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If you've reached age 70½, and you're philanthropically inclined, you can make cash donations to IRS-approved charities out of your IRA. These so-called "qualified charitable distributions" (QCDs) can save taxes, but you must take action by December 31, 2017, to benefit for 2017.
Tax Benefits of Making QCDs
Qualified charitable distributions (QCDs) can help you save taxes four ways:
1. QCDs aren't included in your adjusted gross income (AGI), lowering the odds that you'll be affected by various unfavorable AGI-based rules. This includes rules that can cause more of your Social Security benefits to be taxed, less of your rental estate losses to be deductible and more of your investment income to be hit with the 3.8% Medicare surtax. Also, QCDs are exempt from the rule that says your itemized charitable write-offs for the year can't exceed a specified percentage of your AGI (50% in most cases) and the rule that phases out up to 80% of itemized charitable deductions for higher-income individuals.
2. A QCD from a traditional IRA counts as a distribution for purposes of the required minimum distribution rules. Therefore, you can arrange to donate all or part of your 2017 required minimum distribution amount (up to the $100,000 limit) that you would otherwise be forced to withdraw and pay taxes on.
3. Suppose you own one or more traditional IRAs to which you've made nondeductible contributions over the years. Your IRA balances consist partly of a taxable layer (from deductible contributions and account earnings) and partly of a nontaxable layer (from nondeductible contributions). Any QCDs are treated as coming straight from the taxable layer (even though you pay no tax). Any nontaxable amounts are left behind in your account. Later on, those nontaxable amounts can be withdrawn tax-free by you or your heirs.
4. QCDs reduce your taxable estate.
How Do these Donations Work?
QCDs come out of your traditional IRA free of any federal income taxes. In contrast, other IRA distributions are taxable. Unlike garden-variety cash donations to charities, you can't claim itemized deductions for QCDs.
However, the tax-free treatment of QCDs equates to a 100% deduction, because you'll never be taxed on those amounts. In addition, you won't have to worry about the aforementioned percent-of-AGI limitations that apply to itemized deductions for charitable contributions.
But there's a $100,000 limit on total QCDs for any one year. If you and your spouse have separate IRAs, each of you is entitled to a separate $100,000 limit, for a combined total of $200,000, whether you file jointly or separately.
If you inherited an IRA from the deceased original account owner, you too can do the QCD drill if you've reached 70½.
Tax Law Requirements
A QCD must meet all of the following tax law requirements:
A Roth IRA distribution can meet the last requirement if it's not a qualified (meaning tax-free) distribution. However, making QCDs out of Roth IRAs generally isn't advisable.
Why? It's generally best to leave Roth balances untouched for as long as possible rather than taking money out for QCDs, because the tax rules for Roth IRAs are so favorable. For example, you can take tax-free Roth IRA withdrawals after at least one Roth account owned by you has been open for more than five years and you're age 59½ or older. Your heirs can take tax-free withdrawals from inherited Roth IRAs if at least one Roth account owned by you has been open for more than five years.
Also, for original account owners (as opposed to account beneficiaries), Roth IRAs aren't subject to the required minimum distribution rules until after you die.
Want more information? Contact your tax advisor to see whether this strategy would be beneficial in your situation.