COVID-19: CARES Act Allows $100,000 Tax-Free IRA Grab-and-Repay

Under this new law, you may be able to take money from your IRA and other retirement accounts, avoid early withdrawal penalties, and have generous options on repayment (or not). Additionally, you may not have to take the required minimum distribution from your IRA.

COVID-19-Related Distributions from IRAs Get Tax-Favored Treatment

If you are an IRA owner who has been adversely affected by the COVID-19 pandemic, you are probably eligible to take tax-favored distributions from your IRA(s).

For brevity, let’s call these allowable COVID-19 distributions “CVDs.” They can add up to as much as $100,000. Eligible individuals can recontribute (repay) CVD amounts back into an IRA within three years of the withdrawal date and can treat the withdrawals and later recontributions as federal-income-tax-free IRA rollover transactions.

In effect, the CVD privilege allows you to borrow up to $100,000 from your IRA(s) and recontribute the amount(s) at any time up to three years later with no federal income tax consequences. There are no income limits on the CVD privilege, and there are no restrictions on how you can use CVD money during the three-year recontribution period.

If you’re cash-strapped, use the money to pay bills and recontribute later when your financial situation has improved. Help your adult kids out. Pay down your HELOC. Do whatever you want with the money. 

CVD Basics

Eligible individuals can take one or more CVDs, up to the $100,000 aggregate limit, and these can come from one or several IRAs. The three-year recontribution period for each CVD begins on the day after you receive it. You can make recontributions in a lump sum or make multiple recontributions. You can recontribute 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 transactions are treated as tax-free IRA rollovers. If you’re under age 59 1/2, the dreaded 10 percent 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 privilege if he or she qualifies (see below).  

Do I Qualify for the CVD Privilege?

That’s a 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 COVID-19-related distribution is a distribution of up to $100,000 from an eligible retirement plan, including an IRA, that is made on or after January 2, 2020, and before December 31, 2020, to an individual

  • who is diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention; or
  • 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; or
  • who experiences adverse financial consequences as a result of being quarantined, furloughed, laid off, or forced to reduce work hours due to COVID-19; or
  • who is unable to work because of a lack of childcare due to COVID-19 and experiences adverse financial consequences as a result; or
  • who owns or operates a business that has closed or had operating hours reduced due to COVID-19, and who has experienced adverse financial consequences as a result; or
  • who has experienced adverse financial consequences due to other COVID-19-related factors to be specified in future IRS guidance. 

We await IRS guidance on how to interpret the last two factors. We hope and trust that the guidance will be liberally skewed in favor of IRA owners. We shall see. 

What If I Don’t Recontribute a CVD within the Three-Year Window?

Another good question. You will owe income tax on the CVD amount that you don’t recontribute within the three-year window, but you don’t have to worry about owing the 10 percent early withdrawal penalty tax if you are under age 59 1/2.

If you don’t repay, you can choose to spread the taxable amount equally over three years, apparently starting with 2020.

Example. Tomorrow you withdraw $90,000 from your IRA, and you don’t recontribute it and don’t elect out of the three-year spread; you have $30,000 of taxable income in years 1, 2, and 3.

Here it gets tricky, because the three-year recontribution 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 tax return to report some additional taxable income from the three-year spread. The language in the CARES Act does not address this issue, so the IRS will have to weigh in. Of course, the IRS may not be in a big hurry to issue guidance right now, because it has three years to mull it over.  

You also have the option of simply electing to report the taxable income from the CVD on your 2020 Form 1040. You won’t owe the 10 percent early withdrawal penalty tax if you are under age 59 1/2.

Can the One-IRA-Rollover-per-Year Limitation Prevent Me from Taking Advantage of the CVD Deal?

Gee, you ask a lot of good questions. The answer is no, because when you recontribute CVD money within the three-year window, it is deemed to be done via a direct trustee-to-trustee transfer that is exempt from the one-IRA-rollover-per-year rule. So, no worries there.

