Taxation of Coronavirus-Related Distributions

The CARES Act, passed in March 2020, included trillions of dollars of economic stimulus. Most people recognize the CARES Act because it was the legislation that provided for the first round of economic impact payments as well as the popular Paycheck Protection Program (PPP) loans. In addition to these programs, the CARES Act provided for “coronavirus-related” distributions from certain qualified retirement plans.

Participants who chose to take advantage of the program could avoid the normal 10% early withdrawal penalty for distributions taken before age 59 ½ and spread the income over a three-year period for federal income tax purposes.

Some mistakenly thought that because the penalty for early distributions was waived, that they would owe no tax at all for these distributions. However, the withdrawal of pre-tax contributions and any earnings thereon is included in taxable income, but the CARES Act allows taxpayers to spread the income over three years.

Those that had no federal income tax withheld from their coronavirus-related distribution may be surprised that they have a significant amount of tax due with their 2020 return. On the other hand, if you elected to have federal income tax withheld from your distribution, you may find that you are due a sizable refund because only one-third of your distribution may be taxable in 2020.

If you repay the distribution to your retirement plan before the end of the three-year period, you can file an amended federal tax return to recover the taxes paid on the distribution. (i.e.If you repay the distribution in 2021, you can file an amended 2020 return to recover the taxes you paid on the first third of your distribution; If you repay the distribution in 2022, you could file amended 2020 and 2021 returns to recover the taxes you paid on the first two thirds of your distribution.)

Setting the federal income tax situation aside, it is important to note that Pennsylvania does not recognize the CARES Act relief measures for coronavirus-related distributions. Therefore, the entire distribution is taxable in the year it was received. Unlike the federal rules, you cannot get these taxes back even if you pay the distribution back to your retirement plan within three years. You can, however, add the repayment to your basis so that the funds won’t be taxed again when you withdraw them during retirement.

Have more questions? Schreiber Accounting and Advisory can help with comprehensive tax return preparation and tax planning services. Contact the firm for more information.

Material discussed is for informational purposes only. It is not to be interpreted as investment, tax, or legal advice. Individual situations vary, and this information should only be relied upon when coordinated with individual professional advice.