The $2 trillion coronavirus economic recovery bill is expected to be passed by the House Friday and signed into law by President Trump shortly thereafter. The legislation has been dubbed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).
The new law is a daunting 880 pages long, but it contains lots of good news for individuals and businesses, including meaningful tax relief. This column explains one tax-relief measure that can potentially benefit many IRA owners. Here’s what you need to know:
Coronavirus-related distributions (CVDs) from IRAs are tax-favored
IRA owners who are adversely affected by the coronavirus pandemic (and there will be plenty of them) will be eligible to take tax-favored coronavirus-related distributions from their IRAs. To keep things simple, let’s call these distributions CVDs. They can add up to as much as $100,000. You can recontribute a CVD back into your IRA within three years of the withdrawal date and treat the withdrawal and later recontribution as a totally tax-free rollover.
In effect, the CVD drill allows you to borrow up to $100,000 from your IRA(s) and repay the amount(s) any time up to three years later with no federal income tax consequences. And there are no limitations on what you can use CVD funds for during the three-year period.
As long as you re-contribute the entire CVD amount within the three-year window, the whole deal is treated as a tax-free IRA rollover transaction or a series of tax-free rollover transactions.
If you’re cash-strapped, you can use the money to pay the bills and re-contribute later when your financial situation has improved. You can help your adult kids out. You can pay down your HELOC. You can invest the money in the stock market and hope to collect low-taxed long-term gains. Whatever.
You can take one or more CVD’s up to the $100,000 limit, and they can come from different IRAs. The three-year re-contribution period for each CVD begins on the day after you receive it. You can make your re-contributions in a lump sum, or you can make multiple re-contributions. You can re-contribute to one or several IRAs, and they don’t have to be the same account(s) you took the CVD(s) from in the first place.
As long as you recontribute the entire CVD amount within the three-year window, the whole deal is treated as a tax-free IRA rollover transaction or a series of tax-free rollover transactions. If you’re under age 59½, the dreaded 10% penalty tax that usually applies to early IRA withdrawals does not apply to CVDs.
If your spouse owns one or more IRAs in his or her own name, your spouse is apparently eligible for the same CVD deal if he or she qualifies.
How do you qualify for CVDs?
Good question. Some IRA owners will clearly qualify while others may have to wait for IRS guidance. For now, here’s what the CARES Act says.
A coronavirus-related distribution is a distribution of up to $100,000 from an eligible retirement plan, including an IRA, that is made on or after 1/1/20 and before 12/31/20 to an individual:
* Who is diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention.
* Whose spouse or dependent (generally a qualifying child or relative who receives more than half of his or her support from you) is diagnosed with COVID-19 by such a test.
* Who experiences adverse financial consequences as a result of being quarantined, furloughed, laid off, or having work hours reduced due to COVID-19.
* Who is unable to work because of lack of child care due to COVID-19 and experiences adverse financial consequences as a result.
* Who owns or operates a business that has closed or had operating hours reduced due to COVID-19 and has experienced adverse financial consequences as a result.
* Who has experienced adverse financial consequences due to other COVID-19-related factors to be specified in future IRS guidance.
We need the IRS to weigh in on the last two factors. I hope and trust that the guidance will be liberally skewed in favor of the IRA owners of the world. Fingers crossed.
What if I don’t re-contribute the CVD?
Another good question. You will be taxed on the CVD amount that you don’t re-contribute within the three-year window, but you don’t have to worry about owing the dreaded 10% early withdrawal penalty if you are under age 59½.
You can choose to spread the taxable amount equally over three years, apparently starting with 2020. But here it gets tricky, because the three-year window won’t close until sometime in 2023. Until then, it won’t be clear that you failed to take advantage of the tax-free CVD rollover deal.
So, you may have to amend a prior-year return and report some additional taxable income from the CVD. Details to follow, because I don’t think our beloved Congress gave much thought to this issue when drafting the CARES Act.
You also have the option of simply reporting the taxable income from the CVD on your 2020 Form 1040. You won’t owe the 10% early withdrawal penalty if you are under age 59½.
Can I take a CVD from my tax-favored company retirement plan?
Yes, if your company allows it under rules similar to those for IRAs. Employers and the IRS have work to do to figure out the details.
The bottom line
The CVD deal can be a helpful tax-favored financial arrangement for eligible IRA owners. Thankfully, the CARES Act includes a bevy of other potentially valuable tax breaks to help get us through this mess. Explaining them will keep us busy for a while. Stay tuned.