Did you take a coronavirus distribution (CVD) of up to a combined limit of $100,000 from one or more of your traditional IRAs in 2020?
You can recontribute the CVD amount(s) back into one or more traditional IRAs within three years of the withdrawal date(s). You treat each withdrawal and later recontribution within the three-year window as a federal-income-tax-free IRA rollover transaction. That’s the tax advantage.
The non-tax advantage is that there are no restrictions on how you can use CVD funds. You can use the money to pay bills and recontribute later—within the three-year window—when your financial situation permits. You can help out your adult kids now and recontribute later. Whatever.
Key point. The favorable tax treatment applies equally to CVDs taken from garden-variety traditional IRAs, SEP-IRAs, SIMPLE-IRAs, and employer retirement plans that allowed CVDs.
Unfortunately, you must put up with some potentially awkward interim tax consequences before you arrive at the tax-free-rollover-equivalent outcome. The interim tax consequences can diminish the cash-management advantages of the CVD deal, and they require filing amended returns to gain federal-income-tax-free treatment.
You always have the option of simply keeping all or part of your CVD money. You’ll have taxable income from the CVD amount that you don’t recontribute.
Good news. Regardless of what you choose to do with your CVD, you won’t owe the dreaded 10 percent early withdrawal penalty tax that generally applies to traditional IRA withdrawals taken before age 59 1/2. CVDs are completely exempt from the penalty tax.
The same is true for the SIMPLE-IRA. IRS Notice 2020-50 clarifies that CVDs taken from a SIMPLE-IRA are exempt from the 25 percent early distribution penalty tax that generally applies to SIMPLE-IRA withdrawals taken before age 59 1/2.
More good news. When you recontribute a CVD amount within the three-year window, it’s deemed to be a direct trustee-to-trustee transfer that’s exempt from the one-IRA-rollover-per-year limitation.
Bad news. According to IRS Notice 2020-50, beneficiaries of inherited IRAs can receive CVDs as long as
- they are eligible individuals,
- they can follow the three-year ratable inclusion rule to report taxable income from CVDs, and
- their CVDs are exempt from the 10 percent early distribution penalty tax.
But only an IRA CVD that is otherwise eligible for tax-free rollover treatment can be recontributed. Therefore, CVDs received by beneficiaries of inherited IRAs (other than the surviving spouse of the IRA owner) cannot be recontributed. So, no tax-free-rollover-equivalent deal for those folks. Sorry.
If you have questions about your CVDs, please don’t hesitate to contact us!