Executive Summary Amongst the various “extenders” included in the American Taxpayer Relief Act of 2012 (ATRA) was the reinstatement of rules allowing an individual to make a “Qualified Charitable Distribution” (QCD) from an IRA to a charity with favorable tax consequences, assuming the individual has reached the minimum 70 1/2 age, stays within the $100,000 dollar limit, and meets other requirements regarding the distribution and the receiving charity. Unfortunately, though, bringing back QCDs retroactively for 2012 was of limited use when the law wasn’t even passed until the first week of 2013 and the 2012 tax year was already closed! To accommodate, Congress included two special lookback rules under ATRA – the first allows QCDs done in January of 2013 to be treated as a 2012 QCD, and the second allows December 2012 IRA distributions to be recharacterized as a QCD if a comparable amount of cash is donated to a charity after the IRA distribution but before the end of January, 2013. While these two rules are nice to have, though, the reality is that neither may be very useful, except for a few unique situations, such as those who already plan to max out their QCDs up to the $100,000 limit for 2013 and are looking to donate more. In addition, most clients will still benefit more by contributing appreciated securities to a charity, than by donating cash (with or without the QCD treatment). Nonetheless, the new rules do open up some useful planning scenarios for some client situations, and with only a few weeks available to take advantage of the rules, the time window is short to decide whether or not to take advantage of the two new special 2012 lookback rules for QCDs!

Basic Rules For QCDs

Under ATRA, Qualified Charitable Distributions (QCDs) from IRAs to charities in 2013 will follow the same “old” rules for QCDs that were in effect in 2011. As a result, to be eligible for QCD treatment:

– Funds must be transferred directly from the IRA to the charity (i.e., made payable directly to the charity) – Applies only to distributions from IRAs (not 401(k)s or other qualified plans) – The IRA owner must be age 70 1/2 or older on the date of the donation from the IRA to the charity – The maximum limit is $100,000 per person in a single year (although a married couple could do $100,000 each, as long as each makes the distribution from his/her own IRA) – Must be to a public charity; Split-interest gifts (e.g., Charitable Remainder or Lead Trusts, or charitable gift annuities) do not qualify, nor do gifts to private foundations, grant-making supporting organizations, or donor-advised funds – The QCD counts towards satisfying the IRA owner’s RMD obligation for the year

If the above rules are followed, there is no charitable deduction for the donation, but instead the QCD is excluded from income entirely (which is superior to being taxed as an IRA distribution with a usually-not-perfectly-offsetting itemized charitable deduction anyway). And notably, distributions from IRAs for QCDs are assumed to come from the gains first (i.e., the pre-tax funds); the normal “pro-rata” rule for IRA distributions does not apply.

Special Rules For 2012 QCDs

In addition to the reinstatement of the “standard” rules for QCDs in 2013, the recent tax legislation instituted two “special lookback” rules on QCDs for 2012 – to make up for the fact that QCDs were reinstated retroactively for 2012 at a point so late (the first week of 2013!) there was no way to actually completely a timely 2012 QCD under the new rules!

The first special rule states that the taxpayer can elect to have any QCD made during the month of January 2013 be treated as though it was made on December 31, 2012 (i.e., to count toward the 2012 tax year). This provides a way to make 2012 QCDs, for those who would have liked to do so but had been waiting all along for the legislation (which came too late).

The second special rule states that the taxpayer can treat an IRA distribution that occurred in December 2012 to be treated as a QCD (retroactively), to the extent that a comparable amount is contributed to a charity after the IRA distribution occurred, and is done no later than January 31, 2013. Notably, the amounts contributed to a charity to qualify under this provision must be made in cash (not appreciated securities), and the receiving charity must otherwise be eligible to receive QCDs (i.e., still can’t be to a split-interest charitable trust, private foundation, donor-advised fund, etc.).

Notably, the key dates here are important. The first rule can only be used if the QCD happens in January of 2013 (to apply to the 2012 tax year). The second rule can only be used if the prior IRA distribution happened in December of 2012, the charitable contribution occurred after the IRA distribution, and the charitable contribution is done by January 31, 2013.

Planning And Reporting Implications Of The New QCD Special Rules

So where are these two special QCD rules useful?

The primary value of the first rule is for those who plan to fully utilize the QCD rule in 2013, up to the $100,000 maximum, and want to contribute even more than this amount. Under the special rule, that individual can do up to $100,000 of QCDs in January of 2013 (and apply them against the 2012 limits), and then do up to another $100,000 of QCDs for 2013 as well (and again, each member of a married couple can do this, up to $400,000 combined, if they are so inclined towards charity). On the other hand, if someone doesn’t already anticipate hitting the $100,000 QCD limit in 2013 (noting that it is effectively $200,000 for a married couple, as long as each does up to $100,000 from his/her own IRA), then he/she/they can simply do 2013 QCDs and claim them for the 2013 tax year. As a result, there’s little reason to use this rule outside of those making very large gifts (except perhaps as a “get-out-of-trouble free” card for those who forgot to take a 2012 RMD in a timely manner and want to make up for it now). Nonetheless, for those who do plan to utilize QCDs for this much charitable giving, this first special rule is a very nice option to have.

