Section 2202 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), provides provisions whereby qualified individuals are eligible to receive favorable tax treatment with respect to distribution from eligible retirement plans for coronavirus-related distributions (CRD). With millions of Americans finding themselves out of work or underemployed following the unprecedented shutdown of major portions of the U.S. economy, utilizing the provisions of Section 2202 to take a CRD can go a long way towards making ends meet if you’ve been financially impacted by coronavirus. However, prior to taking any CRD from a retirement account, you should familiarize yourself with the basic requirements surrounding such distributions, as failing to meet the requirements outlined in §2202 could mean thousands of dollars in additional tax at a time when you’re likely already struggling financially.
What tax benefits apply to coronavirus-related distributions?
The main benefit afforded to CRDs is that they are not subject to the additional 10% tax normally applicable to early distributions under §72(t) of the IRC (or 25% in the case of certain distributions from SIMPLE IRAs under §72(t)(6)). For a $100,000 distribution from a traditional IRA, for example, this means a savings of $10,000 over a non-coronavirus-related distribution.
Pre-tax contributions to retirement accounts are generally treated as taxable income, and that hasn’t changed under §2202. However, the law also provides taxpayers the ability to spread the recognition of the taxable income ratably over a 3 year period. Furthermore, if taxable amounts are recontributed to an eligible retirement plan within the 3 year period, the recontributed income will be treated as a tax-free rollover and will not be subject to income tax.
What types of retirement plans are eligible for coronavirus-related distributions?
The types of retirement plans that qualify for CRDs are listed under §402(c)(8) of the IRC, and include:
An individual retirement arrangement (IRA) under §408(a) or (b),
A qualified plan under §401(a) including 401(k) plans,
An annuity plan under §403(a),
A 403(b) plan, and
A governmental deferred compensation plan under §457(b).
Who is eligible to take a coronavirus-related distribution?
Section 2202(a)(4)(A(ii) of the CARES act describes the following individuals as eligible to receive tax-advantaged treatment corona-virus related distributions:
An individual who is diagnosed with COVID-19 by a test approved by the CDC;
An individual whose spouse or dependent is diagnosed with COVID-19 by a test approved by the CDC, or;
An individual who experiences adverse financial consequences as a result of:
the individual being quarantined, being furloughed or laid off, or having work hours reduced due to COVID-19;
The individual being unable to work due to lack childcare due to COVID-19; or
Closing or reducing hours of a business owned or operated by the individual due to COVID-19.
Furthermore, the IRS has exercised its rulemaking authority to expand the list of factors that make an individual qualified for a CRD to include an individual who experiences adverse financial consequences as a result of:
The individual having a reduction in pay (or self-employment income) due to COVID-19 or having a job offer rescinded or start date for a job delayed due to COVID-19;
The individual’s spouse or member of the individual’s household being quarantined, being furloughed or laid off, or having work hours reduced due to COVID-19, being unable to work due to lack of childcare due to COVID-10, having a reduction in pay (or self-employment income) due to COVID-19, or having a job offer rescinded or start date for a job delayed due to COVID-19; or
Closing or reducing hours of a business owned or operated by the individual’s spouse or member of the individual’s household due to COVID-19.
How much can be withdrawn and treated as a coronavirus-related distribution?
Section 2202(a)(2) provides that the aggregate amount of distributions (i.e. the sum total of distributions taken across all qualified retirement accounts) that can be treated as a CRD for any taxable year cannot exceed $100,000. This is on a per-individual basis, meaning married couples are eligible to withdraw up to $200,000 (provided they each have $100,000 in their own respective retirement accounts).
How long do you have to request a coronavirus-related distribution?
As of now, Section 2202(a)(4)(A) of the CARES Act defines a CRD as any distribution from an eligible retirement plan made on or after January 1, 2020, and before December 31, 2020, to a qualified individual. Therefore, if you meet the requirements to be treated as a qualified individual, and are considering withdrawing money from a retirement account, be sure to request the distribution before the end of the year. However, as we approach the end of 2020, and the adverse financial consequences of the pandemic are still ongoing, it would be unsurprising if Congress extends the timeframe for taking a CRD.
