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CARES allows early retirement fund access

IRS recently released guidance (Notice 2020-50) for the tax treatment of qualified coronavirus-related distributions from retirement plans. The recent CARES legislation allows a CV-related distribution to escape the 10% penalty for early withdrawals, be reported over a three-year period, and avoid any reported income if the distribution is repaid within three years.Jim Hamill

The guidance explains how both plan administrators and beneficiaries should treat the payments and provides a sample certification statement to be made by the recipient of the distribution. A new IRS form (8915-E) will be created by year end to report the tax consequences of the distribution.

Many people are experiencing financial challenges as a result of the COVID-19 pandemic. The retirement plan provisions of CARES are designed to allow plan beneficiaries to tap retirement assets to meet short-term financial needs. The provisions also allow participants to recontribute funds to the plan if their financial circumstances allow that within the next three years.

The basic provisions allow qualified individuals to withdraw as much as $100,000 in calendar 2020 with the three previously mentioned tax benefits – no early withdrawal penalty, three-year income spread, and three-year repayment option to eliminate any tax effect.

A qualified individual is one who has a positive COVID test result or who has a spouse or dependent with a positive test. More broadly, it includes anyone who has experienced adverse financial consequences as a result of the COVID-19.

Adverse financial consequences is broadly defined to include the effects of being quarantined, being furloughed or laid off, having reduced work hours, being unable to work due to lack of childcare, or the closing or reduction of hours of a business owned or operated by the individual.

The interesting aspect of the guidance is that a qualified individual does not need to demonstrate a need for the funds withdrawn and there is no requirement that the distribution correspond to any actual adverse financial consequence.

Note that a positive COVID test alone makes one a qualified individual without regard to any demonstrated financial consequence of that test result. Without a positive test qualification requires satisfying one of the adverse consequence situations.

Let’s say Lisa is a 39-year-old self-employed individual with 2019 income of $200,000. Lisa provides consulting services to various clients and her income allows her to save $40,000 per year. One of Lisa’s clients is in Chicago and Lisa travels to the client’s offices to perform services. She earns $30,000 per year from the Chicago client.

Because of COVID-19, Lisa’s Chicago client informs her they will not be using her services in 2020. The client’s offices are closed and they have decided that Lisa’s services are beneficial only in person. Lisa takes a $30,000 distribution from her IRA. She does not need the funds to satisfy any specific financial need and her other income allows her to cover all expenses and to also save some money in 2020. Her plan is to return the $30,000 to the IRA within three years so the distribution is nontaxable.

Lisa is a qualified individual because she has experienced a reduction in her self-employment income due to COVID-19. She does not need to show any specific need for the distribution. The IRS Notice provides a sample certification that she can provide to the plan administrator.

Lisa will be able to spread the $30,000 income over three years. Even if she does not return the funds she will report $10,000 as income in 2020, $10,000 in 2021, and $10,000 in 2022. There will be no penalty for taking the funds before age 59½.

If Lisa returns all $30,000 before the due date of her 2020 tax return, she will report no income in 2020 (or any other year). This gives her until as late as Oct. 15, 2021. to return the funds provided she files an extension and waits until the last filing date. Lisa could also wait until 2022 to return the $30,000. This will require her to include $10,000 as income on her 2020 return and also $10,000 on her 2021 return, unless she returns the funds before the 2021 return is filed. She will have to amend the 2020 return (and perhaps 2021) to remove the previously reported income.

James R. Hamill is the Director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.

 

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