If you are over the age of 70 ½ and give to charitable organizations, get the most out of your charitable giving at tax time.
A Brief History Charitable Giving and Tax Laws
In 2018, the Tax Cuts and Jobs Act of 2018 made it less advantageous for taxpayers to itemize deductions. Although deductions on top of standard deductions were allowed, the amount was limited. Many people deprioritized charitable giving as a tax strategy. However, recent changes to the tax law may have you rethinking your approach.
For the 2021 tax year, if you take the standard deduction, you can deduct an additional $300 as a single filer and $600 for married filing jointly filers for contributions to a qualifying charity. The most recent tax law changes for 2022 have eliminated this additional deduction in its entirety.
Current Charitable Giving Tax Opportunities
If you are at least age 70 ½, you can give through a Qualified Charitable Distribution*or a QCD. A QCD is a withdrawal from an individual retirement account (or IRA) made to a qualifying charity. Because IRA dollars have not been taxed yet, the amount taken out will be taxable as income when you make a withdrawal. However, if you take a withdrawal as a QCD, it is excludable from income.
Here’s what that means as a simplified example. If you pay 30% to federal taxes, it will cost you $100 to give directly from your IRA. If you give that $100 in cash, it will cost you $142.85 ($100 in taxes + $42.85 in taxes).
Required Minimum Distributions and Taxes
Required minimum distributions, or RMD, also play a role in determining your tax strategy. When you reach age 72, you are required by the IRS to take RMDs from your IRA. Remember that dollars in your IRA haven’t been taxed. Once you start taking RMDs, you will be required to pay taxes as ordinary income, even if you don’t need the money.
Charitable Giving + Required Minimum Distributions
It’s essential to start with an understanding of the tax implications of QCDs and RMDs, so you can plan your tax strategy. If you already make charitable contributions, consider giving with IRA dollars. Dollars taken from your IRA as a QCD will apply toward your RMD amount for the year, reducing your taxable income.
A Few Scenarios
To better understand how QCDs can reduce your taxable RMD amount, let’s look at a few hypothetical scenarios.
- Scenario 1: Sally takes a portion of her annual RMD as a QCD. Sally’s total RMD amount for the year is $40,000. Sally makes a $20,000 QCD for her annual giving to her alma mater. This is excludable as income. Sally has a remaining RMD of $20,000 that will be taxable as income.
- Scenario 2: Terry takes his entire annual RMD as a QCD. Terry’s total RMD amount for the year is $50,000. Terry makes a $25,000 QCD to his church for missions fund and a $25,000 QCD to local food bank. Terry has satisfied his full RMD amount by making a QCD. His taxable income is $0 rather than $50,000.
- Scenario 3: Becky takes her entire annual RMD as a QCD and donates an additional amount. Becky’s total RMD for the year is $25,000. Becky makes a $25,000 QCD to the local animal shelter and makes an additional QCD of $5,000 to her local art museum. Becky’s RMD taxable income is $0 rather than $25,000 , and she further reduces her IRA balance with the additional QCD of $5,000, which could potentially reduce future RMD amounts.
With ever-changing tax laws, it’s important to review your tax strategy for the year ahead every January with a trusted advisor. In Scenario 2 above, if Terry had taken his full RMD of $50,000 in January and made a QCD of $14,000 later in the year, the $14,000 wouldn’t apply to his RMD. However, it would be excludable as income. If Terry had worked with an advisor, he would have planned his giving through QCDs earlier in the year and reduced his taxable income.
Ready to start planning your tax strategy? Contact us to learn more about how we can help you make the most of tax-efficient strategies.