Can I Take a CVD from My Company’s Tax-Favored Retirement Plan?

Yes, if your company allows it. The tax rules are similar to those that apply to CVDs taken from IRAs. That said, employers and the IRS have lots of work to do to figure out the details for CVDs taken from employer-sponsored qualified retirement plans. Stay tuned for more information.       

More Good News: Retirement Account Required Minimum Distribution Rules Are Suspended for 2020

In normal times, after reaching the magic age, you must start taking annual required minimum distributions (RMDs) from traditional IRAs set up in your name (including SEP-IRA and SIMPLE-IRA accounts) and from tax-favored company retirement plan accounts. The magic age is 70 1/2 if you attained that age before 2020 or 72 if you attain age 70 1/2 after 2019.

And you must pay income tax on the taxable portion of your RMDs. Thankfully, the CARES Act suspends all RMDs that you would otherwise have to take in 2020.

The suspension applies equally to your initial RMD if you turned 70 1/2 last year and did not take that initial RMD last year (the initial RMD is actually for calendar year 2019). Before the CARES Act, the deadline for taking that initial RMD was April 1, 2020. Now, thanks to the CARES Act, you can put off any and all RMDs that you otherwise would have had to take this year. Good!

For 2021 and beyond, the RMD rules will be applied as if 2020 never happened. In other words, all the RMD deadlines will be pushed back by one year, and any deadlines that otherwise would have applied for 2020 will simply be ignored.

Takeaways

The CVD privilege can be a very helpful and very flexible tax-favored financial arrangement for eligible IRA owners.

  • You can get needed cash into your hands right now without incurring the early withdrawal penalties.
  • You can then recontribute the CVD amount anytime within the three-year window that will close sometime in 2023—depending on the date you take the CVD—to avoid any federal income tax hit.

The suspension of RMDs for this year helps your 2020 tax situation, because you avoid the tax hit on RMDs that you otherwise would have had to withdraw and include as taxable income this year.

2019 Last-Minute Year-End Tax Strategies for Your Stock Portfolio

When you take advantage of the tax code’s offset game, your stock market portfolio can represent a little gold mine of opportunities to reduce your 2019 income taxes.

The tax code contains the basic rules for this game, and once you know the rules, you can apply the correct strategies.

Here’s the basic strategy:

  • Avoid the high taxes (up to 40.8 percent) on short-term capital gains and ordinary income.
  • Lower the taxes to zero—or if you can’t do that, then lower them to 23.8 percent or less by making the profits subject to long-term capital gains.

Think of this: you are paying taxes at a 71.4 percent higher rate when you pay at 40.8 percent rather than the tax-favored 23.8 percent.

To avoid the higher rates, here are seven possible tax planning strategies.

Strategy 1

Examine your portfolio for stocks that you want to unload, and make sales where you offset short-term gains subject to a high tax rate such as 40.8 percent with long-term losses (up to 23.8 percent).

In other words, make the high taxes disappear by offsetting them with low-taxed losses, and pocket the difference.

Strategy 2

Use long-term losses to create the $3,000 deduction allowed against ordinary income.

Again, you are trying to use the 23.8 percent tax loss rate to kill a 40.8 percent tax rate (or a 0 percent loss to kill a 12 percent tax, if you are in the income tax bracket of 12 percent or lower).

Strategy 3

As an individual investor, avoid the wash-sale loss rule.

Under the wash-sale loss rule, if you sell a stock or other security and purchase substantially identical stock or securities within 30 days before the date of sale or after the date of sale, you don’t recognize your loss on that sale. Instead, the code makes you add the loss amount to the basis of your new stock.

If you want to use the loss in 2019, then you’ll have to sell the stock and sit on your hands for more than 30 days before repurchasing that stock.

Strategy 4

If you have lots of capital losses or capital loss carryovers and the $3,000 allowance is looking extra tiny, sell additional stocks, rental properties, and other assets to create offsetting capital gains.

