Required Minimum Distributions (RMDs) are included in your Adjusted Gross Income (AGI), while QCDs are not. Thus, QCDs can lower your AGI dollar-for-dollar, and a lower AGI can trigger further tax advantages and reduce overall tax liability.
1. Potential to Deduct More Medical and Dental Expenses
If you itemize deductions, starting in 2021, you can deduct medical expenses only in excess of 10% of your AGI. Therefore, the lower your AGI is, the more of your medical and dental expenses you can deduct.
For example, if your AGI is $75,000, 10% is $7,500 and all expenses over $7,500 are deductible. If your AGI is $50,000 then the threshold is $5,000.
2. Potential to Reduce Medicare Premium Surcharges
If you are above a certain income threshold, you are required to pay a surcharge on top of your standard Medicare premiums. This extra charge is known as an Income Related Monthly Adjustment Amount (IRMAA) and applies to Medicare Part B (which covers outpatient services and doctors’ fees) and Medicare Part D (which covers prescription drugs).
In 2021, the IRMAA surcharges apply to persons with Modified Adjusted Gross Income (MAGI) >$88K on a single return or >$176K on a joint return.
Lowering your AGI by using a QCD could potentially reduce this surcharge.
Note: In 2021, the MAGI amount used is based on the taxpayer’s 2019 return
3. Potential to Limit Exposure to NIIT Tax
QCD’s can help limit exposure to the 3.8% Net Investment Income Tax (NIIT). Also known as the 3.8% Medicare surcharge, this tax effects those with AGI exceeding certain thresholds: over $200,000 (Single) or over $250,000 (Married Filing Jointly). Effective tax planning will seek to keep AGI below NIIT thresholds.
*See video to learn how NIIT is calculated and how a QCD can reduce this cost*
4. Potential to Lower Social Security Taxes
The taxability of your Social Security is based on “combined income,” which is defined as:
Combined income = AGI + Non-taxable interest + ½ of Social Security
If your combined income is greater than $25,000 for single filers or greater than $34,000 for married or filing jointly, then your benefits become taxable. In reducing your AGI through using a QCD, you may reduce the taxability of your Social Security income.
5. Get “Full Credit” for Your Contribution
Because of increases to the standard deduction, many find it is less advantageous to itemize deductions.
If the sum of your non-charitable contribution itemized deductions is less than the standard deduction, you might not receive a dollar-for-dollar deduction for your charitable gifts. A QCD reduces your taxable income by the amount of the QCD, independent of the standard deduction, which has the same impact as if the charitable gift was fully deductible.
Regardless of whether you itemize or take the standard deduction, you can get “full credit” for your QCD by having that amount taken out of your AGI. Lowering your AGI could potentially reduce your thresholds and allow you to take greater advantage of your deductions.