How to Reduce Your Taxes and AGI by Giving to Charity

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How to Reduce Your Taxes and AGI by Giving to Charity

Individual retirement accounts (IRAs) with required minimum distributions (RMDs) may be a boon. After all, you worked hard your whole life to acquire a consistent source of income in retirement. When you reach the age of 72, you may begin collecting RMDs from your conventional IRA. This is a non-negotiable condition of the account.

The received payouts are then taxed at regular income tax rates. As such, they might be a hardship since they can increase your yearly income, potentially pushing you into a higher tax rate. However, there is a method to put these distributions to good use, thereby lowering your bottom line. Given the effect RMDs may have on your tax bill, it’s important developing long-term plans around this law.

Key Takeaways

  • The qualified charitable distribution (QCD) rule enables conventional individual retirement plan (IRA) owners to deduct required minimum distributions (RMDs) on their tax returns if the money is given to a charity.
  • By decreasing your adjusted gross income, the rule may effectively cut your income taxes (AGI).
  • These payouts are limited at $100,000 per person per year.
  • They must be made directly to a charity that has been authorized.
  • If you contribute a part of your RMD, you must accept the balance of the distribution yourself.

Who Can Use the Qualified Charitable Distribution (QCD) Rule?

In 2015, Congress made qualified charitable distribution (QCD) a permanent norm. It permits conventional IRA owners to deduct RMDs from their AGI if they donate the money to designated charities, often known as qualified charitable organizations.

You may deduct the amount you contribute from your IRA under the QCD rule. The QCD is included in your yearly RMD amount, and the distribution must be made straight from your IRA to the eligible charity. As a result, if you are at least 72 years old, you may utilize the QCD rule to avoid paying taxes on your RMDs.

You have the option of making full or partial RMD payments to charity. For example, if your RMD is $5,000 each year, you may give $3,000 to charity and pocket the remaining $2,000 yourself. If you choose, you may donate the whole $5,000 to charity.

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This is how it works. Once you’ve decided to make a QCD, choose a charity and ensure that it meets IRS criteria for charitable organizations. You must notify your IRA custodian of your intentions and the amount, since they will be the ones to make the donation on your behalf. The investing business then forwards the check to the organization or to you, who subsequently forwards it to the charity.

QCDs can only be produced from your IRA. A payment received to you and subsequently passed on to a nonprofit organization does not qualify.

Eligible Distributions

QCDs are available for any contributions and profits accumulated inside a regular IRA. The IRS limits the amount you may gift as a QCD straight from your IRA each year at $100,000. Anything beyond this amount must be claimed as an itemized deduction. Although it lowers your AGI, you cannot deduct charitable contributions on your yearly tax return.

Nondeductible donations are an exception since they are regarded a tax-free return of basis. Joint giving techniques are likewise not accessible for QCDs, so a couple cannot take both of their aggregate RMD amounts from a single account and deduct the full amount from their AGI. For both to qualify, they must each take their RMD from their own account.

The QCD method may also help conventional IRA owners who desire to transfer their balances to Roth IRAs by lowering the amount of taxable money in the account.

On its website, the IRS provides a searchable directory of authorized organizations.

The AGI Advantage

When you contribute money to a 501(c)(3) charitable organization, you may normally claim an itemized tax deduction, lowering your AGI. Keep in mind, however, that you must have enough deductions to justify itemizing. However, in order to gain from itemizing, you must have at least $13,000 in deductions for single filers (or $26,000 for married couples filing jointly) since the standard deduction in 2022 for a single filer is $12,950 for singles and $25,900 for married couples filing jointly.

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The QCD rule allows you to lower your AGI by making a charitable contribution without having to itemize your deductions. Because AGI is used in many tax calculations, having a lower number allows you to stay in a lower tax bracket, reduce or eliminate the taxation of Social Security or other income, and maintain eligibility for deductions and credits that would otherwise be lost if you had to declare the RMD amount as income.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 raised the age at which IRA owners must start taking RMDs from 70 to 72. However, the age at which you may begin taking QCDs remains 7012, establishing an 18-month gap during which IRA distributions qualify as charitable contributions that reduce AGI even if they are not RMDs.

Should I Use the QCD Rule?

The key criteria for QCDs is that disbursements must be made directly to the charity rather than to you. This implies the cheque must be made payable to the charity. If it is not, it is a taxable distribution. You may accept the check and present it to the organization, but you cannot deposit it and write another check to the charity. The charity must provide a written receipt for the gift amount.

However, the issue remains: Should you apply the rule? It is dependent on your circumstances. It also makes sense if other aspects of your scenario make sense. It makes sense to apply the rule if you:

  • If you don’t need the money, it will push you into a higher tax rate.
  • Ideally, you’d want your IRA balance to offer you with fewer RMDs in the future.
  • Want to contribute to qualified charities rather than a foundation or donor-advised fund (which are not charitable organizations)?
  • Want to make a greater gift than you would with cash?

In certain circumstances, an IRA RMD might not give the optimum benefit as a charitable giving. Securities, such as stocks, give a bigger tax advantage if their value has increased from the time of purchase since you will not have to pay capital gains. This also helps to lower any capital gains taxes you may have to pay in the future if you decide to dispose these assets.

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Remember that you may employ the QCD rule for Roth IRA distributions. However, you will get no tax advantage since your payouts are already tax-free.

What is the benefit of a qualified charitable distribution (QCD)?

A qualified charitable donation (QCD) permits you to reduce your adjusted gross income (AGI) while simultaneously meeting the Internal Revenue Service’s required minimum distribution (RMD) limits (IRS).Other taxes, such as Social Security, may be offset by this.

When can I make a QCD from my individual retirement account (IRA)?

You may make a QCD from your individual retirement account (IRA) whenever you make any other withdrawals, which means you can make a QCD once you reach the age of 712.

How do I report a QCD on my tax return?

On the line for IRA distributions, you record the whole amount of the QCD. Enter zero on the line for the taxable amount, then put “QCD” next to it. Additional information may be found on IRS Form 1040.

The Bottom Line

If you have an IRA and want to reduce your AGI, you may utilize the QCD rule to quickly distribute funds to a charity of your choosing. This technique is preferable to accepting the distribution and subsequently contributing to charity, since the latter may not lower your AGI. If used correctly, the QCD rule will reward you with a tax advantage for years to come while also meeting your charitable goals.

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