While protecting small businesses is the CARES Act’s primary purpose, it also contains provisions that benefit our clients.
On March 27, 2020, Congress passed, and the President signed the Coronavirus Aid, Relief, and Economic Security Act, also known as the CARES Act (the Act). While protecting small businesses is the Act’s primary purpose, it also contains provisions that benefit our clients.
Waiver of Required Minimum Distributions in 2020
The Act waives required minimum distributions (RMDs) for specific defined contribution plans and IRAs for the 2020 calendar year. The waiver not only applies to participants and account owners, it also applies to beneficiaries who inherited IRAs. The Act also waives RMDs for individuals who turned 70 1/2 in 2019 but elected to defer their initial RMD to April 1, 2020; both the 2019 and 2020 RMDs are waived. If an individual has taken their RMD, the waiver is not a deferral. Waived RMDs need not be made up.
However, the Act affects no other distribution rules, including the right to rollover the distribution within 60 days of receipt. If someone took an RMD before the effective date of the Act and 60 days have not passed since the time of the distribution, they may rollover the distribution. Usually, there is a mandatory 20 percent tax withholding requirement for distributions from qualified plans and 10percent for IRAs; however, the individual can replace the tax withheld with their personal assets.
The Act provides no relief from the 60-day requirement if the individual received the RMD January 1, 2020, prior to the effective date of the Act. If over 60 days have passed since the distribution of the RMD, the individual cannot roll over the RMD. However, in Notice 2020-23, the IRS extended the rollover period to July 15, 2020, for those who took (or take) RMDs between February 1, 2020, and May 16, 2020. When RMDs were waived in 2009, the IRS ultimately granted a waiver from the 60-day rule for any distribution in 2009. It is possible the IRS may reverse this position.
The following questions and answers provide examples under the Act.
Q1. Fred takes his RMD before the effective date of the CARES Act.
As long as Fred redeposits it into either the pre-existing IRA or opens a new IRA within 60 days after he receives the RMD, the distribution will not be taxable in 2020.
Q2. Barney opts to take his RMD monthly. He receives distributions on January 3, February 3, and March 1, 2020.
Barney cannot redeposit the January payment because more than 60 days have elapsed since he received the distribution. Even though the February and March payments are within the 60-day window, he can only rollover one RMD. Each payment constitutes a separate distribution to limit an individual to one rollover every 12 months.
Q3. George turned 70½ in September 2019. He elected to take his RMD by April 1, 2020.
Under the CARES Act, he need not take either his 2019 or 2020 RMDs.
Q4. Ralph received his 2020 RMD within the past 60 days. Ralph received the RMD, minus income tax withholding. Ralph now wants to roll over his RMD.
Ralph has a choice. If he rolls over his net distribution, the withheld amount is taxable income. As an alternative, he can take his assets and make up the amount withheld and roll over an amount equal to the total RMD. The tax withheld is simply treated as an estimated payment and applied to his 2020 tax liability.
Q5. Betty took her 2020 RMD and more than 60 days have passed, what can she do?
For the time being, nothing. In 2009, when there was a similar waiver of RMDs, the IRS eventually allowed the rollover of an RMD taken in 2009. Previously, the IRS implemented self-reporting for delinquent rollovers. If the IRS determined reasonable cause existed for the delinquency, the rollover of the delinquent RMD was valid. There is speculation whether the IRS will view the CARES Act as a reasonable cause.
Q6. Alice is the beneficiary of an inherited IRA. Does the RMD waiver apply to inherited IRAs? If she already received her 2020 RMD, can she roll it over?
Yes. The waiver applies to inherited IRA’s.
No. Rollovers of RMDs from inherited IRAs were always prohibited.
Hardship IRA/401(k) Withdrawals
The Act allows coronavirus-related withdrawals from 401(k), and IRA accounts up to $100,000 during 2020. Individuals under age 59½ do not incur the 10 percent penalty for early withdrawal if:
1. An account owner is diagnosed with COVID-19, or
2. A spouse or dependent is diagnosed with COVID-19, or
3. An individual who experiences adverse financial consequences because of being quarantined, furloughed, laid off, having work hours reduced, being unable to work due to lack of child care due to the coronavirus, or
4. Closing or reducing hours of a business owned or operated by the individual due to coronavirus, or
5. Other factors, as determined by the Treasury Secretary.
Distinguish the difference between distributions from qualified retirement plans and an IRA. While both must meet the COVID-19 requirements above, under ERISA, qualified plans can permit loans to plan participants. The Act doubles the available loan amount to $100,000. As long as the loan is repaid in full within the 3-year term of the loan, income tax is not due on the amount loaned.
The treatment of COVID-19 distributions is different for IRAs. Under the Internal Revenue Code, IRAs cannot make loans to account holders. Therefore, COVID-19 distributions are not loans. Only rollovers within 60 days of receipt and additional repayments by the last day of 2020 are exempt from income tax. The outstanding balance on December 31, 2020, is taxable income. If there are additional repayments in the next 2 years, the taxpayer should file an amended 2020 income tax return showing the repayments and claim a refund. This differs significantly from a loan from a 401(k); income tax is not due during the period of the loan. There is no income tax if the participant repays the loan within 3 years. The unpaid balance of the loan at the end of the term is taxable income.
Treatment of Charitable Deductions
Under the Tax Cuts and Jobs Act of 2017, taxpayers must itemize their deductions to take advantage of charitable deductions. The CARES Act provides each person can make charitable gifts up to $300 and can take a charitable deduction even if they do not itemize deductions; however, if they do itemize deductions, they cannot use this above the line deduction.
Also, under certain circumstances, the Act increases the limit of deductibility of charitable deduction to 100 percent of adjusted gross income. As an example, if there is a Roth conversion, an individual can contribute an amount equal to the taxable income generated by the Roth conversion, and wipe out the tax liability of the Roth Conversion.
This article is based on a literal reading of the text of the CARES Act. There are still several questions raised by the Act; the IRS has indicated guidance is forthcoming.