With the passage of the Tax Cuts and Jobs Act that increases the standard deduction to $24,000 for married couples ($26,600 for those 65+) and $12,000 for single filers, the textbook recommendations for itemizing deductions are being rewritten. A key deduction that hasn’t been altered significantly despite the changes in the tax code is the charitable contribution deduction, where you can deduct your cash and in-kind gifts to charity, subject to certain limits.
Now with state and local tax deductions capped at $10,000 per year, miscellaneous deductions suspended, medical expenses subject to a high threshold, and mortgage interest rates just creeping up from all-time lows, crossing the new, higher hurdle to itemize has become more challenging.
Perhaps there’s a more tax-efficient way to make charitable contributions? If you’re over age 70 ½, one option is the Qualified Charitable Distribution.
A QCD is a direct transfer from your IRA account to a qualified charity after you attain age 70 ½. Assuming the transfer goes directly to the charity, and is under $100,000, you can exclude the full amount of the distribution from income. It also counts toward your required minimum distribution for the year.
By strategically using the QCD in place of making deductible charitable contributions, you can save a significant amount in taxes. Let’s look at an example.
John and Jane, both age 72, have pension income of $50,000 per year, investment income of $20,000, taxable Social Security income of $40,000, and required minimum distributions of $25,000. Their mortgage is paid off, and they typically donate $15,000 a year to the local children’s hospital. Their state and local taxes are $10,000 per year.
| Qualified Charitable Distribution |
Itemized Deduction
|
|
| Income | ||
| Dividend Income | $20,000 | $20,000 |
| IRA Distributions | $10,000 | $25,000 |
| Pension Income | $50,000 | $50,000 |
| Taxable SS Income | $40,000 | $40,000 |
| Adjusted Gross Income | $120,000 | $135,000 |
| Itemized Deductions | ||
| State and Local Taxes | $10,000 | $10,000 |
| Charitable Donations | $15,000 | |
| Total Itemized | $10,000 | $25,000 |
| Standard Deduction | $26,600 | $26,600 |
| Greater of Itemized or Standard | $26,600 | $26,600 |
| Taxable Income | $93,400 | $108,400 |
| Total Tax | $10,860 | $14,333 |
| QCD Tax Savings | $3,473 |
In the case of John and Jane, they will save almost $3,500 in taxes by using a QCD as opposed to making the charitable gift with after-tax money.
If you choose to use a QCD for your charitable gifting, it’s important to carefully document the amounts donated and the charities that received your gifts.
Additionally, your IRA custodian might provide you with a 1099-R that shows a normal distribution from the account. Be sure to notify your tax preparer if you did a QCD so that they can properly report it. At Vintage, we send letters each January to clients who completed a QCD in the prior year for them to provide their tax preparer.
In addition to the income tax savings, high income seniors can use the QCD strategy to reduce their Medicare Part B premiums. The standard Part B monthly premium for 2018 is $134 per person for joint filers with income below $170,000 (Modified Adjusted Gross Income) but rises to $428.60 for incomes over $320,000. A couple with $300,000 in MAGI could reduce their income to $200,000 with a $100,000 QCD which would reduce their Part B premiums by over $3,800. The premium savings takes a couple years to kick in but is in addition to the income tax savings from the charitable gift.
The Tax Cuts and Jobs Act significantly decreased the number of taxpayers who itemize their deductions, but careful planning and use of a QCD can help maximize the tax benefits of your charitable contributions.
