A key provision of the Coronavirus Aid, Relief, and Economic Security (CARES) Act is intended to help alleviate some of the economic hardship many Americans are experiencing as a result of the novel coronavirus (COVID-19) pandemic. It allows tax-favored treatment for distributions from retirement accounts in certain situations.
Penalty waiver and more
Under the CARES Act, IRA owners who are adversely affected by the COVID-19 pandemic are eligible to take tax-favored “coronavirus-related” distributions (CVDs) of up to $100,000 from their IRAs. If you’re under age 59½, the early withdrawal penalty that normally would apply is waived. Any eligible IRA owner can recontribute (repay) a CVD back into their IRA within three years of the withdrawal date and treat the withdrawal and later recontribution as a tax-free rollover. There are no limitations on what you can use CVD funds for during that three-year period.
The CARES Act also may allow you to take tax-favored CVDs from your employer’s qualified retirement plan, such as a 401(k) or profit-sharing plan, if the plan allows it. If allowed, the tax rules for CVDs taken from qualified plans are similar to those for CVDs taken from IRAs. As of this writing, a lot of details still need to be figured out about how CVDs taken from qualified plans will work. Contact the appropriate person with your employer for more information.
7 basic rules
There are seven basic rules for taking CVDs from IRAs:
1. You can take one or more CVDs up to the $100,000 limit.
2. CVDs can come from different IRAs.
3. The three-year recontribution period for each CVD begins on the day after you receive it.
4. You can make your recontributions in a lump sum or through multiple recontributions.
5. You can recontribute to one or several IRAs, and they don’t have to be the same accounts you took the CVDs from.
6. As long as you recontribute the entire CVD amount within the three-year window, the whole transaction or series of transactions are treated as tax-free IRA rollovers.
7. If you’re under 59½, the 10% penalty tax that usually applies to early IRA withdrawals is waived for CVDs, even if you don’t recontribute.
If your spouse owns one or more IRAs in his or her own name, he or she may be eligible for the same distribution privilege.
CVDs can be taken from January 1, 2020, through December 30, 2020, by an eligible individual. That means an individual:
- Who’s diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention,
- 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,
- Who experiences adverse financial consequences as a result of being quarantined, furloughed, laid off or having work hours reduced due to COVID-19,
- Who’s unable to work because of lack of childcare due to COVID-19 and experiences adverse financial consequences as a result,
- Who owns or operates a business that has closed or has had operating hours reduced due to COVID-19 and has experienced adverse financial consequences as a result, or
- Who has experienced adverse financial consequences due to other COVID-19-related factors.
As of this writing, IRS guidance on how to interpret the last two factors is needed. Check in with us for the latest developments.
When taxes are due
You’ll be taxed on any CVD amount that you don’t recontribute within the three-year window. But you won’t have to worry about owing the 10% early withdrawal penalty if you’re under 59½.
You can choose to spread the taxable amount equally over three years, apparently starting with 2020. But here it gets tricky, because the three-year 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 return to report some additional taxable income from the CVD. As of this writing, the IRS is expected to issue guidance to clarify this issue. Again, check in with us for the latest information.
You also have the option of simply reporting the taxable income from the CVD on your 2020 individual income tax return Form 1040. Again, you won’t owe the 10% early withdrawal penalty if you’re under 59½.
Getting through the crisis
CVDs can be a helpful, flexible tax-favored financial tool for eligible taxpayers during the pandemic. But it’s just one of several financial relief measures available under the CARES Act that include tax relief, and other relief legislation may be forthcoming. We can help you take advantage of relief measures that will help you get through the COVID-19 crisis.
How Employers Can Get Some Financial Relief with the Retention Tax Credit
To help reduce layoffs during the coronavirus (COVID-19) pandemic, the Coronavirus Aid, Relief and Economic Security (CARES) Act created a new federal income tax credit for employers that keep workers on their payrolls. The credit equals 50% of eligible employee wages paid by an eligible employer in a 2020 calendar quarter. It’s subject to an overall wage cap of $10,000 per eligible employee. Here are answers to some FAQs about the retention credit.
