Qualified Charitable Distributions from an IRA with Basis

A reader writes in, asking:

“I’ve seen articles about how to calculate the taxable amount of an RMD when the distribution from the Traditional IRA contains both pre-tax and post-tax dollars.

I’ve seen articles about how taking a QCD from your Traditional IRA reduces the taxable amount of your RMD to be reported to the IRS.

But I have not seen anything (and research has come up empty) about taking QCDs from a “mixed” Traditional IRA.  Specifically, (a) how to calculate the taxable amount of the RMD to be reported on Form 1040 and (b) how to calculate the remaining basis of the Traditional IRA.”

First, let’s give a bit of background on what this reader is asking about. Qualified charitable distributions (QCDs) are distributions from an IRA directly to a charity. And despite being a distribution from a traditional IRA, they are not taxable. (See “Qualified Charitable Distributions vs. Donating Appreciated Stock” for more details.)

And, the other topic in question here is how distributions work from a traditional IRA when you have basis (i.e., when you have made nondeductible contributions to your traditional IRA). When you have basis in your traditional IRA, a portion of each distribution is nontaxable. Specifically (when there’s no QCD also involved), that nontaxable percentage is calculated as:

• Nontaxable percentage of the distribution = Your basis in the traditional IRA ÷ (traditional IRA balance at the end of the year + distributions/rollovers/conversions out of traditional IRA during the year).*

When we add a qualified charitable distribution into the mix as well, then the first thing to know is that the QCD is always nontaxable. And, provided that your non-basis amounts in the IRA exceed the amount of the QCD, then:

• The QCD does not reduce your basis, and
• For the sake of calculating how much of the other distributions are taxable/nontaxable (and how much basis is left in the IRA afterwards), it’s as if the QCD amount was gone from the IRA before the year even began.**

This is because the QCD is not included at all on Form 8606 as a distribution. (On the line for reporting distributions, the form itself explicitly says: “do not include […] qualified charitable distributions.” The instructions say the same thing.)

Let’s Walk Through an Example

Imagine that you only have one traditional IRA, and at the beginning of the year, the account balance is $100,000 and you have $12,000 of basis in the IRA (from having made $12,000 of nondeductible contributions). During the year you make a qualified charitable distribution of $7,000 and you take other distributions of $6,000. At the end of the year, the IRA balance is $90,000.

First things first: the QCD is nontaxable. Because those are just the rules for QCDs.

Then to calculate how much of the $6,000 of other distributions are taxable, we follow our math from above:

• Nontaxable percentage = basis ÷ (balance at the end of the year + distributions/rollovers/conversions out of the account during the year).
• Nontaxable percentage = 12,000 ÷ (90,000 + 6,000) = 12.5%.

Remember, we exclude the QCD from this math. That’s why the denominator is $96,000 rather than $103,000.

So, 12.5% of the $6,000 distribution is nontaxable ($750). The remaining 87.5% of the $6,000 distribution is taxable ($5,250). In total, $13,000 of distributions were made from the IRA, and $5,250 is the amount that would be taxable. And at the end of the year, you would have $11,250 of basis in the IRA (because $750 of the basis was distributed tax-free this year).

*If you have multiple traditional IRAs, they are considered to be one IRA for this purpose.

**If the amount of the distribution to charity exceeds your non-basis amounts in traditional IRAs, then the QCD is limited to your non-basis amounts, because QCDs are limited to the amount that would otherwise be taxable. For example, imagine that your traditional IRA balance includes $6,000 of basis from nondeductible contributions and $2,000 of earnings — and that’s it. And you have $5,000 distributed directly to a charity. The QCD is limited to $2,000 because it’s only the earnings that would normally be taxable. The rest of the distribution ($3,000) is still nontaxable, but it’s considered to be nontaxable distribution of basis rather than QCD.