In December 2019, the Setting Every Community Up For Retirement Enhancement (SECURE) Act was passed into law, making many substantial updates to long-standing retirement account rules. While one rule repealed the maximum age for making Traditional IRA contributions (as now IRA owners beyond age 70 1/2, and in fact of any age, are allowed to contribute to their accounts, as long as they have compensation [generally earned income] to contribute), another such rule was created that, in essence, limits the amount of Qualified Charitable Distributions (QCDs) a Traditional IRA account holder can make, depending on the cumulative amount of those post 70 1/2 deductible contributions claimed.
Qualified Charitable Distributions (QCDs) are tax-efficient methods of making charitable donations with funds from a Traditional IRA (or inherited Traditional IRA). Essentially, an account holder (or beneficiary) age 70 1/2 or older can transfer up to $100,000 each year directly to charity. While the distribution from the account can count toward the account holder’s annual RMD, it is not included as Adjusted Gross Income (AGI), and thus does not need to (and cannot) be included as a charitable gift itemized deduction, making it a ‘perfect’ pre-tax donation.
With the passage of the SECURE Act, however, IRA account owners must now reduce their intended QCDs by any contribution amounts made into their IRAs after age 70 1/2 (the age cap in place to make IRA contributions before passage of the SECURE Act), to the extent they have not already been used to reduce their QCD. In other words, IRA contributions made after age 70 1/2 cannot be turned around to be used as QCDs… and the rules effectively require a “LIFO” treatment that ensures post-age-70 1/2 contributions will first and foremost be used to reduce future QCDs.
Going forward, there are four steps used to calculate allowable QCDs (to account for the potential impact of post-age-70 1/2 contributions):
- Determine current-year distributions made and intended to be counted as QCDs;
- Calculate total remaining distributions to be denied QCD status (this includes any deductible Traditional IRA contributions made by the account owner after reaching age 70 1/2 minus any QCD amounts disallowed in prior years);
- Determine current-year distributions that will be denied QCD status (by identifying the lesser of the amount determined in steps 1 and 2); and
- Determine current-year distributions which will be treated as a QCD (by taking the amount from step 1 and subtracting the amount from step 3).
Presumably, this QCD ‘anti-abuse’ provision is meant to prevent individuals from deducting Traditional IRA contributions (above-the-line deductions that reduce a taxpayer’s AGI) and then donating those contributions on a pre-tax basis (as a QCD), particularly in scenarios where they otherwise were not itemizing deductions and could not have otherwise made a pre-tax charitable contribution.
Despite this new provision, though, financial advisors can use numerous strategies to help clients benefit from QCDs. For example, Traditional IRA contributions can be voluntarily removed if done by October 15th of the year following the year in which the contribution was made. Thus, an account holder who makes a contribution, who then decides they would instead prefer to make a QCD, can withdraw the contribution within the allowable timeframe, preventing any reduction to their QCD. Alternatively, married spouses who each have their own IRA account can choose to use one account to receive post-70 1/2 deductible contributions and the other to make QCDs. A third option would be for account holders to simply ‘burn’ through their post-70 1/2 contributions by making charitable donations from their IRAs that ‘use up’ QCD-disqualifying contributions as quickly as possible. While this means that taxable income will be reported for those account distributions, charitable gifts may be reported as itemized deductions, with future QCDs to be unaffected by these contribution amounts.
Some additional strategies available to advisors and their clients work to avoid the anti-abuse rule altogether. These include using other tax-efficient means to make charitable contributions (such as donating highly appreciated stock in a taxable account, which avoids potential capital gains taxes from selling the stock outright and, for those who itemize, allowing the contribution to be itemized as a charitable donation), contributing to employer-sponsored retirement plans (e.g., 401(k)s, and even SEP IRAs and SIMPLE IRAs) or Roth IRAs instead of Traditional IRAs (since contributions to Traditional IRAs only result in QCDs being denied), and choosing not to claim the deduction on Traditional IRA contributions (even if otherwise available) and deliberately making non-deductible contributions instead (to at least preserve the non-taxable treatment of those contributions for the future).
Ultimately, the key point is that the SECURE Act’s repeal of the age limit cap on Traditional IRA contributions has complicated the coordination of post-70 ½ contributions and QCDs with its introduction of the anti-abuse provision, which reduces allowable future QCDs by the amount of post-70 ½ IRA contributions. However, financial advisors can help their clients continue to make QCDs successfully with a range of planning strategies, some of which work with the anti-abuse provision, and some that avoid it altogether.
On December 20, 2019, President Donald Trump signed the Setting Every Community Up for Retirement Enhancement (SECURE) Act into law. The bill, which had been stalled in the Senate since the summer of 2019, was finally able to get a vote when it was tacked onto a larger appropriations package (the Further Consolidated Appropriations Act of 2020, H.R. 1865) that needed to be passed to keep the Federal government funded, and up and running.
The SECURE Act has had the greatest direct impact on the rules for retirement accounts since the Pension Protection Act of 2006, both in terms of volume and significance. For the most successful retirement savers, the biggest impact of the SECURE Act will be the loss of the ‘stretch’ provision of their unused retirement account balances bequeathed to their beneficiaries. But other provisions of the SECURE Act also have important planning implications that should not be ignored.
One such provision is the SECURE Act’s repeal of the maximum age for making Traditional IRA contributions. On the surface, this would seem to be nothing but good news, making it feasible for those who are still working page age 70 ½ (and thus are still generating earned income), or who have a spouse who is still working, to contribute to a pre-tax traditional IRA.
