Avoiding Year-End Qualifying Charitable Distribution Mistakes

Make sure you avoid these errors if you're thinking about doing a QCD.

Traditional IRAs are one of the best assets to donate to a charity. This is because most of a traditional IRA is composed of before-taxed dollars. After the traditional IRA is donated to a qualified charity, the qualified charity withdraws the traditional IRA and as a qualified charity, owes no federal or state income taxes. For those traditional IRA owners who are eligible to make qualified charitable distributions (QCDs), the distributions can result in tax benefits to the traditional IRA owner, but only if the QCD is performed properly. The tax benefit is that when the traditional IRA is distributed to a qualified charity, the IRA proceeds are not included in the traditional IRA owner’s income in the year of distribution.

QCDs can only be made by traditional IRA owners and beneficiaries who are older than age 70.5. QCDs can only be made from a traditional IRA and not from a qualified retirement plan (such as from a 401(k)-retirement plan or from the Thrift Savings Plan). The annual QCD limit is $100,000 per year per IRA owner. Properly timed QCDs can offset required minimum distribution (RMD) income. Note that even though the RMD age is now age 73, the minimum QCD age of 70.5 has not changed. This means that QCDs can be done even before traditional IRA RMDs begin.

As a result of the passage of the Tax Cuts and Jobs Act of 2017, most individuals do not itemize deductions. The most recent statistic from the IRS is that 90 percent of individual taxpayers do not itemize on their federal income tax return. Instead of itemizing, they take the higher standard deduction, which in 2023 for traditional IRA owners aged 65 or older is $30,700 (married filing jointly) and $15,700 for a single individual aged 65 and older. This means a QCD provides a tax benefit for an individual taking the standard deduction because a QCD is not included in adjusted gross income (AGI), thus lowering the individual’s taxable income and federal and state income tax liabilities.

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However, the tax benefits associated with a QCD can be forfeited if the QCD rules are not followed. Several of these QCD rule violations occur towards the end of the year in December. The following discussion focuses on common QCD pitfalls and violations.

Correct Timing of the QCD

As mentioned, a key benefit of a QCD is for traditional IRA owners who have reached their required beginning date (QCD) and must take a traditional IRA RMD each year. A QCD involves a distribution from an IRA and given directly to a qualified charity. Under IRS rules, a QCD which is large enough can satisfy the traditional IRA owner’s annual RMD. A traditional RMD is normally included in the traditional IRA owner’s income. But a QCD large enough to satisfy is not included in the IRA owner’s income.

However, if a traditional IRA owner previously took his traditional IRA RMD earlier in the calendar year before taking his or her QCD, then while QCD will not be included in income, the traditional IRA RMD will be included in income. In other words, the QCD cannot offset the IRA RMD income. To avoid that from happening, a traditional IRA owner who has reached his or her required beginning date for traditional IRA RMDs needs to make sure to make a QCD before taking the IRA RMD in any calendar year.

Beware of Deductible Traditional IRA Contributions

A traditional IRA contribution can either be deductible (and reported on the traditional IRA owner’s federal income tax return as an Adjustment to Income), or as nondeductible made with after-taxed dollars (and reported as nondeductible on the traditional IRA owner’s federal income tax return on IRS Form 8606).

A deductible traditional IRA contribution in the same year a QCD is made can invalidate the QCD tax benefit. The following example illustrates:

Elizabeth, age 74, made a deductible traditional IRA contribution of $7,500 in June 2023. She also made a $10,000 QCD during 2023. Of the $10,000 QCD, only $2,500 of the QCD would be excluded from Elizabeth’s income. The remaining $7,500 would be a taxable QCD, eliminating the tax benefit.

Taking an IRA deduction in the same year as doing a QCD was not an issue until the passage of the SECURE Act in 2019. One of the provisions of the SECURE Act is to allow individuals over age 70.5 with earned income to contribute to a traditional IRA. Prior to the SECURE Act passage, individuals over age 70.5 could not contribute to a traditional IRA, even if an individual had earned income. But with the passage of the SECUIRE Act, effective January 1, 2020, the age limit for making traditional IRA contributions was removed. This means that an individual aged 70.5 and older with earned income (salary, wages or net self-employment income, or married to someone with such income) can make a deductible traditional IRA contribution and make a QCD in the same year, thus losing the tax benefit associated with the QCD.

A solution to this problem of making deductible traditional IRA contributions in the same year making a QCD is for the individual to contribute to a Roth IRA. Roth IRA contributions are never deductible. If an individual is not eligible to contribute to a Roth IRA because their adjusted gross income is too large, the individual should use the “back door” Roth IRA conversion/contribution process in which a nondeductible traditional IRA contribution is made and then converted to a Roth IRA. Individuals who are interested in using a “back door” Roth IRA contribution are advised to check with their tax advisor to make sure that the Roth IRA conversion/contribution process is performed correctly.

QCDs Made Via “Checkbook” IRAs

QCDs that are made for calendar year 2023 must be completed by December 31, 2023. The traditional IRA funds must leave the traditional IRA and be sent to the charity before December 31, 2023.

If a traditional IRA uses a “checkbook” traditional IRA to issue a QCD for 2023, then those checks must be received by the qualified charity and cleared by December 31, 2023. If the checks are not cashed by the qualified charity by close of business December 31, the checks will not show up as a distribution for 2023 for tax reporting purposes. Note that December 31,2023 is a Sunday; therefore, traditional IRA owners should make sure their traditional IRA checks are received by the qualified charity no later than Thursday, December 28, 2023.

Traditional IRA Beneficiary QCDs

Traditional IRA beneficiaries who are age 70.5 and older can also make QCDs. The fact that the original traditional IRA owner was over age 70.5 has no impact on this requirement. If a traditional IRA beneficiary attempts a QCD before reaching age 70.5, the QCD will not qualify and will not be excluded from income. Even for qualifying beneficiaries (those over age 70.5), the QCD ordering rules will also apply. In particular, if the IRA beneficiary is subject to beneficiary IRA RMD, then the beneficiary should make a QCD before taking the beneficiary RMD. Otherwise, the QCD will not offset the RMD income.

Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street - Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.