Tax Relief on Corona-related Retirement Distributions
As the coronavirus disease 2019 (COVID-19) continues to impact all of our lives, for those who are experiencing financial difficulties, the Coronavirus Aid, Relief, and Economic Security (CARES) Act has provided various means of providing support.
One of those means is providing tax relief on coronavirus-related distributions and loans from qualified retirement plans. On June 19, 2020, the IRS issued Notice 2020-50, which provides guidance on the relief provided within Section 2202 of the CARES Act.
The first part is understanding who is considered a qualified individual under this section of the CARES Act. For this purpose, a qualified individual is:
- Someone who either themselves, or whose spouse or dependent is diagnosed with the virus SARS-CoV-2 or with the COVID-19 by a test approved by the Centers for Disease Control and Prevention (CDC) including a test authorized under the Federal Food, Drug, and Cosmetic Act.
- Someone who either themselves, their spouse, or an individual who shares the same principal residence has experienced adverse financial consequences as a result of COVID-19 from:
- Being quarantined, being furloughed or laid off, or having work hours reduced;
- Being unable to work due to lack of childcare;
- Closing or reducing hours of a business owned or operated by an individual, their spouse or a member of the individual’s household;
- Having a reduction in pay (or self-employment income); or
- Having a job offer rescinded or start date for a job delayed.
With that understanding, we can now look at what the CARES Act defines as a coronavirus-related distribution. A coronavirus-related distribution is one made to a qualified individual as described above, that is withdrawn from a qualified retirement plan on or after January 1, 2020 and before December 31, 2020, up to $100,000.
Typically, distributions from a retirement plan for those that have not yet reached the age of 59 ½ and that do not meet any other early withdrawal exceptions under the law are subject to a 10% early withdraw penalty (or potentially a 25% additional tax for SIMPLE IRAs). Under the CARES Act, those early withdrawal penalties do not apply to coronavirus-related distributions.
In addition, whereas the full amount of the distribution would be included in income in the tax year of the withdraw, qualified individuals will have the option to include the coronavirus-related distribution in income ratably over 3 years. Subject to certain limitations, if any of the funds are recontributed to an eligible retirement plan during the 3-year period that begins when the distribution funds were received, the withdraw will be treated as a direct rollover and be excluded from income. If you reported a coronavirus-related distribution in 2020, and recontributed the contribution in 2021 or 2022, you will file an amended return for the related income that was included in your taxable income in those preceding tax years.
Administrators of the retirement funds are typically required to withholding 20% for Federal Income Tax. That requirement is waived, though it is important to remember the income is still taxable, so some withholding would still be recommended if there is no intention of recontributing the funds.
When it comes time to file your 2020 Federal Income Tax returns, these items will be reported on Form 8915-E, Qualified 2020 Disaster Retirement Plan Distributions and Repayments.
The other relief provided in Section 2202 of the CARES Act applies to loans taken from an eligible retirement plan. The CARES Act increases the amount an individual may borrow from their retirement account from $50,000 to $100,000 for loans made to a qualified individual on or after March 27, 2020 through September 22, 2020, capped at the individuals vested benefit under the plan. In addition, for any loan outstanding on or after March 27, 2020 that has a repayment due on or after March 27, 2020 through December 31, 2020, the repayment may be delayed up to one year.
Do keep in mind that the additional relief provisions provided under Section 2202 of the CARES Act are only available if the qualified retirement plans are amended to take advantage of the expanded benefits. Employers are not required to make amendments to their retirement plans and may be selective in which benefits they do decide to provide, if any. Therefore, employers may choose to amend their plan to allow for coronavirus-related distributions but choose not to allow for expanded loan and repayment benefits, or vice versa.
Within the CARES Act, under Section 2203, another item of relief was provided for those over the age of 70 ½ in 2020 that would have been required to make Required Minimum Distributions (RMD). This section provides a temporary waiver from making these withdraws. The IRS issued Notice 2020-51 on June 24, 2020 providing guidance on this, and indicating that anyone who had taken distributions for 2020 that would have been an RMD prior to the CARES Act has until August 31, 2020 to recontribute the funds back into their plan, and it will be treated as a tax-free rollover.
If you already have, or plan to make a coronavirus-related distribution from your qualified retirement account, make sure to reach out to your tax advisor to ensure proper steps are taken.