COVID-19: CARES Act Allows $100,000 Tax-Free IRA Grab and Repay

COVID-19-Related Distributions from IRAs Get Tax-Favored Treatment

If you are an IRA owner who has been adversely affected by the COVID-19 pandemic, you are probably eligible to take tax-favored distributions from your IRA(s).

For brevity, let’s call these allowable COVID-19 distributions “CVDs.” They can add up to as much as $100,000. Eligible individuals can recontribute (repay) CVD amounts back into an IRA within three years of the withdrawal date and can treat the withdrawals and later recontributions as federal-income-tax-free IRA rollover transactions.

In effect, the CVD privilege allows you to borrow up to $100,000 from your IRA(s) and recontribute the amount(s) at any time up to three years later with no federal income tax consequences.

There are no income limits on the CVD privilege, and there are no restrictions on how you can use CVD money during the three-year recontribution period.

If you’re cash-strapped, use the money to pay bills and recontribute later when your financial situation has improved. Help your adult kids out. Pay down your HELOC. Do whatever you want with the money.

CVD Basics

Eligible individuals can take one or more CVDs, up to the $100,000 aggregate limit, and these can come from one or several IRAs. The three-year recontribution period for each CVD begins on the day after you receive it.

You can make recontributions in a lump sum or make multiple recontributions. You can recontribute to one or several IRAs, and they don’t have to be the same account(s) you took the CVD(s) from in the first place.

As long as you recontribute the entire CVD amount within the three-year window, the transactions are treated as tax-free IRA rollovers. If you’re under age 59 1/2, the dreaded 10 percent penalty tax that usually applies to early IRA withdrawals does not apply to CVDs.

If your spouse owns one or more IRAs in his or her own name, your spouse is apparently eligible for the same CVD privilege if he or she qualifies (see below).   

Do I Qualify for the CVD Privilege?

That’s a good question. Some IRA owners will clearly qualify, while others may have to wait for IRS guidance. For now, here’s what the CARES Act says.

A COVID-19-related distribution is a distribution of up to $100,000 from an eligible retirement plan, including an IRA, that is made on or after January 2, 2020, and before December 31, 2020, to an individual

• • who is diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention; or
• • 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; or
• • who experiences adverse financial consequences as a result of being quarantined, furloughed, laid off, or forced to reduce work hours due to COVID-19; or
• • who is unable to work because of a lack of child care due to COVID-19 and experiences adverse financial consequences as a result; or
• • who owns or operates a business that has closed or had operating hours reduced due to COVID-19, and who has experienced adverse financial consequences as a result; or
• • who has experienced adverse financial consequences due to other COVID-19-related factors to be specified in future IRS guidance.

We await IRS guidance on how to interpret the last two factors. We hope and trust that the guidance will be liberally skewed in favor of IRA owners. We shall see.

What If I Don’t Recontribute a CVD within the Three-Year Window?

Another good question. You will owe income tax on the CVD amount that you don’t recontribute within the three-year window, but you don’t have to worry about owing the 10 percent early withdrawal penalty tax if you are under age 59 1/2.

If you don’t repay, you can choose to spread the taxable amount equally over three years, apparently starting with 2020.

Example. Tomorrow you withdraw $90,000 from your IRA, and you don’t recontribute it and don’t elect out of the three-year spread; you have $30,000 of taxable income in years 1, 2, and 3.

Here it gets tricky, because the three-year recontribution 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 tax return to report some additional taxable income from the three-year spread. The language in the CARES Act does not address this issue, so the IRS will have to weigh in. Of course, the IRS may not be in a big hurry to issue guidance right now, because it has three years to mull it over.   

You also have the option of simply electing to report the taxable income from the CVD on your 2020 Form 1040. You won’t owe the 10 percent early withdrawal penalty tax if you are under age 59 1/2.

Can the One-IRA-Rollover-Per-Year Limitation Prevent Me from Taking Advantage of the CVD Deal?

Gee, you ask a lot of good questions. The answer is no, because when you recontribute CVD money within the three-year window, it is deemed to be done via a direct trustee-to-trustee transfer that is exempt from the one-IRA-rollover-per-year rule. So, no worries there.

Can I Take a CVD from My Company’s Tax-Favored Retirement Plan?

Yes, if your company allows it. The tax rules are similar to those that apply to CVDs taken from IRAs.

That said, employers and the IRS have lots of work to do to figure out the details for CVDs taken from employer-sponsored qualified retirement plans. Stay tuned for more information.        

More Good News: Retirement Account Required Minimum Distribution Rules Are Suspended for 2020

In normal times, after reaching the magic age, you must start taking annual required minimum distributions (RMDs) from traditional IRAs set up in your name (including SEP-IRA and SIMPLE-IRA accounts) and from tax-favored company retirement plan accounts. The magic age is 70 1/2 if you attained that age before 2020 or 72 if you attain age 70 1/2 after 2019.

And you must pay income tax on the taxable portion of your RMDs. Ugh!

Thankfully, the CARES Act suspends all RMDs that you would otherwise have to take in 2020.

The suspension applies equally to your initial RMD if you turned 70 1/2 last year and did not take that initial RMD last year (the initial RMD is actually for calendar year 2019). Before the CARES Act, the deadline for taking that initial RMD was April 1, 2020. Now, thanks to the CARES Act, you can put off any and all RMDs that you otherwise would have had to take this year. Good!

For 2021 and beyond, the RMD rules will be applied as if 2020 never happened. In other words, all the RMD deadlines will be pushed back by one year, and any deadlines that otherwise would have applied for 2020 will simply be ignored.

Takeaways

The CVD privilege can be a very helpful and very flexible tax-favored financial arrangement for eligible IRA owners.

