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As the year anniversary for the Covid-19 crisis has passed, many Americans will experience a lingering impact on their finances. Signed into law on March 27, 2020, the CARES Act provided a number of financial lifelines such as the stimulus checks and the Paycheck Protection Program (PPP).
The CARES Act also included a provision that allowed those with 401(k), 403(b) or IRA accounts to take an early distribution of up to $100,000. Unlike early distributions in normal times, the CARES Act gave taxpayers a few unique opportunities if the distribution was due to the Covid-19 crisis. There is no 10% penalty for those under age 59 ½ and the income taxes due on the distribution can be spread evenly over three years in 2021, 2022 and 2023.
The 2020 tax season is in full swing and correctly accounting for these distributions is complicated. It can be a minefield, especially when it comes to ensuring that the 1099-R you receive is coded correctly and properly reporting how/when you are paying the taxes.
1099-R Reporting
To be sure that the 1099-R is correct, take a look at Box 7 which reports to the taxing authorities what type of distribution occurred in 2020. Taxpayers who want to take advantage of the CARES Act distribution rules need to make sure that there is a 2 in the box, indicating that an exception applies to the early distribution.
If there is a 1 in Box 7, there is a chance the 1099-R was coded improperly and the taxpayer should contact the payor and see if it can be amended.
If that is not possible (there will be payors who refuse to reissue), it’s important to have your tax professional available to help file Form 4852 to explain to the IRS why the 1099-R is in error.
There is also a chance that some 1099-Rs will come to the taxpayer uncoded. A tax professional can help ensure that it is reported in a manner where no penalty applies.
Tax Return Reporting
Once the taxpayer has the correct(ed) 1099-R form, it is time to actually file and report the distribution. This is done with Form 8915-E, to report Qualified 2020 Disaster Retirement Plan Distributions.
This form is complicated and a tax professional will be helpful in completing the return. Taxpayers need to report all distributions and then code the ones that are going to be seen as qualified. The amount needs to be properly spread over the three years.
While the tax can be spread over three years, some taxpayers may not want to elect that. Perhaps the taxpayer’s 2020 income was exceptionally low, with 2021 and 2022 income projected to be higher. It might be better to pay all the taxes in a single year. The taxpayer needs to alert the IRS of this by checking the box in Part II showing that they are not spreading the tax.
Finally, this is not a one and done transaction. This form is going to be relevant when filing for the next two years, so working with the same tax professional is important to make sure nothing gets missed.
Still Financially Precarious
But complexity remains. When Americans took these early distributions last year, it seemed that the pandemic would likely be over in 2021. As of March 2021, however, it appears that we are still months away from the conclusion of the crisis.
Some taxpayers might not have the cash flow to pay the tax bill, but they should file anyway and request a payment plan from the IRS. It is always better to be in compliance with the taxing authority rather than delinquent.
Taxpayers who now find themselves financially stable should discuss with their tax professional whether they should repay the distribution rather than pay the tax. That might be a better long-term strategy in building one’s asset base.
Hire A Professional
Ultimately the various stimulus bills have created a lot of moving pieces for taxpayers reporting the various transactions. Hiring a tax professional to navigate these complexities will likely prove extremely valuable for many taxpayers.