By Anthony Diosdi
Recently, President Donald Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”). The CARES Act allows retirement savers to take “coronavirus-related distributions” of up to $100,000 from their Individual Retirement Account (‘IRA”) and 401(k) plans without the 10 percent penalty that normally applies to people under age 59 1/2. If effect, the new law allows individuals that made contributions to retirement plans to borrow up to $100,000 from the plan and re-contribute the amount borrowed at any time with up to three years with no federal income tax consequences. In other words, if an individual takes a distribution from a retirement account, he or she will have three years to repay the money withdrawn from the retirement plan. If the individual does not replace the funds distributed from a retirement plan, the retirement saver will be taxed on the distribution. However, the individual will not be assessed the 10 percent penalty. There are no income limits on the withdrawal and no restrictions regarding how the withdrawn money is used.
Distribution and Repayment Terms
Individuals can take distributions from more than one retirement account as long no more than $100,000 is taken in the aggregate.The three-year re-contribution period begins to run on the day a distribution is taken from a retirement account. An individual can pay the money back in a lump sum or make multiple re-contributions back to his or her retirement plan(s). The retirement saver can re-contribute to one or several retirement accounts. The individual does not need to repay the same account that he or she took a distribution from in the first place. As long as the individual repays the same distribution taken from his or her retirement accounts within the three-year window discussed above, the payments will be treated as tax-free rollovers. In addition, as discussed above, the 10 percent early withdrawal penalty will not be assessed by the Internal Revenue Service (“IRS”).
Who Can Take a Distribution from a Retirement Account Without an Early Withdrawal Penalty?
The CARES Act provides that a distribution of up to $100,000 from an eligible retirement plan that is made on or after January 2, 2020 and before December 31, 2020, may qualify for the beneficial tax treatment as long as the individual satisfies one of the following criteria:
1. The individual is diagnosed with coronavirus (“COVID-19”) by a test approved by the Centers for Disease Control and Prevention;
2. The individual’s spouse or dependent is diagnosed with coronavirus by such a test;
3. The individual experiences adverse financial consequences as a result of being quarantined, furloughed, laid off, or forced to work reduced work hours due to coronavirus;
4. The individual is unable to work because of a lack of child care due to the coronavirus and experiences adverse financial consequences as a result;
5. The individual operated a business that has closed or had operating hours reduced due to the coronavirus, and has experienced adverse financial consequences as a result;
6. The individual has experienced adverse financial consequences due to other coronavirus related factors to be specified in future IRS guidance.
The IRS has yet to issue regulations or any guidance regarding the last two factors discussed above.
What are the Federal Income Tax Consequences of not Re-contributing Distributions Within a Three-year Window
If a retirement saver does not re-contribute money taken from his or her retirement plans, the individual will owe federal income tax on the withdrawal(s). However, the individual will not be assessed a 10 percent early withdrawal penalty if he or she is under 59 ½ years old.
If a retirement saver elects not to repay the funds withdrawn from his or her retirement accounts, the retirement saver can elect to spread the taxable amount of the distribution equally over a three year period starting with the 2020 tax year.
Below please see an illustration how the three-year window operates.
Illustration
On May 1, 2020, Uncle Sam decides to withdraw $75,000 from his IRA and does not elect out of the three-year spread. This means that Uncle Sam will have $25,000 of taxable income in 2020, 2021, and 2022. However, since the three-year recontribution window will not close until May 1, 2023, it will not be clear if Uncle Sam decided to take advantage of the tax-free rollover provisions of the CARE Act. Thus, Uncle Sam may need to amend his 2020, 2021, and 2022 individual income tax returns to report the tax consequences of the IRA distribution.
The Mandatory Withdrawal for Retirement Account Holders that Turned 70 ½ Has Changed
As part of the new law, Congress is permitting savers to skip so-called required minimum withdrawals or RMDs from their retirement accounts in 2020. These mandatory withdrawals must be taken each year after account holders turn 70 ½. Beginning in 2020, the RMDs age was raised to 72.
Anthony Diosdi is a partner and attorney at Diosdi Ching & Liu, LLP, located in San Francisco, California. Diosdi Ching & Liu, LLP also has offices in Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises clients in tax matters domestically and internationally throughout the United States, Asia, Europe, Australia, Canada, and South America. Anthony Diosdi may be reached at (415) 318-3990 or by email: adiosdi@sftaxcounsel.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.