Information on Coronavirus Stimulus Packages
Information on Coronavirus Stimulus Packages All of the acts, programs, loans, etc that have been released with the Coronavirus Stimulus Packages can get confusing. If you have tax clients that…
November 9th, 2020
We are all painfully aware of the economic issues created by the coronavirus pandemic. You may find clients (or for that matter, yourself) in dire financial straits and wondering what alternatives might be available outside of filing bankruptcy. For you or your clients with IRAs or qualified plans, recent tax laws provide the means to access qualified plan money and perhaps avoid not just early withdrawal penalties but also tax on qualified plan distributions.
While I am not attempting to provide financial planning advice, and it could easily be argued that accessing qualified plans prior to retirement may be considered the worst advice possible, the changes and options described below may give you or your client options beside financial ruin and provide the ability to put things back the way they were prior to the crisis.
Distributions must have occurred after January 1, 2020 and before December 31,2020 for the CARES Act provision to apply.
If you are concerned as to what degree your client may have been impacted by the coronavirus, here are the rules:
PL 116-136, §§2202(a)(1) and (a)(4)(A)(4): DEFINITIONS.—For purposes of this subsection— (A) CORONAVIRUS-RELATED DISTRIBUTION.—Except as provided in paragraph (2), the term ‘‘coronavirus-related distribution’’ means any distribution from an eligible retirement plan made— (i) on or after January 1, 2020, and before December 31, 2020, (ii) to an individual—
(I) who is 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,
(II) whose spouse or dependent (as defined in section 152 of the Internal Revenue Code of 1986) is diagnosed with such virus or disease by such a test, or
(III) who experiences adverse financial consequences as a result of being quarantined, being furloughed or laid off or having work hours reduced due to such virus or disease, being unable to work due to lack of child care due to such virus or disease, closing or reducing hours of a business owned or operated by the individual due to such virus or disease, or other factors as determined by the Secretary.
Definition (III) should be the one which impacts many, if not all, of your clients.
John McWilliams, a longtime client of your firm, contacted you back in early April. He was concerned that his family needed cash, so he asked you what made the most sense from a tax perspective. You explained to him that thanks to the CARES Act, he could borrow up to 100% of his 401(k) plan or $100K, whichever was less. And, that borrowed funds would not be taxable income unless he did not repay the loan. John thanked you for the advice.
John called your office again in June. He was concerned that he had made a mistake taking the 401(k) loan because, due to the business impact of the coronavirus pandemic, he lost his job and has no means to repay the 401(k) loan. You explained that prior to the enactment of the TCJA in December of 2017, taxpayers who lost the ability to repay their 401(k) loans via payroll deduction had to come up with funds to repay the loan within 60 days of termination or be forced to treat the loan as an early distribution, subject to tax and penalty. The new law, you explained, under TCJA, gives John until the due date of his tax return, plus extension, for the year of default (2020 in our example), to repay the loan amount to another qualified plan or IRA and not be subject to the tax and penalty. In other words, John has until October of 2021 before the loan default creates a problem.
John thanked you for the advice but is fearful given the economic climate created by the pandemic that he will not be able to get the money reinvested by October of 2021 and asked you if there are any other strategies he could pursue. Assuming John cannot repay the 401(k) loan, his default will be considered a deemed distribution from a qualified plan, subject to tax but not an early withdrawal penalty because you can argue it was a coronavirus-related distribution.
You mentioned that the CARES Act also provides a mechanism to repay early, pandemic-related withdrawals within three years of the time it was withdrawn (as long as the withdrawal occurred after January 1, 2020 and before December 31, 2020) and remove the inclusion of the income from being taxed. You explained that we will at least need to report the distribution ratably over the three years but if John would find himself in a position to reinvest some or all of the distribution, we could amend the earlier returns and recover the taxes he paid.
In early 2022, John contacted you and explained that his aunt passed away and left him $250K. Eager to minimize any potential tax consequence, he inquiries what can be done. You remind him of the provisions mentioned under the CARES Act and in 2022 John reinvests $100K to an IRA. You amend his 2020 and 2021 returns (2022 wasn’t filed yet) to remove the ratably included deemed distributions from 2020 and 2021. John will now be refunded the tax he paid in the earlier years for the ratably included distribution.
As explained at the outset, accessing IRAs and qualified plans may be a huge mistake from a retirement planning perspective, but the provisions afforded taxpayers via recent legislation may save clients from financial ruin while providing an opportunity to make their accounts whole again. While few clients may experience a windfall as John in our example did, three years may provide time to least reduce the impact of 2020 withdrawals, reduce the tax burden created by these withdrawals and get your client back on the path to a more stable and comfortable retirement.
by Tom O’Saben, EA
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