10 things advisors need to know about qualified charitable distributions

By Sarah Brenner

Do you have clients with IRAs who are charity inclined? If so, be sure to let them know about Qualified Charitable Distributions (QCD). If advisors neglect this powerful strategy, their clients may be missing out on a valuable tax benefit. Here are 10 things every advisor should know about CDQs.

1. A QCD is a way to transfer funds from the IRA to a charity, tax-free. When a QCD is performed, the amount is excluded from income. Excluding income is an even better tax benefit than receiving a tax deduction, as it keeps Adjusted Gross Income (AGI) lower. This can allow a client to take advantage of more tax benefits based on AGI, which translates into lower taxes. Many older customers no longer itemize and instead use the standard deduction. A QCD provides a way to still get tax relief for a charitable contribution. (However, no additional deduction can be taken for the charitable contribution when a QCD is made.)

2. QCDs are available to IRA owners and beneficiaries age 70.5 and older. While the Secure Act deferred the age at which required distributions must begin until age 72, the age of QCDs remains unchanged at 70½. This requirement can be confusing for clients, as it requires the person to be effectively 70.5 years old at the time of the QCD. A QCD cannot be done earlier, even if the person will turn 70.5 later in the year.

IRA beneficiaries can also perform QCDs. Many clients who inherit an IRA may not be aware of this. The beneficiary must be 70 and a half years old and the age of the deceased owner of the IRA does not matter.

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3. Deductible IRA contributions after age 70.5 can reduce QCD. The Secure Act removed the age limit for traditional IRA contributions. However, for those who make both QCD and deductible IRA contributions, the rules now limit the portion of QCD that is excluded from income, creating a taxable QCD.

Advisors should tell clients not to make tax-deductible IRA contributions after 70½ if they also make QCDs. The QCD tax advantage could be reduced. Older QCD clients who wish to make IRA contributions should be encouraged to contribute to Roth IRAs instead. Roth IRA contributions do not disrupt CDQs.

4. QCDs cannot be made from employer plans or active SEPs or SIMPLE IRAs. Clients looking to do a QCD from their 401(k) plan or from another employer will be out of luck. This is IRA-only tax relief and is not available to “active” SEPs or SIMPLE IRAs. (A SEP or SIMPLE is active if a contribution is made for the year.) A possible workaround for advisors could be to ask the client to make a direct transfer from the plan to an IRA or a transfer from the active SEP or SIMPLE to an IRA. Then the QCD can be performed from the IRA.

Another restriction is that QCDs only apply to amounts taxable in IRAs. After-tax dollars in an IRA do not qualify, and any pre-tax IRA dollars are considered distributed first as QCD. This is an exception to the proration rules that normally apply to IRAs. As such, a QCD can be a good strategy for isolating the after-tax base in a traditional IRA and converting funds into a Roth IRA tax-free.

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5. QCDs are capped at $100,000 per person per year. There is no problem with smaller QCDs and no problem with multiple QCDs, as long as the total does not exceed $100,000. Some IRA custodians, however, may have limits on the size and number of QCDs. For a married couple where each spouse has a separate IRA, each spouse can contribute up to $100,000 from their own separate IRA.

>> See: Five IRA rules for spouses

6. A QCD must be made through a direct transfer from the IRA to the charity. The funds must go directly. A client cannot take a distribution payable to him and then remit the funds to the charity. (Although a check made payable to the charity may be sent to the account holder for delivery.)

seven. QCDs cannot be paid to private granting foundations, donor-advised funds or charitable annuities. Make sure customers understand these limits. A QCD to an ineligible beneficiary will result in an unexpected taxable distribution.

8. A QCD of an IRA can satisfy a required minimum distribution (RMD). This is good news for customers who don’t need their RMD or want the tax account. However, timing is important here. Once an RMD is taken, that income cannot be offset by a future QCD.

Advisors should identify all clients who may be eligible for a QCD and contact them before they travel. Recommend that the QCD be completed as early in the year as possible.

This will reduce the possibility of someone missing the chance to offset the RMD income with a QCD or the risk of them being forced to take additional dollars later in the year.

9. Charitable substantiation requirements apply. Customers will want to keep good records in case the IRS has questions in the future. Advisors should monitor all clients who perform QCDs to ensure the charity provides contemporaneous written acknowledgment at the time the tax return is filed. The contribution to the charity should have been fully deductible had it not been made from an IRA. There can be no benefit to the taxpayer.

10. There is no special code for a QCD on the form 1099-R. The fact that there is no special code on the 1099-R for custodians to report a QCD creates a golden opportunity for advisors to add value. During busy tax season, without information appearing on Form 1099-R, tax preparers can easily miss a QCD on a tax return. This could result in an erroneous taxable IRA distribution and no itemized deduction for the QCD (because the transfer went directly from the IRA to the charity and was missed by the tax preparer).

About the Author: Sarah Brenner, JD is a retired Director of Education at Ed Slott and Company. She has worked for nearly 20 years helping clients resolve complex technical IRA questions. She has contributed to numerous texts, articles and training manuals on the IRA and has been quoted in national financial and tax publications such as CCH IRA Guide. She is an experienced speaker who has trained thousands of financial industry professionals, including lawyers, CPAs, bankers, financial advisors and brokers, on pension plan rules. Sarah has received accolades for her ability to communicate complex laws in an easy-to-understand manner and provide practical strategies to clients.

Sarah is the editor and managing editor of Ed Slott’s IRA Advisor newsletter, distributed to thousands of financial advisors nationwide, and writes for several areas of the company’s website, www.irahelp.com.