How the mechanics of a coronavirus-related distribution works in practice:
In the case of an employer retirement plan, an employer is permitted to choose whether, and to what extent, to treat distributions under its plans as coronavirus related distributions. In general, plan administrators are permitted to rely on a taxpayer’s own certification that they meet the eligibility requirements for a CRD, though they are not required to do so. However, IRS guidance makes it clear that even if a plan administrator does not treat a distribution as coronavirus-related, a qualified individual may treat the distribution as a CRD on their federal tax return if it meets the eligibility requirements.
That being said, as plan administrators are required to report the distribution to the IRS via form 1099-R (even if the distributed amounts are recontributed to the plan in the same calendar year), it’s best practice to reach out to your plan administrator and advise them in advance of the distribution that you intend to treat the distribution as a CRD. Guidance suggests that plan administrators making CRDs are permitted to report the distribution using distribution code 2, indicating an early distribution with an exception to the additional 10% tax under §72(t). If the plan administrator is unaware that the distribution is intended to be a CRD, or otherwise disagrees with the taxpayer’s self-certification, they’re more likely to report the distribution using distribution code 1, meaning an early distribution with no known exception to the additional 10% tax. While your 1099-R showing a distribution code of 1 does not impact your ability to report the distribution as a CRD (assuming you meet the eligibility requirements), it does seem more likely to trigger IRS scrutiny if the distribution is later reported as a CRD.
Once the distribution has been made, there are two methods for a taxpayer to report the taxable portion of the distribution on their tax returns: (a) they can include the distribution ratably over a 3 year period beginning in the year of distribution (i.e. one-third of the income is includable on each of the individual’s tax returns for tax years 2020, 2021, and 2022). Alternatively, a taxpayer may elect to include the entire amount of the taxable distribution in the year of the distribution (in this 2020, unless Congress expands the deadline for CRDs beyond December 31, 2020). This election cannot be made or changed after the timely filing of the individual’s federal income tax return (including extensions) for the year of the distribution, and the reporting methodology chosen must apply to all CRDs taken by the taxpayer. To my knowledge, the IRS has not yet clarified whether spouses that elect to file Married Filing Jointly can elect disparate recognition methodologies for their respective CRDs.
The situation becomes a bit more complicated, however, when one considers the ability of taxpayers to recontribute amounts distributed at any time during the 3-year period beginning the day after the date of a CRD. Under either recognition method above, either a portion or all of the income associated with the distribution needs to be recognized in the year of the distribution (2020 in this case), yet if a taxpayer recontributes the distributed amounts to a retirement account, even in a later year, they’re not subject to tax on the distribution. Which puts taxpayers in the situation of having previously reported taxable income that is no longer considered taxable. The methodology for undoing the previously reported taxable income depends on how the taxpayer chose to recognize the income:
If a taxpayer elects to include all CRD as gross income in the first year of distribution, the taxpayer will need to file Form 8915-E with their federal income tax return for the year of distribution, reporting the amount of recontribution. If the amounts are contributed after the due date of the return for the year of distribution, the taxpayer would need to file an amended federal income tax return, including Form 8915-E, to report the amount of the recontribution and reduce the gross income previously reported on the return.
If a taxpayer elects to include the CRD in gross income amounts ratably over 3 years, any recontributions made before the timely filing (including extensions) of any return will reduce the ratable portion of the CRD that is includible in gross income for that tax year.
If a taxapyer elects the 3-year inclusion methodology and recontributes an amount that exceeds the amount that is otherwise includible in gross income for that tax year, the excess amount of the recontribution can be carried forward to reduce the amount of CRD that is includible in gross income in the next tax year in the 3-year period. Alternatively, the taxpayer is permitted to carry back the excess amount of the recontribution to a prior taxable year or years in which the individual included income attributable to a CRD, which will require the filing of an amended return to include Form 8915-E.
This is a broad overview of the provisions surrounding coronavirus-related distributions, and does not address changes made to retirement loan provisions under the CARES Act. The provisions of Section 2202 provide ample opportunity for tax planning, allowing you to tailor both the timing of income recognition and repayment to suit your individual needs. However, additional guidance is still expected in the future. If you’re considering taking a coronavirus-related distribution, please call us. We can advise you on your options and handle your tax filings to ensure both income and repayment amounts are handled property, so you don’t get hit with a surprise tax bill by the IRS.