Congress Provides Retirement Account Tax Relief for 2020 but Creates Complexity and Record Keeping Burdens
By: Robert S. Schwartz, Esq.
June 25, 2020
The Coronavirus Aid, Relief, and Economic Security Act (the “Act”) became law on March 27, 2020. The Act mainly targets many of the adverse effects of coronavirus. One big adverse effect has been the loss of paychecks, or their substantial reduction, for millions of families. Act Section 2202 provides relief from what otherwise often are the adverse tax consequences of using accumulated retirement benefits as a source of cash to pay bills. Another adverse effect of coronavirus has been reductions in values of retirees’ IRA, Section 401(k) and similar employee contribution oriented retirement accounts compared to December 31, 2019. Most often holders sell retirement account investments to raise RMD cash. Act Section 2203 provides relief from what otherwise would be the adverse tax consequence of a 50% excise tax for not drawing out sufficient cash to satisfy a year’s required minimum distribution (“RMD”) amount.
Section 2202 provides relief from what would otherwise be adverse tax consequences of a worker using accumulated retirement benefits as a source of cash to pay bills. This relief extends to an individual’s current retirement account, as well as any IRA account an individual might have, which is typically the result of a “rollover” from a prior employer retirement account. Basically, Congress is allowing up to $100,000 penalty-free coronavirus-related distributions during 2020. Also, retirement plan administrators or IRA custodians need not withhold 20% of a distribution as an income tax prepayment on qualifying distributions. For a worker having a contribution oriented retirement plan account, as well as a worker having a rollover IRA, distributions are income taxable and ordinarily, premature distributions, i.e., pre-age 59 ½, draw a 10% penalty. The 10% penalty exceptions, notably the “hardship exception,” are complex enough to make one’s head spin. Section 2202 is more focused.
A coronavirus-related distribution means one or more 2020 distributions totaling not more than $100,000 from an eligible retirement plan account and/or an IRA made to (1) an individual 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, or, (2) an individual whose spouse or a dependent is so diagnosed, or (3) an individual “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.…” Let’s denominate these as “The Three Ways.”
Section 2202 contains other taxpayer favorable, but complex, provisions for coronavirus-related distributions. Only general observations make any sense. There is no substitute for getting specific tax planning advice. Section 2202 indicates that federal income taxes are due on 2020 coronavirus-related distributions, but total 2020 distributions are spread equally over the 2020, 2021 and 2022 Form 1040. The spread effect often will be that the distributee will be paying income taxes at a lower tax rate compared to having to include all of the 2020 distributed amount in 2020 taxable income. As if to demonstrate just how varied are the tax situations of the tens of millions of Form 1040 filers, however, Section 2202 permits taxpayers to include all of the 2020 distributions as income on their 2020 Form 1040s. For a relative few this choice is going to be more income tax efficient than three-year spreading. One can further observe that state income tax rules for 2020 are not going to be the same as these Section 2202 rules, unless a given income taxing state independently adopts them, already excludes retirement plan and IRA distributions from state taxable income, such as New Jersey might for in-service distributions, up to $100,000 like Section 2202’s, or if the state’s income tax system largely conforming to the federal system embraces these rules, such as the New York State system might embrace these rules.
Section 2202 also allows for extra retirement plan contributions to the extent that they do not exceed 2020 coronavirus-related distributions and to the extent that they are made within thirty-six (36) months after the first distribution. The simple way to meet this rule is to plan for a single 2020 distribution in order to carry the family through 2020. For example, a July 1, 2020, $50,000 distribution can be turned into $50,000 of additional retirement account contributions made one or more times by June 31, 2023. Maybe a pay raise or bonus or a better paying job will come along and allow for additional contributions. Who knows?
