Thursday February 22, 2024
Article of the Month
Secure Act 2.0: New Year, New Rules
The new year is a great time to kick start charitable gifts. During this time, donors will be working with their professional advisors to understand their anticipated tax liabilities in the new year and may explore charitable giving options. For many of these donors, IRAs will be the largest-value asset they own and a potential source of charitable giving. It is important for professional advisors to understand the rules surrounding IRA-funded charitable gifts and the new funding limits for IRA gifts in 2024.
This article will provide an overview of qualified charitable distribution (QCD) gifts, the Secure Act 2.0 and the funding and timing limits related to IRA-funded legacy gifts. This article will also look at the types of donors that professional advisors should be discussing IRA-funded legacy gifts with and the benefits these donors will gain by making IRA gifts.
Qualified Charitable Distributions (QCD)
The concept of QCDs was first introduced in the Pension Protection Act of 2006. The provision was originally set to expire in 2007 but was extended until it was made permanent in the Protecting Americans from Tax Hikes Act of 2015.
A QCD allows IRA owners age 70½ or older to directly transfer up to a certain amount from an IRA to a qualified public charity each year. The QCD amount counts toward the IRA owner’s required minimum distribution (RMD) for the year. The QCD amount is not included in taxable income and does not create a charitable deduction. From its inception through 2023, the maximum QCD amount was unchanged at $100,000, each year per IRA owner. The QCD may offset the IRA owner’s RMD, if applicable.
Secure Act 2.0 One-Time Election QCD
On December 21, 2023, the Joint Committee on Taxation (JCT) released the "Blue Book" that explains tax provisions passed by the 117th Congress. The JCS-1-23 publication in Title III, Paragraph 7, explains the JCT interpretation of the QCD to life-income plans.
JCT notes the $100,000 QCD for a gift directly from an IRA to a qualified nonprofit is indexed. The $100,000 direct IRA charitable rollover is increased to $105,000 in 2024. Similarly, the $50,000 IRA to life-income rollover is increased to a one-time election QCD of $53,000 in 2024.
An IRA owner who has reached age 70½ may elect to distribute $53,000 in 2024 through a one-time transfer from an IRA to a split-interest entity if the election has not been made in a prior tax year. The split-interest entity may be a charitable remainder annuity trust (CRAT) under Sec. 664(d)(1), a standard charitable remainder unitrust (CRUT) under Sec. 664(d)(2) or an immediate charitable gift annuity (CGA) under Sec. 501(m). The trust or annuity must be funded by a QCD only. A CGA must have a minimum payment of 5% and is required to make the first payment within one year. If an IRA owner made the election to use a QCD to fund a life-income plan in 2023 up to the $50,000 limit, the IRA owner is precluded from making an additional election in 2024 even though the limit increased to $53,000. The one-time election is for a single tax year and can only be exercised once in a lifetime.
The CRAT or CRUT qualifies only if the entire value of the remainder interest would be a qualified deduction under Sec. 170. A CGA is qualified for the one-time election if the charitable value would also qualify for a deduction under Sec. 170.
The life-income agreement is qualified if the IRA owner, IRA owner’s spouse or IRA owner and spouse are the trust income or annuity beneficiaries. The income interest in the split-interest entity must be nonassignable.
All distributions from the CRAT or CRUT will be treated under Sec. 664 as Tier I ordinary income. Because there is no investment in the contract under Sec. 72(c), all payments from the CGA will also be ordinary income.
The JCT explanation fails to answer one question. When the initial IRA rollover (QCD) was passed in 2006, the JCT stated that the distribution would qualify for the RMD. JCT Technical Explanation of PPA 2006 (JCX-38-06) states on page 266, "Qualified charitable distributions are taken into account for purposes of the minimum distribution rules applicable to traditional IRAs to the same extent the distribution would have been taken into account under such rules had the distribution not been directly distributed under the provision." The 2023 JCT explanation does not discuss the QCD issue. Because the split-interest QCD in Sec. 408(d)(8)(F) is subject to the QCD provisions of Sec. 408(d)(8)(A), tax advisors may take the position that the prior determination the QCD qualifies for the RMD also applies to the split-interest QCD.
