While the new tax laws that took effect at the beginning of 2018 will likely lower most tax rates and the overall tax burden for most taxpayers, the new laws will also force a record amount of people to claim the Standard Deduction.
Standard Deduction vs. Itemized Deductions
Every year, every taxpayer gets to choose between the Standard Deduction and Itemized Deductions. Whichever number is more favorable (higher) is the one they elect to use. Typical itemized deductions include state and local income taxes, real estate taxes, mortgage interest, and charitable deductions.
For example, let’s take a retired couple that are both 71 years of age with the following deductions:
- State and Local Taxes (SALT): 8,000
- Real Estate Taxes: 7,000
- Charitable Donations: 10,000
Total Itemized Deductions = 25,000
Under the old tax rules this couple would have itemized deductions since 25,000 is greater than the 2017 Standard Deduction of 15,200 (married couple over age 65).
Under the new tax rules SALT and Real Estate Taxes are capped at 10,000 for itemized deductions. In 2018 this couple would only be able to claim a total of 20,000 in Itemized Deductions (10,000 SALT/Real Estate + 10,000 Charity). However, one of the big changes to the tax rules is the increase in the Standard Deduction. In 2018 this couple will receive a Standard Deduction of 26,600 (married couple over age 65). Since this amount is greater than their allowed Itemized Deductions, they automatically take the higher Standard Deduction to reduce their taxable income.
Qualified Charitable Distribution to the Rescue
Herein lies the problem many people will face in 2018 and beyond. This couple will no longer receive a deduction for their charitable contributions. Whether they contribute 10,000 to charity or contribute nothing, their tax liability will be exactly the same.
This is where the Qualified Charitable Distribution (QCD) from an IRA can come into play so that you still receive a tax benefit for charitable contributions while using the Standard Deduction.
How QCD Works
If you are age 70.5 or older and have an Individual Retirement Account (IRA), you can donate to charity directly from your IRA without paying taxes on the distribution.
IRA owners must start taking Required Minimum Distributions (RMDs) from their Traditional IRA’s and other pre-tax retirement accounts starting at age 70.5. Whether or not the owner needs or wants to take money from their IRA, the government starts to force annual withdrawals. These distributions are taxed as income at the owner’s ordinary income tax bracket.
With the QCD strategy you can directly send funds to a charity and not pay taxes on the distribution. An additional benefit is that the distribution counts toward the IRA owners RMD amount.
Let’s say the retired couple from the above example has an RMD amount of 35,000 in 2018. If they give 10,000 to charity, directly from their IRA, this would reduce their remaining Required Distribution to 25,000 and it would save them from paying tax on the 10,000 that went to charity. If we assume the couple is in the new 22% bracket, this would end up saving them 2,200 in federal tax.
Additional Details and Considerations
- The QCD is limited to 100,000 of charitable contributions per year.
- Your IRA custodian will need to make a check payable directly to the charity.
- You should plan your QCD and remaining RMD in coordination with each other as you cannot recharacterize a distribution you received directly as a Qualified Charitable Distribution.
- You will need to tell your tax preparer that you made a QCD as the tax form you receive from your custodian will likely not separate this item from other normal (taxable) distributions from your IRA.
- Have you not yet reached age 70.5? You can still plan ahead and determine how much you should be contributing to pre-tax retirement accounts for future Qualified Charitable Distributions.