By now, the major coronavirus relief programs put in place by the CARES Act in March – Pandemic Unemployment Assistance, the Paycheck Protection Program, Economic Impact Payments, etc. – have been well-covered.
But there’s a lot more to the $2 trillion stimulus bill, the largest in U.S. history, and there are a few lesser-known sections that can provide an addition lifeline for those whose cashflow has dried up during this economic crisis.
Hardship Retirement Savings Withdrawal
Generally, a withdrawal from a retirement savings account like an IRA or 401(k) before the age of 59 ½ is subject to a 10% penalty fee, on top of the income tax that must be paid on the funds. Under the CARES Act, this penalty fee is being waived on withdrawals of up to $100,000 from retirement accounts between Jan. 1 and Dec. 31, 2020.
There are different tax implications to be aware of for an IRA and a 401(k) withdrawal. In addition, the $100,000 is an aggregate limit for all retirement plans. You’ll still owe income taxes on the money you take as a distribution, but you’re allowed three years to pay the taxes or pay back the money you withdrew into your retirement account.
Who is eligible?
The new rules to take a withdrawal from your retirement will apply to you if:
· You have been diagnosed with COVID-19 by a CDC-approved test.
· Your spouse or a dependent has been diagnosed with COVID-19 by a CDC-approved test.
· You have experienced “adverse financial consequences” due to the pandemic. For example, you or your spouse:
- Are being quarantined, furloughed, laid off, or are working less because of the virus or disease.
- Are unable to work due to lack of childcare because of the virus or disease.
- Own or operate a business and have lost hours or had reduced hours due to the virus or disease.
Withdrawals from an IRA
There are a few provisions to keep in mind before making a withdrawal from your IRA:
· You must be prepared to show documentation of how you are using the money.
· If you do not use all of the funds, you can return some back to your IRA account to avoid having to pay income tax on it.
· You can return this cash to your IRA whenever you want over the next three years to avoid owing the taxes pro-rata.
· You have three years to pay the taxes off, which means you can split it up equally between 2020, 2021 and 2022.
There is no clear guidance yet on whether beneficial IRAs that have been inherited from deceased parents are included in this CARES Act provision.
Withdrawals from a 401(k) or 403(b) fund
To use your 401(k) or 403(b) funds as part of the CARES Act provisions, you must first see if your employer allows for a distribution to be taken as part of the Act. It is ultimately up to your employer to decide if this type of distribution is available. It is considered a “plan event” if the employer allows you to use it and, generally, you need to be working at your employer to get a distribution from your 401(k).
If you do qualify for a 401(k) distribution under the CARES Act, it is important to know that these distributions are not taxed, and you can take out up to 100% of your vested balance up to $100,000 without the usual 10% penalty if you meet the guidelines stated above.
How to report a COVID-19 retirement distribution
Taxpayers can designate any eligible distribution from a retirement plan as a coronavirus-related distribution to a maximum of $100,000 and report it on their individual federal income tax return for 2020. The taxable portion of the distribution can be spread over the 3-year period of 2020-2022, unless you elect to include the entire amount in income in 2020. The IRS will be providing Form 8915-E before the end of 2020 to report any repayment of a coronavirus-related distribution and to determine the amount of any coronavirus-related distribution includible in income for a year.
Net Operating Losses
The Act also makes several important changes to Net Operating Loss (NOL) provisions, which may help free up your freelance cash flow. Under this provision, businesses can use NOLs from tax years prior to January 1, 2021, to fully offset their income. This is a change from the 2017 Tax Cuts and Jobs Act, which limited the offset to 80% of income.
The CARES Act also provides that taxpayers can, for tax years 2018, 2019, and 2020, carry their NOLS back to their five prior taxable years, which could result in a tax refund.
If you are unsure about the impact of using your IRA or 401(k) for funding to offset COVID-19 financial pressures, or how you can use the NOL provisions, please consult with a financial professional. They can help you ensure that you are applying these relief measures correctly while providing some much-needed additional cash flow.
Jonathan Medows is a New York City–based CPA who specializes in taxes and business issues for freelancers and self-employed individuals across the country. He provides tax, accounting, and business articles for freelancers on his website, http://www.cpaforfreelancers.com— which also features a blog and a comprehensive freelance tax guide. Please note, due to the high volume of inquiries in regard to COVID-19, Jonathan is not able to respond to individual requests for information at this time.