InnOvation Capital & Management, LLC
IntelDigest
LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR
DECEMBER 29 , 2018
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We have devoted the December issues of IntelDigest to 2018 Year-End matters and planning, closing the most recent issue with an outline of the basic strategy behind donating cash or assets directly from retirement plans to charities. A more detailed discussion follows.
The calendar is about to flip to the New Year, and this approach can be an important element in your financial, tax, and estate planning going forward. It can be implemented at any time of year … after due deliberation … and can afford a taxpayer the benefit of a donation to charity without actually itemizing deductions.
Donations – Giving RMD to Charity – The Basics
A taxpayer who has attained age 70½ is required … according to the Internal Revenue Code … to take a minimum annual distribution from his/her retirement funds. This is referred to as the Required Minimum Distribution (RMD), and includes all Qualified Retirement Plans and all Individual Retirement Accounts (IRAs).
The RMD is based on the account balances from all such accounts, but the actual distribution of cash or assets may be taken from one of the accounts or from several, in whatever percentage works for each taxpayer.
The distribution is includible in gross income for income tax purposes.
Planning Point – By making a charitable donation directly from an RMD, a taxpayer can satisfy the RMD requirement AND avoid income taxes on the distribution.
Qualified Charitable Distribution (QCD)
A taxpayer can direct the distribution of up to $100,000 each year from employer-sponsored retirement plans or IRAs to one or more qualified charitable organizations; this is called a Qualified Charitable Distribution (QCD).
Such a distribution satisfies the RMD, avoids taxation, and accomplishes a charitable gift without having to choose between Standard and Itemized Deductions.
The charity must be approved by the Internal Revenue Service (IRS) as a 501(c)(3) organization, which allows donors to take tax deductions for their donations. The IRS website, irs.gov, contains a search function allowing taxpayers to confirm that a prospective charity has 501(c)(3) status. Other entities, such as private foundations and donor-advised funds, are not eligible for this tax benefit.
When you have determined that the prospective charity is an eligible 501(c)(3) organization, it’s easy to make a QCD. You can direct the retirement plan (or IRA) administrator to send a check or wire transfer directly to the charity. Or, you may specify that the administrator send the check, made payable to the charity, to you so that you can deliver it to the charity.
Report the full amount of your retirement plan distributions on Line 4 of the new (2018) Form 1040. On the same line, report the “taxable” amount as Zero if the total distribution was composed of the QCD. Enter “QCD” next to the entry.
You may have to also file IRS Form 8606, Nondeductible IRAs, if:
you made the qualified charitable distribution from a Traditional IRA in which you had basis, and you received a distribution from the IRA during the same year other than the qualified charitable distribution; or
the qualified charitable distribution was made from a Roth IRA … coming from a Roth IRA, the amount does not count as an individual’s RMD for the year … only the taxable earnings, if any, can be part of a QCD.
The advantages of turning your RMD into a Qualified Charitable Distribution include:
earning the tax benefit of a charitable donation, even when taking the Standard Deduction
eliminating taxation of the RMD, which lowers Adjusted Gross Income (AGI) on the tax return
lowering AGI could also lower or eliminate the 3.8% tax on net investment income
lowering AGI also results in lower Medicare premiums for the taxpayer
lowering AGI can also lead to greater Medical Expense deductions for those who itemize deductions
lowering AGI will also result in lower state income taxes in most states, because the state income tax calculation starts with the Federal AGI
Appreciated Capital Gain Property
There are two scenarios where a QCD may not be advisable; both pertain to Appreciated Capital Gain Property.
In some circumstances, a taxpayer can save more tax by making a charitable gift of substantially-appreciated long-term capital gain property. This gift would NOT come from a retirement plan or IRA. By donating such property (instead of selling it and making a separate charitable contribution), the taxpayer will avoid capital gain taxes AND enjoy a large itemized deduction.
Avoiding tax on the sale of a capital gain is a significant saving. Taxpayers in the highest marginal bracket for their long-term capital gains can be taxed at a rate as high as 37%, including state income tax. There is an additional 3.8% federal surtax on net investment income.
In the second scenario, a taxpayer with substantially-appreciated assets may wish to save the assets for his/her heirs to inherit. An heir can benefit from a “step-up” in basis, meaning that the heir’s cost for the asset is set as of the taxpayer’s date of death. So, all the taxable capital gain during the taxpayer’s life is wiped out.
However, while holding stock until death may result in tax savings, it may also result in greater risk of investment loss and lower eventual investment return. A prudent investor reviews his/her portfolio regularly, rebalances the investment mix, and disposes of assets which have met their full potential.
Achieving a tax benefit along with a charitable donation … either through a qualified donation of an RMD or a donation of appreciated assets … is an optimum form of investment and tax management.