How does the SECURE Act coordinate traditional IRA contributions and qualified charitable distributions (QCDs)?

Question of the week: How does the SECURE Act coordinate traditional IRA contributions and qualified charitable distributions (QCDs)?

September 02, 2020

Q. Can a client who is 70½ make a deductible IRA contribution and also exclude a qualified charitable distribution (QCD)?

My client Amir turned 70½ in 2017 and has been taking his required minimum distributions (RMDs) each year (2017 through 2019) until now, as the 2020 RMD isn’t required under the CARES Act. Since he is still working, he decided to take advantage of the new retirement law that allows him to make an IRA contribution.

Although he’s also in a 401(k) plan at work, his modified AGI is under the traditional IRA deduction phaseout range for active participants in employer plans, so he’ll be able to deduct his 2020 contribution of $2,500 in full.

Looking forward to 2021, Amir is planning on making an IRA contribution again. He’ll also have to resume RMDs and is wondering what will happen if he takes a qualified charitable distribution instead. The RMD would be about $6,000.

Can Amir make a deductible IRA contribution and, at the same time, take a QCD to avoid paying tax on his RMD?

A. Under a SECURE Act rule, the QCD must be reduced by deductible contributions since age 70½ less prior years’ QCD reductions.

Amir can take a qualified charitable distribution in 2021, but if he also makes a deductible IRA contribution the amount of the QCD he’ll be able to exclude will be reduced.

The SECURE Act repeals the maximum age limitation for making traditional IRA contributions. The Act also provides a rule for coordinating IRA contributions and QCDs. Under §408(d)(8)(A), the amount of a QCD that is not includable in gross income is reduced (but not below $0) by:

  • All IRA deductions allowed for all years ending on or after the date the taxpayer turns 70½, less
  • All QCD reductions for all years preceding the current year.

In essence, the SECURE Act allows taxpayers who are 70½ and working to continue making deductible IRA contributions if they wish but they can’t further reduce AGI by fully offsetting required distributions with QCDs. Applying the new law to Amir’s situation, suppose he makes a $2,500 deductible IRA contribution in 2021 and also takes a $6,000 QCD. Here we’ll assume the QCD is equal to his RMD.

  • Reduction formula for 2021:
    • $5,000 cumulative IRA deductions ($2,500 in 2020 and 2021) less $0 cumulative prior year QCD reductions = $5,000 reduction
  • Portion of the QCD excludable for tax purposes in 2021:
    • $6,000 - $5,000 reduction = $1,000

Thus, Amir can exclude only $1,000 of the QCD from gross income in 2021. The remaining $5,000 is included in gross income and subject to tax.

 

Suppose Amir makes a $2,500 deductible IRA contribution in 2022 and takes another $6,000 QCD.

  • Reduction formula for 2022:
    • $7,500 cumulative IRA deductions ($2,500 each year 2020, 2021, and 2022) less $5,000 cumulative prior-year QCD reductions = $2,500
  • Portion of the QCD excludable for tax purposes in 2022:
    • $6,000 - $2,500 reduction = $3,500

Amir would be able to exclude $3,500 of the QCD and the remaining $2,500 would be included in gross income.

Of course, Amir’s 2022 IRA contribution, RMD, and QCD could all be different from the 2021 amounts. In any case, he’ll need to keep track of his deductible IRAs and both the portion of his QCDs he can exclude from gross income and the portion he must treat as a taxable distribution every year so that he can properly compute the current year’s reduction.

Note that the portion of the QCD that Amir must include in income can be claimed as a charitable contribution deduction on Schedule A if Amir itemizes deductions.

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