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Jan 20, 2021

You Have Options for Paying Tax on COVID-19 Distributions

If you were eligible to take a “coronavirus-related distribution” (CRD), you can take advantage of the following tax relief on up to $100,000 of your withdrawals from IRAs and employer-sponsored retirement plans in 2020:

1. Waiver of the 10% early distribution tax (applies to individuals under age 59 ½)

2. Option to claim the entire amount withdrawn in your taxable income for 2020 or claim the distribution amount in three equal portions on your 2020, 2021, and 2022 federal tax returns

3. Option to repay any portions of the 2020 CRD to your IRA within three years and recoup any tax paid on the amount re-paid or avoid paying tax on amounts you haven't yet included in income (The repayment options is not available for non-spouse beneficiary distributions.)

 See our blog IRA Distribution Tax Relief in 2020 & Beyond or the IRS website FAQS for more information on qualifying for a CRD.

Spreading taxation over 3 years or claiming it all for 2020

You will be treated as choosing to include the CRD in your taxable income ratably over 3 years unless you elect to include the entire amount in taxable income for 2020. Whichever option you choose must apply to the entire amount you claim as a CRD. This election cannot be made or changed after you file your 2020 tax return. 

Your taxation election does not affect your eligibility to claim an exception to the 10% early distribution tax for CRDs, or your option to repay any or all of the CRD.

Example: Rachel withdrew $30,000 from her IRA on October 1, 2020. She met the criteria for a CRD distribution and wants to treat the entire withdrawal as a CRD. If Rachel elects to include the CRD in her taxable income over 3 years, she will include $10,000 in her taxable income on her federal income tax return for 2020, 2021, and 2022. If she elects to claim the entire CRD as taxable income in 2020, she must include $30,000 as income on her 2020 federal tax return.

Seek tax advice before you file your taxes to make certain you are making the best choice for your current and future financial situation. There are several variables that could factor into your decision, such as whether you…

• Earned less in 2020 than in prior years (and may be in a lower tax bracket for 2020)

• Received unemployment compensation in 2020 (you may already owe additional tax if you did not apply withholding) 

• Expect your earnings in 2021 or 2022 to be higher than in 2020 and prior years

• Will file under a different tax-filing status in 2021 or 2022 as compared to 2020 (e.g., newly married or single)

Reporting your CRD to the IRS

You will receive a Form 1099-R from your IRA custodian for any IRA withdrawals you took in 2020. The Form 1099-R will provide information that you must include on your Form 1040 but will not reflect whether a distribution qualifies as a CRD. Qualifying for a CRD is based on your personal circumstances (for example, your work hours or pay were negatively affected by COVID-19). Your IRA custodian cannot make that determination for you. 

To report a CRD for 2020 and elect the tax treatment option, you must file Form 8915-E, Qualified 2020 Disaster Retirement Plan Distributions and Repayments, with your federal income tax return. If you are not required to file a tax return, you must file Form 8915-E on its own to report a CRD.

Repaying a CRD to Your IRA

You may repay all or part of a CRD to your IRA within three years after the date you received the distribution. If you repay a CRD, you will not owe federal income tax on the amount you repay. Depending on whether you chose to claim the entire taxable amount in 2020 or spread it over three years and when and how much you repay, you may have to file an amended tax return for a prior year to recover taxes already paid. 

Full repayment example: Manuel received a CRD in 2020 and choose to include the distribution amount in income over the 3-year period. Then he repaid the full amount to his IRA in July 2022. Manuel will need to file amended federal income tax returns for 2020 and 2021 to claim a refund of the tax attributable to the amount of the distribution that he included in income for those years. He will not be required to include any amount of the CRD in income when he files his 2022 tax return. 

If you choose the 3-year spread option and repay a portion of the CRD within the 3-year period, the repayment will first be used to offset the amount of CRD that should be included in income for that year. The deadline to make a repayment for a tax year is the tax-filing deadline for that tax year, plus extensions. If you make a repayment after this deadline, it will be attributed to the next year’s tax liability for the CRD.  

If the repayment exceeds the amount that must be included in gross income for that tax year, the excess amount may be carried forward to reduce the amount of the CRD you would include in income in the next tax year. Or you may carry back the excess amount to a prior year to reduce your taxable income by the excess amount in that year. To do this, you would need to file an amended federal income tax return for the prior taxable year and report the amount of the repayment on Form 8915-E.

Partial repayment example: Diane received a $75,000 CRD from her IRA on December 1, 2020. She elected to spread the tax liability for the CRD over 3 years. 

On her 2020 tax return, Diane claimed $25,000 as taxable income for the CRD. 

On April 10, 2022, before filing her 2021 tax return, Diane makes a repayment of $25,000 to her IRA. She files her 2021 federal income tax return on April 15, 2022 and does not include any CRD income for 2021 because she made the repayment for 2021 before the 2021 tax return due date. 

For 2022, Diane must claim $25,000 for the CRD in income on her tax return unless she makes another repayment before she timely files her 2022 tax return in 2023.

Seek Tax Advice

Remember to seek tax advice to make sure you understand your options and the filing requirements before you file your tax return for 2020 and again in 2021 and 2022 if you elect the three-year spread.

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