End of Year Charitable IRA Giving for 2021
This blog posts covers the Qualified Charitable Deduction (QCD) strategy for making charitable gifts to a charity.
How Are Withdrawals from a Traditional IRA Typically Taxed?
General rule: withdrawals from a Traditional IRA triggers “ordinary” income that is taxed at your marginal income tax rate.
George is in the 25% marginal income tax bracket. In 2021 he withdraws $10,000 from his Traditional IRA.
Tax result? George has additional income of $10,000 that is taxed at his 25% rate.
In this simplified example that means George’s additional tax caused by his IRA withdrawal is $2,500 (that is $10,000 x 25% tax rate).
Some clients may end up owing more than $2,500 in additional tax because many deductions and credits phase out based on a taxpayer’s AGI (adjusted gross income) which increases due to a Traditional IRA withdrawal.
Does It Make Sense to Make Withdrawals From a Traditional IRA and Then Gift the Withdrawn Money to a Charity?
This strategy may result in losing some of the income tax benefit of your charitable giving.
Reason: regular charitable gifts are typically only deductible if your itemized deductions exceed your standard deduction (see IRS Form 1040, schedule A).
Typical itemized deductions include:
- Real estate taxes
- Mortgage interest
- Charitable deductions
If your total itemized deductions in a given calendar year are less than your standard deduction in that year, you receive NO TAX BENEFIT from your itemized deductions.
Example (rounded figures):
Laura’s standard deduction in 2021 is $12,000.
Laura is considering withdrawing $10,000 from her Traditional IRA into a checking account in her name and SSN. She will then gift the $10,000 from her checking account to the charity.
Laura has no other itemized deductions.
Is this approach good income tax planning for Laura?
Under these facts: no.
The withdrawal from Laura’s IRA with trigger taxable income of $10,000 for Laura.
It is true that Laura would report $10,000 of taxable gifts on Schedule A of her personal income tax return (IRS Form 1040).
However, Laura’s standard deduction of $12,000 is larger than her itemized deduction of $10,000 from her charitable gift.
Result = in this example, Laura receives NO TAX BENEFIT from her charitable gift.
How Can Laura Get a Tax Benefit From Her Charitable Gift Even If She Is Unable to Itemize Her Deductions?
Your author humbly posits that the result in the example above is not very good for Laura. Proposed solution below.
Laura should contact the custodian for her Traditional IRA and instruct them:
“Please make a direct Qualified Charitable Distribution (QCD) to XYZ charity on my behalf. Please mark the resulting IRS Form 1099R as being zero percent taxable to me.”
Result of these instructions:
- The custodian of Laura’s IRA, e.g., Fidelity, Vanguard, Charles Schwab, will withdraw $10,000 from Laura’s traditional IRA and turn around and give the $10,000 directly to Laura’s named charity.
- The IRA custodian will (correctly) report on the annual IRS Form 1099R tax form that while Laura did cause $10,000 to leave her Traditional IRA account, no part of that $10,000 is subject to income taxes for Laura REGARDLESS of whether or not Laura has enough itemized deductions to outweigh her standard deduction.
- Note – some custodians do not update their Form 1099Rs correctly to indicate that the Traditional IRA withdrawal is not subject to tax. If that happens a CPA can correct that reporting on Laura’s income tax return.
The benefit of this approach is that if Laura is charitably inclined and wishes to make a charitable contribution from her IRA, she can get a tax benefit from the gift (IRA withdrawal not subject to income taxes) regardless of whether or not she has enough itemized deductions to outweigh her standard deduction.
This approach is well suited to:
- Charitably inclined taxpayers
- In high tax brackets
- Looking to reduce the size of their taxable estate
- Who do not have substantial itemized deductions.
Does This Approach Have Any Limitations?
Yes, limitations of this QCD approach include:
- It is only good for up to $100,000 of Traditional IRA withdrawals in a year
- The gift to QCD cannot be made to a donor-advised fund (e.g., you have set up a charitable foundation that you are managing).
I hope this has been helpful!
Sincerely, Christopher Ha, staff attorney, Certified Financial Planner ®.