Hello. Thank you for the opportunity to ask a question. This year I directed my traditional IRA custodial institution to send a contribution as a qualified charitable distribution. Much of the money in the IRA is from taxed income. How is this QCD reflected on IRS form 8606 that tracks the proportion of IRA funds that are taxable? Thank you in advance.
Congratulations on using qualified charitable distributions (QCD). For IRA owners over 70 ½, that is usually the most tax efficient way to give to qualified charities. It is especially good for persons that are subject to required minimum distributions and use the standard deduction.
Normally, when one has nondeductible (after-tax) contributions to an IRA and later distributes funds from an IRA, a portion of the distribution is deemed to be a return of those after-tax contributions and is not taxed again. There is a calculation that reduces the amount of nondeductible contributions available for future years.
A simplified example is say you had a total of $100,000 in your IRAs and you had made $20,000 of nondeductible contributions over the years. You decide to pull $10,000. Because $20,000 of the $100,000 is after tax and 20%, $2,000 of your $10,000 withdrawal is deemed “basis” and is untaxed. You now have $18,000 of basis that will be similarly applied “pro rata” to future withdrawals.
This is all accounted for on Form 8606 and is done on a calendar year basis. If the $10,000 came out in four $2,500 transactions, you get the same result as one $10,000 distribution. Note that all your IRAs are aggregated for this calculation. Both the $20,000 and the $100,000 could be from any combination of IRA accounts.
Qualified charitable distributions (QCD) are treated differently. QCD are deemed to be entirely pretax dollars first. So, if the $10,000 is a QCD and your required minimum distribution is $10,000 or less, Form 8606 isn’t needed and the basis stays $20,000.
Now, if an amount other than QCD is taken as a distribution then the amount of QCD taken is excluded from the pro rata calculation via Line 7 of Form 8606. Say, $2,000 of the $10,000 that was distributed during the year was a QCD. The prorated basis is still 20%. Therefore $2,000 goes to charity via the QCD and $1,600 of the $8,000 (20%) is untaxed. The basis for future years becomes $18,400.
Up to $100,000 in QCDs can be made by a taxpayer in a given year. Depending on the amounts of after-tax funds, pretax funds and your giving goals, it may be possible to donate all of your pretax funds as QCD. When that occurs, and the IRA balances represent all after-tax funds, donations are usually made through other means because no distributions from the IRA would be taxable. This all after-tax status makes a great time to convert the IRA moneys to a Roth IRA, once any RMD is satisfied. No taxes would be due on such a conversion, RMD would cease, and earnings would be untaxable no later than five years out.
If you have a question for Dan, please email him with ‘MarketWatch Q&A’ on the subject line.
Dan Moisand is a financial planner at Moisand Fitzgerald Tamayo serving clients nationwide from offices in Orlando, Melbourne, and Tampa Florida. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some reader questions are edited to aid the presentation of the subject matter.