If you received a retirement plan distribution in 2020, including what was intended to be a required minimum distribution, you may not have to pay tax on the total amount in the year of the distribution. If you are a qualified individual and receive amounts from an eligible retirement plan, up to $100,000 may be subject to tax over a three-year period or not at all, if amounts are recontributed to an IRA or an employer retirement plan within the three-year period.
Who Qualifies?
The definition of a qualified individual is very broad, including a person who meets any of the following criteria:
- Was diagnosed with COVID-19
- Has a spouse or dependent who was diagnosed with COVID-19
- Experiences adverse financial consequences as a result of:
- Being furloughed, quarantined, laid off or having work hours reduced due to COVID-19
- Being unable to work due to a lack of childcare due to COVID-19
- Closing or reducing hours of a business owned or operated by the individual
- Having a reduction in pay or self-employment income due to COVID-19
- Having a job offer rescinded or a job start date delayed due to COVID19
- Experiences or who has a member of their household experience adverse financial consequences as a result of:
- Being quarantined, furloughed or laid off, or having work hours reduced due to COVID-19
- Being unable to work due to a lack of childcare due to COVID-19
- Having a reduction in pay or self-employment income due to COVID-19
- Having a job offer rescinded or start date of a job delayed due to COVID-19
- Experiences adverse financial consequences as a result of closing or reduced hours of a business owned or operated by the individual’s spouse or a member of the individual’s household due to COVID-19
For these rules, a member of the individual’s household is anyone who shares the individual’s principal residence. The rules apply to anyone who is a qualified individual irrespective of why the funds were distributed or if the amount distributed exceeded the adverse financial conditions resulting from COVID-19.
The Favorable Tax Rules
If a qualified individual received a retirement plan distribution in 2020, the first $100,000 of that distribution qualifies for favorable tax treatment including:
- The elimination of a 10 percent additional tax on early retirement plan distributions
- The ability to recognize income in the 2020, 2021 and 2022 taxable years by including up to $33,333.34 in income each year
- The opportunity to avoid income recognition to the extent amounts are transferred back to an IRA or employer’s qualified retirement plan during the three-year period beginning the day after the distribution.
The rules regarding income recognition and repayment of amounts of up to $100,000 give qualified individuals lots of flexibility. An individual can decide to include amounts in income in 2020 or include equal amounts in income in 2020, 2021 and 2022. Once the individual decides the timing of income recognition by the amount included in income on the 2020 Form 1040, the decision is irrevocable. To avoid income recognition that would otherwise be required that year, transfer of amounts to an IRA or retirement plan can occur in the year of the income inclusion or the following year, up until the due date, including extensions, of the individual’s income tax return.
Thus, if $45,000 is received in 2020 and that amount is contributed to an IRA in March 2021, no amount is included in income. If the individual elects to tax the distribution over 3 years and $15,000 is contributed to an IRA or retirement plan in March 2021, no amount is included in income in 2020. If an amount is included in income in 2020 and then the entire distribution is contributed to an IRA or retirement plan in December, 2021, the 2020 income tax return will need to be amended to exclude the 2020 distribution from income.
Given the planning opportunities for taxing 2020 retirement plan distributions for qualified individuals, care should be taken to maximize tax benefits. Even qualified individuals who received retirement plan distributions that would have been required minimum distributions if the law eliminating required minimum distributions for 2020 had not passed should consider delaying the taxation of amounts or recontributing such amounts to an IRA to delay taxation even further.
For more information or questions related to the taxability of retirement plan distributions, contact your Cherry Bekaert professional or Deb Walker, CPA, Director of Compensation and Benefits.
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