The Tax Cuts and Jobs Act (TCJA) that was passed by Congress in late 2017 brought some important changes to the Federal tax code that will have a material impact on many Americans. While many taxpayers will see their tax burden shrink for 2018 as a result of these changes, others will be less fortunate and will actually end up paying more in taxes than they would have under previous law. Changes such as the cap on deductibility of state and local taxes (SALT) and the elimination of certain miscellaneous deductions have caused many taxpayers (especially those in states and municipalities with high local taxes) to look for strategies to offset some of the adverse consequences of the TCJA. One such strategy that is available specifically to older taxpayers is the Qualified Charitable Distribution.
The Qualified Charitable Distribution is a potentially powerful tax savings strategy for retirees. To determine if you are able to take advantage of this strategy, simply answer these two questions:
- Are you at least 70½ years old and subject to Required Minimum Distribution (RMD) requirements?
- Do you make charitable donations?
If you answered “yes” to both of these questions, then you may be able to take advantage of the Qualified Charitable Distribution strategy. What, exactly, is the strategy? It’s actually fairly simple. An individual who must take an RMD but who also wants to donate to a charity may make the donation directly from his or her IRA (or other qualified account) in order to satisfy all or part of the RMD. The amount of the donation is then excluded from income. This is an important point because it means that one does not have to itemize deductions in order to enjoy the benefit. For many people, charitable donations are a tax deduction from which they can benefit only if they itemize deductions. However, in this case, the donation is not a deduction but rather an exclusion from income, so taxpayers who have few deductions can benefit from making a donation while still taking the (recently increased) standard deduction. It is truly a win-win strategy.
In order to make the strategy totally clear, an example may be helpful. Let’s imagine a hypothetical retired couple, both aged 75. We’ll assume that together they must take $35,000 in required minimum distributions from their IRAs. In addition to their RMDs, the couple also receive $100,000 per year in income from Social Security, pensions, and some consulting work. The couple typically donate $10,000 per year to various non-profit organizations. Their home is paid-off, so aside from their charitable donations, the couple only have $10,000 in other deductible expenses (such as state income taxes and property taxes). If the couple decide to donate to their favorite charities from sources other than their IRAs, their taxable income will total $135,000 (the sum of their RMDs and their other income). Their deductions amount to $20,000, which falls short of the $24,000 standard deduction, so they will not itemize on their taxes. In this imaginary scenario, assuming no other complicating factors, the couple will owe $16,299 in Federal income taxes. Now, if instead they decide to make their charitable donations from their IRAs (i.e., they use the Qualified Charitable Distribution strategy), their taxable income will only be $125,000 because their donation not only satisfies a portion of their RMDs but also is excluded from their income. Their deductions amount to $10,000, so they will still take the standard deduction of $24,000. In this scenario, again assuming no other complicating factors, the couple will owe $14,099 in Federal income taxes, meaning they will save $2,200 in taxes without changing their charitable donations!
It should be easy to see why I described the Qualified Charitable Distribution as a potentially powerful tax-savings strategy for those who qualify. Older taxpayers can reduce their tax burden and support charitable causes that are important to them, simply by making donations from their qualified retirement accounts. As with any tax strategy, you should consult a tax professional before making a Qualified Charitable Distribution, as everyone’s situation is unique. But for older taxpayers who meet the requirements, this strategy has the potential to be a game-changer.
This article is prepared by Appleseed Capital for informational purposes only and is not intended as an offer or solicitation for business. The information and data in this article does not constitute legal, tax, accounting, investment or other professional advice. There are no assurances that any predicted results will actually occur or that this investment strategy will outperform any other. The views expressed are those of the author(s) as of the date of publication of this report, and are subject to change at any time due to changes in market or economic conditions.