But along with the SECURE Act’s repeal of the age limitation (for making Traditional IRA contributions) comes a new “anti-abuse rule” designed to limit the potential for individuals to (mis)use the new-found ability to make post-70 1/2 deductible Traditional IRA contributions alongside Qualified Charitable Distributions (QCDs, still allowed at age 70 1/2 even though the mandatory RMD age has been increased to 72). For instance, absent the new anti-abuse rule, a 70 1/2-or-older individual with earned income who claims the standard deduction could make a deductible traditional IRA contribution, followed immediately by a QCD of that amount, to essentially receive an above-the-line deduction for what effectively amounts to a charitable contribution (normally a below-the-line itemized deduction). Thus, this new anti-abuse provision is designed to prevent individuals from skirting the limitations associated with ‘regular’ charitable giving.
Unfortunately, though, the new QCD anti-abuse rule designed to combat relatively simple potential abuses is deceptively complex in practice. And worse yet for those who are charitably inclined, it has the potential to reduce, or even completely eliminate, any benefits provided by the SECURE Act’s newly authorized ability to make deductible Traditional IRA contributions at or beyond age 70 1/2 in the first place!
Qualified Charitable Distribution (QCD) Basics
For those who are charitably inclined, Qualified Charitable Distributions (QCDs) represent one of the most tax-efficient ways of giving to charity. Such distributions allow IRA owners and IRA beneficiaries (only, as such transactions may not be made from non-IRA-based employer-sponsored retirement plans) who are (actual-age) 70 1/2 or older to transfer up to $100,000 per year from their IRA/inherited IRA accounts directly to charity.
There is no need to itemize deductions on one’s tax return for the amounts transferred as QCDs, but that’s because the distributions get the even-better tax treatment of being excluded from income (despite being distributed from a pre-tax retirement account) in the first place! Accordingly, QCDs increase neither an individual’s Adjusted Gross Income (AGI), nor their final Taxable Income; instead, they simply make an IRA’s pre-tax value ‘disappear’ as a(n implicitly) pre-tax charitable contribution automatically.
By contrast, ‘regular’ charitable contributions that are made from a Traditional IRA (and not as a QCD) would increase AGI and would lower only taxable income (but not AGI) if/when an individual subsequently reports the charitable contribution as an itemized deductions.
Given the potential benefits of QCDs, it’s no surprise that they are a favorite way for many 70 1/2-and-older taxpayers to support their charitable inclinations. Especially since QCDs can also count towards an individual’s Required Minimum Distributions that were also due past age 70 1/2 (now past age 72) Though the age threshold for QCDs is still age 70 1/2 under the SECURE Act, even though the RMD age itself has been increased to 72 (which simply means that QCDs in those initial years won’t also count towards RMDs that don’t exist, but still otherwise get the favorable pre-tax treatment of the charitable contribution).
A new wrinkle introduced by the SECURE Act, however, may complicate matters for some IRA owners… while opening up planning opportunities for others.
SECURE Act Repeals Maximum Age For Making Traditional IRA Contributions
Section 107 of the SECURE Act repealed the age-limit restriction that applied to Traditional IRA contributions. Prior to the SECURE Act, taxpayers were prohibited from making Traditional IRA contributions (whether deductible or not) beginning in the year that they reached age 70 1/2. The SECURE Act eliminated this restriction for Traditional IRA contributions made for 2020 and future years.
(Nerd Note: The SECURE Act’s change is effective for contributions made for 2020 and future years; not for contributions made in 2020 and future years. Thus, individuals who were 70 1/2 or older in 2019 still may not make contributions for the 2019 tax year in 2020 before the April 15, 2020 tax-filing deadline, but they may make contributions for tax years 2020 and later.)
Thus, regardless of age, the only requirement a taxpayer must meet (now that the SECURE Act is in effect) to make a Traditional IRA contribution is that they must have “compensation” (which is generally “earned income”, such as W-2 wages or self-employment income) to contribute in the first place. This should come as particularly good news to the roughly 30% of individuals who continue to work past age 70, as such individuals can now contribute to their Traditional IRAs for as long as they continue to have compensation (effectively aligning Traditional IRAs with Roth IRAs and employer retirement plans that already permitted later contributions for those who otherwise had earned/employment income to contribute).
It should be noted that the nature of the deductibility (or not) of such Traditional IRA contributions is still dependent on the ‘regular’ rules. Therefore, while most 70 1/2-or-older contributions made to Traditional IRAs will be eligible for a deduction, that won’t be the case for all such contributions. Individuals with income above their applicable threshold and who are active participants in an employer-sponsored retirement plan, or those with income above their applicable threshold and who have a spouse who is an active participant in an employer-sponsored retirement plan, will continue to see their deduction for such contributions eliminated (or reduced) and will, therefore, only be able to make non-deductible Traditional IRA contributions instead.
SECURE Act’s New Anti-Abuse Rule Diminishes The Benefit Of Qualified Charitable Distributions (QCDs) By ‘Coordinating’ With Post-70 1/2 Deductible IRA Contributions
Gaining the ability to contribute to Traditional IRAs at 70 1/2 and beyond is definitely a win for many older workers. But this new benefit doesn’t come without a few strings attached, as for those individuals who wish to (currently or someday in the future) make QCDs, the benefit of the SECURE Act’s repeal of the age limit on Traditional IRAs contribution is greatly diminished for those post 70 1/2 contributions.
More specifically, Congress was apparently really concerned that some people would use their new-found ability to make post-70 1/2 deductible IRA contributions and then (GASP!), use some of those IRA dollars to (immediately or at some point thereafter) support charities via QCDs on a pre-tax basis (rather than just make a charitable contribution and claim what may or may have been an itemized deduction to achieve the same result). The horror! (Note the copious amounts of dripping sarcasm.)
In fact, Congress was so concerned about this sort of conduct that, as part of the repeal of the age at which Traditional IRA contributions can be made, they included an anti-abuse provision which rejects any QCD to the extent there have been any post-70 1/2 deductible IRA contributions (which have not, already, ‘rejected’ other QCD amounts in previous years).
