One perk in the recently enacted coronavirus relief law that allows for penalty-free withdrawals from an IRA will likely cause headaches for tax professionals in subsequent years.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136) was enacted “quite hastily,” said Natalie B. Choate of Nutter McClennen & Fish LLP, with over 800 pages of new law providing tax relief, loans, grants, and more to help mitigate the impact of the coronavirus.
One provision that appears rushed is a waiver for the 10 percent early withdrawal penalty on distributions of up to $100,000 from a retirement plan taken before age 59-1/2 for participants who have been affected by the pandemic, Choate said.
That’s a nice benefit for younger taxpayers, but the extra relief related to that provision is where things start to get complicated, Choate said during an April 9 Leimberg Information Services Inc. webinar.
In addition to the penalty waiver, the CARES Act gives taxpayers who take a distribution in 2020 the option of paying the income tax on it in 2020, 2021, or 2022. But the “greatest benefit,” according to Choate, is that the new law also allows a taxpayer to roll all or part of a distribution into a qualified plan or IRA anytime during the next three years, starting on the day after the distribution.
“So instead of 60 days to roll this money over, you’ve got three years to get it back into the plan,” Choate said. Further, these rollovers won’t be treated as a normal rollover; rather, they’ll be treated like a trustee-to-trustee transfer, “even though it obviously isn’t a trustee-to-trustee transfer, it’s obviously just a rollover that’s occurring up to three years after the distribution,” she said.
That means many of the normal restrictions on rollovers won’t apply here, Choate said. For example, any income tax paid on the transfer will be retroactively erased, and the one IRA rollover per year limit won’t apply either, she said.
“This is probably the best benefit of a [coronavirus-related distribution], as far as I can see. But it’s going to be messy,” Choate said. A taxpayer who has already paid taxes on the distribution and rolls it over now must go back and file amended returns — and if they took their coronavirus distribution over a period of time so there were, for example, five different distribution dates, “that gives you five different three-year rollover deadlines, one for each of those distributions,” she explained.
“Ay yi yi,” Choate said.
Special Treatment
One thing that remains unclear is how to decide which $100,000 of distributions qualifies. The penalty waiver is limited to $100,000 per individual, so if a taxpayer takes out $300,000 in distributions from various retirement plans, only $100,000 gets the special treatment. The CARES Act doesn’t specify which $100,000 gets that treatment — whether it’s the first $100,000 that is withdrawn or “dealer’s choice” on which amounts qualify, Choate said.
Another quirk related to the drafting of the CARES Act provision is that for a distribution to qualify for this treatment, it must be made in 2020, and the law specifies that it has to be made before December 31, 2020. “If you take a distribution on December 31, 2020, that’s not good enough, apparently,” Choate said.
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