By Jim Terwilliger
On Dec. 18, 2015, President Obama signed into law the Protecting Americans from Tax Hikes Act of 2015 (PATH Act). This legislation addressed many individual and business tax provisions, which expired at the end of 2014.
One provision made “permanent” that benefits seniors is the so-called qualified charitable distribution (QCD). We covered this change briefly in a past column. Let’s take a closer look to better understand and appreciate the value that this option offers to seniors.
Understand that IRAs are tax-efficient goldmines when it comes to charitable giving, both pre-and post-death. The use of QCDs from IRAs during one’s lifetime can provide some very attractive tax-reduction benefits.
Quite simply, the QCD provision allows a taxpayer aged 70 1/2 and older to transfer up to $100K annually directly to one or more charities from his or her traditional pre-tax IRA and not have the distribution included in taxable income.
Perhaps the most-valuable feature is that required minimum distributions (RMDs) may be used to fund these transfers. This bestows the greatest benefit on folks who do not need their RMDs for household cash flow. In this case, such transfers allow both RMD obligations and charitable interests to be satisfied simultaneously.
The big advantage here is that such distributions are not included in adjusted gross income (AGI). Why is this important?
• Medicare Part B premiums are now greatly impacted by AGI. Per-person premiums start at a base of $121.80/month for modified AGIs (AGI plus tax-exempt income) up to $85K for single taxpayers or up to $170K for married filing jointly. At the other end of the scale, for modified AGIs exceeding $214K single or $428K married, the Part B per-person premium jumps to $389.80/month with an additional Part D premium of $72.90/month thrown in for good measure. In between, there are an additional three tiers of increasing Part B and Part D premiums tied to increasing modified AGIs.
In 2017, the rates are projected to increase substantially, and in 2018, the tiers will become more aggressive in terms of lowering the modified AGI thresholds to engage more Medicare beneficiaries in the higher tiers.
Note that the connection between Medicare premiums and income has a two-year gap. In other words, your 2015 modified AGI will impact your 2017 premiums.
• Taxation of Social Security benefits is impacted by income (defined as “combined income” which is equal to AGI plus tax-exempt interest income minus one half of the Social Security benefit). The portion of benefits that is taxable increases from zero to a maximum of 85 percent. The maximum is reached when combined income exceeds $34K for single taxpayers and $44K for married filing jointly.
• Exposure to the 3.8 percent Medicare tax on net investment income is impacted by income. Here, the tax is 3.8 percent times the lesser of 1) net investment income or 2) AGI less $200K for single taxpayers or less $250K for married filing jointly. Note that while net investment income itself does not include IRA distributions, taxable IRA distributions are includable in AGI, which in turn can mean the difference between being in the 3.8 percent tax territory or not.
Some additional benefits of QCDs are:
• Since a QCD is not taxable, charitable gifts made in this manner cannot also be listed as itemized deductions. No double dipping allowed. But for higher income taxpayers who find that itemized deductions are partially phased out (the so-called Pease limitation), a QCD transfer is a better tax deal compared to a charitable itemized deduction.
• For taxpayers who do not itemize deductions and do not need their RMDs, use of the QCD yields a tax benefit for charitable dollars given via this approach that otherwise would be lost if given directly to the charity in cash.
• QCDs can also be used with inherited IRAs for which annual RMDs must start in the year following the original IRA owner’s death.
• QCDs are exempt from the rule that charitable deductions for cash gifts cannot exceed 50 percent of your AGI in the year of the gift.
Other features and watch-outs include: 1) QCDs are not allowed for gifts to donor-advised funds; 2) QCDs are not allowed from employer retirement plans such as 401(k)s; 3) QCDs can only include distributions that otherwise would be 100 percent taxable; 4) QCDs can only include transfers that would otherwise be 100 percent tax-deductible; and 5) Roth IRAs are not suitable QCD sources.
Proper and beneficial use of QCDs requires knowledgeable planning. Be sure to consult with your financial planner to make the best use of this attractive charitable-giving option.
James Terwilliger, CFP®, is senior vice president, financial planning officer at Wealth Strategies Group, Canandaigua National Bank & Trust Company. He can be reached at 585-419-0670 ext. 50630 or by email at firstname.lastname@example.org.