In December 2015, the federal government once again met to hammer out what has become the “Annual Extenders Bill.” This year’s extender bill had over 50 provisions that had expired or were about to expire. Our expectations have been that the bill would only extend the various provisions for one year and not provide the fix that was necessary. We received so much more this time. The Protecting Americans from Tax Hikes Act of 2015 was signed on December 18, 2015, and extended some provisions for multiple years and other provisions surprisingly became permanent.
One of the permanent provisions was the Qualified Charitable Donation (QCD). A QCD is when a taxpayer that is at least 70 ½ has their IRA trustee make a tax-free IRA distribution up to $100,000 directly to a charitable organization. This transfer could be your entire minimum required distribution from your IRA or only a portion. The result of this donation is that your IRA will not be included as taxable income on your tax return and the donation will be removed from your itemized deductions.
The removal of your IRA distribution from your Adjusted Gross Income (AGI) can be beneficial in a few different ways. The AGI is utilized to determine many different benefits. For example reducing AGI could provide you with:
- A lower monthly adjustment to Medicare premiums – According to the Social Security Administration, if you have higher income, you will pay an additional premium amount for Medicare Part B and Medicare Prescription Drug coverage. The additional amount is the income-related monthly adjustment amount. This calculation begins with your Modified Adjusted Gross Income (MAGI). If you file Married Filing Jointly (MFJ) and your MAGI is greater than $170,000 then you will pay higher premiums ($85,000 if you file Single).
- Increased Financial Aid – College financial aid formulas are heavily weighted toward income. Income has a much greater impact on eligibility for need-based financial aid than assets. The starting point of this income is the AGI.
- Allowing Education Credits – The American Opportunity Credit provides a credit of $2,500 on your federal tax return, but if you file MFJ, once your AGI exceeds $180,000 ($90,000 for single) you cannot claim the credit. For the Lifetime Learning Credit of $1,500, if your AGI exceeds $131,000 for MFJ ($65,000 for single) then you cannot claim this credit.
- Increasing Itemized Deductions – If your AGI is more than $311,300 for a MFJ ($155,650 for single), then your itemized deductions are reduced by 3% of the amount by which your AGI exceeds these same limits.
- Reduced Tax Bracket – The AGI is reduced by Itemized deductions and personal exemptions to determine taxable income. If the taxable income exceeds $466,950 for MFJ ($415,050 for single), then you are subject to the 39.6% tax bracket and your long term capital gains will be subject to a tax rate of 20% and not the more beneficial rate of 15%.
- Avoiding the Net Investment Income Tax – The Net Investment Income Tax is an additional tax of 3.8% which is assessed on taxable interest income, dividend income, capital gains and other passive income sources. Excluded income examples are wages, alimony, social security benefits, and income subject to self-employment taxes. The threshold for determining if you are subject to this additional tax is your MAGI. If your filing status is MFJ and your MAGI exceeds $250,000 ($200,000 for single), then your income will be subject to the Net Investment Income Tax.
The Qualified Charitable Donation could be a wonderful planning tool. By making a charitable donation from your IRA you can provide funding to your beloved alma mater, a local community service group, or an organization that provides aid all over the world. A great by-product of this donation is that it assisted you in capitalizing on various financial opportunities and a worthy charitable organization also benefited from your philanthropic goodwill.