How to Reduce Your Taxes and AGI by Giving to Charity

If you have a traditional individual retirement account (IRA), you must start withdrawing money from it by a certain age. That age has been adjusted several times, but as of Jan. 1, 2023, it's the year that you turn age 73.

This is a non-negotiable rule (and the penalty is hefty). Why? Because you haven't paid income taxes on that money yet, and the Internal Revenue Service (IRS) wants its cut.

The money you take out is then taxed at the ordinary income tax rate. As such, the withdrawals can cause a problem because they can boost your annual income—sometimes into a higher tax bracket.

But there’s a way that you can put these distributions to good use and reduce your tax burden. Given the impact that required minimum deductions (RMDs) can have on your tax bill, it may be worth creating a long-term planning strategy with the qualified charitable distribution (QCD) rule. 

What Is the Qualified Charitable Distribution Rule?

The QCD rule allows owners of a traditional IRA to exclude RMDs from their adjusted gross income (AGI) if they give the money to an approved charity, also known as a qualified charitable organization.

Under the QCD rule, you can give an amount from your IRA directly to charity without receiving it as income. That enables you to donate the full amount that you withdraw rather than what's left after you pay the individual income tax due on the funds you withdrew.

In addition, you can start taking QCDs at age 70½; you don't have to wait until you reach age 73. But when you reach 73, the age at which you have to begin taking RMDs, QCDs count as part of your annual RMD amount.

Thus, if you are at least age 73, you can use the QCD rule to exempt your RMDs from taxation.

Donate a Partial or Full RMD

You can choose to donate partial or full RMDs to charities. For example, if your RMD amount is $5,000 a year, you can direct a $3,000 distribution to charity and take the remaining $2,000 yourself, paying taxes just on $2,000.

Or, you can give the full $5,000 to charity if you choose and owe no taxes on your RMD for that year.

How It Works

1. Once you decide to make a QCD, choose a charity and make sure that it qualifies as a charitable organization under Internal Revenue Service (IRS) rules.
2. Then, let your IRA custodian know of your intention to donate your distribution and the amount.
3. It will cut the check made out to the charity on your behalf.
4. The IRA custodian then sends the check to the organization (or to you, for you to send to the charity).
   

Eligible Distributions

All contributions and earnings that accumulate within a traditional IRA are eligible for QCDs. The IRS caps the amount that you can donate each year at $100,000. Anything in excess of this amount must be taken as an itemized deduction.

A QCD reduces your AGI, a benefit to a taxpayer at any age. However, you cannot claim a QCD as a tax deduction on your annual tax return.

Exceptions

The exception to this is nondeductible contributions, as they are considered a tax-free return of basis.

Joint gifting strategies are also ineligible for the purpose of QCDs, which means that a couple cannot take both of their aggregate RMD amounts from a single account and exclude the entire amount from their AGI.

Each of them must take their RMD from their own account for both to qualify.

The QCD strategy can also benefit traditional IRA owners who want to convert their balances to Roth accounts, as the QCD will reduce the amount of taxable money in the account.

The AGI Advantage

Generally, you can take an itemized tax deduction when you donate money to a charitable organization. Such a donation reduces your adjusted gross income. In most cases, the amount of charitable cash contributions taxpayers can deduct as an itemized deduction is limited to 60% of the taxpayer’s AGI.

Keep in mind, though, that it's best to have enough deductions to make itemizing worthwhile when compared to the amount you're entitled to with the standard deduction.

For the 2023 tax year, the standard deduction is $13,850 for single filers and $27,700 for married couples filing jointly. For 2024, the standard deduction is $14,600 for single filers and $29,200 for married couples filing jointly.

The QCD (qualified contributions deductions) rule offers you a way to reduce your AGI through a charitable donation without having to itemize deductions. Individuals may deduct qualified contributions of up to 100% of their AGI, and corporations may deduct qualified contributions of up to 25% of their taxable income. To qualify, the contribution must be a cash contribution or the charitable organization has to be a qualifying organization.

Because AGI is used to determine your taxable income, having a lower AGI can help you to stay in a lower tax bracket, reduce or eliminate the taxation of Social Security benefits or other income, and still remain eligible for deductions and credits that might be lost if you had to declare the RMD amount as income.

Who Should Use the QCD Rule?

The main qualifier about QCDs is that the distributions must be made directly to the charity, not to you. This means that the check must be made out to the charity. If it isn’t, it is recognized by the IRS as a taxable distribution to you.

You can receive the check made out to the charity and send it on to the organization yourself, but don’t deposit the check and make out another one to the charity. In addition, the donation amount must be acknowledged by the charity with a written receipt.

The question arises: Should you use the rule? It depends on your situation. Using the rule makes sense if you:

• Don’t need the RMD money or it would put you into a higher tax bracket that you want to avoid
• Want to lower your RMD amount in future years
• Want to support an approved charity rather than a foundation or donor-advised fund (neither of which qualifies as a charitable organization)
• Want to make a larger donation than you could in cash

There are cases in which an IRA RMD can't provide the best benefit as a charitable donation. For example, donating securities such as stocks provides a greater tax benefit to you if they appreciated in value since the time of purchase, as you won’t have to pay the capital gains tax.

Keep in mind that the QCD rule for distributions pertains to a Roth IRA as well as a traditional IRA. But there's no tax benefit, as your Roth IRA distributions are already tax-free. What's more, RMDs are not required from Roth IRAs.

The Bottom Line

If you own a traditional IRA and want to lower your adjusted gross income for tax purposes, you can use the QCD rule to donate to an IRS-approved charity of your choice, as long as you've reached age 70½.

If you use this strategy, don't take the distribution yourself and then donate it to charity. The distribution check must be made payable to the charity.

If used properly, the QCD rule can get you a handy tax deduction for years to come while fulfilling your philanthropic goals.