From WealthManagement.com written by Conrad Teitell
The rules of tax-free direct charitable/IRA distributions and crucial deadlines.
You probably know that the law allowing tax-free direct charitable individual retirement account distributions is now permanent. But many donors and clients are still unaware of this additional way to benefit charities.
Alert. Gifts of cash and securities can most often be made at the last minute. But IRA administrators generally can’t or won’t make an eleventh-hour direct IRA distribution to the designated charity by the midnight Dec. 31 deadline.
Tax-free direct charitable/IRA distributions (tax-free charitable IRA rollover)—maltum in parvo (in a nutshell). An individual age 70½ or older can make direct charitable gifts annually of up to $100,000 from an IRA to public charities (other than donor-advised funds (DAFs) and supporting organizations) and not have to report the IRA distributions as taxable income on his federal income tax return. Most private foundations (PFs) are ineligible donees, but private operating and pass-through (conduit) foundations are. There’s no charitable deduction for the IRA distributions. However, not paying tax on otherwise taxable income is the equivalent of a charitable deduction. Tax-free distributions are for outright (direct) gifts only—not life-income gifts.
Traditional and Roth IRAs only. Distributions from traditional and Roth IRAs are the only ones that are tax free. Distributions from employer-sponsored retirement plans, including Savings Incentive Match Plan for Employees IRAs and simplified employee pensions aren’t qualified charitable distributions (QCD); nor are distributions from Keoghs, 403(b) plans, 401(k) plans, profit sharing and other plans.
Doing a two-step to qualify: (1) Roll over a non-qualified pension plan into a qualified IRA. That’s generally tax free (make sure that’s so). (2) The qualified IRA then makes the distributions directly to the charity.
Pointer on DAFs of community foundations (CFs). As noted, IRA distributions to those funds don’t qualify. But IRA distributions to a CF’s endowment and field-of-interest funds do qualify—as long as the donor has no advisory rights.
Distributions from a qualified IRA must be made directly by the IRA’s administrator or trustee to a qualified charity. A payment to the donor who one honko-second later gives it to the charity doesn’t qualify (a honko-second is the shortest measure of time—the time that elapses between a traffic signal turning green and the driver of the car behind honking his horn).
The entire distribution must be paid to the charity with no quid pro quo. The exclusion applies only if a charitable deduction for the entire distribution would have been allowable (determined without regard to the generally applicable percentage limitations). Thus, if the donor receives (or is entitled to receive) a chicken dinner in connection with the transfer to the charity from the IRA, the exclusion isn’t available for any part of the IRA distribution.
Example. $100,000 from a donor’s IRA is distributed to the charity. He receives (or is entitled to receive) a benefit worth $25. The entire $100,000 will be taxable to the donor.
Substantiation required. The exclusion won’t be available if the IRA distribution to the charity isn’t properly substantiated. The charity must give the donor a timely written acknowledgment that it’s received the IRA distribution and that no goods or services were given in connection with the IRA distribution. See “Sample Receipt” at the end of this article.
Favorable rules on charitable distributions when the donor had made earlier deductible and nondeductible contributions to his IRA. If the IRA owner has any IRAs that include contributions that were nondeductible when contributed to the IRA, a special rule applies in determining the portion of a distribution that’s includible in gross income (but for the qualified IRA/QCD) and thus is eligible for QCD treatment. The special rule works this way: The distribution is treated as consisting of income first, up to the aggregate amount that would be includible in gross income (but for the QCD) if the aggregate balance of all of the donor’s IRAs were distributed during the same year. In determining the amount of subsequent IRA distributions includable in income, adjustments are to be made to reflect the amount treated as QCDs.
Examples of QCDs
These examples illustrate the determination of the portion of an IRA distribution that’s QCD. In each example, it’s assumed that the requirements for QCD treatment are otherwise met (for example, age 70½ or older, qualified public charity) and that no other IRA distributions are made during the year.
Example 1. Scott, over 70½, has an IRA with a $100,000 balance, consisting solely of deductible contributions and earnings. He has no other IRA. The entire IRA balance is distributed to an Internal Revenue Code Section 170(b)(1)(A) charity (other than a supporting organization or a DAF). Under earlier law, the entire $100,000 distribution would have been includible in Scott’s gross income. Under the IRA/charitable distribution rules, the entire $100,000 distribution is a QCD, and thus, no amount is includible in his income. Further, the distribution isn’t taken into account in determining the amount of Scott’s allowable charitable deductions for the year.
Example 2. Zelda, over 70½, has a $100,000 IRA consisting of $80,000 of deductible and $20,000 of nondeductible contributions. The IRA distributes $80,000 to charity. She has no other IRA. Notwithstanding the usual treatment of IRA distributions, the distribution to the charity is treated as consisting of income first, up to the total amount that would be includible in gross income (but for the charitable IRA distribution rules). Under these rules, the entire $80,000 distributed to the charity is a QCD, and no amount is included in Zelda’s income as a result of the distribution. Further, the distribution isn’t taken into account in determining the amount of Zelda’s charitable deductions for the year. And when the $20,000 remaining in Zelda’s IRA is distributed to her, it won’t be subject to tax because it came from non-deductible IRA contributions when placed in her IRA.
