Tax season is just around the corner and during this time of year the chatter on how to reduce your tax bill picks up quite a bit. Giving to charities is a popular way to do that, whether your motivation is charitable, financial, or a combination of the two, if the donation is done correctly both parties win!
A typical scenario we run into with our retired clients is although they are donating to charities, they aren’t receiving a tax deduction for doing so. This is simply attributable to the fact that the majority of our retired clients don’t itemize their deductions. A quick refresher on the income tax calculation…
Each taxpayer has the option of itemizing their deductions or taking a standard deduction whichever is higher. Common itemized deductions include charitable donations, mortgage interest, a portion of medical expenses, and property and state taxes. If you total up all your itemized deductions and they aren’t greater than the standard deduction, then obviously you’ll take the standard deduction. For a married couple over age 65, the standard deduction is $15,100.
The Pension Protection Act of 2006 introduced a new provision to the tax code which prevents individuals over the age of 70 ½ from losing their charitable deduction by taking the standard deduction.
It’s called a Qualified Charitable Distribution (QDC). A QDC allows an individual who is subject to required minimum distributions to direct the required minimum distribution to a charity and eliminate that distribution from gross income instead of taking it as an itemized deduction. An ideal client for a QDC would be the following:
Grandma and Grandpa are both age 75, retired and have an IRA which they’re required to withdraw $5,000 from this year. Although the extra income is nice, they don’t need it since their social security and pension payments are sufficient to cover their needs. Therefore, they decide to donate the $5,000 to a local charity. Grandma and Grandpa don’t have many deductions since they no longer have a mortgage, are in good health and pay minimal property and state taxes. Their total deductions, including the charitable donation equal $10,000. Instead of itemizing their deductions they take the standard deduction, which for them would be $15,100.
If Grandma and Grandpa take their required minimum distribution, deposit it in their bank account and in turn write a check to the charity of their choosing, they will not receive a tax deduction for the donation simply because they are taking the standard deduction.
However, if Grandma and Grandpa perform a QDC by instructing the custodian of their IRA to direct the distribution straight to the charity of their choosing, Grandma and Grandpa can exclude that distribution from gross income entirely and still take the standard deduction.
In this case, your grandparents saved $750 by doing a QDC ($5,000 distribution X 15% tax rate)
Even if you itemize your deductions, I would still recommend doing a QDC since it will effectively lower your Adjusted Gross Income (AGI). Your AGI directly affects your capital gains and dividend tax rates as well as the deductions and credits you can take. The higher up on the tax return you can exclude/deduct income the better!
QDCs are simple and effective. Keep an eye out for friends and family who are eligible for this tax saving strategy.