Contemporaneously preparing and keeping written records for at least seven years that can serve as strong evidence of coronavirus-related distributions becomes a must for any working person who decides to take 2020 retirement or IRA account coronavirus-related distributions. How else, for example, will a worker who changes jobs and wants to make additional contributions to his or her new employer’s 401(k) plan be able to prove entitlement to make additional contributions allowed by Section 2202? Lastly, Section 2202 is unclear about whether the permitted extra retirement plan contributions also reduce the amount of coronavirus-related distributions taxable income. IRS guidance set forth in Notice 2020-50 (posted June 19, 2020) decides in favor of taxable income. Consequently, a distributee will need extra funds from somewhere to take 100% advantage of the additional retirement contributions rule.
For account owners who satisfy one of The Three Ways, Section 2202 also increases the limit for retirement account borrowing from the current lower of vested account balance or $50,000 to the lower of vested account balance or $100,000. However, any and all loans must be taken by September 23, 2020, unless Congress in later coronavirus relief legislation extends the borrowing period. Section 2202 also allows for a one-year deferral of the payback due date for retirement plan loans becoming due between March 27 and December 31, 2020, if the plan sponsor and trustees agree. In this regard, they are required by other laws to limit plan borrowing in the best interests of all plan participants. The foregoing summary does not address every nuance of Section 2202. More comprehensive Section 2202 guidance can be found in Notice 2020-50.
Section 2203 relief has three aspects. They have in common the fact that when an RMD is not taken in 2020, there is no 2020 federal income taxation of RMD. First, Congress has simply eliminated retirement plan account and IRA RMDs for 2020 for all those many persons whose “required beginning date” began in a year before 2020. (The “required beginning date” can be defined, practically, as the final day during the final year a retiree can defer his or her first RMD from an IRA or employer sponsored defined contribution plan like a 401(k) plan in order to avoid the 50% excise tax on under-distributions.) For those who have already taken 2020 distributions, and want to “roll the money back in” to save 2020 federal income taxes, consult with your retirement plan or IRA administrator. IRS guidance set forth in Notice 2020-51 (posted June 23, 2020) indicates that rolling the money back in is generally allowed, but the ways and limitations are quite detailed, such as the presence of at least one timing deadline of August 31, 2020.
Second, the Act tweaks the rules for retirees whose required beginning date was April 1, 2020. Such a relatively small number of persons who had waited past the last minute (or past April 1, 2020) to take their first RMD are now in deferred status until 2021 without imposition of the 50% excise tax. For April 1, 2020, required beginning date retirees who have already taken their RMD and want to roll the money back in, consult with your retirement plan or IRA administrator. Some IRS guidance set forth in Notice 2020-51 is specifically directed at this situation.
Third, for retirement plan or IRA named beneficiaries who are currently owners of inherited accounts, the relevant maximum period of time by which all distributions must be taken has been extended by one year for beneficiary owners now subject to the five-year maximum payout period. The IRS guidance set forth in Notice 2020-51 states that this one-year extension does not cover the situation where an account owner or a prior beneficiary dies in 2020, but is limited to account owner deaths before 2020.
A collateral consequence of taking advantage of Section 2203 income tax deferral for 2020 is that the account value component of computing the amount of 2021 RMD can be larger. Every retiree’s situation is different. One can generally observe that an increase in the RMD account value component for 2021 can be of material adverse income tax consequences for 2021 income taxes, bracket-wise, if the security markets achieve positive growth by December 31, 2020, compared to December 31, 2019. Estimating one’s retirement account portfolio value “as of” December 31, 2020, one’s 2020 and 2021 federal income tax brackets, and taking into account other relevant income tax factors, if any, will make for a better decision whether or not to defer.
As of the time of writing, Congress might enact further tax relief later this year, and the President is open to signing. The experienced attorneys at Herold Law, P.A., can be of service to you if you find yourself mystified by what you are reading or hearing in the media or finding on other internet sites or newsletters, by IRS Notices 2020-50 and 2020-51, or by what you are told by administrators that does not square with what you believe CARES Section 2202 or 2203 allows for. Among them is Robert S. Schwartz, Esq., who may be reached at 908-647-1022 or contacted at [email protected].