What employers are eligible?
Eligible employer status for the retention credit is determined on a 2020 calendar quarter basis. The credit is available to employers, including nonprofits, whose operations have been fully or partially suspended during a 2020 calendar quarter as a result of an order from an appropriate governmental authority that limits commerce, travel or group meetings due to COVID-19.
The retention credit can also be claimed by employers that have experienced a greater-than-50% decline in gross receipts for a 2020 calendar quarter compared to the corresponding 2019 calendar quarter. However, the credit is disallowed for quarters following the first calendar 2020 quarter during which gross receipts exceed 80% of gross receipts for the corresponding 2019 calendar quarter.
To illustrate: Suppose a company’s 2020 gross receipts are as follows compared to 2019:
- First quarter: 86%
- Second quarter: 43%
- Third quarter: 92%
The company had a greater-than-50% decline in gross receipts for the second quarter of 2020. So, it’s an eligible employer for purposes of the retention credit for the second and third quarters of 2020. For the fourth quarter of 2020, it’s ineligible because its gross receipts for the third quarter of 2020 exceeded 80% of gross receipts for the third quarter of 2019.
What wages are eligible?
The retention credit is available to cover eligible wages paid from March 13, 2020, through December 31, 2020. For an eligible employer that had an average of 100 or fewer full-time employees in 2019, all employee wages are eligible for the credit (subject to the overall $10,000 per-employee wage cap), regardless of whether employees are furloughed due to COVID-19.
For an employer that had more than 100 full-time employees in 2019, only wages of employees who are furloughed or given reduced hours due to the employer’s closure or reduced gross receipts are eligible for the retention credit (subject to the overall $10,000 per-employee wage cap, including qualified health plan expenses allocable to those wages).
The amount of wages eligible for the credit is capped at a cumulative total of $10,000 for each eligible employee. The $10,000 cap includes allocable health plan expenses. For example, a company pays an employee $8,000 in eligible wages in the second quarter of 2020 and another $8,000 in the third quarter of 2020. The credit for wages paid to the employee in the second quarter is $4,000 (50% x $8,000). The credit for wages paid to the employee in the third quarter is limited to $1,000 (50% x $2,000) due to the $10,000 wage cap. Any additional wages paid to the employee are ineligible for the credit due to the $10,000 cap.
What other rules and restrictions apply?
The retention credit is not allowed for:
- Emergency sick leave wages or emergency family leave wages that small employers (generally those with fewer than 500 employees) are required to pay under the Families First Coronavirus Response Act (FFCRA), because they’re covered by federal payroll tax credits granted by the FFCRA,
- Wages taken into account for purposes of claiming the pre-existing Work Opportunity Tax Credit, and
- Wages taken into account for purposes of claiming the pre-existing employer credit for paid family and medical leave.
In addition, the retention credit isn’t available to small employers that receive a potentially forgivable Small Business Administration (SBA) guaranteed Small Business Interruption Loan under the CARES Act’s Paycheck Protection Program.
How is the credit claimed?
Technically, an eligible employer’s allowable retention credit for a calendar quarter is offset against the employer’s liability for the Social Security tax component of federal payroll taxes. That component equals 6.2% of the first $137,700 of an employee’s 2020 wages.
But the credit is “refundable.” That means an employer can collect the full amount of the credit even if it exceeds its federal payroll tax liability.
The allowable credit can be used to offset all of an employer’s federal payroll tax deposit liability, apparently including federal income tax, Social Security tax and Medicare tax withheld from employee paychecks. If an employer’s tax deposit liability isn’t enough to absorb the credit, the employer can apply for an advance payment of the credit from the IRS.
Can you benefit?
If your business has suffered financially during the COVID-19 pandemic, the CARES Act’s 50% employee retention credit might help you keep workers on the payroll during the crisis. Keep in mind that additional guidance could be released on the credit or more legislation could be signed into law extending or expanding the credit. We can apprise you of any updates, help you determine whether you’re eligible and explore other tax-saving and financial assistance opportunities that may be available to you during this challenging time.