QCD Funding Amounts
With an overall QCD limit of $105,000 in 2024, making a one-time QCD to a life-income plan will impact the overall QCD limit. Section 408(d)(8)(F)(i) states that the $50,000 QCD (now $53,000 in 2024) is governed by subparagraph (B)(i), which refers to the QCD provision of the $100,000 limit of subparagraph (A). Thus, the subparagraph (F) $53,000 limit is part of the subparagraph (A) $105,000 amount for 2024.
Sally is 80 years old and wishes to take advantage of using her IRA to fund a one-life CGA in 2024. Sally decides to max out the full contribution limit of $53,000 in exchange for a CGA with her favorite charity. As such, Sally will have a remaining available QCD limit of $52,000 that she can transfer tax-free to charity as an outright QCD gift for 2024.
Potential QCD Reductions
Contributions made to an IRA after an IRA owner reaches 70½ will cause a reduction in the QCD amount a donor can make to fund either an outright gift or a life-income plan. Sec. 408(d)(8)(A)(i). If an IRA owner makes contributions after age 70½, the amount of the contribution cannot be used as a QCD and will be included as part of the donor’s taxable adjusted gross income (AGI). This “anti-abuse” provision is intended to prevent a donor from using post-70½ IRA contributions to reduce their AGI through a deduction, and then support charities through a QCD. Rather than being treated as a QCD, under Sec. 408(d)(8)(A) any amounts sourced from post-70½ contributions are disallowed under the anti-abuse provision and will be treated as taxable income but may be an itemized charitable deduction.
If a donor makes a charitable gift using their post-70½ contributions in exchange for a CGA or CRT, that portion of the gift will not qualify as a QCD and will be included as part of the donor’s taxable income for that year. Given the significance of excluding the QCD amount from a donor’s taxable income, the donor will need to work closely with their professional advisor to determine the extent of their post-70½ contributions to their IRA. Professional advisors can assess the contribution amounts and determine the amount the donor can contribute to a life-income plan as a QCD and the exact amount that will be excluded as part of the donor’s AGI.
QCD Timing Limits
QCDs must be completed by the year’s end if the donor wants it to satisfy their RMD. A donor does not have to transfer the full statutory limit at one time in order to take advantage of using the QCD, either for outright giving or to fund a life-income plan. For outright QCDs, the limit can be reached over the course of the taxable year through multiple gifts not in excess of the limit. While the QCD to a life-income plan is a once-in-a-lifetime election, a donor can reach the limit by giving over the course of the year. For instance, a donor is permitted to fund multiple CGAs using their QCD in the same taxable year so long as the cumulative amounts for the CGAs do not exceed the statutory limit and all the CGAs are created by the end of the same taxable year. When creating a CRAT or CRUT, it is more logical for a donor to fund the trust up to the complete statutory limit at the time of creation.
Bill is 75 years old and wants to use a QCD to fund a CGA for himself and his wife in 2024. In January 2024, Bill decides to take $20,000 from his IRA to fund a CGA. In September 2024, Bill decides to fund an additional CGA using a QCD in exchange for a two-life CGA for both him and his wife. Because Bill already used $20,000 from his IRA to create the first CGA, Bill is now able to use his remaining available QCD amount of $33,000 to fund the two-life CGA. Bill was able to complete both CGAs in 2024 and did not exceed the $53,000 QCD limit in creating both CGAs.
Benefits of IRA Legacy Gifts
Donors with traditional IRAs will benefit the most from making a QCD. Conversely, Roth IRAs are not the intended asset for making a QCD. While Roth IRAs may not be specifically excluded under the Secure Act 2.0, an owner of a Roth IRA is not required to take RMDs and enjoys tax-free distributions from the IRA. As such, Roth IRA owners should consult with a professional advisor before making a QCD from the account.