As for the second rule, there are really two scenarios where it applies. The first is where the client took RMDs (or really, any IRA distribution) in December of 2012, and after that point, still in 2012, made a charitable contribution. In such a situation, the client can retroactively call that transaction a QCD (even though the money was NOT directly contributed to a charity as would normally be required). There isn’t really any “planning” to do in this situation; it just turns out that, in retrospect, there’s a more favorable way to claim the donation (as a QCD, instead of a charitable contribution), which makes it more of a reporting opportunity than a proactive planning opportunity. Nonetheless, this more favorable reporting may be especially appealing for those who were bumping into charitable contribution limits for 2012, or for those who weren’t even itemizing deductions (and wouldn’t have enjoyed any tax deduction for the donation). Remember, though, the charitable contribution must have been made in cash for this to apply.

The second scenario where this rule can apply is for someone who makes a charitable contribution of cash in January 2013, and wants to retroactively match it to a corresponding IRA distribution taken in 2012 to avoid reporting that distribution in income. This differs from the first rule because the whole QCD (withdrawal and donation) isn’t happening in 2013, just the donation part is done in 2013 (matched to a prior December 2012 withdrawal). Notably, though, most people who intended to donate an amount equal their 2012 RMD already did so in 2012, and most people who intend to make charitable contributions in 2013 can simply do a QCD for 2013. In other words, unless – as with the first special rule – there’s a plan to max out QCDs in 2013, there’s little reason to use this rule to match a 2013 charitable donation to a 2012 RMD (or any other IRA withdrawal) to make it a 2012 QCD.

Example. Jeremy took a $5,000 IRA distribution on December 15th, 2012, to satisfy his required minimum distribution for the year, but made no subsequent charitable contributions in the last two weeks of 2012. In January of 2013, Jeremy could contribute up to $5,000 and retroactively treat his 2012 IRA distribution as a QCD, which allows him to avoid reporting that IRA distribution in income altogether. However, if Jeremy wasn’t already planning to make a charitable contribution, he would have been better off to just hold on to his money, pay the taxes, and keep what’s left over, rather than donating the money and keeping none of it. On the other hand, if Jeremy already was planning to make the contribution sometime in 2013, he may as well just do QCD in 2013 to satisfy his 2013 RMD; otherwise, any benefits received from the 2012 QCD may be partially or fully offset by the lack of a charitable deduction or QCD in 2013!

Are QCDs Really A Good Deal In The First Place?

Ironically, perhaps the biggest caveat to using the new QCD rules are simply that they are not actually a very good deal in the first place. As I’ve written previously on this blog, QCDs are superior to donating cash to offset the income from an IRA distribution, but are still inferior to just contributing appreciated securities in the first place. Granted, there are some scenarios where contributing appreciated securities has limited value, such as where the taxpayer is bumping into the maximum charitable deduction limits, where the donor doesn’t itemized deductions, or where the investor simply doesn’t have any appreciated investments to donate in the first place. And in some situations, QCDs may be more favorable at a state level than contributing appreciated securities (however, in other states, there’s a risk that the state may allow donations of appreciated securities but not honor a “brand new” QCD rule just because it’s permitted at the Federal level, so check your state!).

Notwithstanding the occasional limits on donating appreciated securities, though, the superior leverage of the strategy – and the increased availability of appreciated securities in most portfolios after several years of a bull market – means that most clients who might be eligible for the two new special lookback rules for QCDs may not utilize them simply because it’s preferable to just donate appreciated securities in the first place, especially for the most affluent clients who make the biggest donations and may be subject to the new top capital gains tax rate of 20% and the new 3.8% Medicare surtax on investment income (for a combined top long-term capital gains tax rate of 23.8%!). In addition, even if the individual is bumping into the maximum deduction limits for charitable contributions for 2013, donating highly appreciated securities can still be superior to QCDs, as long as the deduction can be used at some point within the 5-year carryforward limits.

Thus, the bottom line is that those who already took a December 2012 IRA distribution and made late 2012 charitable contributions in cash may still wish to use the lookback rule to more favorably report a 2012 IRA-distribution-and-subsequent-contribution as a QCD. But most who are looking at making charitable contributions in 2013 would be better served to look at donating appreciated securities, rather than utilizing these new special QCD lookback rules, unless deductions are either too low to itemize at all, or charitable contributions are already anticipated to be too high to be eligible for any further charitable donation tax benefits. And remember that if the client is going to donate money (whether cash or appreciated securities, QCD or not), do it for the charity, not the tax benefits – because no one ever ends out with more money by doing a QCD or otherwise donating money than by just keeping the remaining-after-tax IRA money in the first place!

(This article was included in the Carnival of Wealth, Hawai’ians Are Ignorami Edition on Control Your Cash, the Carnival of Retirement on Good Financial Cents, the Carnival of Financial Planning on Term Life Insurance Inc., and the Carnival of Personal Finance #396 on Adam Hagerman Financial Coach.)