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Congress Provides Retirement Account Tax Relief for 2020 but Creates Complexity and Record Keeping Burdens

By: Robert S. Schwartz, Esq.

May 4, 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 could be adverse tax consequences of using accumulated retirement benefits as a source of cash to pay bills. Another adverse effect of coronavirus has been substantial reductions in values of retirees’ IRA, Section 401(k) and similar employee contribution oriented retirement accounts. Act Section 2203 provides relief from what otherwise could be the adverse tax consequences of not liquidating account investments in order to draw out cash to satisfy the year’s required minimum distribution (“RMD”) amount.

Section 2203 is the simpler of the two. First, Congress has simply eliminated retirement plan account and IRA required minimum distributions for 2020 for all those many persons whose “required beginning date” began in a year before 2020. (The “required beginning date” long has been defined, practically, as the final day during the final year a retiree can defer his or first required minimum distribution from an IRA or employer sponsored defined contribution plan like a 401(k) plan to avoid the 50% excise tax on under-distributions.) For those who have already taken 2020 distributions, and want to “put the money back in” to save 2020 federal income taxes, consult with your retirement plan or IRA administrator. Section 2203 itself is pretty unhelpful; the IRS might provide guidance at any moment. Second, the Act tweaks the “required beginning date” rules for retirees whose required beginning date is April 1, 2020. Such a relatively small number of persons who had waited past the last minute or past April 1, 2020, now have their first required minimum distributions deferred until 2021 without penalty. For those retirees whose required beginning date is April 1, 2020, and who have already taken distributions and want to put the money back in, consult with your retirement plan or IRA administrator. Third, as to retirement plan or IRA named beneficiaries who are currently the owners of inherited accounts, the relevant maximum period of time by which all distributions must be taken has been extended by one year, seemingly whether beneficiary owners are subject to the five-year or the ten-year maximum payout period. All three Section 2203 provisions have in common the fact that when RMDs are not taken in 2020, there is no 2020 federal income taxation of the RMD.

A collateral consequence of taking advantage of Section 2203 for 2020 is that the account value base component of computing the RMD amount for 2021 distributions will be somewhat larger if a required minimum distribution is not taken in 2020. Although every retiree’s situation is different, one can generally observe that an increase in the RMD computation base for 2021 is unlikely to be of material adverse income tax consequences for 2021 income taxes, bracket-wise, unless the security markets come roaring back by December 31, 2020. That said, carefully watching one’s retirement account portfolio value and knowing the 2020 federal income tax brackets will make for a better decision.

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 previous 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, such as 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 advice when doing 2020 income taxes. 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, but only to a ceiling amount, 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 June 1, 2020, $50,000 distribution can be turned into $50,000 of additional retirement account contributions made one or more times by May 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 is welcome about this obviously important consideration. If guidance allows for reduced taxable income to the extent of timely additional contributions, then good record keeping becomes all the more critical because, in general, taxpayers have the burden of proof on all matters of fact.

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 Sections 2202 and 2203. Furthermore, IRS ad hoc notice guidance as to these sections is going to be relevant as some of the provisions are hard to decipher or are capable of more than one interpretation. In addition, Congress is quite active in legislating coronavirus fiscal and tax relief bills, and the President is open to signing them. Consequently, at least some of the rules summarized here might have already been rewritten by the time you read this. It is a good bet that for the most part, changes will not be taxpayer unfriendly. Other retirement plan and IRA tax-related rules might be legislated as well.

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 you are told things by administrators that do not square with what you believe the law allows for or does not allow for. Among them is Robert S. Schwartz, Esq., who may be reached at 908-647-1022 or contacted at [email protected].