Qualified Charitable Distributions: Five Common Mistakes

In our experience, qualified charitable distributions (QCDs), which have been around since the mid-2000s as a provision under the Pension Protection Act, have increased in popularity for older owners of individual retirement accounts (IRAs), who are often searching for ways to:¹

• Offset unneeded required minimum distributions (RMDs)
• Reduce taxable income
• Stay below income phaseout limits for items such as Medicare Part B premiums.

More specifically, QCDs allow IRA owners over the age of 70 1/2 to make direct charitable gifts from their IRAs, up to $100,000 per donor in any calendar year.² While this may seem relatively straightforward, QCDs have some nuance to them, which makes their execution more susceptible to missteps if proper planning is not done. For those who are thinking about implementing a QCD strategy, here are five common mistakes to watch for:

1. Making the transaction too soon

As mentioned above, an IRA account owner must be at least 70 1/2 to implement a QCD strategy. Unlike the RMD rules, which require you to begin taking distributions in the year you attain age 72, QCDs are based on the actual date on which you turn 70 1/2 (and not the year in which you attain this age). For example, if you were born on January 1, 1953, you won’t be eligible to make a QCD until June 1, 2023. If you attempt to make a QCD prior to reaching 70 1/2, the entire distribution will be treated as taxable income, and you won’t be able to retract the distribution once taken.³

2. Using the wrong account

While QCDs can be a powerful tool, they are only available for certain retirement accounts. Common vehicles for QCDs are traditional, rollover and inherited IRAs.⁴ SEP IRAs and SIMPLE IRAs can also be used, but only if they are “inactive” plans (inactive plans are those that receive no contributions in a given tax year).⁵ Many people might be surprised to find out that QCDs are unavailable to qualified plans such as 401(k)s.⁶ In our view, this factor should be considered when determining whether you should roll your 401(k) account into an IRA after retiring (but that’s a topic for another time).

3. Transferring between spouses

While the annual limit for a QCD is $100,000 per IRA owner, this figure is not transferable between spouses. If two spouses both have IRAs and are both past age 70 1/2, one spouse cannot transfer the other’s unused benefit to make $200,000 of QCDs in a single year. In other words, the benefit is not $200,000 per married couple. Each spouse must individually elect to use their $100,000 limit when making QCDs.⁷

4. Not sending funds directly to charity

A common mistake we see regarding QCDs is the mishandling of the actual distribution process. A hard-and-fast rule of QCDs is that they must be transferred directly to the charity, typically via check made payable to the charitable organization.⁸ However, what we sometimes see is the IRA owner making the distribution payable to themselves and then subsequently gifting the funds to the charity. Doing this immediately disqualifies the distribution from being treated as a QCD, which results in the funds being treated as taxable income.⁹ For these reasons, we suggest to always remember to make QCDs directly payable to the charitable entity and never to yourself. It’s permissible to have checks mailed to your address so that you can pass the funds to the charity personally; however, it’s imperative that the distribution check be made out directly to the charity.¹⁰

5. Failing to communicate and report

Lastly, one step in the QCD process that can often get overlooked is communication with your accountant. When preparing tax returns, accountants should look at your 1099-R form to determine the amount of IRA distributions taken during the year. However, the form does not distinguish between the different types of distributions, which may lead your CPA to believe that a QCD was an ordinary taxable distribution.¹¹ If gone unnoticed, this small detail could create adverse tax consequences and even more headaches when going back to amend the original return. To mitigate these risks, we recommend communicating with your accountant early in the process regarding your intentions to make QCDs. By being proactive, you may help prevent potential mistakes and avoid future headaches all in one swoop.

While QCDs can be a tax-advantaged way to give to charity and prevent exceeding income phaseouts, it’s not always the optimal solution. Depending on your specific situation, gifting appreciated stock in taxable accounts or utilizing donor-advised funds may be a better strategy. We recommend talking to your CPA and your Corient Wealth Advisor to help you determine the most suitable approach for your circumstances.

¹ https://www.irs.gov/charities-non-profits/pension-protection-act-of-2006-revises-eo-tax-rules
² https://www.irs.gov/newsroom/qualified-charitable-distributions-allow-eligible-ira-owners-up-to-100000-in-tax-free-gifts-to-charity
³ https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras-distributions-withdrawals
⁴ https://www.forbes.com/sites/kristinmckenna/2021/08/23/how-to-donate-your-rmd-using-qualified-charitable-distributions/
⁵ https://dev-rlc-public-site.netlify.app/resources/2021-qualified-charitable-distributions-from-iras/
⁶ https://www.forbes.com/sites/stevevernon/2022/01/24/retirees-beware-of-traps-for-the-unwary-regarding-qualified-charitable-distributions/
⁷ https://www.irs.gov/newsroom/reminder-to-ira-owners-age-70-and-a-half-or-over-qualified-charitable-distributions-are-great-options-for-making-tax-free-gifts-to-charity#:~:text=For%20a%20married%20couple%2C%20if,itemizes%20deductions%20on%20Schedule%20A
⁸ https://www.fidelity.com/learning-center/personal-finance/retirement/qcds-the-basics
⁹ https://www.irs.gov/newsroom/reminder-to-ira-owners-age-70-and-a-half-or-over-qualified-charitable-distributions-are-great-options-for-making-tax-free-gifts-to-charity
¹⁰ https://www.irs.gov/newsroom/qualified-charitable-distributions-allow-eligible-ira-owners-up-to-100000-in-tax-free-gifts-to-charity
¹¹ https://etf.wi.gov/benefits/taxes-and-my-benefits/form-1099-r-form-1042-s-distributions

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