Common Mistakes Surrounding Qualified Charitable Distributions

In our experience, Qualified Charitable Distributions (QCDs), which have been around since the mid-2000s as a provision under the Pension Protection Act, have increased in popularity for older IRA owners who are often searching for ways to:

• Offset unneeded required minimum distributions (RMDs)
• Reduce taxable income
• Stay below income phaseout limits for items such as Medicare Part B premiums

More specifically, QCDs allow IRA owners over the age of 70.5 to make direct charitable gifts from their IRAs, up to $100,000 per donor in any calendar year. While this may seem relatively straightforward, QCDs have some nuance to them which makes their execution more susceptible to malfunctions if proper planning is not done. For those who are thinking about implementing a QCD strategy, here are several common mistakes to look out for:

As mentioned above, an IRA account owner must be at least 70.5 or older to implement a QCD strategy. Unlike the RMD rules, which require you to begin taking distributions in the year you attain age 72, QCDs are based on the actual date in which you turn 70.5 (and not the year in which you attain this age). For example, if you are born on January 1^st, 1953, then you will not be eligible to make a QCD until June 1^st, 2023. If you attempt to make a QCD prior to reaching 70.5, the entire distribution will be treated as taxable income, and you won’t be able to retract the distribution once taken.

While QCDs can be a powerful tool, they are only available for certain retirement accounts. Common vehicles for QCDs are Traditional, Rollover, and Inherited IRAs. SEP and SIMPLE IRAs can also be used, but only if they are “inactive” plans (inactive plans are those that receive no contributions in a given tax year). Many people are shocked to find out that QCDs are unavailable to qualified plans such as 401(k)s. This factor should be considered when determining whether you should roll your 401(k) account into an IRA after retiring (but that’s an article for another time!).

While the annual limit for a QCD is $100,000 per IRA owner, this figure is not transferable between spouses. If two spouses both have IRAs and are past age 70.5, one spouse cannot transfer the other's unused benefit to make $200,000 of QCDs in a single year. In other words, the benefit is not $200,000 per married couple. Each spouse must individually elect to use their $100,000 limit when making QCDs.

The most common mistake we see regarding QCDs is the mishandling of the actual distribution process. A hard-and-fast rule of QCDs is that they must be transferred directly to the charity, typically via check made payable to the charitable organization. However, what we typically see is the IRA owner makes the distribution payable to themselves and then subsequently gifts the funds to the charity. Doing this immediately disqualifies the distribution from being treated as a QCD and results in the funds being treated as taxable income. For these reasons, always remember to make QCDs directly payable to the charitable entity, and never to yourself! It is permissible to have checks mailed to your address so that you can pass the funds to the charity personally, however it is imperative that the distribution check be made out directly to the charity.

Lastly, one step in the QCD process that often gets overlooked is communication with your accountant. When preparing tax returns, accountants will look at your 1099-R to determine the amount of IRA distributions taken during the year. However, the form does not distinguish between the different types of distributions which can lead your CPA to believe that a QCD was an ordinary taxable distribution. If gone unnoticed, this small detail could create adverse tax consequences and even more headaches when going back to amend the original return. To mitigate these risks, we recommend communicating early on with your accountant about your intentions to make QCDs. By being proactive, you may help yourself prevent potential mistakes and avoid future headaches all in one swoop.

While QCDs can be a tax-advantaged way to give to charity and prevent exceeding income phaseouts, it is not always the optimal solution. Depending on your specific situation, gifting appreciated stock in taxable accounts or utilizing Donor Advised Funds may be a better strategy. We recommend talking to your CPA and/or financial advisor to learn more about the different options above so you can determine which is most suitable for you.

This information is for educational purposes and is not intended to provide, and should not be relied upon for, accounting, legal, tax, insurance, or investment advice. The contents are not, and are not intended to be, advice tailored to any particular person or situation. We believe the information provided is accurate and reliable, but do not warrant it as to completeness or accuracy.