Strategies for Maximizing Tax Reductions through Year-End Charitable Contributions

Strategies to Maximize Year-End Tax Reductions through Generous Charitable Contributions

Saving taxes through retirement accounts is beneficial during wealth accumulation. However, the tax scenario becomes less appealing once you begin mandatory withdrawals based on age. If you're philanthropically inclined and wish to minimize taxes on retirement account withdrawals, a strategy of qualified charitable distributions (QCD) might assist you in paying lower taxes throughout your lifetime.

Many of my new clients donate more than $100,000 annually to various charities. One reason they engaged my services was because their previous financial advisor didn't provide tax-planning advice or suggestions. This lack of expertise led my clients to pay excess taxes each year and limit their charitable donations due to increased income. The additional income led to increased Medicare premiums and pushed other income into higher tax brackets at both state and federal levels. While you're obliged to pay the taxes due on your income, there's no benefit in overpaying the IRS.

Implementing a QCD strategy (for the charitable donations they intended to make) allowed them to reduce their overall taxes, lessen their Medicare premiums, and derive more value from the standard deduction annually. If your financial advisor isn't providing you with valuable tax guidance on your retirement income, it might be time to seek a financial advisor better suited to your needs.

What Exactly Is A Qualified Charitable Distribution?

To enjoy the various tax benefits of a qualified charitable distribution (QCD), you need to adhere to its rules. If you have an IRA, you can exclude your required minimum distributions (RMDs) from your adjusted gross income (AGI) when you donate the funds to a qualified nonprofit.

Following the QCD guidelines, you can transfer funds directly from your IRA to the charity without first receiving the income. This tax-planning strategy enables you to donate the total amount you withdraw from your IRA instead of just the remaining amount after paying income taxes to the federal government and your state.

Before using the QCD tax-planning strategy, you must meet a few prerequisites. You can start using this strategy at age 70.5. However, you don't have to wait until you're compelled to start taking RMDs. And yes, QCDs can contribute to your required minimum distribution for each year.

Congress made the qualified charitable distribution rule permanent in 2015. Given the current gridlock in Congress, I find it unlikely that they could repeal this tax-planning strategy even if they wanted to.

How The QCD Tax Strategy Works

If you decide to make a QCD, choose a qualified nonprofit and ensure it complies with IRS rules.
Inform your IRA custodians of your intention to do a QCD. There will likely be a form to sign. If this sounds complicated, don't worry. Your trustworthy financial advisor should guide you through this process.
Once you submit the request, your IRA custodian will send a check to the charitable organization on your behalf.
Make sure your tax preparer is aware that you made a QCD to ensure you get all the tax benefits. Some tax forms involving QCDs can be complex, even for tax professionals.

All QCDs must be made directly from your IRA. You will not receive these specific tax benefits if the funds are sent to you first and then donated to the nonprofit.

What Assets Are Eligible For A QCD Distribution?

Any assets in your IRA are eligible for QCD distributions. However, the IRS caps the annual QCD donation at $105,000 in 2024 (subject to inflation increases). The 2025 QCD limit will be $108,000. Funds exceeding this amount may still be tax-deductible if taken as an itemized tax deduction.

Technically, QCDs do not offer more tax deductions when you file your taxes. However, they reduce your AGI, often providing more tax savings.

The Exceptions To Assets Eligible For QCD

Nondeductible contributions are not eligible for QCD distribution. The good news is that they are already considered a tax-free return on a cost basis, so you won't owe taxes when you withdraw these funds.

In addition, for married couples, you must make a QCD for each spouse's individual RMDs. You cannot combine larger QCDs from one spouse to cover the total household RMDs for the year.

The AGI Tax Advantages From QCDs

The QCD reduces your AGI through a charitable donation without requiring you to itemize deductions. Individual taxpayers may deduct qualifying charitable contributions up to 100% of their AGI, while corporations may deduct up to 25% of their taxable income. Donations must be made in cash, and the charitable organization must be a qualifying organization.

Since your AGI is used to determine your taxable income, having a lower AGI can help you remain in lower tax brackets, reduce or eliminate taxes on Social Security benefits or other income, and remain eligible for deductions and credits that might be lost if you had to declare the RMD amount as income and then claim an itemized deduction for your charitable contributions.

The age requirement for taking RMDs was recently raised from 72 to 73 as of January 1, 2023. This change applies to withdrawals from traditional IRAs, 401(k) accounts, and SEP-IRAs. RMDs are still not required for Roth IRAs.

Who Would Benefit from Implementing the QCD Tax-Savings Strategy?

Whether you gain from executing a QCD relies on your unique circumstances. The QCD strategy makes the most sense if:

· You won't require the RMD funds immediately.

· Not implementing a QCD could push you into a higher tax bracket or make other income taxable.

· You aim to decrease your future RMD amounts.

· Charitable donations were already a part of your plans.

· You donate to charity but often overlook itemizing tax deductions.

There are instances where an RMD might not be the optimal asset for donation. The most common example is for individuals possessing highly valued, non-retirement account-held stocks with considerable appreciation. Donating these highly appreciated stocks directly to charity eliminates the need to pay capital gains taxes. The tax deduction will be based on the current stock value as opposed to the initial investment cost.

At What Age Can I Initiate a QCD From My IRA?

You can initiate a QCD from your IRA once you reach 70.5 years of age.

If you are beyond 70.5 and have the intention of regularly giving to charity, it would be advantageous to consider implementing a QCD. The potential tax savings could enable you to make a larger charitable donation or retain a little more retirement income for personal enjoyment. If this sounds like your situation and your financial advisor has at least mentioned this excellent tax strategy, it may be time to seek some proactive tax-planning guidance.

Instead of donating from their regular income, some individuals can benefit from donating directly from their IRA through qualified charitable distributions (QCDs), which can reduce their taxable income and, consequently, lower their taxes.
Tax-planning advice is crucial for individuals with substantial charitable donations, as improper tax planning could lead to paying excess taxes and limiting charitable donations due to increased income.
Taxes on charitable donations made through QCDs are not deducted from the adjusted gross income, which can help individuals maintain lower tax brackets and avoid paying taxes on Social Security benefits or other forms of income.