Individuals with traditional IRAs must begin taking RMDs when they reach 73 (or 75 in 2033) but will enjoy added benefits by making the one-time QCD election to a CGA or CRT. First, the QCD will reduce the overall IRA balance and thus reduce future RMDs. The reduction in future RMDs helps IRA owners avoid being pushed into a potentially higher tax bracket. Additionally, while the annuity payments from the CGA or CRT are taxed as ordinary income to the donor, the payments are spread over the donor’s lifetime, minimizing tax liability compared to taking out larger RMD payments.
QCD Funded CGA vs CRT
With the once-in-a-lifetime option to use a QCD to fund life-income charitable plans, donors are left with the choice of funding either a CGA or a CRT. A CRT is an irrevocable trust that pays income to the income beneficiaries with the remainder passing to charity. A CRT can be established as either a charitable remainder unitrust or a charitable remainder annuity trust. The primary difference is that a CRUT pays out a fixed percentage of the trust’s balance and additional contributions are permissible. Whereas a CRAT pays out a fixed annuity amount and additional contributions are prohibited.
With a CRT funded by a QCD, there are additional limitations such as additional funding to the trust is not permissible. A CRT allows a donor to have control over investments if they serve as trustee and all payments made from the trust must be reported to the beneficiaries on Schedule K-1. An attorney is needed to draft the trust and a trustee is required to administer the trust and file the appropriate tax returns each year. There are ways to minimize costs, but costs will still exist in most cases.
The $53,000 QCD maximum funding amount may be considered too low of a funding amount for a CRT given the creation and annual administrative costs associated with CRTs. Additionally, many organizations’ gift acceptance policies limit the ability to administer a CRT unless there is a minimum funding amount. Typically, the funding threshold is much higher than $53,000 for a CRT. However, if both spouses are over age 70½, they have the option to use $53,000 from their respective IRA QCDs to fund a CRT. Since QCDs cannot be added to an existing CRT, the donor couple would need to create a new CRT and simultaneously fund the trust with their respective QCDs, reaching a combined $106,000 in 2024.
A CGA is a contract between the charity and the donor. The donor transfers property to the charity and the charity promises to pay the fixed annuity amount for one or two lives. With the CGA being a contractual obligation, the annuity payments are secured by all the assets of the charity. As such, donors will want to transact with financially secure organizations. Many nonprofits have an attainable threshold for funding, which may be as low as $5,000. A CGA funded with the QCD maximum of $53,000, would meet the funding threshold at many organizations. CGAs may be state regulated and in some cases, charities are required to obtain a permit or license to issue CGAs to annuitants in certain states. The suggested maximum payouts based on annuitants’ ages are issued by the American Council on Gift Annuities (ACGA) and adopted by most charitable organizations.
CGAs offer a great solution for donors who prefer fixed payouts without having to manage the annuity’s investments or pay administration costs. Annuity payments will be reportable to the annuitants on Form 1099-R. Professional advisors may find that the QCD-funded CGA is an advantageous option for IRA owners, due to its minimal set up costs and lower threshold for funding. As such, the remainder of this article will discuss QCDs in the context of a CGA.
Professional advisors may consider discussing QCD to CGA gifts with seniors who are charitably minded and want to receive a steady stream of income for the rest of their lives. It is important to segment the donor pool to ensure that the 70½ age threshold is met so that IRA gifts can be treated as a QCD. There are different types of IRA donor profiles and examining each one will help professional advisors identify donors more likely to benefit from using a QCD to fund a life-income gift.
Many charitably minded IRA owners will choose to take advantage of the QCD to CGA because it is a very convenient gift. These donors will most likely have created other CGAs in the past and are already familiar with the benefits that a CGA offers. Additionally, those who have made a QCD in the past are great candidates as they are also familiar with how QCDs work and are accustomed to working with their IRA custodians in making a transfer directly to charity. With the ability to use a QCD from their IRA, donors can avoid complicated tax reporting procedures since all income from an IRA-funded legacy gift is taxed as ordinary income to the donor. Furthermore, CGAs are very straightforward gift vehicles that can be completed very easily. The largest group of donors will be those who find this method of giving to be a very simple and convenient way to use their IRA to make more charitable gifts.
