Qualified Charitable Distribution (QCD)
The qualified charitable distribution (QCD) is a provision in the tax code that allows taxpayers to transfer money from their IRA directly to a qualifying charity without having to pay income taxes on that withdrawal if specific criteria are met.
The QCD provision was established through the Pension Protection Act of 2006, and it made two important changes to the tax code.
- It allowed traditional IRA accounts to be donated directly to charitable organizations without having to pay income taxes on that money; and
- Taxpayers could take distributions from their IRAs while still in their working years and have those funds qualify for a charitable deduction, which in turn lowers their adjusted gross income (AGI).
Congress passed this provision in part because it allowed older individuals, who might otherwise have to take distributions from their IRAs during the year, to make larger donations than they would be able to do if they had to wait until after receiving their income tax return.
Who Can Take Advantage of This Tax Break?
The QCD provision was intended to help older individuals who were no longer working and required some of their IRA assets in order to pay for living expenses.
However, planners have been able to take advantage of the rule by setting up a donor-advised fund at their local community foundation, which can be established by anyone over the age of 70 1/2.
How Much Can You Take Out in a Year?
QCDs are limited to $100,000 per year or 100 percent of an individual’s IRA account balance, whichever is less.
However, any amount of the distribution that is donated to a charitable organization is not included in taxable income.
Why Would Someone Want to Do This?
The QCD provision was designed with older individuals who had limited financial resources in mind, but it can also be used by anyone who wants to lower his or her adjusted gross income.
For instance, someone who is retired and has no dependents but also has limited resources might want to use this provision in order to avoid paying income taxes on their IRA distributions.
However, in today’s low-interest-rate environment, qualified charitable distributions can be an attractive option for individuals who are looking to generate an additional return on their investments.
The Consequences of Not Taking Advantage of This Opportunity
Although QCDs allow individuals to direct funds from their IRA accounts directly to a qualifying charity without having to pay income taxes on that distribution, there are still some significant disadvantages.
Qualified charitable distributions will increase an individual’s adjusted gross income (AGI), which means that these distributions could impact not only the taxpayer who takes advantage of this provision but his or her dependents as well.
Secondly, qualified charitable distributions can also affect eligibility for certain tax benefits.
Lastly, QCDs are not automatically deducted from an individual’s IRA account balance.
It is up to the taxpayer to remember that he or she has made such distribution and then recalculate his or her adjusted gross income accordingly.
It is important for individuals to understand how these distributions will affect their financial situation and make sure that they are using this provision in the most advantageous way possible.
What Are the Qualified Charities?
There are several organizations that meet the requirements for a QCD, but only some of them are public charities.
An organization automatically qualifies as a public charity if it is officially recognized by the IRS or if it has private foundation status.
Certain types of private foundations might also qualify as public charities.
Specific organizations that automatically qualify as a QCD include:
- The United States or any state, county, city, or town
- A community chest or corporation that is created exclusively to benefit certain types of qualifying organizations
- Any organization that is operated only for religious or charitable purposes
- A nonprofit educational organization (including an elementary, secondary, or higher education organization)
- Any other organization that is designated as a public charity by the IRS.
- Organizations that are not automatically recognized as public charities can apply to become one through Form 1023.
The Bottom Line
Qualified charitable distributions are an attractive option for individuals who want to lower their taxable income or avoid taxation on IRA distributions altogether.
However, it is important that individuals have a better understanding of this provision before taking advantage of it.
Only certain types of organizations qualify for QCDs, and individuals who are planning to take advantage of this provision should look carefully at the types of organizations that will benefit them.
Since qualified charitable distributions do not automatically reduce an individual’s IRA account balance, he or she must remember to recalculate his or her adjusted gross income accordingly.
It is important that individuals take the time to work with their trusted financial advisors to ensure they are taking advantage of this provision in the smoothest way possible.
Disclaimer: The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.