Do QCDs Actually Reduce AGI?
It has come to our attention that confusion exists as to how qualified charitable distributions (QCDs) impact one’s taxes. It is said that QCDs can reduce adjusted gross income (AGI). But is this true? Yes, it is true…but there is more to the story. Simply “doing a QCD” is not a magic AGI-reduction bullet.
First, recognize that not everyone is eligible to do a QCD. They are only available to IRA owners who are age 70½ and over. Also, QCDs cannot be done from employer plans like a 401(k) or 403(b). Donations paid directly from an IRA to an eligible charity may be excluded from income, and there can be no benefit back to the taxpayer.
Version 1
Jack is age 75 and has an IRA. It is late in the year, and Jack has already taken his $20,000 required minimum distribution (RMD) from his IRA. (He used the funds to pay for a lovely European vacation with his family, although he could have easily funded the trip with money from another source.) Jack estimates that his total AGI for the year, including the $20,000 RMD, will be $100,000. Jack would like to reduce his income by $10,000. Will doing a $10,000 QCD now, before the end of the calendar year, reduce Jack’s AGI?
ANSWER: It will not. Why? Jack’s AGI is $100,000. If he does a $10,000 QCD now, that involves processing another distribution from his IRA. The $10,000 QCD is excluded from income, so it is essentially a wash. The $10,000 would come out of the IRA as a QCD, the same $10,000 would be excluded from income, and Jack’s AGI would remain unchanged at $100,000. The extra, unplanned QCD does nothing to help Jack’s immediate desire to reduce his AGI.
Version 2
Let’s reframe the situation. It is now the following year, and Jack is facing another RMD for about $20,000. When the RMD is added to his other income, Jack projects his total AGI to be, once again, $100,000. Jack would like to minimize this projected AGI. Instead of taking the full $20,000 RMD, Jack will do a QCD to offset half of it. Jack takes a $10,000 taxable distribution from his IRA to make repairs on his home. He then requests a $10,000 QCD to his favorite charity. At the end of the year, Jack’s projected AGI of $100,000 has been reduced to $90,000. Will doing another QCD before year-end reduce Jack’s AGI further? No, it will not. As we saw in the previous scenario, another QCD would be a wash. Money would come out of the IRA, the distribution would be excluded from income, and Jack would still have an AGI of $90,000. Had Jack paid for his home repairs from another source and done a QCD to offset his entire $20,000 RMD, he could have dropped his projected AGI to $80,000.
There are other benefits to doing QCDs. For example, if Jack did proceed with an unplanned large QCD late in the year, it would not reduce the projected AGI he calculated at the beginning of the year, but it would reduce the total value of his IRA. With a lower total IRA balance, Jack would have a lower RMD the following year (vs. if he did not do the large, unplanned QCD).
The point here is that, as mentioned, QCDs are not a magic AGI reducer. One cannot simply do an unplanned QCD to drop AGI. However, what QCDs can do is reduce projected AGI, especially for proactive IRA owners staring a large IRA RMD in the face.
By Andy Ives, CFP®, AIF®
IRA Analyst
Ed Slott and Company, LLC
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Christian Cordoba, founder of California Retirement Advisors, has been a member of Ed Slott's Master Elite IRA Advisor Group since 2007.