CARES Act Relief: Retirement Distributions

Did you take an early distribution from your retirement account in 2020?

Many of my clients find themselves with an unexpected tax liability when financial hardship, and sometimes poor planning, force them to take an early distribution from their retirement plan. Normally, taxpayers who are under 59 ½ years of age must pay a 10% penalty in addition to income tax on early distributions. In many cases, an early distribution can push the taxpayer’s taxable income to a higher tax bracket, making matters more severe. The problem is exacerbated by the fact that plan administrators generally withhold only 20% or less of the proceeds to cover the tax bill.

Signed into law on March 27, 2020, the CARES Act provides taxpayers with significant relief options relating to retirement distributions taken during 2020.

Do you qualify for relief?

Current criteria to qualify for relief are as follows. The IRS may expand guidance before filing:

• You are diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (COVID-19) by a test approved by the Centers for Disease Control and Prevention;

• Your spouse or dependent is diagnosed with SARS-CoV-2 or with COVID-19 by a test approved by the Centers for Disease Control and Prevention;

• You experience adverse financial consequences as a result of being quarantined, being furloughed or laid off, or having work hours reduced due to SARS-CoV-2 or COVID-19;

• You experience adverse financial consequences as a result of being unable to work due to lack of child care due to SARS-CoV-2 or COVID-19; or
• You experience adverse financial consequences as a result of closing or reducing hours of a business that you own or operate due to SARS-CoV-2 or COVID-19.

Penalty relief for early distribution.

The CARES Act allows for early distributions up to $100,000 taken during the 2020 tax to be exempt from the 10% penalty.  Taxpayers must meet the above eligibility requirements set forth by the IRS. In order to exclude the penalty, taxpayers must file the appropriate form with their individual return.

You can spread the income over three years.

The IRS allows you to spread the income from your qualified distributions ratably over a three-year period (2020, 2021, and 2022). For example, if you take a $30,000 qualified distribution during 2020, you may report this income ratably in each year ($10,000 in 2020, $10,000 in 2021, and $10,000 in 2022). You may also elect to include the entire distribution in 2020.

You can repay the distribution before the end of the 2022 tax year.

One of the most exciting aspects of this section of the CARES Act is that it allows taxpayers to repay all or a portion of their retirement distributions within three tax years. If you choose to do this, you must file amended tax returns to remove the income related to any repaid distributions allocated to 2020 and 2021. You will be able to claim a refund for the reduction in tax related to those distributions that were repaid. The repayment of the distribution is treated as a trustee-to-trustee transfer.

Summary

We can expect the IRS to expand guidance as we get closer to the 2020 tax season. If you are planning to take a distribution from a qualified retirement account, you should consider speaking with your tax professional to determine CARES Act relief eligibility as well as potential tax implications. Feel free to contact the professionals at Murtha & Murtha to assist in your tax planning needs.

Patrick Murtha

Partner

Murtha & Murtha LLC