When visiting your CPA at tax time, they probably ask you about any donations you may have made. Afterward, you may hear them talk about deductions, adjusted gross income, itemizing, standard deductions, and other exciting tax terms and financial nomenclature.
What is your CPA talking about, and why do they have so many questions? Giving to charity can be accomplished with tax benefits. It can also be done without.
A good accountant tracks how you made the contribution to report it properly to the IRS. A good financial planner is out ahead of this process to make sure you know what the options are and what gifting strategy makes sense given your individual circumstances. We consider ourselves the latter, so consider the following:
Itemizing Has Become Old School
Before the 2017 Tax Cuts and Jobs Act dramatically increased the available standard deduction, 46.5 million American households opted to itemize deductions on their tax return.
Changes to the tax code for 2018 meant that the standard deduction was nearly twice as valuable as before. Because of this, only 18 million filers itemized deductions in 2018.1 But since charitable donations are only deductible to those itemizing, nearly 30 million households were now unable to get credit for their charitable contributions.
Most taxpayers don’t have more than the standard deduction in itemized deductions ($12,950 if single and $25,900 if married filing jointly in 2022), so it makes more sense for them not to itemize.
This change has made charitable contributions less attractive to taxpayers and harder to procure for charitable organizations. In 2021, the IRS allowed up to $300 in charitable contributions ($600 for joint filers) to be temporarily deducted without itemizing. For 2022, that option is gone.
Is There a Workaround?
Luckily, if you are over the age of 70.5 years old and a non-itemizer, there is a way around this restriction.
The IRS allows an account holder to take what is known as a “qualified charitable distribution” from their traditional IRA and send the funds directly to qualified charities without owing taxes on the distribution (maximum of $100,000 annually). Below is an example of how this technique provides the same tax benefit as someone in a 25% tax bracket taking a “deduction” for the charitable contribution.
Typical Charitable Donation for an Itemizer:
An itemizing tax payer makes a $10,000 contribution to charity.
A $10,000 deduction is applied to income for the year.
This saves the taxpayer $2,500 in federal income tax.
Qualified Charitable Distribution:
A non-itemizing taxpayer using the standard deduction makes a $10,000 contribution to charity via qualified charitable distribution directly to the charity and avoids taxation on the entire distribution. This also saves $2,500 in federal income tax.
As you can see, the net impact is the same for both taxpayers. This makes a qualified charitable distribution a fantastic option for those looking to lower taxable income.
Please note that you must be at least 70.5 years of age on the date of the actual distribution to qualify. For charitably-inclined taxpayers over 72 years of age, QCDs can be exceptionally useful. If you are over 72, you’re subject to required minimum distributions from your IRA. If cash flow needs are already met, a qualified charitable distribution can be a great way to save on taxes whether you wind up itemizing or not.
How To Do It
Talk to the custodian of your IRA or your financial advisor about the mechanics of the distribution. They can show you how to initiate the process.
In practice, it’s quite simple. You’ll elect to withhold 0% in income tax on the distribution and request a check be made out directly to the charity. The custodian will then send you the check that you can personally deliver to the organization. Keeping a copy of the check for your records is also a good idea.
It’s important to note that you will receive a Form 1099-R for the distribution at tax time, but most custodians will not differentiate the distribution from a normal taxable distribution. You will need to alert your tax preparer that a portion (or all) of your distribution was forwarded to a charity and should not be taxable. Legacy clients using QCDs will receive a letter from us at tax time reminding them to note the distribution as such.
As always, seek the advice of a tax professional if you have questions about your individual tax preparation.