The U.S. government extended a series of helpful financial lifelines as we navigated the 2020 peak of the COVID-19 pandemic. Chief among the implemented measures was the Coronavirus Aid, Relief, and Economic Security, or CARES, Act. This key legislation included a provision allowing investors to tap into retirement funds for emergencies without having to worry about IRS scrutiny.
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What Are COVID Distributions?
Under normal circumstances, a distribution from a tax-advantaged account taken prior to age 59 ½ would be subject to taxes and an additional 10% penalty. However, thanks to the CARES Act, retirement plan investors could take early distributions up to $100,000 for COVID-related expenses without having to pay the penalty. COVID-related expenses included anything from medical costs to lost income from losing a job or working reduced hours.
How Do I Report These Distributions?
The deadline to take advantage of permitted early distributions was December 30, 2020. But now, with the tax filing deadline looming (though extended to May 17), how would you report these distributions if taken in 2020?
Despite avoiding the 10% penalty, income taxes still apply on withdrawn COVID-related balances, though you’re under no obligation to pay your tax bill all at once. In fact, you have three years to pay taxes on your COVID distributions. For example, if you withdrew a total of $30,000 for COVID expenses, you could simply add $10,000 to your income each year for the next three years to spread out your tax payments. You could also pay taxes on the full $30,000 at once if you have the means.
The Bottom Line: You don’t need to make a special IRS filing to pay taxes on your COVID distributions. It is as easy as adding some or all of the distribution amount to your 2020 income, filing your normal return, and paying the taxes.
Can I Reimburse My Account to Avoid Taxes?
If you withdrew money for COVID expenses but now find yourself in a better financial situation, you can re-contribute your COVID distributions anytime up to three years after your distribution date. Normally the IRS wouldn’t allow this, but, by virtue of the CARES Act, re-depositing tax-advantaged money is regarded as a trustee-to-trustee transfer in this case.
This would carry zero tax implications. You could even file an amended return and receive a tax refund if you pay taxes on a COVID distribution but later decide to reimburse your account.
Know Your Options
The IRS endeavored to simplify tax considerations as COVID-19 aimed to complicate everything else. If you capitalized on penalty-free early distributions for COVID expenses last year, you have three years of flexibility when it comes to covering the taxes or reimbursing your account.
If there’s anything we can assist with when it comes to your self-directed IRA, Solo 401(k), or Health Savings Account, please feel free to give us a call at 877-742-1270 or send us a message through the Client Portal.