Over 70 ½? Get a Tax Benefit from Contributions without Itemizing

It’s been estimated that the number of people who itemize will fall by more than half in 2018 because of changes made by the Tax Cuts and Jobs Act (TCJA). That’s bad news for many charitable givers, but those who are age 70½ or older can continue to gain a tax benefit from their charitable contributions even if they don’t itemize. The key is to make the gift by way of a qualified charitable distribution (QCD) to make annual contributions from an IRA and reduce distributions by a commensurate amount.

Qualified charitable distributions. An annual exclusion from gross income, not to exceed $100,000, is available for otherwise taxable IRA distributions that are QCDs. Such distributions aren’t included in gross income, can’t be claimed as a deduction on the taxpayer’s return, and aren’t subject to the general percentage limitations that apply for making charitable contributions. Even though a QCD from an IRA to a charity is not included in the taxpayer’s gross income, it is taken into account in determining the owner’s Required Minimum Distribution (RMD) for the year.

A qualified charitable distribution is one that is made: (1) on or after the IRA owner attained age 70½, and (2) directly by the IRA trustee to a qualified charitable organization (other than a supporting organization or a donor advised fund).  Using QCDs instead of making charitable gifts from other sources can result in meaningful tax savings for charitable-minded older taxpayers who are receiving RMDs and will not itemize their deductions.

Illustration. Fred and Anne Able are both age 72 and will have $110,000 of adjusted gross income (AGI) for 2018, including $40,000 of RMDs that Fred is required to take from his IRAs. They will not be able to itemize deductions. Each year, they give a $2,000 check to their place of worship and another $1,000 to a children’s hospital. If they make the same gifts this year by writing checks to these charities, their taxable income will be $83,400 ($110,000 minus $26,600 standard deduction) and their federal income tax bill will be $10,227. Alternatively, they can withdraw only $37,000 from Fred’s IRAs, and make their $3,000 of charitable gifts via QCDs from those IRAs. This way, they will satisfy their charitable giving goals, meet Fred’s RMD requirement, and reduce their taxable income to $80,400 ($107,000 minus $26,600 standard deduction). Their tax bill will be $9,567, or $660 less than doing things the usual way.

Can the strategy work for itemizers as well? The answer is “yes.”

If the age-70½-or-older taxpayer would be able to itemize even without claiming gifts to charity and has high medical expenses, the QCD strategy is beneficial. An amount paid out to a charity as a QCD instead of being received as a regular RMD reduces AGI and may qualify the taxpayer for a higher medical expense deduction. Under the TCJA, medical expenses can be claimed as an itemized deduction for 2018 only to the extent they exceed 7.5% of AGI (above 10% of AGI for 2019 and later).

Additionally, the reduced AGI may help avoid or mitigate the effect of the 3.8% surtax on net investment income. This surtax is levied on the lesser of (1) net investment income or (2) the excess of modified AGI over the threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for marrieds filing separately, and $200,000 for other taxpayers).