Coordination With Qualified Charitable Distributions.—Add at the end of section 408(d)(8)(A) of such Code the following: “The amount of distributions not includible in gross income by reason of the preceding sentence for a taxable year (determined without regard to this sentence) shall be reduced (but not below zero) by an amount equal to the excess of—
(i) the aggregate amount of deductions allowed to the taxpayer under section 219 for all taxable years ending on or after the date the taxpayer attains age 70 ½, over
(ii) the aggregate amount of reductions under this sentence for all taxable years preceding the current taxable year.’’
Instead of being treated as QCDs, any amounts disallowed as a QCD via this anti-abuse provision will be treated as a taxable distribution and subsequent ‘regular’ charitable contribution (that can potentially then be itemized as a deduction separately). Which may still produce the equivalent result of a pre-tax contribution (with the income from the IRA distribution being offset by the deduction from the charitable contribution), though in practice some ‘slippage’ often occurs where the deduction doesn’t fully offset the impact of the income (e.g., due to the impact of higher AGI on other deductions, credits, Medicare IRMAA charges, etc., or the current limitations on itemizing deductions in the first place)… which, of course, is why QCDs have typically been more appealing in the first place (where permitted)!
Four-Step Process To Calculate Non-‘Rejected’ QCD Amount
The amount of a current year distribution that would otherwise qualify as a QCD, but is ‘rejected’ due to the new QCD anti-abuse rule, can be determined using a Four-Step Process, as follows:
- Step #1: Determine total current-year distributions made, which follow QCD rules;
- Step #2: Calculate total remaining distributions to be denied QCD status (by subtracting total lifetime ‘rejected’ QCD amounts from total lifetime post-70 1/2 deductible Traditional IRA contributions);
- Step #3: Determine current-year distributions made following QCD rules which will be denied QCD status (which will be the lesser of the result in Step #1 or Step #2);
- Step #4: Determine current-year distributions made, which will be treated as a QCD (by subtracting the result in Step #3 to the result in Step #1).
The following example shows how post-70 1/2 IRA contributions are used to deny QCD status.
Example #1a: Ruby is a single IRA owner who is still working, and who will be 70 1/2 on January 15, 2020. Thanks to the SECURE Act’s changes to the RMD rules, she does not need to begin taking any RMDs from her IRA until 2021, when she will turn 72, but she does have the option of continuing to make IRA contributions under the new rules.
Thus, in both 2020 and 2021, Ruby makes a $7,000 (including catch-up contributions) deductible contribution to her Traditional IRA, giving her a total of $14,000 of deductible Traditional IRA contributions from the year she reached age 70 1/2 and onwards.
In 2021 Ruby calculates the RMD for her IRA to be $12,000. Ruby, who is charitably inclined, follows all of the ‘regular’ QCD rules and has $12,000 sent directly from her IRA to her favorite charity, thereby satisfying her RMD requirement for the year.
Despite following all of the ‘normal’ QCD rules, however, the $12,000 will not be treated as a QCD.
Rather, using the Four-Step Process as outlined in the graphic above, since the $12,000 amount intended to be treated as a QCD is actually less than Ruby’s $14,000 of post-70 1/2 deductible IRA contributions (and none of that amount has reduced a previous amount that would have otherwise been a QCD), the anti-abuse rules require that the entire $12,000 be treated as a ‘regular’ taxable IRA distribution, followed by a ‘regular’ deductible charitable contribution.
At the end of 2021, Ruby has $14,000 - $12,000 = $2,000 of remaining post-70 1/2 deductible Traditional IRA contributions that have not already been used to ‘reject’ what would have been a QCD.
Notably, while contributions made after age 70 1/2 can prevent charitable distributions from being treated as QCDs, they can only do so once; charitable distributions that exceed the amount of past contributions that have disqualified QCDs in the past can still be counted as QCDs. Or viewed another way, once prior post-age-70 1/2 contributions have been used to offset QCDs, those amounts are ‘used up’ and no longer apply to the QCD calculation in future years.
Example #1b: Fast-forward another year, to 2022, and Ruby, from our example above, is now turning 73 and must take her second RMD, which has been calculated at $13,000. Ruby is now retired, and as such does not (cannot) make a deductible Traditional IRA contribution for 2022 (not because of her age, but simply because she has no earned income to contribute once she is actually “retired”).
She continues, however, to be an active supporter of her favorite charity. As such, Ruby, once again, follows the regular QCD rules and has her $13,000 RMD amount sent directly from her IRA to the charity, satisfying her 2022 RMD requirement.
As was the case in the previous year (as shown in Example #1a, above), Ruby will not be able to treat the full amount of her distribution as a QCD. However, unlike the previous year, some (and, in fact, most) of her distribution will receive that favorable treatment.
More specifically, as illustrated in the graphic above showing the Four-Step Process, only $2,000 (the excess of Ruby’s post-70 1/2 deductible Traditional IRA contribution amount that has not already offset an earlier QCD) of the $13,000 gross IRA distribution will be denied QCD status.
Instead, it will be treated as a ‘regular’ taxable IRA distribution, followed by a ‘regular’ deductible charitable contribution. However, the remaining $13,000 - $2,000 = $11,000 will be excluded from income and still be treated as a QCD!
The QCD Anti-Abuse Rule Functions Like A Last-In, First Out (LIFO) Rule
As evidenced by the examples above, Congress worded the QCD anti-abuse provision of the SECURE Act essentially to function in a Last-In, First Out (LIFO) manner, whereby all of an individual’s post-70 1/2 deductible Traditional IRA contributions (which, by their very nature, are the ‘last’ contributions, since pre-70 1/2 deductible contributions to Traditional IRAs would obviously be made before one reaches 70 1/2!) must come out first, rejecting any would-be QCDs (turning such amounts into ‘regular’ IRA distributions, followed by ‘regular’ charitable contributions) before any actual QCDs can be made.
Given this restriction, it’s reasonable to wonder just how fair (or not) the anti-abuse rule is, particularly for those with existing IRA balances at the time they turn 70 1/2. Such individuals, who would like to both make QCDs with RMD dollars, as well as take advantage of the new ability to continue to contribute to a deductible Traditional IRA after 70 1/2, may find themselves essentially forced to pick one or the other.
