Misconceptions and Clarifications About the Charitable IRA Rollover

Question: When Is a Charitable IRA Rollover not a rollover?

Answer: Never! Or - Always! Say what? Read on!

The so-called “Charitable IRA Rollover” goes back to 2006, where it started out as a temporary provision in the Pension Protection Act of 2006. The provision expired at the end of 2007, but it was then reinstated retroactively for 2008. Over the next several years, the provision would be allowed to expire multiple times and was then reinstated, sometimes retroactively. This caused a great degree of uncertainty and rendered strategic planning around the provision quite difficult. The 2015 Tax Act (Protecting Americans from Tax Hikes or “PATH”) finally made the provision permanent.

Despite widespread use of the term “Charitable IRA Rollover,” in reality, there is no such thing. The official and technical name for the transaction is “Qualified Charitable Distribution” or “QCD” under IRC Sec 408(d)(8). The term “charitable IRA rollover” (or even worse, “IRA rollover”) is especially confusing for the financial services industry, because in contrast, a “Rollover IRA” is a very real and common thing. Under certain circumstances, individuals must close out particular types of qualified retirement plans and move the money elsewhere, but into similar types of financial vehicles.

The best example is when an employee leaves a company and needs to liquidate all of his or her funds held in the company-sponsored 401(k) plan. The common practice is to “roll over” the money into a traditional IRA – hence the term “Rollover IRA.” The money goes directly from one tax-exempt account to another, and the owner is not taxed on any of the money at that point. The money represents earned income that has never been taxed, but it will remain untaxed until it is taken out in later years as “qualified distributions”. This is truly a rollover – moving money between similar vehicles. The QCD, on the other hand, moves money between vehicles that are quite different, and therefore, the transaction should not be referred to as a rollover.

So now that we’re calling it by the right name, let’s review the basic characteristics of the QCD. You are probably already familiar with these: up to $100,000 can be transferred directly from a traditional IRA to a charitable organization each calendar year, and, provided that a number of conditions are met, the distribution from the IRA will not be subject to income tax. On the charitable side, the gift may and should be acknowledged by the charity as a generous gift, but it will not earn a charitable income tax deduction for the donor.

Those two details are the most notable aspects of the QCD. For the donor, avoiding income tax on a qualified distribution from an IRA is a big deal: at the top federal income tax bracket, the tax could be as much as $37,000 on a transfer of $100,000. But at the same time, the donor is foregoing a charitable income tax deduction for the full amount of the gift – $100,000 at the most – which means tax savings of up to the same $37,000. Perhaps in some cases the transaction is basically a wash for tax purposes, but there could other variables – much less obvious – that add to or detract from the appeal of using the special transaction. The best example of this would be the donor who is no longer itemizing deductions, due to the recent doubling of the standard deduction.

As mentioned above, there are a number of limitations and restrictions on the QCD, most importantly the following:

1. The donor – the IRA owner – must be at least 70 ½ years old at the time of the QCD transaction. The provision is designed to benefit those specific IRA owners who have a Required Minimum Distribution (RMD) each calendar year.  The full amount of the transfer will count toward the RMD, up to a maximum of $100,000.
2. The distribution transfer must go directly to the charitable organization. The donor cannot take a distribution and then re-direct it to the charity.  However, a check drawn on the IRA account payable to the charity but mailed to the donor for delivery to the charity is acceptable.  Similarly, a check payable to the charity written by the donor from an IRA checkbook issued to the donor by the IRA custodian is also acceptable. Transfer of the distribution requires coordination with the IRA administrator and there should be full documentation of the transfer as a QCD, including an acknowledgement from the charity.
3. The charitable organization must be a public charity – it must be a 501(c)(3) organization; it cannot be a private foundation, a supporting organization, or a donor advised fund.
4. The transfer must be a complete and outright gift to the charity.  It cannot be used to establish any kind of split-interest gift arrangement – any funding of charitable gift annuities, or contribution to a charitable remainder trust, or contribution to a pooled income fund is not allowed.
5. The transfer must be completed by December 31 in order to count as a QCD. If the IRA administrator does not make the distribution by that date, the transfer will not count for the calendar year. This could also mean that the donor is subject to a 50% penalty tax for any portion of the RMD that is not satisfied for that year.

The topic of QCDs, while having been popular for many years, has generated even more interest since the passage of the Tax Cuts and Jobs Act of 2017. With the doubling of the standard deduction, it is expected that far fewer taxpayers will be itemizing deductions beginning in 2018. In contrast, there may be larger numbers of donors who are interested in charitable contributions that provide benefits other than the charitable income tax deduction.

This is an extensive and ongoing conversation well beyond the scope of this article, but readers take heart: PG Calc’s very own Michael Valoris will be offering a webinar in March 2019 specifically on the subject of gifts from IRAs. Entitled The Do’s and (a few) Don’ts of Gifts from IRAs, it promises to be a fascinating and informative session. Register for this webinar now so you don't forget!