Other Helpful Hints
Your client turns 70½ for purposes of qualifying for the IRA/charitable distribution when he’s actually 70½. He should pay it safe not have any distributions made to charity until at least one or two days after he reaches age 70½.1
Caveat on year-end charitable distributions. A donor who by U.S. mail sends checks and securities to a charity this year that are received by the charity next year has made a charitable gift this year. Will a distribution mailed by the IRA trustee/custodian to the charity this year, but received by it next year, qualify for tax-free treatment? Unless clarified by the Internal Revenue Service, make sure that the charity actually receives the distribution this year.
Death-time distributions to charity from IRAs—reminder. Current and continuing laws allow tax-free distributions to charities at death for both outright and charitable remainder gifts. Income in respect of a decedent (IRD) isn’t taxable to charities and charitable remainder trusts (CRTs). When a CRT beneficiary receives payments, he’ll be taxable on the IRD. Less than 1 percent of estates are subject to the estate tax. If those estates have IRD, the IRA beneficiaries are entitled to itemized deductions on their income tax returns spread over their life expectancies for estate taxes attributable to their bequests. Consider this when deciding whether to create a testamentary CRT funded with an IRA. But this isn’t an issue for over 99 percent of estates. Also, outright bequests of IRAs to charity avoid tax on the IRD. So, clients should give appreciated stock outright to family members who will get a stepped-up basis and give the IRA and other IRD “items” to charity. The charity, being tax exempt, doesn’t pay tax on the IRD. Other IRD items include: salary and wages earned before death but paid after death; accounts receivable; unpaid royalties; commissions and partnership income earned before death but paid after death; unpaid royalties; payments under installment obligations paid after death; and interest or dividends earned before death but paid after death.
For death-time transfers from IRAs, there isn’t a ceiling or limitation on the types of charitable donees. Thus, distributions to all PFs and public charities (including supporting organizations and DAFs) qualify. To avoid IRD concerns, the gift must be properly structured.
Guidance From the IRS
In 2007, the IRS—fleshing out the IRC and the explanation by the staff of the Joint Committee on Taxation— favorably filled in the blanks to some unanswered (and some already answered) questions:
- Check payable to charity but delivered to the charity by the IRA owner. The payment to the charity will be considered a direct payment by the IRA trustee to the charity and thus a QCD.
- For inherited IRAs. The exclusion from gross income for QCDs is available for distributions from an IRA maintained for the benefit of a beneficiary after the death of the IRA owner if the beneficiary has attained age 70½ before the distribution is made.
- Multiple IRAs. The income exclusion for QCDs only applies to the extent that the aggregate amount of QCDs made during any taxable year for an IRA owner doesn’t exceed $100,000. Thus, distributions from multiple IRAs are capped at a maximum total of $100,000.
- For married individuals filing jointly. The limit is $100,000 per individual IRA owner.
- QCDs don’t affect the adjusted gross income (AGI) deductibility ceiling. Although charitable IRA distributions aren’t deductible as IRC Section 170 charitable contributions, QCDs that are excluded from income under IRC Section 408(d)(8) aren’t taken into account for purposes of the AGI ceilings for traditional charitable gifts.
- Substantiation requirements. Although not deductible, QCDs must still satisfy the deductibility requirements under Section 170 (other than the AGI percentage limits of Section 170(b)) and the substantiation requirements under Section 170(f)(8).
- QCDs aren’t subject to withholding. An IRA owner who requests a charitable distribution is deemed to have elected out of withholding under IRC Section 3405(a)(2).
- IRA trustees and custodians are off the hook. In determining whether a distribution requested by an IRA donor satisfies the QCD requirements, the IRA trustee or custodian may rely on reasonable representations made by the IRA owner.
- Required minimum distributions (RMDs). A QCD is taken into account in determining whether the RMD requirements have been satisfied.
- Treatment of a QCD manqué. If an intended QCD is paid to a charity but fails to satisfy Section 408(d)(8)’s requirements, the amount paid is treated as: (1) a distribution from the IRA to the IRA owner that’s includible in gross income (under Section 408 and Section 408A’s rules), and (2) a contribution from the IRA owner to the charity that’s subject to Section 170’s deductibility rules (including the AGI percentage limits and the substantiation rules).
