MONEY MATTERS: Looking at IRA qualified charitable distributions

By Edward F. Adams

The Daily Record Newswire

In mid-December of 2010, last minute federal income tax legislation extended a valuable tax provision first enacted in 2006 -- the direct distribution to a qualified charitable organization of funds of up to $100,000 from an IRA whose owner is 70.5 years of age or older in both 2010 and 2011, may be excluded from gross income.

Under this provision, IRA funds distributed by the IRA custodian can satisfy all or a portion of the IRA owner's required minimum distribution. Such qualified charitable distributions (QCDs) are excluded from gross income of the owner rather than being included in income and do not qualify as a charitable deduction to be claimed by those who itemize deductions.

This provision represents a rare planning opportunity to reduce gross income and, by so doing, reduce the negative impact that higher gross income can have on deductions, credits and the federal alternative minimum tax.

As tax planning strategies are reviewed before year end, most taxpayers will consider the impact on their income tax liabilities of strategies intended to reduce income and to increase deduction and credits. Often the complexity of the tax law leads to confusion and out-right errors in selecting and implementing tax planning strategies.

A taxpayer's facts and circumstances can lead to difficult choices that warrant an actual estimated tax calculation to ensure the intended outcome will be realized and that the most tax-efficient strategy is employed.

Following are a number of considerations when planning to employ QCDs.

Typically, owners of traditional IRAs, including inherited IRAs, who are 70.5 years of age or older may arrange for QCD to be made from funds that they would otherwise be required to distribute to themselves as ordinary income.

While the gross distributions from the IRA are reported on Form 1099-R, the QCDs are actually excluded in computing gross income on the tax return. As noted, the QCDs do not give rise to a charitable deduction claimed as an itemized deduction. Rather, gross income is reduced with the consequence that many items, although not all, in the income tax return impacted by the magnitude of gross income are favorably impacted and the taxpayer's estate is reduced.

For example, the taxation of Social Security entitlements depends on the extent of the taxpayer's gross income so that QCDs may reduce the taxation of entitlements. Itemized deductions for medical expense, casualty loss and miscellaneous deductions are phased out by a percentage of gross income so that QCDs may increase allowable deductions.

Certain credits and passive activity loss limitations can be positively impacted as gross income is reduced by QCDs. Exposure to the Federal alternative minimum tax is reduced by a reduction in gross income because more of the basic exemption allowed in the AMT calculation may be allowed.

These examples of reductions in the so-called stealth tax provisions also extend to state taxation as well where reduced income may result in less phase out of deductions and lower taxes. On the other hand, reduced income as a result of the use of the QCD strategy may reduce the allowable federal sales tax deduction and may result in lowered charitable contribution deduction limitations applying.

Suffice to say that an understanding of the implications of strategies impacting gross income, including the QCD strategy, may or may not be intuitive, but almost always warrant scrutiny to ensure tax liabilities are reduced. Similarly, it should be understood that the QCD strategy may not always be the most tax-efficient charitable giving strategy.

Depending on facts and circumstances, a taxpayer may still be better off making a gift of highly appreciated property, particularly marketable securities. The donation of marketable securities also simplifies the documentation of the gift's fair value as compared to more complex valuations of alternative types of tangible and intangible property gifts.

However, property gifts do require the application of certain limitations to charitable deductions that do not apply to QCDs. Comparative analysis is necessary to confirm an appropriate choice of charitable giving strategy and the funding of those charitable gifts.

The future of the QCD strategy remains in question as tax legislation would be required to extend the current provision that is now set to expire after Dec. 31.

Current tax legislation rhetoric includes limiting the Federal tax benefit of charitable deductions to no higher than 28 percent while the highest tax rate may climb to 39.6 percent. It is easy to understand why some would accept the limitation of a contribution deduction benefit in the future if they could count on an outright exclusion of IRA distributions from gross income by the acceptance of a permanent QCD provision -- QCDs would garner a 39.6 percent tax benefit compared to a charitable itemized deduction benefit of 28 percent.

For 2011, many will benefit by employing the QCD strategy while it is still available. However, a QCD may not necessarily be more tax-efficient than some alternatives. Discuss your options with your tax advisor.


Edward F. Adams is a principal in the firm of Mengel, Metzger, Barr & Co. LLP; he consults with the firm's clients on all aspects of tax and financial planning. He can be contacted at (585) 672-1833 or

Published: Thu, Nov 24, 2011