a charitable organization does not count.
All contributions and earnings that accumulate inside a traditional IRA are eligible for QCDs. The IRS caps the amount you can donate each year as a QCD directly from your IRA account to $100,000. Anything in excess of this amount must be taken as an itemized deduction.
Although it reduces your AGI, you cannot claim your charitable donation as a tax deduction on your annual tax return.
The exception is nondeductible contributions, as they are considered a tax-free return of basis. Joint gifting strategies are also not available for the purpose of QCDs, which means that a couple cannot take both of their aggregate RMD amounts from a single account and exclude the entire amount from their AGI. Each of them must take their RMD from their own account for both to qualify.
The QCD strategy can also benefit traditional IRA owners who want to convert their balances to Roth accounts, as the QCD will reduce the amount of taxable money in the account.
The IRS offers a searchable database of approved charities on its website.
The AGI Advantage
You can generally take an itemized tax deduction when you donate money to a 501(c)(3) charitable organization, which reduces your AGI. Keep in mind, though, that you must have enough deductions to make itemizing worthwhile. But you need to have at least $13,000 for single filers (or $26,000 for married couples filing jointly) in deductions to benefit from itemizing since the standard deduction in 2022 for a single filer is $12,950 for singles and $25,900 for married couples filing jointly.
The QCD rule offers you a way to reduce your AGI through a charitable donation without having to itemize your deductions. Because AGI is used for many tax calculations, having a lower number allows you to stay in a lower tax bracket, reduce or eliminate the taxation of Social Security or other income, and remain eligible for deductions and credits that might be lost if you had to declare the RMD amount as income.
The SECURE Act of 2019 increased the age at which IRA owners must begin RMDs to 72. But the age at which you can start taking QCDs remains 70½, creating an 18-month window in which IRA distributions qualify as charitable contributions that lower AGI even though they are not RMDs.
Should I Use the QCD Rule?
The main rule about QCDs is that the distributions must be made directly to the charity, not to you. This means that the check must be made out to the charity. If it isn’t, it is counted as a taxable distribution. You can receive the check and deliver it to the organization, but you can't deposit the check and make out another one to the charity. The donation amount must be substantiated by the charity with a written receipt.
But the question remains: Should you use the rule? This depends on your situation. It also makes sense if other things make sense in your situation.
Using the rule makes sense if you:
Don't need the money or it would put you into a higher tax bracket
Want your IRA balance to provide you with lower RMDs in the future
Want to support approved charities rather than a foundation or donor-advised fund (which don't qualify as charitable organizations)
Want to make a larger donation than you would if you did so with cash
There are cases when an IRA RMD doesn't provide the best benefit as a charitable donation. Securities like stocks provide a greater tax benefit to you if they appreciate in value since the time of purchase as you won't have to pay capital gains. This also helps reduce any capital gains you may have to pay if you decide to liquidate these assets later in the future.
Keep in mind that you may use the QCD rule for distributions from a Roth IRA account. But doing so doesn't provide you with any tax benefit as your distributions are already tax-free.
What Is the Benefit of a QCD?
A QCD allows you to lower your AGI while also satisfying the RMD amounts set by the IRS.
This can help offset other taxes, such as Social Security.
When Can I Make a QCD From My IRA?
You can make a QCD from your IRA whenever you would make any other withdrawals, which is to say that you can make a QCD anytime once you reach the age of 70½.
How Do I Report a QCD on My Tax Return?
You report the full amount of the QCD on the line for IRA distributions. On the line for the taxable amount, enter zero, then write “QCD” next to it. IRS Form 1040 has additional information.
The Bottom Line
If you own an IRA and wish to lower your AGI, you can use the QCD rule to efficiently disperse money to a charity of your choice. This strategy is superior to taking receipt of the distribution yourself and then donating to charity, because that may not reduce your AGI. If you use it properly, the QCD rule will provide you with a convenient tax deduction for years to come
while fulfilling your philanthropic needs.