Example #2: In 2021 Vance turns 72 and will have to begin taking RMDs from his retirement accounts. Vance has substantial assets in an old 401(k), which are more than enough to fund all of Vance’s spending needs. He also has an IRA that had a 2020 year-end balance of $179,200.
While Vance plans to keep his 401(k) dollars for personal use, he has long planned to give his IRA RMDs to charity via QCDs. As such, Vance’s intention is to give his $179,200 account balance ÷ 25.6 life expectancy factor = $7,000 IRA RMD for 2021 to charity.
Suppose, however, that Vance becomes bored with retirement and decides to take a part-time job that will earn him $20,000 in 2021. Vance doesn’t need the money though, so he’d like to take advantage of the SECURE Act’s change that allows him to make a deductible Traditional IRA contribution.
Unfortunately, Vance cannot accomplish both of his goals (to make both a QCD of his RMD and a deductible Traditional IRA contribution). Instead, he must decide to either make a deductible Traditional IRA contribution or to make a QCD with his $7,000 RMD.
Because despite the fact that Vance has a $7,000 IRA RMD at the start of 2021 and nearly $180,000 of existing IRA dollars before he makes any post-age-70 1/2 deductible Traditional IRA contributions, as soon as he makes such a contribution, such amounts will ‘reject’ an equivalent amount of distributions that would have otherwise qualified as a QCD!
Suppose, for instance, that Vance does not make a deductible Traditional IRA contribution for 2021. The result is that his 2021 RMD of $7,000 can be directed towards charity and treated as a QCD.
But the moment Vance decides to make a deductible Traditional IRA contribution of $7,000 for 2021, the nature of that distribution changes, as the first $7,000 of Vance’s distributions that would otherwise qualify to receive QCD treatment is ‘rejected’, and no longer able to be treated as such.
This is especially important for Vance if he does not benefit from itemizing his charitable donation due to the standard deduction amount exceeding what he would be able to claim as itemized deductions in the first place. In other words, the $7,000 charitable donation he would make from his RMD would benefit him neither as a tax-free QCD (because the deductible contribution he made to his IRA disallows this) nor as an itemized deduction (because the standard deduction is too high for him to benefit from itemizing). And even if Vance does itemize deductions, the rejection of the QCD would still result in higher AGI (followed later by an itemized deduction for a charitable contribution), which could impact Vance’s other deductions, credits, Medicare Part B/D premiums, etc.
The fact that Vance had (plenty of) ‘other’ money in his Traditional IRA is irrelevant, as such funds are essentially ‘ignored’ until the total amount of post-70 1/2 deductible Traditional IRA contributions has been distributed as a would-be QCD.
It seems somewhat unfair that Congress would choose to ignore all the ‘other’ dollars (i.e., contributions made before age 70 1/2) in an individual’s Traditional IRA until all post-70 1/2 deductible Traditional IRA contributions have been ‘used’ to ‘reject’ a QCD – especially when Congress has applied pro-rata formulas to Traditional IRA distributions in other circumstances (such as determining how much of a distribution is from non-deductible IRA contributions) – but, as they say… “It is, what it is.”
Why Did The SECURE Act Need To Include A QCD Anti-Abuse Rule?
Given the (arguably unfair) outcome described above, is it fair to wonder if the anti-abuse rule was really necessary in the first place? The answer, debatably, is “probably”.
Let’s start with the premise that when it comes to the Internal Revenue Code, it’s fair for Congress to assume that where a so-called loophole or other gap in the tax law exists, taxpayers will attempt to drive a proverbial Mack Truck’ through that gap to exploit it to the extent legally permissible. Frankly, finding and using and maximizing those gaps is the principal job of many tax professionals and a significant component of the role that many Financial Advisors play for their clients!
With this in mind, one can begin to understand why Congress crafted its potentially-charitable-giving-disincentivizing QCD anti-abuse rule into the SECURE Act. Because without it, an individual could use the new ability to make a deductible Traditional IRA contribution, coupled with the continued ability to make QCDs, and skirt the limitations of ‘regular’ charitable contributions by essentially using a deductible Traditional IRA contribution to really make a charitable contribution. Interestingly, however, Congress seems to only take issue with post-70 1/2 deductible Traditional IRA contributions, as such a contribution made in an individual’s age-69-year (or anytime prior to the 70 1/2 year) could be used to make a QCD without fear of ‘running into’ the QCD anti-abuse rule in future years.
More specifically, as noted earlier, ‘regular’ charitable contributions only provide a benefit (at least for Federal income tax purposes) if an individual has enough total itemized deductions to exceed their Standard Deduction ($24,800 for Joint Filers, and $12,400 for Single Filers in 2020, plus an “Additional Standard Deduction” amount of $1,300 per person for individuals 65 and older).
Furthermore, even when itemized deductions exceed the Standard Deduction (and thus, results in a potential tax benefit for amounts contributed), charitable contributions are “Below-The-Line” deductions which have no impact on Adjusted Gross Income (AGI), to which most income-related benefits (e.g., credits phased out at various income levels) and/or additional costs (e.g., Medicare Part B/D Income-Related Monthly Adjustment Amounts, or IRMAAs) are tied.
By contrast, the deduction for an IRA Contribution is an “Above-The-Line” deduction. It is, therefore, available whether or not the taxpayer itemizes deductions on their return and has the power to reduce not only taxable income but AGI as well (thus potentially decreasing AGI-based costs).
As such, absent the anti-abuse rule, individuals could use a Traditional IRA deductible contribution-QCD ‘combo’ to artificially depress AGI, or even to potentially receive a reduction in taxes for a gift to charity when one would not have otherwise been available.
