A Neglected Tax-Saving Strategy: Qualified Charitable Distributions

By February 13, 20202020, Money Moxie, Newsletter

There are two types of people who complain about paying taxes, men and women. We all recognize the importance of taxes, but Gerald Barzan said it best, “Taxation with representation ain’t so hot either.” Yes, tax evasion is illegal, but tax avoidance…that’s wisdom. Tax avoidance should also be a financial advisor’s specialty. This is precisely why I’m so surprised by the number of financial and tax professionals who are unfamiliar with, or do not utilize, the Qualified Charitable Distribution.

The Qualified Charitable Distribution, or QCD, is a powerful tax savings strategy available to individuals age 70.5 and older who donate to 501(c)(3) organizations. Examples of 501(c)(3) organizations include religious, educational, and scientific organizations, public charities, and private foundations.

When you take a distribution from a tax-deferred retirement account, the distribution will be taxed at your marginal tax rate. However, if the distribution is from an Individual Retirement Account (IRA) and is sent directly to a 501(c)(3) organization, it qualifies as a QCD and becomes tax-free.

For example, Elliott has a required minimum distribution from her IRA of $3,000. Her tax rate is 20% federal and 5% state. Elliott plans to donate $3,000 to a 501(c)(3) organization this year. If Elliott takes the $3,000 distribution and pays the tax, she’ll receive $2,250 from her IRA. When she makes her $3,000 donation, she will be $750 short.

However, Elliott has a wise financial advisor who tells her about the QCD. So, she sends her $3,000 IRA distribution directly to the charity, and Elliott doesn’t pay tax on the distribution at all. Elliott’s required minimum distribution is satisfied for the year, she donates the desired $3,000 to charity, and her wise financial advisor saved her $750 in taxes.

Every year, we educate financial and tax professionals regarding the QCD and how to report it on the form 1040. Too often, we see it reported incorrectly. If you make a QCD and do not report it accurately, you won’t receive the benefit. If Elliott or her CPA doesn’t understand how to report her $3,000 QCD, she’ll pay an extra $750 to the IRS, and the QCD won’t save her anything.

On tax form 1040, line 4a asks for “IRA distributions,” and line 4b asks for the “taxable amount” as shown below.

Elliott took a $3,000 distribution from her IRA and will write $3,000 on line 4a. She will then subtract her QCD amount from 4a and write the balance on line 4b. In Elliott’s case, she will write $0 on line 4b, and no tax will be due from her IRA distribution. A tax penny saved is a tax-free penny earned.

Please help us get the word out regarding the Qualified Charitable Distribution. If you, your CPA, or your friends have questions about QCDs or other tax-saving strategies, please contact us. Tax planning is our specialty, and tax avoidance is the goal.

TAGS: , , , , , ,