The primary benefit of a qualified charitable distribution (QCD) is that it is excluded from the donor’s income. A pertinent question then becomes whether one can make a QCD with amounts that would already be excluded from income by nature of being after-tax funds (basis).
The general QCD rules are discussed in the article “How to Make a Tax-Free Donation From Your IRA,” which mentioned that QCDs may be made from Roth IRAs. The reference to Roth IRAs and after-tax amounts in that article prompted inquiries from readers, mainly regarding whether QCDs could be made from Roth IRAs and traditional IRAs that hold basis.
We’ll answer those questions here.
Background on basis
First, remember: A distribution of basis is nontaxable!
A traditional IRA’s basis comes from nondeductible contributions and rollovers of after-tax amounts from employer plans.
Distributions from traditional IRAs typically include a pro-rated amount of basis and pre-tax amounts unless an exception applies. One exception is a QCD, where pre-tax amounts are distributed before any basis.
Reminder: For this purpose, every traditional, SEP, and SIMPLE IRA owned by an individual is aggregated and treated as one traditional IRA. Inherited/beneficiary IRAs are not aggregated with the individual’s own IRAs.
For Roth IRAs, 100% of a qualified distribution is basis. For a nonqualified distribution, the ordering rules apply, and earnings (the only amount that is not basis) are distributed only after all basis amounts are distributed. Please see the article “Is Your Roth IRA Distribution Taxable?” for details.
However, a QCD is an exception to this rule, under which earnings are distributed before basis, thus creating the opportunity to convert up to $105,000 (2024 limit) from a taxable to a nontaxable distribution.
The following examples demonstrate.
Making a QCD from a Roth IRA
While a QCD can be made from a Roth IRA (see IRS Notice 2007-07, Q-36), basis amounts would not be included when applying the QCD treatment to the donor’s tax return. The donor could instead claim the amount as an itemized deduction on their tax return. Donors should consult with their tax advisors regarding whether they should itemize. Also, see IRS Topic no. 501, Should I itemize?
Example 1: 74-year-old Tyrone instructs the custodian of his Roth IRA to send $20,000 to his church for a QCD.
Tyrone has held a Roth IRA for at least five years, which means that his Roth IRA distribution is qualified and, therefore, fully tax-free.
While Tyrone’s custodian will make the check payable to the charity (a requirement for QCDs), his tax preparer cannot treat it as a QCD on his tax return. Instead, if Tyrone itemizes deductions on Schedule A of his tax return, the $20,000 would be deductible as a charitable contribution, subject to adjusted gross income (AGI) limits.
Tax planning tip: If Tyrone has the cash available in a traditional IRA, particularly pre-tax funds, making the QCD from the traditional IRA would be more tax-efficient. Consider, too, that making the QCD from his Roth IRA would mean giving up the opportunity for tax-free growth on the $20,000.
Example 2: 72-year-old Kaya instructs her IRA custodian to send $30,000 to an eligible charity for a QCD.
Kaya’s Roth IRA balance consists only of a rollover of a nonqualified distribution of $70,000 from her Roth 401(k), which consists of $30,000 basis from her regular Roth 401(k) contributions and $40,000 earnings.
This Roth IRA is Kaya’s first Roth IRA. Therefore, she has not held a Roth IRA for the required five years for qualified distributions.
If Kaya had taken a regular distribution of $30,000, it would be attributed to the $30,000 basis under the ordering rules and would be tax-free. Her remaining balance would then be:
$00.00 basis
$40,000 earnings
$40,000 total
Since this would be year one for Kaya’s Roth IRA, she would have to wait four more years before being eligible to take tax-free distributions from the $40,000. See “Is Your Roth IRA Distribution Taxable?” for how the five-year period is counted. But since Kaya used the $30,000 as a QCD, it is attributed to the earnings, and her remaining balance would be:
$30,000 basis
$10,000 earnings
$40,000 total
Kaya could take tax-free distributions of $30,000 at any time. But she must wait four more years for the $10,000 to become eligible for a tax-free distribution.
Making a QCD from a traditional IRA that includes basis amounts
The pro-rata rule does not apply to a QCD. Instead, if an IRA balance includes basis, a QCD would first be attributed to the otherwise taxable portion. If a distribution sent to a charity includes basis, the donor could claim such basis amount as an itemized deduction on their tax return if their tax advisor so advises.
Example: 74-year-old Mandisa instructs her IRA custodian to send $50,000 to an eligible charity as a QCD.
The aggregate total of Mandisa’s traditional, SEP and SIMPLE IRA balance is:
$40,000 pre-tax funds
$20,000 basis
$60,000 total
If Mandisa had taken a regular IRA distribution of $50,000, it would include a pro-rated amount of her pre-tax and after-tax balance. But since Mandisa used the $50,000 as a QCD, it is attributed to the pre-tax amount first, and her remaining balance would be:
$00 pre-tax funds
$10,000 basis
$10,000 total
The $10,000 basis included in the $50,000 would not be reported as a QCD on Mandisa’s tax return. But her tax preparer could claim the $10,000 on her tax return if they itemize deductions and file Schedule A.
Tax planning tip: Mandisa’s tax preparer must file IRS Form 8606 to report the basis-related activity. Form 8606 would show how much remains as a basis in the IRA.
Convenience is the name of the game for Mandisa.
Mandisa could have asked her custodian to do a QCD for $40,000 and send the remaining $10,000 to her. But that would mean writing a check for the $10,000 to the charity. Mandisa saved herself a step by having the custodian send the entire $50,000 to the charity.
Reporting a QCD on a tax return
IRA custodians must report QCDs like any regular (non-QCD) distribution, which for traditional IRAs means that the amount would be reported as fully taxable on IRS Form 1099-R. For Roth IRAs, the distribution would be reported as qualified or nonqualified.
The IRA owner’s tax preparer is responsible for reporting a QCD as nontaxable on their tax return by inputting the total distribution from their IRAs on “Line 4a IRA distributions,” excluding any true QCD amount from the total reported on “Line 4b Taxable amount,” and entering “QCD” next to line 4b to indicate that an amount is nontaxable due to being a qualified charitable distribution.
For this article, a “true QCD” is the otherwise taxable portion of a distribution treated as QCD by the IRA custodian. See Mandisa’s example, where the custodian treated the $50,000 as a QCD, but only $40,000 can be treated as a QCD on her tax return.
Can a QCD be made from a nontaxable IRA amount?
While a QCD can be made from a Roth IRA or a traditional IRA that holds after-tax amounts, any nontaxable amount included in the donation would not be treated as a QCD for tax purposes. Since an IRA custodian has no responsibility to determine if a requested QCD includes basis, the IRA owner’s tax preparer must identify any such amount and determine if they should claim the nontaxable portion as a deduction.