Coronavirus Distributions: Adverse Financial Consequences and Recontributions

Thanks to the IRS, people whose adverse financial consequences count for getting a coronavirus-related distribution now include spouses and other household members. The IRS has also clarified with lots of examples the thorny intersection between recontributions, taxes, and amended returns.

The new IRS guidance presents the rules set out in Act Sec. 2202 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136).  The guidance provides safe harbors for employers, including employee certifications and plan loan payment relief. The focus here, however, is on individuals and their taxes.

Coronavirus-related distributions and loans

The CARES Act provides that qualified individuals may treat as coronavirus-related distributions up to $100,000 in distributions made from their eligible retirement plans (including IRAs) between January 1 and December 30, 2020. To qualify, the distributions must be made to an individual:

• who is diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (Covid-19) by a test approved by the Centers for Disease Control and Prevention;
• whose spouse or dependent is diagnosed with such virus or disease by such a test, or
• who experiences adverse financial consequences as a result the coronavirus.

The CARES Act lists several “factors” that would count as an individual suffering adverse financial consequences due to the virus. These factors include:

• being quarantined;
• being furloughed or laid off;
• having work hours reduced;
• being unable to work due to lack of child care;
• closing or reducing hours of a business owned or operated by the individual; or
• other factors as determined by the Secretary of the Treasury.

Comment: Basically, these factors include lost wage or business income due to the effect of the virus on the individual’s employer, business, or day care provider. The net is cast pretty wide considering it would include the shut-down and longer-term changes in shopping, dining, travel, entertainment and commuting habits.

Additional factors

Note that the CARES Act invites the Treasury Department to identify other factors. The Treasury through its agency the IRS has added the following factors:

• reduction in pay or self-employment income;
• rescission of a job offer;
• delayed start date for a job; or
• any of these things (including the original CARES Act factors) happening to the individual’s spouse or other member of the individual’s household.

A member of the individual’s household, for these purposes, is someone who shares the individual’s principal residence.  Working age children or life partners would qualify.

Comment: One might have gleaned reduced wage rates and reduced self-employment income from the initial list, but it is good they are spelled out.  Interference with a new job is more of a departure, but is thoroughly in keeping with the initial list of lost wage income.

Expanded universe. What could not be gleaned from the initial list is the expansion of adverse financial consequences to a spouse or other household member.  Adverse financial consequences is to be measured on a household basis rather than an individual basis.

Comment: The expansion of the universe of people to whom bad financial things must happen before one can qualify for a distribution is significant.  Most people do not have substantial retirement plan balances.  This is especially true for “second” income spouses or partners, or working age children.  Now their adverse financial consequences can be used to unlock the household’s retirement assets even if the job of assets’ owner has been unaffected.

Recontributions

The new guidance goes into some detail about recontributions providing many examples. Individuals have up to three years to recontribute qualified distributions. Recontributed dollars are not taxed, so earlier returns may have to be amended. The rules differ depending on whether the individual is recognizing income over three years or entirely in the year of distribution.

Taxpayers recognizing income in year of distribution

If a taxpayer includes all coronavirus-related distributions received in a year in gross income for that year and recontributes any portion during the three-year recontribution period, the amount of the recontribution will reduce the amount of the related distribution included in gross income for the year of the distribution.

Example 1. Robert receives a $45,000 coronavirus distribution from his employer plan on November 1, 2020. Robert recontributes $45,000 to an IRA on March 31, 2021. He reports the recontribution on Form 8915-E and files the 2020 federal income tax return on April 10, 2021. No portion of the coronavirus-related distribution is includible as income for the 2020 tax year.

Example 2. The facts are the same as in Example 1, except that Robert timely requests an extension of time to file the 2020 federal income tax return and makes a recontribution on August 2, 2021, before filing the 2020 federal income tax return. He files the 2020 federal income tax return on August 10, 2021. As in Example 1, no portion of the coronavirus-related distribution is includible in income for the 2020 tax year because he made the recontribution before the timely filing of the 2020 federal income tax return.

