The Coronavirus Aid, Relief and Economic Security (CARES) Act , signed into law in March 2020, provided a lifeline to many Americans struggling in the wake of the COVID-19 pandemic and the economic turmoil that followed. Among the law’s many provisions was the ability for certain taxpayers impacted by COVID-19 to take distributions of up to $100,000 from an IRA or eligible retirement plan in 2020, with the option of spreading the tax liability over a three-year period. In addition, taxpayers have up to three years to recontribute all or a portion of those funds.
If you took a qualifying distribution from your retirement plan in 2020, here’s what you need to know before you file your tax return.
The IRS defines a coronavirus-related distribution (CRDs) as a distribution that is made from an eligible retirement plan to a qualified individual from January 1, 2020, to December 30, 2020, up to an aggregate limit of $100,000 from all plans and IRAs. As a result, individuals under age 59 ½ would not be subject to the 10% early withdrawal penalty (25% on SIMPLE IRAs) on qualifying distributions.
You can spread your tax liability over one or three years
In order to receive the favorable tax treatment, taxpayers must report all CRDs on IRS Form 8915-E, which is expected to be finalized and available to taxpayers later this month. Taxpayers will have a choice between reporting their entire distribution under one year or spreading it equally over three years. For example, if you took an eligible distribution of $75,000, you could elect to report the entire amount on your 2020 tax return or choose to report $25,000 on each of your 2020, 2021, and 2022 tax returns. Spreading the reporting of the distribution over three years reduces the single year tax burden that may result from a large taxable withdrawal.
However, determining how to spread the tax liability can get complex. In part, it depends on whether you expect your taxable income in subsequent years to be lower or higher than it was in 2020. That makes it important to consult with your tax and financial advisors now, since the election to spread the distribution over three years must be made at the time you file your 2020 tax return and cannot be made or changed after that time.
Keep in mind, if you took multiple coronavirus-related distributions in 2020, you must treat them all the same. You must either include all eligible distributions on your 2020 tax return or elect to spread them all over a three-year period.
How does the new stimulus bill impact CRDs?
The Consolidated Appropriations Act, 2021, which was signed into law on December 27, 2020, did not extend the time available for retirement plan participants to take CRDs beyond the December 30, 2020 expiration date for the CARES Act provision. However, it did add money purchase pension plans as a plan type from which participants could take a CRD in 2020, retroactive to the passage of the CARES Act.
The Consolidated Appropriations Act, 2021, also allows for distributions from retirement plans for participants affected by disasters other than the COVID-19 pandemic, as declared by the president. As reported by PlanAdvisor.com, participants in 401(k), 403(b), money purchase pension and government 457(b) plans may take up to $100,000 in aggregate from whatever retirement plan accounts they own without tax penalties. Participants have until 180 days after enactment of this new bill to take qualified disaster distributions. Similar to the rules for CRDs, income tax on these distributions may be spread over three years, and participants may repay them into a plan that is designed to accept rollovers within three years. (Before taking action, be sure to discuss this with your tax advisor to make sure your distribution qualifies under these new rules.)
Why should I consider repaying my distribution(s)?
Eligible taxpayers who took qualified CRDs in 2020, or qualified disaster distributions, will have up to three years to repay all or a portion of the funds to an eligible retirement plan. According to IRS guidelines, CRDs may be recontributed under the following conditions:
- Recontribution is only allowed for distributions that would normally be eligible for tax-free rollover treatment. For example, non-spouse beneficiaries of IRAs are not allowed tax-free rollovers under general IRA regulations. While these taxpayers could qualify for favorable tax treatment of their coronavirus-related distributions, they would not have the option of repaying any distributed amounts under the CARES Act provisions.
- The amount repaid to eligible retirement plans cannot exceed the total of the taxpayer’s coronavirus-related distributions. In other words, you can’t recontribute more than you withdrew.
- Repayment(s) must be made within the 3-year recontribution period which begins on the day after the date of a coronavirus-related distribution.
While there is no requirement to recontribute the funds, there are several good reasons to do so. First, if the distribution is taxable income, repaying all or a portion of it will reduce or eliminate the associated tax liability. Second, even if the distribution is not taxable (certain Roth distributions), repaying the distributed amount(s) would enable those funds to grow on a tax-deferred basis. Remember, the longer those funds sit outside of your retirement account, the longer it may take to reach your retirement planning goals.
As is the case with coronavirus-related distributions, eligible recontributions will be reported to the IRS using Form 8915-E. The timing of the reporting will depend on when the recontribution is made and whether the taxpayer chooses to report the entire distribution as income in 2020 or split the report of income over three years. Additionally, in some cases, the recontribution will require an amendment to a previously filed tax return.
Since the reporting of distributions and recontributions can be complex, it’s important to consult your tax advisor to ensure proper reporting of these transactions. Then be sure to schedule time to meet with your financial advisor to talk about ways to get back on track toward your important retirement goals.
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