New Tax Law Improves QCD Benefits

Seniors who must take withdrawals from their IRAs may be able to benefit from a special tax provision for qualified charitable distributions (QCDs). Briefly stated, this provision allows people in their 70s and older to transfer funds directly from an IRA to a charity without any adverse tax consequences. The new SECURE 2.0 law enhances these tax benefits, beginning in 2023.

The Basics

Normally, distributions from a traditional IRA are taxed at ordinary federal income tax rates currently topping out at 37%. The distributions may also result in net investment income tax (NIIT) complications. Therefore, seniors who don't need the money often choose to postpone distributions for as long as possible, subject to certain restrictions.

Of course, people who itemize can deduct distributions they take from an IRA that are donated to charitable organizations. However, their deductions only offset the federal income tax due on the distributions—and donors who claim the standard deduction receive no such deductions.

Notably, due to a combination of tax law changes under the Tax Cuts and Jobs Act (TCJA), fewer taxpayers are itemizing today than before the law went into effect. Most of the relevant TCJA changes are effective for 2018 through 2025. The standard deduction for single filers is $13,850 for 2023 (up from $12,950 for 2022). The standard deduction for married people who file jointly is $27,700 for 2023 (up from $25,900 for 2022). If the amount of your itemized deductions (including mortgage interest) is less than the applicable standard deduction amount, you can't itemize.

In any event, you must begin taking required minimum distributions (RMDs) from traditional IRAs after you've attained a specified age. The RMDs are based on life expectancy tables and your account value on December 31 of the prior year. For instance, RMDs for 2023 are based on retirement plan account values on December 31, 2022.

For decades, the required beginning date (RBD) for RMDs was April 1 of the year after the year you reached age 70½. But the SECURE Act of 2019 increased the age threshold for the RBD to age 72. And starting in 2023, the SECURE 2.0 bumps up the RBD to age 73. (It's scheduled to increase to age 75 in 2033.)

Certain RMD rules also apply to beneficiaries who have inherited traditional IRAs. But mandatory lifetime distributions aren't required for participants in Roth IRAs. (Roth IRA beneficiaries must also empty out their accounts under special rules.)

How QCDs Work

QCDs provide an easy way to meet your RMD obligations. By using a QCD, you avoid a usual step involved in transferring IRA funds to charity. The money goes directly from your IRA to the organization. In other words, it never touches your hands. You must make the necessary arrangements with your IRA custodian.

If certain requirements are met, the transfer isn't treated as a taxable distribution to you subject to federal income tax. Conversely, you can't deduct the charitable contribution either, even if you itemize. Essentially, Uncle Sam considers it a "wash."

To qualify for this favorable tax treatment, you must be at least 70½ years old at the time of the transfer. In addition, the maximum annual QCD is limited to $100,000 per taxpayer. This limit is doubled to $200,000 if each spouse qualifies and contributes the full amount.

Important: Certain charities—including donor-advised funds, private foundations and supporting organizations—aren't eligible to receive QCDs. Roth IRAs may be used for QCDs, but there's no tax advantage to doing this because Roth IRAs are designed to provide tax-free income in the future.

New Rules

QCDs were a tax-smart move prior to SECURE 2.0. The new legislation improves the benefits in two significant ways.

1. Under prior law, the $100,000 limit wasn't indexed for inflation. While the limit remains at $100,000 for 2023 ($200,000 for a married couple), it will be indexed annually for inflation, starting in 2024. So if you're inclined, both you and your spouse may be able to contribute more in the future.
2. Beginning in 2023, you can include in your QCD a one-time gift of up to $50,000 to a split-interest equity, such as a charitable remainder trust (CRT) or charitable gift annuity (CGA). The $50,000 limit will be indexed for inflation, starting in 2024.

The CRT can be a charitable remainder annuity trust (CRAT) or a charitable remainder unitrust (CRUT). With a CRAT, the payment must be a fixed amount at least equal to 5% of the initial value of the trust property. In contrast, a CRUT requires payment of a fixed percentage (not less than 5%) of trust assets. Whether you use a CRAT or a CRUT, the trust term can't exceed 20 years.

A CGA is a similar arrangement where you make a sizeable gift to a charity and designate a beneficiary to receive a stream of income during their lifetime. The donor may be the annuity recipient.

Important: The corresponding current tax deduction is often an integral part of split-interest gifts, but no deduction is available with this QCD either. Nevertheless, the distribution still counts as an RMD.

Other Considerations

Be aware that a QCD reduces your adjusted gross income for various other tax purposes. This may have a domino effect on the rest of your tax return, including deductions and credits you may claim, alternative minimum tax liability, and imposition of the NIIT.

Also, if you're receiving Social Security benefits, the benefits may be subject to tax under a complex formula. A QCD enables you to effectively lower your income for this calculation, thereby potentially reducing another tax liability.

What's Right for You?

The QCD strategy isn't right for everyone who qualifies for it. Discuss the pros and cons with your SSB tax and financial advisors to determine whether this tax planning tool makes sense for your situation.