How the Anti-Abuse Rule of the CARES Act Changed Qualified Charitable Distributions – Part 2
June 22, 2020
By George Dulgeryan and Carí Jackson Lewis, CCF Senior Development Officers
and William Strickland, CCF Planned Giving Officer
Part One of our series analyzing the effect of the SECURE and CARES Acts on IRA holders entitled “How the CARES and SECURE Acts Changed Required Minimum Distributions (“RMD”)” addressed the raising of the RMD start age from 70 ½ to 72, the repeal of the age 70 ½ age cap for making IRA contributions, and the waiver of the RMD requirement for the tax year 2020. In that article, we provided information about RMDs, their operation within IRAs, and the effect of the changes on retirement savers. We concluded that the three adjustments to the RMD rules serve to promote the tax-free accumulation of IRA assets and to increase the longevity of IRAs, in the hope and expectation that these changes will allow IRAs to support retirement savers through a longer period of their post-employment years. In this Part Two of the series we will review the dramatic changes to the rules regarding qualified charitable distributions, the parameters of which IRA-holders should be made aware.
Qualified Charitable Distributions (QCD)
A quick recap from Part One: IRA accounts are retirement savings accounts, contributions to which are made on a tax-free basis (either through pre-tax salary deductions via an employer-sponsored account, or upon taking the tax deduction on a personal return). Distributions from IRA accounts are taxed as ordinary income. An IRA holder or IRA beneficiary who reached the age of 70 ½ in or prior to 2019, or who will reach the age of 72 in 2020 or later, is generally required to withdraw funds from their IRA annually and pay income taxes on the amounts withdrawn, until the funds are extinguished. These mandatory annual withdrawals, called Required Minimum Distributions (“RMD”), are the minimum amounts that IRA holders must take each year.
This means that if a retirement saver reached the age of 70½ in 2019, the pre-SECURE Act rule applies, and they should have taken their first RMD by April 1, 2020. If, however, the IRA holder reaches age 70 ½ in 2020 or later, they must take their first RMD by the later of April 1 of the calendar year after the IRA holder reaches age 72 or the calendar year in which the IRA holder retires.
IRA holders can take more than their annual RMD amount without penalty. However, an IRA holder who does not take their RMD, takes less than the amount that they are required to take, or misses the deadline for taking the RMD, will be heavily penalized. The amount not withdrawn (that should have been withdrawn) is taxed at 50%.
This means that if Preston was supposed to have withdrawn $25,000 from his IRA and only withdrew $15,000, absent the grant of a waiver based upon a compelling showing of a “reasonable error” (dementia, death in the family, illness, change of address, etc.), Preston will have to write a check to the Treasury Department for $5,000 ($25,000 – $15,000 = $10,000. 50% of $10,000 = $5,000). There is no statute of limitations on this penalty. This harsh provision has meant that IRA holders with an RMD requirement have been forced to withdraw the funds, and pay the income taxes thereon, whether they needed the RMD funds or not.
A solution for a charitably minded IRA holder who does not need the income from their annual RMD is a charitable contribution to a public charity like CCF via a qualified charitable rollover, or Qualified Charitable Distribution (“QCD”). Generally, retirement savers aged 70 ½ and older may contribute up to $100,000 of their IRA to a charitable organization like CCF and exclude the amount of that contribution from their taxable income during the year of the gift. Married couples with two IRA accounts (one for each person) may contribute up to $200,000 in one year ($100,000 from each IRA). A QCD may also be applied in satisfaction of a retirement saver’s RMD requirement for that year, subject to certain restrictions.
RMD funds may not be applied as a QCD to a donor-advised fund, supporting organization or private foundation, but may be applied to a variety of other CCF community initiative funds, such as the COVID-19 LA County Response Fund, Los Angeles Scholars Investment Fund, as well as our field of interest funds, restricted funds, and scholarship funds.
QCD Anti-Abuse Provision
While the SECURE and CARES Acts have provided more flexibility in respect of donor’s IRA options, these Acts have also added some complexity to the use of a QCD to support an IRA holder’s favorite charity. The SECURE Act instituted a QCD anti-abuse provision that prevents older working IRA holders from “double-dipping”; that is, reusing their tax-deductible IRA contributions as QCDs. Specifically, IRA holders who have earned income, and who are contributing to an IRA after age 70 ½ and taking a tax deduction for that contribution, will not be allowed to make a QCD until all the post-age ½ IRA tax deductible contributions have been subtracted from the proposed QCD amount.
For example: Lynelle is 71 years old and works part-time at a Los Angeles-based nonprofit organization. Every year, Lynelle contributes the maximum $7,000 to her traditional IRA for ten years until she finally retires. Lynelle’s total post-age 70 ½ IRA contributions amount to $70,000 ($7,000 x 10 years). After Lynelle retires, she assumes the chair of the board of a national nature conservancy nonprofit. In one of her first acts as Board Chair, Lynelle uses some of the assets of her IRA to make a sizeable contribution to the organization’s capital campaign in the amount of $80,000. This is Lynelle’s first QCD.
Under the new QCD anti-abuse rules, Lynelle must first deduct the total amount of all her post-age 70 ½ deductible traditional IRA contributions in order to calculate her allowable QCD amount. Essentially, all Lynelle’s post-age 70½ deductible traditional IRA contributions will have to be “burned through” before the pre-age 70 ½ deductible traditional IRA contributions assets are reached (tax-deductible contributions made to an IRA prior to reaching age 70 ½ are not subject to the QCD anti-abuse rule).
Only after all Lynelle’s post-age 70 ½ deductible traditional IRA contributions ($70,000) have been subtracted from Lynelle’s post-age 70 ½ charitable contribution ($80,000) will the remaining amount of her contribution qualify as a QCD. The below table illustrates the calculation process.
The $70,000 worth of post-age 70 ½ deductible IRA contributions is subtracted from Lynelle’s contribution to the charity, and therefore only $10,000 of her contribution will qualify as a QCD and be excluded from her taxable income for that year. The $70,000 that would otherwise have qualified as QCD is disallowed due to the anti-abuse rule. However, if Lynelle itemizes her taxes, subject to the rules regarding charitable contributions and adjusted gross income limits, Lynelle may be able to deduct the $70,000 from her taxes as a charitable contribution.
Tips for sidestepping QCD anti-abuse rule
One solution for philanthropic married IRA holders to is to make post-age 70 ½ IRA contributions to one spouse’s IRA, and to distribute post-age ½ QCDs out of the other spouse’s IRA. This technique would allow the first spouse to take an income tax deduction for their IRA contribution, and it would allow the second spouse to use their QCD to satisfy some or all of their RMD requirement without increasing their taxable income.
Another option for a donor with both a Roth IRA and a traditional IRA is for the donor to make post-age 70 ½ contributions to the Roth IRA and make post-age 70 ½ QCDs out of their traditional IRA. A Roth IRA is essentially the opposite of a traditional IRA, in that contributions to Roth IRAs are made with after-tax earnings, and when withdrawals are made from a Roth IRA, those funds are income-tax free. QCDs cannot be made from Roth IRAs. A larger explanation of Roth IRAs is beyond the scope of this article. In both techniques identified, tax-deductible contributions are not made to accounts from which QCDs are made, thereby eliminating the post-age 70 ½ anti-abuse issue.
This article is not intended to be inclusive of all the rules and regulations that govern IRAs, and it should not be considered legal or financial advice. Please consult your legal and financial professionals for more information about your particular circumstances.
If you have any questions about charitable giving with Individual Retirement Accounts, and the application of the provisions within the SECURE and CARES Acts discussed above, please contact us to discuss how we may be of assistance.
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