Should Qualified Plan or IRA Distributions be Included on the 2020 Return?

Making the Argument to Include Entire Qualified Plan or IRA Distributions on the 2020 Return.

To assist taxpayers financially during the pandemic, Congress enacted several changes to early withdrawal rules from qualified plans and IRAs. These changes allow taxpayers early access to their funds without penalty and permit spreading out the inclusion of distributions in income. In addition to these relaxed rules, Congress also provided a mechanism for taxpayers to return the funds to qualified plans and IRAs within three years of 2020 distributions.

What provisions am I describing?

1. Before 2018, employees who borrowed from their qualified plans and then left employment had only 60 days to reinvest the funds or have the loan treated as an early, deemed distribution subject to taxation and an early withdrawal penalty. Beginning in 2018, the Tax Cuts and Jobs Act (TCJA) increased the time to reinvest the loan proceeds from 60 days to the due date of the tax return for the year of deemed distribution, plus extension. (Referred to as “loan offset” rules)
2. The Further Consolidated Appropriations Act (FCAA) removed the 10% penalty for early distributions from qualified plans for withdrawals up to 100% of an account balance or $100K, whichever is less. The $100K limit was an increase from the previous $50K or 50% of the account balance limit. This law introduced the ability to reinvest the early withdrawal within three years and also the ability to include the distribution as income ratably over three years. The caution to consider here is that these withdrawal provisions were placed into effect for taxpayers impacted by disasters and had qualified disaster distributions. IRS Publication 590-B provides more guidance in this area.
3. The Coronavirus Aid, Relief, and Economic Security Act (CARES) (PL 116-136) built off the provisions of the FCAA by including persons impacted by the coronavirus pandemic as being able to avoid the 10% early withdrawal penalty, withdraw up to $100K, and have three years to reinvest withdrawals as provided by the FCAA, or report the distribution ratably over three years. In essence, the CARES Act provisions provide that the coronavirus rises to the level of a disaster for persons impacted by the pandemic.

Distributions must have occurred after January 1, 2020, and before December 31, 2020, for the CARES Act provisions to apply.

If you are concerned as to what degree the coronavirus may have impacted your client, 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 that impacts many, if not all, of your clients.

Let’s assume taxpayers took early distributions under these rules. Why should you consider advising clients to report ALL of the distribution in 2020 rather than reporting the income ratably over tax years 2020, 2021, and 2022?

Our training and experience as tax professionals have us programmed to accelerate expenses and defer income recognition whenever possible. Perhaps the filing of 2020 returns should give us cause to reconsider our long-held programming.

Why?

1. Perhaps the taxpayer’s 2020 income is lower than previous years due to the COVD-19 business environment.
2. The taxpayer expects income to increase in years after 2020.
3. The taxpayer has a 2020 net operating loss (NOL), which you may advise to carry forward instead of carrying it back to years before 2020.
4. Is it possible tax rates in 2021 and 2022 might be higher than they were for 2020?
5. All withholding on those early distributions can only be claimed in 2020.   Withholding cannot be included ratably as the distributions can. That’s good news for 2020 reporting, but not so good news for the balance of those distributions reported ratably in 2021 or 2022.

There’s a Form for that… 8915-E.

Regardless of the client’s decision, early distributions either being included ratably or all in 2020 are reported on Form 8915-E.

The government anticipates most taxpayers will include the distributions ratably and has provided a box to check on the form if the taxpayer has decided to include the income all in 2020. 

One additional note to mention: While the most recent tax legislation enacted in December provides much the same relaxed early withdrawal rules for distributions between January 1 and June 30, 2021, these withdrawals must be disaster-related and not COVID-related. The law specifically makes this distinction (Title III, §302).

Taxpayers who take early distributions for other reasons in 2021 are subject to the “pre” disaster relief rules (such as the 60-day rule, which is still alive and well) unless there is additional action from Congress, which is entirely possible.

Hopefully, this discussion gets you thinking about the valuable planning you can provide taxpayers beyond just accurate number crunching. While not applicable to all clients and all situations, my goal is to provide you with more food for thought.

by Tom O’Saben, EA