As usual, American taxpayers are approaching the year-end with lots of unknowns regarding the future income tax landscape. With all this uncertainty, let’s review some changes and highlight one opportunity to maximize tax savings and charitable intents.
Assume Ms. Smith, age 72, plans on making a $30,000 charitable donation. She is also required to withdraw her required minimum distribution from her 401k plan. What can she do now to optimize her tax savings?
As you may recall, under the Tax Cuts and Jobs Act of 2017 (TCJA), the standard tax deduction was increased. For the 2021 tax year the standard deduction for single taxpayers is $12,550 and for married filing joint taxpayers $25,100. For many taxpayers, normal charitable giving, coupled with other deductions such as mortgage interest or state and local income tax and property tax (capped at $10k) was less than the standard deduction. As a result, many taxpayers began taking the standard deduction and lost the tax benefits of their charitable gifts.
One-way taxpayers could harness tax benefits from their charitable gifts even under TCJA was through a Qualified Charitable Distribution (QCD). Taxpayers, age 70 ½ or older, can make a distribution from their IRA of up to $100,000 directly to qualified charities. In lieu of claiming a charitable itemized deduction for the donation, the QCD directly reduces the amount of the taxable IRA distribution. This was a great way to also satisfy an IRA owner’s required minimum distribution (RMD).
But what if you had a company 401(k) account instead of an IRA? Sorry, the QCD is only allowed from an IRA, and not a 401(k) account.
In 2020, under the CARES Act, RMD’s were waived, however they are required again in 2021. That revives the question: Is it possible to get a tax benefit from your charitable gifts and satisfy your 401(k) RMD, like you can with your IRA?
At first glance, it would seem no, but it is possible using the method described below. However, this is a proactive approach that would affect 2022 and on. You will still need to withdraw your 2021 RMD as usual and be subject to the related income tax. After that, rollover your funds from your 401k into a standalone IRA. This transaction is a nontaxable event. Then, your new IRA is eligible for Qualified Charitable Distribution, and this QCD would satisfy the RMD rules as well.
With some planning before year-end, Ms. Smith can position herself for 2022 to donate to her charity, fulfill her RMD requirement, and have the donation directly reduce her taxable IRA distribution. It’s a win-win-win situation.
If you have any questions, please contact us.