Example #3: In a HYPOTHETICAL alternate reality, the BIZARRO-SECURE Act, a bill identical to our SECURE Act in almost every way, is passed into law. The sole difference between our SECURE Act and the BIZARRO-SECURE Act is that the latter contains no QCD anti-abuse provision.
In that HYPOTHETICAL alternate reality lives Johnny, a single IRA owner who is still working, and who will be 74 on June 12, 2020. Johnny does not typically contribute to his Traditional IRA but makes roughly $2,000 of charitable contributions annually.
Prior to making any charitable contributions for 2020, Johnny has $6,000 of itemized deductions, and as such, even after making $2,000 of charitable contributions, he would use the Standard Deduction and not actually receive any benefits from his itemized charitable deduction.
However, if Johnny uses the Traditional IRA-deductible-contribution-QCD combo (available only in Johnny’s HYPOTHETICAL alternate reality), Johnny could make a deductible IRA contribution to his Traditional IRA of $2,000, which would serve as an above-the-line AGI reduction, and then immediately turn around and distribute $2,000 from his Traditional IRA as a non-income-generating QCD (i.e., the IRA distribution is excluded from taxable income!).
This would, in essence, give him an Above-The-Line deduction for a charitable contribution in a scenario where he could not have otherwise claimed a (below-the-line) charitable deduction. Plus, as an added benefit, the $2,000 would count towards satisfying some (or all) of Johnny’s RMD requirement for the year!
In the real world, the QCD anti-abuse provision included in the SECURE Act prevents this sort of thing from happening.
Of course, the counterpoint to the argument in favor of the anti-abuse rule is that the only way an individual can run into the rule is by giving money to charity via their IRA. And if everyone could always fully claim their charitable contributions for full value as a below-the-line deduction, QCDs wouldn’t produce any net benefit anyway. Which means encouraging such behavior – where a QCD is used in lieu of not-as-favorable-itemized-charitable-deduction – is precisely why the QCD was created in the first place!
So, is the possibility that someone might get a relatively small tax benefit (an Above-The-Line deduction of up to a maximum of $7,000) when one otherwise may not have been available, for what ultimately amounts to a charitable contribution, really worth introducing a complicated and burdensome anti-abuse rule that could potentially discourage amounts from being given to charity?
Congress apparently thought so…
Planning With The QCD Anti-Abuse Rule
Regardless of which side of the “Was an anti-abuse rule really necessary?” fence you happen to fall on, it won’t change the fact that such a rule will now be enshrined as Section 408(d)(8)(A)(i) and 408(d)(8)(A)(ii) of the Internal Revenue Code. As such, advisors must begin to formulate strategies to best deal with this new roadblock.
Potential options to consider should include both those designed to help individuals who may have already made transactions that will subject them to the QCD anti-abuse rule, as well as strategies designed to help those who may want to contribute to retirement accounts later in life and make QCDs to work around the QCD anti-abuse rule so that they can “have their cake and eat it, too”.
Advisors should also be certain to understand how to identify who will really be adversely impacted by the anti-abuse rule in the first place, and who won’t (as some taxpayers will already be able to itemize their charitable contributions as deductions anyway, so their net impact will be limited).
Remove 2020 (Or Future) Unwanted Traditional IRA Contributions As ‘Excess Contributions’
While the SECURE Act has not received the same amount of attention as other recent tax legislation, such as the Tax Cuts and Jobs Act, it has still received a fair amount of coverage, particularly in the financial media. Through such media coverage or otherwise, it’s possible that certain individuals may have become aware of the ability to make post-70 1/2 Traditional IRA contributions without fully understanding the potential impact that such contributions would have on future distributions intended as QCDs.
In such instances, if an individual wishes to make QCDs with existing IRA money, one option would be to remove traditional IRA contributions, to the extent possible, by using the excess contribution rules. Notably, while the excess contribution rules are generally used to remove contributions that cannot be in an IRA (or another retirement account), they may also be used to voluntarily remove legally permissible contributions that the account owner no longer wants in the account… for instance, because of the QCD anti-abuse rules and a plan to make future QCDs!
The deadline to voluntarily remove an unwanted excess contribution is October 15th of the year following the year for which the contribution was made. Thus, for instance, if an individual makes a post-70 1/2 deductible Traditional IRA contribution on March 5, 2020, and later determines that such a contribution is not in their best interest because of its impact on a potential (future) QCD, the contribution (along with any earnings/losses) can be voluntarily removed up until October 15, 2021.
‘Burn’ Through Traditional IRA Deductions Taken In Prior Years Via (Not-Actually-)QCDs
The ability to make post-70 1/2 contributions to Traditional IRAs was only first allowed beginning for the 2020 tax year. Thus, until October 15, 2021, any ‘unwanted’ Traditional IRA contributions impacting (future) QCDs can be ‘fixed’ by removing them from the account using the “excess contribution” strategy discussed above.
However, beginning October 16, 2021, any IRA contributions made for 2020 (the first year that potentially-QCD-interfering-post-70 1/2-deductible-Traditional-IRA contributions could be made) will no longer be able to be voluntarily removed. What then, is the next best thing?
For many charitably inclined individuals, the answer, oddly enough, may be to ‘take their medicine’ in the form of making rejected QCDs. By doing so, such individuals would be able to ‘burn’ through their QCD-rejecting post-age-70 1/2 deductible Traditional IRA contributions, in order to eventually get back down to the IRA money that can be used to make QCDs (i.e., everything other than amounts attributable to post-age-70 1/2 deductible Traditional IRA contributions).
(Nerd Note: Even though initial QCD-esque distributions will be ‘rejected’ and won’t actually be treated as QCDs until an individual has ‘burned’ through all via previous post-70 1/2 deductible IRA contributions, a plain reading of the anti-abuse statute, created by the SECURE Act, would seem to indicate that the only way to ‘burn’ through such amounts [post-70 1/2 deductible IRA contributions] and get back to the ‘untainted’ IRA money is to make such ‘rejected’ QCDs in the first place!)
