Consider bigger gifts to charity from IRAs in 2020
There’s a new opportunity for gifts to charity from IRAs and qualified plans, but think fast and don’t forget about qualified charitable distributions.
Congress and the president have given us a limited time offer to deduct cash gifts to public charities up to a total of 100% of adjusted gross income (AGI). The offer is good for gifts made in 2020.
This change was made by the CARES Act that became law in March 2020. Before this change, the annual deduction limit for gifts of cash was 60% of AGI. In an apparent effort to encourage gifts to public charities as the 2020 pandemic disrupts the economy and increases demand for the services of charitable organizations, lawmakers added this provision to the CARES Act to open the door to larger cash gifts to charity in 2020.
You may have cash available to give to charity, but for reasons discussed below, you may want to consider using a distribution from an IRA or other retirement plan to make the gift to charity. This could appeal to people with lower to modest income who might not otherwise be able to deduct a large contribution to charity. People with substantial holdings may find this to be a very tax-efficient way to meet their giving goals. As with any tax planning, the results can vary depending on a number of factors, so careful planning is needed.
Before going into more detail about this opportunity, it is worth recalling that for people over the age of 70 1/2 there is already a tax advantaged way to make gifts to charity from IRAs—qualified charitable distributions, or QCDs. If you are eligible to make a QCD, that may be the best way for you to make a gift to charity (at least the first $100,000) from your IRA.
Qualified charitable distributions
If you are over 701/2 and you own one or more IRAs, you can direct that up to $100,000 per year be distributed directly to charity. If you are married filing jointly and your spouse is over 70c1/2 and owns an IRA, your spouse can also make a QCD up to $100,000. This is a great way to make substantial gifts to charity, if the all the requirements are met. The QCD has the additional benefit of satisfying in whole or in part the required minimum distributions that generally start for the year you attain age 72.
To meet the requirements of a QCD, the money going to charity must not be distributed to you from the IRA. The money must transfer directly to the charity. You do not pick up the income on your tax return because the money is paid directly to charity, not to you. The charity must be a qualified public charity (donor advised funds, supporting organizations, and many private foundations will not qualify for this purpose).
As with any tax benefit, the particulars matter, so be sure to review all the qualifications before transferring money from the IRA. Many people use QCDs because they can be a convenient and tax-efficient way to give to charity, and, as noted, they count toward satisfying any required minimum distribution for the year of the QCD.
Before there were QCDs, if you wanted to use money in an IRA to make a gift to charity during life, you would need to take a taxable distribution, contribute those dollars to charity, and seek a charitable deduction for those contributions. But the charitable deduction would not eliminate all the income tax on the distribution for the year of the distribution because, assuming your itemize your deductions, those deductions are subject to various limitations tied to percentages of adjusted gross income (AGI) that vary based on the type of gift and the type of charity. For example, as already mentioned, in the year 2019, deductions for gifts of cash to many public charities were limited to 60% of AGI. (As already mentioned and discussed further below, this limit is now 100% for 2020.)
Unused charitable deductions can be carried over for five years, but they remain subject to the limits in future years and may or may not be fully utilized. QCDs neatly (and legally) side-step the AGI limits to produce a more efficient federal tax savings, and may offer state income tax savings, by transferring the dollars directly to charity.
Now that the CARES Act has suspended required minimum distributions for many plan participants and IRA owners for the year 2020 (Click here and here to learn more), people who have been using QCDs to satisfy some or all of their required minimum distributions each year may decide not to make a QCD in 2020 because the value of investments in the IRA may have suffered during the downturn caused by the pandemic, and these people do not want to liquidate investments at depressed values. They may decide to wait to see if those investments recover, perhaps making a larger QCD in the future when values have increased and the QCD counts toward satisfying a required minimum distribution.
Other people will make a QCD in 2020 even though there is no required distribution from an IRA for 2020 because they want to support the work of charitable organizations in the face of an increased demand for services caused by the pandemic of 2020.
What’s new for 2020 - Cash contributions to public charities can be deducted Up to 100% of AGI
Under the CARES Act, cash gifts to qualified public charities in 2020 can be deductrd up to 100% of AGI (to be precise, AGI is calculated for purposes of the charitable deduction limits without net operating loss carrybacks). We’ll call this the “100% limit” for short. Donor advised funds, supporting organizations, and many private foundations are not qualified public charities for purposes of the 100% limit.