- QCDs aren’t prohibited transactions—even if used to satisfy pledges. The Department of Labor, which has interpretive jurisdiction under IRC Section 4975(d), has advised the IRS that a distribution made by an IRA trustee directly to a Section170(b)(1)(A) organization (as permitted by Section 408(d)(8)(B)(I)) will be treated as a receipt by the IRA owner under Section 4975(d)(9) and thus isn’t a prohibited transaction, and that’s so even if the IRA owner had an outstanding pledge to the receiving charity.2
Tax-free distributions from individual retirement plans for charitable purposes. When determining the portion of a distribution that would otherwise be includible in income, the otherwise includible amount is determined as if all amounts were distributed from all of the individual’s IRAs.3
Satisfying a pledge with an IRA distribution—IRS Information Letter. By analogy to Revenue Ruling 64-240, a taxpayer who satisfies a pledge by making a QCD under Section 408(d)(8) from his IRA directly to a charitable organization wouldn’t include the distribution in gross income.4
IRS’ caveat. “This letter is an ‘information letter’, which calls attention to a well-established interpretation or principle of tax law without applying it to a specific set of facts. It is intended for informational purposes only and does not constitute a ruling. See section 2.04 of Rev. Proc. 2010-1, 2010-1 I.R.B. 1, 7.”5
My caveat. To avoid income on satisfying a pledge with a distribution from an IRA, the distribution must qualify under the requirements outlined above.
Advantages of IRA/Charitable Distributions:
- A gigantic additional pool of funds is available for charitable gifts.
- The approximately two-thirds of taxpayers who take the standard deduction—and thus can’t deduct their charitable gifts—can get the equivalent of a deduction by making gifts directly from their IRAs to qualified charities. Not being taxed on income is the equivalent of a deduction. Note: The House Ways & Means Committee’s tax reform proposals would reduce to 5 percent the number of itemizers.
- Itemizers who bump into the AGI ceilings on charitable-gift deductibility can use distributions from IRAs to make additional gifts. Because they won’t be taxed on the distributions, they have the equivalent of additional charitable deductions.
- The carryover can be saved. Deductible gifts made in a current year are taken into account before deducting a carryover from earlier years. Making a gift from an IRA (as opposed to making a gift with other funds or assets) means that a carryover can be used in the current year.
- The IRA/charitable distribution (by not increasing AGI as would be the case if the taxpayer withdraws IRA funds instead of using the charitable distribution) can avoid or minimize the reduction of otherwise allowable benefits that are keyed to AGI—the 10 percent AGI floor on casualty loss deductions, the 10 percent floor on medical and dental expense deductions and the 2 percent AGI floor on miscellaneous itemized deductions.
- As AGI increases, the following benefits can be reduced or eliminated: social security; savings bond interest exclusion for savings bonds used to pay for higher education tuition and fees; the adoption and child care credits; contributions to Roth IRAs; and passive activity losses and credits,
- If a donor’s state income tax law doesn’t allow charitable deductions (for example, Connecticut): Making the gift from the donor’s IRA to the charity can be the equivalent of a state income tax charitable deduction.
Caution. State laws differ, so check out all the ramifications in your state. For example, in some states, IRA distributions directly to the IRA owners aren’t subject to state income tax. A distribution from the IRA to charity thus won’t save state income taxes and the donor could lose a state income tax charitable deduction that might—depending on state law—be available for a gift from the donor to the charity. Of course, consider both the federal and state tax rules. You may have heard this before: Do the arithmetic under various scenarios.
PEP and Pease. The phase out of personal exemptions (PEP) and the reduction of otherwise allowable deductions under the so-called Pease provision can make IRA/charitable distributions especially attractive to high-income donors. Taking distributions from IRAs instead of directing those payments to charity can place high-income people in the income levels in which PEP and Pease apply.
Reminder. It won’t be a QCD if the IRA donor gets a chicken dinner or any other benefit. Don’t “fowl” up an IRA distribution with a quid pro crow.
For donors not to be taxed on the IRA transfers, the donee-charity must properly acknowledge the gift from the donor’s IRA. And this isn’t the usual receipt for gifts of other contributions to charities.
Here’s a sample letter you can adapt and use. This is just a sample. As always, consult your own advisers.
Receipt for a Gift Received from a Donor’s IRA
Charity’s Name and Address
Date sent to donor
Name and address of donor
Dear [donor’s name]:
Thank you very much for your $ gift to [name of charity] from your Individual Retirement Account (IRA), received on [date]. This acknowledges that we received your gift directly from [Name of IRA Administrator] and that it is your intention for all or a portion of your gift to qualify as a qualified charitable distribution from your IRA under the Internal Revenue Code. Note, that you may exclude the qualified gift amount from your gross income, but if you do so, you may not also claim the gift amount as a charitable deduction on your 2017 tax return.
This confirms that [name of charity] is qualified under IRC §170(b)(1)(A) and that your gift was not transferred to either a donor advised fund or a supporting organization.
No goods or services were provided in consideration of this gift.
Thank you again for your gift.
Retain this letter for your tax records for 2017.
- See Internal Revenue Service Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs), p. 13 (2016).
- IRS Notice 2007-7.
- Technical Corrections Act 2007.
- Information Letter from IRS dated August 20, 2010 to Harvey P. Dale, University Professor of Philanthropy and the Law, Director, National Center on Philanthropy and the Law at New York University Law School, written by Michael J. Montemurro, Office of Associate Chief Counsel.
- Revenue Procedure 2017-1 (Jan. 3, 2017).
© Conrad Teitell 2017. This is not intended as legal, tax, financial or other advice. So, check with your adviser on how the rules apply to you.