IRS Expands New Tax Breaks On Retirement Distributions, Loans

IRA and 401(k) owners recently received expand-ed tax breaks, thanks to some new IRS guidance on the Coronavirus Aid, Relief, and Economic Security (CARES) Act.The CARES Act already provided valuable tax breaks. Required minimum distributions (RMDs) are suspended for 2020. Plus, the law relaxed restrictions on taking loans and distributions from retirement plans.

In recent guidance fleshing out the details of the CARES Act, the IRS provided new breaks for taxpayers who already took their 2020 RMDs and want to reverse the RMDs. The IRS also expanded the number of taxpayers who qualify to tap into their retirement plans using the generous provisions of the CARES Act and provided details about distributions and loans under the CARES Act.First, is the big news for those who took RMDs early in 2020. As I explained in the May 2020 issue of Retirement Watch, taxpayers who took their 2020 RMDs early in the year or who have their RMDs distributed monthly were in a bind.

They could return the RMDs to their IRAs (or to other retirement plans) in a tax-free rollover but only if the rollover was executed within 60 days of when the distribution was taken. Because they took their RMDs before the CARES Act even was conceived, the 60-day period expired. They were stuck with the RMDs. In its recent guidance, the IRS extend-ed the 60-day rollover period. Anyone who took a distribution in 2020 that would have been an RMD if not for the CARES Act waiver of RMDs now has until August 31, 2020, to roll over the distribution to an IRA or other qualified retirement plan.

If the August 31 deadline is met, the amount won’t have to be included in gross income for 2020, even if the rollover occurs more than 60 days after the distribution. Note: This deadline extension applies only to distributions that would have been RMDs. The 60-day deadline still applies to other types of distributions. The new IRS guidance also suspend-ed two restrictive rules on rollovers.

Under the guidance, beneficiaries of inherited IRAs who took their RMDs in 2020 can roll them over tax free to an IRA by August 31, 2020. Normally, an RMD from an inherited retirement plan can’t be rolled over.

In addition, the IRS suspended the once-every-12-months limit on IRA rollovers. That means someone who took multiple distributions as part of an RMD, such as someone who scheduled monthly distributions, or took distributions from multiple IRAs can roll all or part of those distributions back to an IRA and do so in more than one transaction. Also, someone who used a rollover in late 2019 isn’t prohibited from using a rollover on a 2020 distribution.These changes are in IRS Notice 2020-29.The IRS also expanded tax relief for retirement plans under other CARES Act provisions.

One CARES Act provision waives the 10% penalty on an early distribution from a retirement plan when the distribution is taken by someone adversely affected by the coronavirus. The penalty ordinarily is imposed when a retirement plan participant takes a distribution before age 59½ and the distribution doesn’t qualify for one of the existing exceptions to the penalty.

Now, the penalty is waived when the distribution was taken for coronavirus-related reasons.Even when the 10% penalty is avoid-ed, the distribution is included in gross income. But under the CARES Act, retirement plan distributions may be included in gross income over a three-year period instead of all in the year of the distribution.

Also, a retirement plan distribution normally can’t be deposited to the same or another retirement plan, unless that is done within 60 days of the distribution. Otherwise, a return of a distribution would be an excess contribution to the plan.But under the CARES Act, instead of paying income taxes on the distribution over three years, the taxpayer can return a coronavirus-related distribution to a retirement plan within three years.

That would be considered a tax-free rollover.The distribution can be re-contributed to the same retirement plan from which it was withdrawn or contributed to another plan of which the individual is a participant at the time of the re-contribution. Annual retirement plan contribution limits won’t apply to a re-contribution.

This provision applies to IRAs as well as 401(k)s and other defined contribution retirement plans.In another CARES Act provision, the amount that can be borrowed from a retirement plan is increased. (Loans can’t be taken from IRAs, only from employer retirement plans.)

The normal maximum amount of a retirement plan loan is the lesser of $50,000 or 50% of the participant’s vested account balance. That limit was increased for the 180 days that began with March 27, the day the CARES Act became effective.The maximum loan amount is doubled to the lesser of $100,000 or 100% of the participant’s vested account balance. There’s an additional benefit for anyone who had an outstanding retirement plan loan as of March 27, 2020. Payments due on those loans through December 31, 2020, can be deferred for one year at the plan sponsor’s option.

In the CARES Act, someone adversely affected by the pandemic is defined as a person who was diagnosed with COVID-19, has a spouse or dependent diagnosed with it, or experienced adverse financial consequences as a result of being quarantined, furloughed, laid off, having work hours reduced, or being unable to obtain work because of a lack of child care, a business closing, or hours being reduced.The CARES Act empowers the IRS to expand the list of qualified individuals. In Notice 2020-50, the IRS recently expanded the list of adversely affected taxpayers to include those who:

• had a reduction in pay or self-employment income because of COVID-19 or had a job offer re-scinded or start date delayed due to COVID-19;

• had a spouse or household member who has been quarantined, furloughed, laid off, or had work hours reduced due to COVID-19, or is unable to work because of lack of child care, had a reduction in pay or self-employment income due to COVID-19, or had a job offer rescinded or start date delayed because of COVID-19; or

• had a business owned or operated by the individual’s spouse or household member that had to close or reduce hours because of COVID-19.

For many people, what’s most import-ant is the effects of the pandemic on a spouse or member of the household are examined to determine if an individual was adversely affected. Another important feature of the Notice is that, unlike a traditional hardship withdrawal, the amount of a coronavirus-related distribution or loan doesn’t have to correspond to the direct financial impact of the pandemic on the individual.

Plan members don’t have to prove the extent to which they were adversely affected, and plan administrators don’t have to sort through an employee’s bills, invoices and receipts to determine the qualifying amount of a loan of distribution.

Employees should know that an employer or other plan sponsor chooses whether to adopt the CARES Act changes on loans and distributions. The Notice makes clear that employers aren’t required to adopt the CARES Act provisions and make them available to employees.