The 100% limit creates a significant, but temporary, opportunity to make gifts to charity with distributions from IRAs or qualified retirement plan accounts in 2020.
Unlike QCDs, you do not need to be 70 1/2 to take advantage of this higher deduction limit, and the deduction is not limited to $100,000, so this opportunity is available to more people and makes bigger gifts possible.
In many cases it will not be practical for participants in qualified retirement plans to take advantage of this opportunity because they generally do not have the same flexibility for taking distributions as IRA owners typically do. Also, the 10% additional tax that applies to many distributions to plan participants and IRA owners under 59 1/2 should be considered.
This raises some interesting possibilities for planning. For example, it may be possible for a 65-year-old IRA owner to take a distribution of any amount from the IRA, contribute 100% of the distribution to a qualifying charity, and get a deduction against his or her federal income taxes for the full amount of that contribution, whether it is $50,000 or $500,000. Note that state income taxes may apply.
We say it may be possible for the 65-year-old in this example to deduct 100% of the contribution because we would not know for certain without knowing more about his or her tax situation. It could be that some of the deduction will need to carry over to future years. There are many variables to factor into the tax calculations to determine how much of the contribution will be deductible. Does the donor itemize deductions? Are there other items of income included in AGI? Have other charitable contributions been made in 2020? Were they made in cash or other property? What type of charity received the distributions? Are there charitable contribution carryovers from prior years? Does the increased AGI caused by the IRA distribution affect other items on the 2020 tax calculation? We recommend running any proposed contributions through a pro forma tax return to estimate the amount of the deduction and the impact, if any, on carry over deductions.
If you are over 70 ½, consider using a combination of a QCD and the 100% limit in 2020. To use another simple example: If you had a $250,000 IRA, and you wanted to give that $250,000 to charity in 2020, you could consider making a QCD to transfer $100,000 to charity, and taking a distribution of the other $150,000 in cash to give to charity. The $100,000 transferred via the QCD is excluded from your income (as discussed above), and you may be able to deduct up to 100% of the $150,000 contribution from your federal income using the 100% limit. Again, the income created by the $150,000 distribution from the IRA may be subject to state income tax.
You must file an election to use the 100% limit, in addition to meeting the other requirements. We expect there will be further guidance and/or instructions regarding making the election and clarifying how the 100% limit interacts with the existing limits. Any of the cash contribution that is not deductible in 2020 can be carried forward for five years, subject the limitations that apply in those years.
This is a good time to point out that IRAs and qualified retirement plans are a great way to save for retirement and that the tax-deferred investment inside these accounts will, given enough time, outperform the same investments in after-tax accounts, even though the retirement distributions are taxed at ordinary rates and the after-tax investments may be taxed at preferred capital gains rates. Qualified retirement plans and IRAs were not designed to be sources for charitable giving, and most people, of course, will use them for their intended purpose—to fund retirement. But, if you have other resources to rely on for retirement and are looking for a way to support your favorite charities, the 100% limit may present a great (temporary) opportunity to save taxes and benefit charity in a big way. Run the numbers.
You may find that a gift of appreciated stock would be a more or tax-efficient gift to charity, and that you are better off preserving the retirement assets for your retirement and making the gift to charity at death because gifts of retirement assets to charity at death can also be very tax-efficient. Or, you may find that you have other assets to fund your retirement, and this is a great opportunity to give a big piece of your IRA to charity and that your heirs will be better off inheriting those appreciated securities and getting a new tax basis on those securities. There are many factors to consider, so there is no general rule. But there are good opportunities for those willing to do the analysis.
QCDs remain a very effective way to make gifts from IRAs to qualified charities, but there are limits, and you need to be 70 1/2. In 2020, QCDs do not carry the extra advantage of counting toward the required minimum distributions, but they still offer advantages. If you are not 70 1/2, but you would like to use retirement plan or IRA funds to make charitable contributions, or even if you are 70 ½ and want to contribute more than the $100,000 maximum available with a QCD, consider taking distributions from a qualified retirement plan or IRA (in addition to any QCDs from the IRA) and contributing those funds in 2020 to qualified charities because the CARES Act significantly increased the allowable deduction limit for 2020. Before taking any of these steps, sit down with your tax adviser and preparer and run the numbers. The opportunity to deduct cash contributions to qualified charities up to 100% of AGI only applies in 2020, so now is the time to do the analysis.
- Senior of Counsel