Recall that Section 107(b) of the SECURE Act states, in part:
“Add at the end of section 408(d)(8)(A) of such Code the following: ‘The amount of distributions not includible in gross income by reason of the preceding sentence for a taxable year (determined without regard to this sentence) shall be reduced…’” (Emphasis Added)
When restated in plain language, it appears that the above provision says “If something was going to be treated as a QCD, don’t treat it as such…” until the amount of cumulative ‘rejected’ QCDs equal the cumulative amount of post-70 1/2 deductible Traditional IRA contributions. It’s that first part, though, that would seem to be the most important…
“If something was going to be treated as a QCD…”
It would stand to reason, then, that if something was not going to be treated as a QCD in the first place, this particular provision would not come into play. Thus, an individual would never ‘burn’ through any amounts attributable to deductible Traditional IRA contributions. And therefore, the ability to make a QCD would continue to be impacted in the future.
Or viewed another way, the fundamental challenge of the QCD anti-abuse rule is that it causes the QCD to be deemed an IRA distribution followed by a separate charitable contribution. Which, of course, an IRA owner can simply do anyway – take a distribution (e.g., their RMD), and subsequently contribute it. However, for those who have RMD obligations and make charitable contributions, it can still be valuable to knowingly do the “disallowed” QCD, for substantively the same tax outcome, because at least doing so does burn through the disallowed QCD amounts and gets closer to permissible QCDs in future years!
Example 4: In November 2022 Charlie, who retired in 2021 and is 75 years old, is planning to take his RMD for the year. Previously, in 2020 and 2021, Charlie made deductible contributions of $7,000 each year to his Traditional IRA (which cannot be voluntarily removed as excess contributions, since the deadline for him to do so has passed). Thus, he has a total of $14,000 of post-70 1/2 deductible Traditional IRA contributions.
After calculating his RMD for 2022, Charlie determines that he must take a distribution of at least $10,000. Furthermore, Charlie has always been charitably inclined and has decided to use his annual IRA RMD to satisfy his charitable intent.
Suppose, now, that Charlie is made aware of the QCD anti-abuse rules, and learns that even if he follows all the QCD rules, his distribution of $10,000 will not be eligible to be treated as a QCD (because it is less than the $14,000 of post-70 1/2 deductible Traditional IRA contributions that have not previously ‘rejected’ a QCD). Given this limitation, Charlie might be tempted to take his RMD like ‘normal’, and then write a check of $10,000 to his favorite charity.
Doing so, frankly, would result in the exact same tax treatment for that year as if he had followed the QCD rules, but had been denied that treatment by virtue of the SECURE Act’s QCD anti-abuse rule. In each case, the $10,000 distribution would have been added to Charlie’s gross income, and Charlie would have been eligible to claim a $10,000 charitable contribution as an itemized deduction.
But by not following the QCD rules in 2022 (even knowing the QCD treatment would not be received that year), Charlie limits his planning opportunities in future years. More specifically, since Charlie has yet to make a ‘rejected’ QCD, he has yet to ‘burn’ through any of the post-70 1/2 deductible Traditional IRA contribution amounts he must exhaust before being able to make an actual QCD!
To see how this limits Charlie’s tax planning opportunities, suppose that in the following year, 2023, he once again has a $10,000 RMD amount. And he once again decides to give it to charity. This time, however, Charlie follows the QCD rules.
Unfortunately, this distribution, too, will fail to receive favorable QCD treatment. Because despite the fact that Charlie already used $10,000 of IRA distributions to fund charitable contributions in the previous year, since that distribution was not made following the QCD rules, Charlie has yet to ‘burn’ through any of his total of $14,000 of post-70 1/2 deductible Traditional IRA contributions!
Thus, while Charlie’s 2023 RMD would reduce that $14,000 amount down to $4,000 (due to the $10,000 ‘rejected’ QCD for that year), it would still be treated as a distribution includable in gross income, followed by a $10,000 charitable contribution includable in itemized deductions.
By contrast, if Charlie had followed the QCD rules with respect to both the 2022 and 2023 distributions, the 2022 distribution of $10,000 would have reduced the $14,000 total of post-70 1/2 deductible Traditional IRA contributions (that had not yet nullified a QCD) down to $4,000.
And the subsequent $10,000 distribution in 2023 would have wiped away the remaining $4,000 (treated as a distribution includable in gross income, followed by a $4,000 charitable contribution includable in itemized deductions), and still have been eligible to be treated as a $10,000 - $4,000 = $6,000 QCD!
Couples Can Divide And Conquer; Use One Spouse’s Traditional IRA For Deductions, And The Other Spouse’s Traditional IRA For QCDs
Let’s review the language of the QCD anti-abuse provision again, shall we? This time, though, we’ll shift the emphasis, quite literally.
Recall (for the last time… really… I promise!) that QCDs are only reduced by “the aggregate amount of deductions allowed to the taxpayer under section 219”. [emphasis added]
Note that the language of the QCD anti-abuse rule references “the taxpayer”. That’s critical because while couples may plan for their retirement together, IRAs (and other retirement accounts) can only be owned by a single individual (which is, after all, what the “I” in “IRA” stands for in the first place!). And only that single individual – “the taxpayer” – can receive a deduction for a contribution made to their Traditional IRA account, even if that deduction is reported on a joint income tax return.
Some couples who would like to make QCDs and post-70 1/2 deductible contributions to a Traditional IRA may choose to keep things simple by using a divide and conquer approach, where one spouse would make post-70 1/2 deductible contributions to their Traditional IRA, and the other spouse would make all of the couple’s QCDs from their Traditional IRA (with perhaps Roth IRA or non-deductible Traditional IRA contributions being made to their account(s) as well). The end result is that the spouse making the QCDs would not be impacted by the SECURE Act’s anti-abuse rule, because it’s the other spouse who made the disallowing post-70 1/2 deductible IRA contributions.