Donors who have an abundance of income from retirement plans and other investments are those most likely to make generous gifts. These donors may give gifts up to their maximum AGI limits (60% for cash gifts and 30% for appreciated property gifts in 2024) but want to do more with their charitable giving. Since a QCD is not included in a donor’s taxable income and does not create a charitable deduction, generous donors can give beyond their AGI deduction limits. Furthermore, generous donors may not need the income that a life-income plan generates and should be aware that they are unable to assign the income to the charity if funded with a QCD under the Secure Act 2.0. However, an option for married donors filing separate tax returns is to set up the CGA to make payments to their spouse to ensure that the spouse is provided for while also making a substantial gift to charity. For donors filing their taxes jointly, the income would be reported regardless of if it is a one-life or two-life CGA. Donors may explore options to minimize the CGA payout percentage and opt for a lower percentage, not to fall below 5%.
Many donors do not have large, itemized deductions, so they take the standard deduction. Seniors who do not itemize their taxes are great prospects for a QCD because currently these individuals may be making charitable gifts but are not receiving any tax benefits. However, a key advantage of a QCD is the gift amount is not included in the donor’s taxable income in the taxable year of the gift, which can offset the donor’s RMD from their IRA. As such, donors are able to lower their taxable income, potentially reduce RMDs due in future years and lower their future income taxes. While donors will report the annuity payments received from the CGA, they will recognize those payments over their lifetime and not have a large RMD that could potentially push them into a higher tax bracket. Donors with large RMDs should consider using their IRA to create a CGA so they can instead recognize the smaller annuity amounts as income while also reducing their future RMD amounts.
Social Security Donors
The taxation of Social Security benefits depends on a combined income calculation, which includes adjusted gross income plus one-half of Social Security payments. If this amount is less than $25,000 for a single individual there is no tax due on the Social Security amount. If the amount is between $25,000 and $34,000 for a single individual, 50% of Social Security benefits will be taxed. If the amount is over $34,000 for a single individual, it will result in 85% of Social Security benefits being subject to tax.
If the combined income is less than $32,000 for married couples filing jointly, there is no tax on the Social Security payments. Combined income between $32,000 and $44,000 for married filing jointly, 50% of Social Security benefits will be taxed. Combined income over $44,000 for married filing jointly, then 85% of the Social Security benefit will be included in taxable income.
Donors should work with their professional advisors to determine whether their Social Security income is subject to tax and to determine if using a QCD to fund a CGA may help reduce their taxable income by reducing the RMD amount on their income taxes. Some individuals may be able to use a QCD to offset their RMD and give part or all of that in exchange for a CGA. By recognizing smaller annuity payments from the CGA, the donor can potentially remain at a lower taxable income level and reduce the level of taxation on their Social Security payouts. Outright QCDs may also be used to reduce RMDs and taxable income.
A donor must be at least 70½ in order to make a QCD. However, not all donors will be ready to elect and make a once-in-a-lifetime IRA charitable rollover gift to a CGA as soon as they are eligible. Given that this is a one-time election, some donors may be willing to save their gifting opportunity until it benefits them more. For example, the QCD amount is $53,000 in 2024, but that amount is indexed for inflation in future years. Since the funding amount will increase, some donors may weigh the benefit of reducing the RMD in future years with the thought of the slight increase to the QCD amount. In some cases, the donor will choose to wait to see what the new limit will be in future years to take advantage of using a higher funding amount from their IRAs or wait until their RMD starts. However, these donors are still great candidates to discuss QCD funded CGA gifts with. While they may not make the gift this year, they will be familiar with the concept when they do decide to establish the CGA and able to complete the gift quickly since their professional advisors have already taken the time to explain the gift.
As the opportunities arising out of the Secure Act 2.0 become more popular among donors, it becomes increasingly important for professional advisors to understand the rules and new funding limits for 2024. Since all donor’s goals and situations are unique, professional advisors should be prepared to recognize the donors who will benefit the most from making gifts using their IRA. With this knowledge, professional advisors will be well-equipped to discuss these opportunities with donors and show the full potential of using a QCD to fulfill the donor’s philanthropic goals.