• • You can get needed cash into your hands right now without incurring the early withdrawal penalties.
• • You can then recontribute the CVD amount anytime within the three-year window that will close sometime in 2023—depending on the date you take the CVD—to avoid any federal income tax hit.

The suspension of RMDs for this year helps your 2020 tax situation, because you avoid the tax hit on RMDs that you otherwise would have had to withdraw this year.

I love it when I can bring you good news. If you would like to discuss the COVID-19 changes to your IRA, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• April 6, 2020

Beat the Unfair $10,000 SALT Cap with a C Corporation

C corporations cause double taxation for business owners, so you probably think you want to avoid them at all costs.

And for many of you, this is true, as the S corporation often provides the lower overall tax outcome.

But for some of you, the C corporation could provide the best tax outcome because it bypasses the $10,000 state and local tax (SALT) deduction cap, which was introduced by the Tax Cuts and Jobs Act (TCJA).

Prior to the TCJA, you could deduct as itemized deductions on your Form 1040, Schedule A—without limit—the following foreign, state, and local taxes:

• Income taxes
• Real property taxes
• Personal property taxes
• Foreign income and real property taxes

Tax reform took two direct actions against your Form 1040 itemized deductions for foreign, state, and local taxes. Beginning in tax year 2018,

• you can’t deduct foreign real property taxes, and
• your combined state and local income, real property, and personal property tax deductions may not exceed $10,000 ($5,000 on a married filing separate return).

If you operate your business as an S corporation, the S corporation passes its net income to your individual tax return. This causes you, the individual, to pay state income taxes on the S corporation income. Those state income taxes are subject to the $10,000 cap.

C Corporation Loophole

But there is an exception: This $10,000 limit applies only to individuals—meaning, taxes deducted on your Form 1040, Schedule A. The limit does not apply to C corporations.

If you operate your business as a C corporation, then your C corporation pays state income taxes on its net income and deducts those taxes on its corporate income tax return.

• By Leon Clinton
• April 5, 2020

Dealing With Deposits in Quickbooks

Recording payments, whether they come in to comply with an invoice you sent or are issued as sales receipts, is one of the more satisfying tasks you do in QuickBooks. The sales cycle is almost complete, and you’re about to have more money in the bank – once you document the payments as bank deposits.

Unless you use QuickBooks Payments, which moves your company’s remittances into an account automatically, you’ll have to deal with your deposits twice. First, you’ll have to make out a deposit slip for the bank. You’ll also need to record the deposit in QuickBooks itself.

Fortunately, the software makes this easy for you. Here’s how it works.

A Special Account

By default, QuickBooks transfers payments received into an account called Undeposited Funds. You can see it in your Chart of Accounts by clicking the Chart of Accounts icon on QuickBooks’ home page and scrolling down a bit. Look over to the end of the line and you’ll see its current balance. This account is an Other current asset. It holds your payments until you record them as deposits and take your money to the bank.

When you’re getting ready to take cash and checks to the bank, click the Record Deposits icon on the home page. The Payments to Deposit window will open.

Figure 1: When money moves into Undeposited Funds from invoice payments or sales receipts, it’s displayed in the Payments to Deposit window.

We recommend completing your physical deposit slip first, based on the checks and cash you have in hand. Then, match them to payments in the window pictured above. You can click in front of each one you’ve matched to create a checkmark. When you’ve finished, click OK. The Make Deposits window will open. Make sure that the account you want to Deposit to is showing in the upper left corner. You can add a Memo and change the Date if needed.

Do you want cash back from your deposit? You may want to move this to Petty Cash, for example. Click the down arrow in the Cash goes back to field and select the correct account. Add a memo if necessary and enter the Cash back amount. When you’re done, save the transaction. QuickBooks now knows that you’re taking a deposit slip to the bank.

The total for your handwritten deposit slip and the final tally in the Make Deposits window should be the same. This will ensure that the amount deposited in your bank account will match the bank deposit amount in QuickBooks when reconciling. If you have leftover cash or checks, you’ll need to track down their origins and create new transactions.

Checking Your Work

It’s a good idea to check your Undeposited Funds account occasionally to make sure that you haven’t left money undeposited. To do this, open your Chart of Accounts again. Right-click Undeposited Funds and click on QuickReport: [number] Undeposited Funds. All should be selected in the Date field in the upper left. Click on Customize Report and select the Filters tab. Scroll down in the Filters list and click on Cleared. Select No and click OK to display your report.

Figure 2: You can customize your QuickReport to see if you’ve neglected to deposit any payments. If this list contains any, open the Banking menu and select Make Deposits to follow the steps above again.

Changing Your Destination Account

As we’ve already mentioned, QuickBooks is set up to automatically move payments into Undeposited Funds. We recommend leaving it this way so you can easily check for money that hasn’t been deposited. You can change this, though. If you feel it’s necessary, please call the office and speak to a QuickBooks professional who will help you modify your destination account.

Working with Payment Methods

QuickBooks comes with a default set of payment methods. You can add to these and/or make existing ones inactive, so they don’t clutter up the drop-down list. Open the Lists menu and select Customer & Vendor Profile Lists | Payment Method List. If you don’t accept Discover cards, for example, right-click on that entry and select Make Payment Method Inactive. To add one, click the down arrow next to Payment Method and then New. The Payment Method should always match the Payment Type.

Precision Critical

Account reconciliation is difficult enough without having to deal with deposit discrepancies. Treat this element of your accounting with great care. If you need help with account management, financial reporting or any other QuickBooks-related issues don’t hesitate to call.

• By Leon Clinton
• March 30, 2020