It may not be perfect, but it’s simple. And it’s still one more deductible Traditional IRA contribution that can be made each year than would have been allowed before the SECURE Act!
Avoiding The Anti-Abuse Rule Using Alternative Planning Strategies
It doesn’t take long to realize that, for many, dealing with the QCD anti-abuse rule is going to be a real… well, you know.
As such, it behooves advisors to prioritize speaking to clients who are still working and 70 1/2 or older (and are, therefore, eligible to make post-70 1/2 deductible Traditional IRA contributions), and who may wish to make QCDs now, or at some point in the future, to see if a better option than a potentially-problematic-future-deductible-Traditional-IRA contribution is available.
What follows are potential strategies to avoid the anti-abuse rule for advisors to consider.
Support Charitable Desires Via Other Tax-Efficient, Non-QCD Means
Perhaps the easiest way to avoid the QCD anti-abuse rule is to avoid making QCDs altogether. Instead, other tax-efficient methods of giving to charity can be considered, such as donating highly appreciated stock and avoiding the capital gains tax that would otherwise be due if the stock were sold instead.
For those who already itemize deductions on their income tax return prior to making any charitable contributions (or are, at least, close to being able to do so), this may be a viable alternative to consider.
Unfortunately, though, when the Tax Cuts and Jobs Act (TCJA) roughly doubled the Standard Deduction, it made it much more unlikely that a taxpayer would Itemize Deductions on their return, and thus, much more difficult to qualify to receive a tax break for charitable contributions.
Consider, for instance, two married spouses who are both 72 years old. In 2020, they have $10,000 of itemized deductions before making any charitable contributions for the year. For such a couple, their Standard Deduction would be $24,800 + $1,300 (for first spouse over age 65) + $1,300 (for the second spouse over age 65) = $27,400. Thus, it would take more than $17,400 of charitable contributions before the couple would see any tax benefit in the form of a higher deduction (as Itemized Deductions would finally exceed their Standard Deduction)!
Few couples in similar situations are likely to be that charitably inclined, regardless of whether the source of the contribution is cash or appreciated stock. And as such, the QCD remains exceedingly valuable in the post-Tax Cuts and Jobs Act world. But for those who do have enough deductions to get over the Standard Deduction line – or can clump enough deductions together, oftentimes using donations of appreciated securities (e.g., to a donor-advised fund) – doing so can be an effective workaround to an otherwise-diminished-or-lost QCD. Especially since, with highly appreciated securities, the tax benefits of donating investments with significant capital gains can actually be worth more than the QCD for some taxpayers anyway (thanks to both the charitable deduction and the foregone capital gains).
Make Deductible Contributions To Employer-Sponsored Retirement Plans Instead Of Traditional IRAs
As discussed earlier, the QCD anti-abuse rule requires that QCD amounts be reduced by “the aggregate amount of deductions allowed to the taxpayer under section 219”. And notably, IRC Section 219 is the Section of the Internal Revenue Code that provides for the deduction for contributions made to Traditional IRAs. And only Traditional IRAs.
So, one logical option for individuals who are 70 1/2 or older and want to lower their taxable income via contributions to a retirement account is to make those contributions to a retirement account that is not a Traditional IRA!
Those individuals who are 70 1/2 or older and work for a company over which they exercise no control will be at the mercy of the company when it comes to whether income-lowering employer retirement plan contributions can be made. If there isn’t a 401(k) or similar option provided by the company, there’s simply not much, if anything, they’ll be able to do about it.
If, however, the employer does offer such a plan, then workers who are 70 1/2 or older can feel free to contribute to the plan, and do so without fear of running afoul of the IRA QCD anti-abuse rules (now or in the future).
Of course, many 70 1/2 and older individuals who are still working are business owners who have complete control over whether their business (which is often a sole proprietorship) offers a retirement plan, and if so, what type of plan is offered. If such individuals have thoughts of making QCDs at some point in the future or would like to retain the flexibility to do so, then any deductible contributions should be channeled first through an employer-sponsored retirement plan.
In general, small business employer retirement plan options include not only 401(k)s and other qualified plans, but also SEP IRAs and SIMPLE IRAs. Notably, though, SEP IRAs and SIMPLE IRAs are IRA-based plans, and as such, follow many of the IRA rules, such as the fact that there is no still-working exception for working beyond (now) 72. However, they do not receive deductions under IRC Section 219 (the deductions come from various other locations in the Internal Revenue Code). Thus, contributions to such plans will not subject an individual to the IRA QCD anti-abuse rules, and thus in effect are treated more like non-IRA employer retirement plans than IRAs for the purpose of these rules.
Make Roth IRA Contributions Instead Of Traditional IRA Contributions
What if no employer retirement plan option is available? Or what if contributions to those plans have already been maxed out? In such cases, it’s necessary to turn to IRAs.
Thankfully, the new anti-abuse rules don’t apply to just any old IRA contributions. Rather, as noted several times throughout this article, QCDs are only be reduced by “the aggregate amount of deductions allowed to the taxpayer under section 219”. (emphasis added)
As a result, one easy way to avoid having to deal with the QCD anti-abuse rule is to avoid taking a deduction for an IRA contribution. To that end, while contributing to a traditional IRA and just not claiming the deduction is an option, contributions to Roth IRAs are never eligible for a deduction and therefore will never result in an individual running afoul of the QCD anti-abuse rules in future years either. And the obviously added benefit for the Roth IRA is that the future growth can be tax-free as well.
Roth IRAs, however, continue to have income limits that can prevent (or reduce) an individual from being able to make such contributions. As such, high-income individuals who are 70 1/2 or older will need to explore other alternatives.
Skip The Deduction For The Traditional IRA Contribution When Not Itemizing (Charitable Contribution) Deductions
While contributions to Roth IRAs may only be made by those with compensation (generally earned income) but whose total (modified Adjusted Gross) income is below an applicable threshold, anyone with compensation can make a contribution to a Traditional IRA. The (AGI) income limits for traditional IRAs merely determine whether the contribution is deductible or not.