If you sell stocks to purge the capital losses, you can immediately repurchase the stock after you sell it—there’s no wash-sale “gain” rule.

Strategy 5

Do you give money to your parents to assist them with their retirement or living expenses? How about children (specifically, children not subject to the kiddie tax)?

If so, consider giving appreciated stock to your parents and your non-kiddie-tax children. Why? If the parents or children are in lower tax brackets than you are, you get a bigger bang for your buck by

  • gifting them stock,
  • having them sell the stock, and then
  • having them pay taxes on the stock sale at their lower tax rates.

Strategy 6

If you are going to make a donation to a charity, consider appreciated stock rather than cash, because a donation of appreciated stock gives you more tax benefit.

It works like this:

  • Benefit 1. You deduct the fair market value of the stock as a charitable donation.
  • Benefit 2. You don’t pay any of the taxes you would have had to pay if you sold the stock.

Example. You bought a publicly traded stock for $1,000, and it’s now worth $11,000. You give it to a 501(c)(3) charity, and the following happens:

  • You get a tax deduction for $11,000.
  • You pay no taxes on the $10,000 profit.

Two rules to know:

  1. Your deductions for donating appreciated stocks to 501(c)(3) organizations may not exceed 30 percent of your adjusted gross income.
  2. If your publicly traded stock donation exceeds the 30 percent, no problem. Tax law allows you to carry forward the excess until used, for up to five years.

Strategy 7

If you could sell a publicly traded stock at a loss, do not give that loss-deduction stock to a 501(c)(3) charity. Why? If you sell the stock, you have a tax loss that you can deduct. If you give the stock to a charity, you get no deduction for the loss—in other words, you can just kiss that tax-reducing loss goodbye.

Avoid the 1099 Prepaid-Rent Mismatch

Two questions:

  • Did you prepay your 2019 rent so that you have a big 2018 tax deduction?
  • How do you identify in your accounting records the monies you put on your IRS Form 1099-MISC for the business rent payments to your landlord?

For the 1099-MISC, do you simply look at your checkbook or payment ledgers to identify the amounts you are going to report? If so, you will create an incorrect 1099 for your landlord that’s going to cause your landlord a tax problem.

One golden rule when it comes to your landlord is “do not cause your landlord tax trouble.”

Let’s say you wrote a $55,000 check to your landlord on December 31 and mailed it that day. Your landlord received the check on January 3. Here’s how your Form 1099-MISC can create a tax problem for your landlord:

  • Your Form 1099-MISC to the landlord shows rent paid of $105,000 ($50,000 paid during the year and then the $55,000 prepayment on December 31).
  • The landlord’s 2018 federal income tax return shows $50,000 in rent received (he received the $55,000 in 2019).
  • IRS computers note the difference and start an inquiry.

An incorrect 1099 that overstates the landlord’s income is a problem that can lead to a tax audit.

IRS Reg. Section 1.6041-1(f) says:

The amount to be reported as paid to a payee is the amount includible in the gross income of the payee . . .

Note. As you will see below, this amount does not necessarily equal the tax deduction claimed by the payor.

Reg. Section 1.6041-1(h) says:

For purposes of a return of information, an amount is deemed to have been paid when it is credited or set apart to a person without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made, and is made available to him so that it may be drawn at any time, and its receipt brought within his own control and disposition.

The 1099-MISC is a “return of information.”

The landlord did not have control of the money until he or she had possession of the check in 2019.

In Cheryl Mayfield Therapy Center, the court stated:

A “payment” is made for purposes of section 6041 information returns when an amount is made available to a person “so that it may be drawn at any time, and its receipt brought within his own control and disposition.”

Surprisingly, the 1099 could contain a taxable amount to the payee that is different from the deduction amount of the payor.

For example, in this case, the correct 1099-MISC amount is $50,000. That’s the amount you should put on the 1099-MISC you send to the landlord for 2018 even though you are going to deduct $105,000 as a cash-basis taxpayer.