With the passage of the new tax reform act, many taxpayers will now be claiming the standard deduction instead of itemizing their deductions. This because the new act nearly doubled the standard deduction coupled with the reduction of allowable itemized deductions.
State and local income and property taxes are capped at $10,000 and miscellaneous itemized deductions such as tax preparation fees, investment advisory fees, and unreimbursed employee business expenses are no longer deductible. The surviving intact deductions are mortgage interest, charitable contributions, as well as medical expenses to the extent they exceed 7½% of income.
Older taxpayers are less likely to have a mortgage, which is typically one’s largest itemized deduction. The result is that most will be better off taking the standard deduction. Thus, donations to charity will not provide any tax savings, or so it seems.
Still preserved is the ability to annually donate up to $100,000 of distributions out of an IRA to charity. IRC 408(d)(8). Once a taxpayer turns 70½, he or she is required to withdraw a certain minimum amount annually from his or her retirement plans, also known as the RMD. This amount, plus any additional funds withdrawn, is taken into taxable income. If the taxpayer then donates this to charity, they would get a charitable deduction. The problem is that this deduction has no benefit if the standard deduction is claimed.
However, if an RMD is instead donated to charity directly by the IRA, it is not counted as income and the amount that can be contributed to charity is not limited by the RMD. This is called a Qualified Charitable Distribution (QCD) and only works when the IRA funds are given directly to charity. The funds cannot go thru the hands of the taxpayer. The result is the best of both worlds—get the higher standard deduction and also directly offset a charitable deduction against income. The QCD is not limited to the amount of the RMD. Thus, a taxpayer who is more charitably inclined can effectively use this strategy to more aggressively deplete the IRA, up to $100,000 per year.
In order to take advantage of this, the taxpayer must be at least 70½ years old and the QCD must come from an IRA. This will not work with a 401(k) or other non-IRA retirement plans. If you are taking RMDs out of a plan that is not an IRA, those plans would need to be rolled into an IRA. Care must be taken prior to rolling any plan into an IRA, as there may be other tax considerations as to why those other accounts should be left as is.
With proper planning and foresight, the QCD can squeeze out some extra tax savings for older taxpayers and can be an effective tool in estate planning. As with anything involving tax, a qualified advisor should be consulted to devise the best strategy for your particular facts and circumstances.
For questions about this and other tax planning matters, please contact Larry Rubin or one of our tax advisors at 301.231.6200.