Generally, a deduction is available for any contribution made to a Traditional IRA (though as noted earlier, that deduction is phased out for individuals with high income that exceeds an applicable threshold who actively participate, and/or who have a spouse who actively participates, in an employer-sponsored retirement plan).
But while such a traditional IRA contribution deduction may be available, there is no rule that requires an individual to claim it. Instead, an individual can opt not to claim a deduction for such a contribution, and classify the amount as a non-deductible IRA contribution (reportable on IRS Form 8606, Nondeductible IRAs).
In general, when available, claiming a deduction for a Traditional IRA contribution is the ‘right move’. However, given the introduction of the QCD anti-abuse rule, individuals who are 70 1/2 or older have some incentive to buck conventional wisdom, and consider not taking the deduction… voluntarily!
This potential strategy is enhanced, somewhat, by the fact that QCDs are only made with pre-tax dollars (they are an exception to the standard pro-rata rule for IRA distributions). This rule, coupled with a voluntary forgoing of a deduction for a Traditional IRA contribution, may be particularly attractive for individuals who claim the Standard Deduction (and would continue to do so even after increasing charitable contribution itemized deductions due to would-be-‘QCDs’ rejected by the anti-abuse rule) but are phased out of being able to make Roth IRA contributions.
Example #5a: Mason is a 73-year-old single taxpayer. He has $150,000 of AGI from employment, Social Security benefits, and other sources, prior to making any Traditional IRA contributions, and prior to taking his RMD of $10,000 for the year from his Traditional IRA consisting entirely of pre-tax dollars. Due to his income, Mason is prohibited from making a Roth IRA contribution.
Suppose, now, that Mason decides to make a $7,000 deductible IRA contribution for 2020. In addition, Mason decides to use his $10,000 RMD to support his favorite charity. As such, he has his $10,000 RMD transferred directly to charity and follows all of the QCD rules.
Although Mason’s AGI will be reduced by $7,000 due to his deductible Traditional IRA contribution, the QCD anti-abuse rule will negate an equal amount of his RMD distribution from QCD treatment, thus causing it to be included in his AGI. As a result, Mason’s ending AGI is $150,000 beginning AGI – $7,000 contribution deduction + $7,000 denied QCD = $150,000, the same as it was before making the contribution and attempted QCD.
If we assume that, even with the $7,000 denied-QCD amount counting as a charitable contribution that Mason claims the Standard Deduction, the result is taxable income for the year of $150,000 AGI – $13,700 Standard Deduction for Single over 65 = $136,300 (and the pre-tax value of the QCD is lost). And, since all of Mason’s Traditional IRA money was pre-tax before, and he claimed a deduction for it this year, all of Mason’s remaining balance is still entirely pre-tax.
But what would have happened if Mason had simply chosen to voluntarily forgo taking the deduction for the IRA contribution he made?
Example #5b: Sylvia is Mason’s twin sister and is, therefore, also 73 years old. She too, is single and has an identical $150,000 of AGI from work, Social Security benefits, and other sources, prior to making any Traditional IRA contributions, and prior to taking her RMD of $10,000 for the year from her Traditional IRA consisting entirely of pre-tax dollars. Due to her income, Sylvia is prohibited from making a Roth IRA contribution.
Suppose, now, that Sylvia decides to make a $7,000 Traditional IRA contribution for 2020. Unlike her brother though, Sylvia voluntarily decides to forgo taking a deduction.
This, however, is the only difference between them, as Sylvia also decides to use her $10,000 RMD to support her favorite charitable organization. As such, she has her $10,000 RMD transferred directly to charity and follows all of the QCD rules.
Sylvia’s AGI is not reduced by any amount for her $7,000 non-deductible IRA contribution. But because Sylvia did not take a deduction for that contribution, she is not subject to the SECURE Act’s QCD anti-abuse rule. Thus, her entire $10,000 RMD is treated as a QCD and does not increase her income. Sylvia’s AGI is, therefore, $150,000 (the same as Mason’s).
Continuing on, like her brother, Sylvia claims the Standard Deduction. As such, her taxable income for the year of $150,000 AGI - $13,700 Standard Deduction for Single over 65 = $136,300… once again, the same as Mason. BUT…
Remember, Sylvia did not take a deduction for her Traditional IRA contribution! Therefore, Sylvia unlike her brother, now has $7,000 of after-tax (non-deductible) money in her Traditional IRA that will (over time) be distributed back to her tax-free!!!
It seems utterly ridiculous that one might benefit in such a manner by rejecting an otherwise allowable deduction. But as the split examples above show, it is precisely what can happen!
If such contributions are made continuously, over a number of years, and perhaps even by both spouses of a married couple, the cumulative tax savings by forgoing the otherwise allowable deductions could reach well into the tens of thousands!
The SECURE Act’s repeal of the maximum age for making Traditional IRA contributions should be welcome news for the roughly 30% of workers who, today, continue to work beyond age 70. Many of those individuals, though, could also benefit from using a Qualified Charitable Distribution (QCD) to help satisfy their charitable desires.
Unfortunately, a new QCD anti-abuse provision contained in the SECURE Act makes taking advantage of both of these opportunities difficult in some situations, and impossible in others. As the anti-abuse rule requires that an amount equal to any post-70 1/2 deductible contributions made to Traditional IRAs be used to offset amounts that would otherwise qualify as QCDs when made.
Thankfully, though, there are potential planning strategies that can help individuals mitigate the impact of this anti-abuse rule. Such strategies range from getting rid of now-unwanted deductible Traditional IRA contributions via voluntary removals as excess contributions to coordinating planning between spouses, and to simply forgoing allowable deductions in the first place (an approach that in just about any other situation would normally amount to a tax planning ‘sin’!).