How to reduce taxes and AGI by donating to charity

For many taxpayers, the minimum distribution required by the IRA can be a burden, disturbingly increasing their annual income, sometimes even higher. But there is a way to benefit RMD, both for others and for your own bottom line. In 2015, Congress made the Qualified Charity Distribution (QCD) rules permanent. This rule allows traditional IRA owners to exclude their required minimum distribution (RMD) from their adjusted total income if they provide money to qualified charitable organizations.

Given that RMD may have an impact on a person’s tax bill, it is worthwhile to develop a long-term planning strategy around this rule.

Key points

  • Qualified Charitable Distribution (QCD) rules allow traditional IRA owners to deduct the minimum required distribution from their tax returns when donating money to charities.
  • By reducing your adjusted total income, QCD rules can effectively reduce your income tax.
  • The upper limit of QCD is USD 100,000 per person per year.
  • The QCD must be provided directly to the charity.

Who can use QCD rules

Any traditional IRA owner or beneficiary who is at least 70½ years old can use the Qualified Charitable Distribution (QCD) rules to exempt them from the required minimum distribution (RMD) tax. The age limit here applies to the exact date when the IRA owner turns 70½ years old. For example, if IRA owners turn 70 on February 15th, they cannot make QCDs before August 15th.

Roth IRA owners are also allowed to use the QCD rules, although they will not see any benefit from it, as their distribution is already tax-free.of

Eligible allocation

All donations and income accumulated in the traditional IRA are eligible for QCD. The exceptions are non-deductible contributions, as they are considered tax-free basic returns.

The upper limit of the amount that can be used as a QCD is US$100,000 per taxpayer per year.

The joint gift strategy is also not suitable for QCD purposes, which means that a couple cannot withdraw their total RMD amount from an account and exclude the entire amount from the adjusted gross income (AGI). Each of them must withdraw their RMD from their account to qualify.

The QCD strategy can also benefit traditional IRA owners who wish to convert their balance into a Roth account, because QCD will reduce the taxable amount in the account.

Advantages of AGI

One of the biggest advantages provided by the QCD rules is that taxpayers can reduce their adjusted total income.​​​ This is more valuable than itemized deductions, which will only reduce taxable income. Since AGI is used in many tax calculations, a lower number allows donors to stay at a lower tax bracket, reduce or eliminate taxes on Social Security or other income, and still be eligible for deductions and credits that may be lost if Taxpayers must declare the RMD amount as income.

Payment rules

The main rule to remember when it comes to QCD is that the distribution must be directly assigned to the charity, not the owner or beneficiary. This means that the distribution check is given to the charity, otherwise it will be considered a taxable distribution. IRA owners or beneficiaries can receive this check and deliver it to the organization, but they cannot deposit the check and issue another check to the charity.

Of course, IRA owners can donate a larger amount than their RMD to charity. However, keep in mind the upper limit of $100,000. Any distribution in excess of $100,000 will not be excluded from AGI, and taxpayers must be eligible for itemized deductions to deduct excess contributions.

The receiving charity must also be a qualified 501(c)3 organization. Tools such as charity gift annuities will not be eligible. Finally, the charity must also prove the amount of donation with a written receipt.

The Security Act passed at the end of 2019 raised the minimum age at which IRA owners must begin to require distribution to 72 years; however, the age for eligible charitable distribution is still 70½ years, which creates a unique one to two years window. Among them, IRA is allocated as a charitable donation, not RMD.

Bottom line

IRA owners who wish to lower their AGI can use a qualified charity distribution strategy to effectively allocate funds to the charity of their choice. This strategy is better than accepting a constructive reception of distribution and then donating to charity, because the second option does not reduce the donor’s AGI. If used properly, the QCD rules will provide convenient tax relief for the next few years for charitable IRA owners.

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