Charitably inclined individuals looking to maximize charitable impact and minimize taxes have a few options. Two of the more popular ones are using Donor Advised Funds (DAFs) and Qualified Charitable Distributions (QCDs). Each has distinct features and benefits. If you are eligible (an IRA QCD can only be used by an individual age 70.5 or older), the choice between a DAF and QCD depends on your goals as well as your personal income tax circumstances. Here are some things to consider when deciding which might be best for you.
- Contributions to a DAF can be invested and grow tax-free, enhancing your future grants to charity, often over several years.
- A QCD must be sent directly to a charity upon withdrawal.
- If you have a charitable budget in mind but need time to finalize which charities to benefit, or in what exact amounts, you can make a lump sum gift to a DAF and then distribute from the DAF to multiple charities later, even in the next year.
- A QCD needs to be specific and pre-determined.
- A DAF has administrative fees for the services it provides. Depending on your use case those fees could be well worth the added conveniences.
- Processing a QCD is generally free from fees, perhaps other than the cost of a stamp to mail a check.
- Grants from a DAF can be anonymous or not, based on your personal choice.
- A QCD check does not keep your identity private from the charity.
- The recordkeeping done for you by a DAF can make giving to many charities easy and most grants can be made online. However, a DAF may limit the minimum size of a grant, often not below $50.
- A QCD can be used for multiple charities in both small and large amounts, but that could mean keeping track of many checks and more administrative work for your tax reporting.
- A DAF allows you to name family members as co-grantors and any balance remaining in a DAF after your passing can be controlled by heirs to continue your charitable legacy.
- QCDs don’t offer much of a way for family to participate. Your IRA beneficiary could make QCDs from an Inherited IRA – but only when that heir is at least 70.5 years old.
A gift to a DAF can provide a tax deduction even if grants aren’t immediately made to charities, while a QCD allows you to withdraw from your IRA without incurring a taxable distribution. Determining which method provides a greater tax advantage can be complex and often requires projecting your tax return to take personal circumstances into account. Here are a few general considerations that can help guide the decision.
- If you would give cash and don’t have long-term appreciated investments to donate, a QCD is generally more advantageous than a cash gift to a DAF.
- If you have a highly appreciated security to donate and you also want to dispose of the holding to decrease concentrated risk in your overall portfolio, the DAF may be the way to achieve multiple goals.
- If you have a highly appreciated security but could realize long-term capital gains at the 0% tax rate, you may not leverage the full tax advantage of a DAF compared to the pretax QCD gift.
- If you are not able to itemize deductions, or your itemized deductions are not much more than the standard deduction, the QCD may provide a clearer tax incentive.
- Other factors may include the size of the gift you would like to make relative to the size of your IRA Required Distribution, whether you have any basis in your IRA from non-deductible contributions, if your gross income is high enough to create a surcharge on your Medicare Premiums, and your age and estate planning intentions for heirs.
- The strategies don’t need to be mutually exclusive or all or none–you can elect to use both a DAF and a QCD in the same tax year, or alternate year-to-year as circumstances change.
One Final Consideration…
Something worth mentioning from our experience over the years is that QCDs can occasionally create tax reporting issues for the unprepared. This is because the 1099-R used in reporting IRA distributions does not have a special code for a QCD. In other words, if you or your tax preparer rely on the 1099-R without making a manual adjustment, one could erroneously report an IRA distribution as fully taxable even when a QCD was used correctly. This seems like a major deficiency on a part of the IRS, considering the QCD option first appeared in 2006 and was made permanent starting with the 2015 tax year. Still, QCDs can be the most effective strategy for persons who don’t need to spend their IRA RMD or would not be able to capture the full benefit of a DAF.
No matter how you contribute to charity, it’s a good idea to be thorough and precise when communicating with your tax advisor to ensure you realize the outcome you were expecting.
Stay tuned for part two of this series on charitable giving strategies where we’ll answer the questions clients ask most often about DAFs and QCDs.
- Can I Do A Qualified Charitable Distribution From My IRA 2023?
- Should I Use A Donor Advised Fund DAF When Giving To Public Charities 2023?