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Interesting Use of the QCD Strategy

Qualified Charitable Distributions (QCDs) are now a permanent part of the tax code. They allow individuals who are at least 70 ½ years old at the time of the transfer to directly transfer IRA funds to a qualifying charity. The individual gets no charitable deduction for these contributed funds, but, they do not have to include the funds in income. It is as if they completely disappear. It’s even better than investing with Bernie Madoff! But wait, there’s more. The QCD transaction can also satisfy a required minimum distribution (RMD) for the year. QCDs are capped at $100,000 per year, per IRA owner.

Now, here’s the twist. An advisor called saying his client, who is over age 70 ½, inherited an IRA several years ago and never took any RMDs from the account. She has now discovered the problem and needs to fix it. They know she has to make up the missed distributions and they have calculated what those RMDs are. They will take out the funds in 2017.

The problem is that all of the missed RMDs will be included in her income for 2017. You cannot take a 2016 distribution in 2017 and include it in your income for 2016. IRA distributions are taxable for the year the funds leave the IRA.

The advisor’s solution to this problem was to use a QCD. His question was, “could the client do a QCD in the amount of the missed distributions?” After some consideration of possible reasons why this might not work, the decision was yes, she could. The tax code and regulations simply say that a QCD can satisfy an RMD. They do not specify that it can only satisfy the current year’s RMD. And, if you miss an RMD the rules are that it gets added to the next year’s RMD. If my RMD for 2016 is $10,000 and I don’t take it, and my RMD for 2017 is $12,000 then my RMD for 2017 is actually $22,000 ($10,000 for 2016 + $12,000 for 2017).

The way this works out for the client is that she takes all the missed RMDs in 2017 generating taxable income for 2017. She has the total RMD amount directly transferred from her IRA to a qualifying charity as a QCD. On her tax return she shows the amount transferred to the charity and indicates that it is not included in her income by using the notation QCD. She has made up all her missed RMDs at no tax cost.

But wait, there’s more. The client still needs to report the missed RMDs to IRS on Form 5329. She needs to file a form for each year she missed an RMD. Missed RMDs are subject to an additional tax of 50% of the amount not taken each year. But the IRS can waive this additional tax for good cause. The client feels she had good cause for missing the RMDs so she is going to request a waiver of all of the 50% additional tax. The IRS generally grants these requests.

In the end, the client will have made up her missed RMDs at no tax cost and received a waiver of the 50% additional tax and benefitted a charity. She can now move forward taking her RMDs each year in accordance with the RMD rules. This all works for this client because she is over 70 ½ and the total of the missed RMDs is less than $100,000.