Dear Pete,
Let’s clarify the connection between deductible contributions to your IRA and eligible charitable donations. While it is true that qualified charitable distributions (QCD) can be a fantastic way to contribute, your CPA is correct in pointing out that making deductible contributions to your IRA affects your eligibility.
Before tax year 2020, individuals who were over the age of 70 ½ were not allowed to make contributions to an IRA. This restriction was in place because 70 ½ was the age at which required minimum distributions (RMD) began. Allowing contributions into an account where money had to be withdrawn seemed counterintuitive.
However, a change in the tax law now permits workers over the age of 70 ½, as well as individuals of any age with earned income, to make contributions to their IRA. While this may sound beneficial, it created a situation where older workers could potentially enjoy excessive tax advantages. To address this concern, a provision was implemented to limit these benefits.
If you have made deductible contributions to your IRA since turning 70 ½, any charitable donations that would have otherwise qualified as QCD will now be taxable. This remains the case until all post-70 ½ contributions have been withdrawn from your account.
Here’s an example to illustrate this: Let’s say you have made a total of $20,000 in deductible IRA contributions since 2020. The first $20,000 that you donate to charity will not be considered QCD and will be subject to taxation. Only after exceeding the $20,000 threshold can subsequent donations be classified as QCD and therefore remain non-taxable—assuming you refrain from making any further deductible contributions to your IRA. It’s important to note that any additional deductible contributions will restrict your future eligibility for QCD.
Best regards,
Reasons Why a QCD Might Show Up as Taxable
Miscommunication with the Tax Preparer
One common reason why a Qualified Charitable Distribution (QCD) might end up being taxable is due to miscommunication with the tax preparer. When the custodian of an IRA issues a 1099-R for the gross amount distributed from the IRA, there is no indication on the form that the distribution was a donation. Unless the taxpayer informs the preparer about the donation, the transaction might not be recorded properly as a QCD. However, this error can be corrected by filing an amended return. It is crucial to obtain copies of acknowledgment letters from charities for donations of $250 or more and share them with your preparer.
Donations Made Indirectly
Another situation where donations from an IRA can become taxable is when the funds are not paid directly to the charity. If you receive a check from the IRA made payable to you instead of the charity, the distribution will not be considered a QCD even if you later write a check to the charity for the same amount. In this case, the donation should be reported on Schedule A, where you will only receive a tax benefit if your total itemized deductions exceed your standard deduction.
Donating to Ineligible Charities
It is essential to donate directly to qualified charities in order to receive the tax benefit of a QCD. Not all nonprofit organizations qualify as eligible charities. Private foundations and donor-advised funds, for example, do not meet the requirements.