Example 3. Celia receives a $15,000 distribution from an employer plan on March 30, 2020. She elects out of the 3-year ratable income inclusion on Form 8915-E and includes the entire $15,000 in gross income for the 2020 tax year. On December 31, 2022, she recontributes $15,000 to her employer plan. Celia will need to file an amended federal income tax return for the 2020 tax year to report the amount of the recontribution and reduce the gross income by $15,000 with respect to the coronavirus-related distribution included on the 2020 original federal income tax return.

Taxpayers recognizing income over three years

If a qualified individual includes a coronavirus-related distribution ratably over a three-year period and the individual recontributes any portion to an eligible retirement plan at any date before the timely filing of the individual’s federal income tax return (that is, by the due date, including extensions) for a tax year in the three-year period, the amount of the recontribution will reduce the ratable portion of the coronavirus-related distribution that is includible in gross income for that tax year.

Example 4. David receives $75,000 from his employer plan on December 1, 2020. He uses the three-year ratable income inclusion method. David makes one recontribution of $25,000 to the plan on April 10, 2022. He files his 2021 federal income tax return on April 15, 2022. Without the recontribution, David should include $25,000 in income with respect to the coronavirus-related distribution on each of his 2020, 2021, and 2022 federal income tax returns. However, as a result of the recontribution, David should include $25,000 in income with respect to the coronavirus-related distribution on the 2020 federal income tax return, $0 in income with respect to the coronavirus-related distribution on the 2021 federal income tax return, and $25,000 in income with respect to the coronavirus-related distribution on the 2022 federal income tax return.

Example 5. The facts are the same as in Example 4 except David recontributes $25,000 to the plan on August 10, 2022. He files the 2021 federal income tax return on April 15, 2022, and does not request an extension of time to file that federal income tax return. As a result of the recontribution, David should include $25,000 in income with respect to the coronavirus-related distribution on the 2020 federal income tax return, $25,000 in income with respect to the coronavirus-related distribution on the 2021 federal income tax return, and $0 in income with respect to the coronavirus-related distribution on the 2022 federal income tax return.

Carryovers

If the taxpayer recontributes an amount for a tax year in the three-year period that exceeds the amount that is otherwise includible in gross income for that tax year, the excess amount of the recontribution may be carried forward to reduce the amount of the distribution includible in gross income in the next tax year in the three-year period. Alternatively, the qualified individual is permitted to carry back the excess amount of the recontribution to a prior taxable year or years in which the individual included income attributable to a coronavirus-related distribution. The individual will need to file an amended federal income tax return for the prior taxable year or years to report the amount of the recontribution on Form 8915-E and reduce his or her gross income by the excess amount of the recontribution.

Example 6. Taxpayer Eliza receives a distribution of $90,000 from her IRA on November 15, 2020. Eliza ratably includes the $90,000 distribution in income over a three-year period. Without any recontribution, Eliza will include $30,000 in income with respect to the coronavirus-related distribution on each of the 2020, 2021, and 2022 federal income tax returns. Eliza includes $30,000 in income with respect to the coronavirus-related distribution on the 2020 federal income tax return. Eliza then recontributes $40,000 to an IRA on November 10, 2021 (and makes no other recontribution in the three-year period). Eliza may do either of the following:

• Option 1: includes $0 in income with respect to the coronavirus-related distribution on the 2021 federal income tax return, and carry forward the excess recontribution of $10,000 to 2022 and includes $20,000 in income with respect to the coronavirus-related distribution on Eliza’s 2022 federal income tax return.
• Option 2: includes $0 in income with respect to the coronavirus-related distribution on the 2021 tax return and $30,000 in income on the 2022 federal income tax return. Also file an amended federal income tax return for 2020 to reduce the amount included in income as a result of the coronavirus-related distribution to $20,000 (that is, the $30,000 original amount includible in income for 2020 minus the remaining $10,000 recontribution that is not offset on either the 2021 or 2022 federal tax return).

Conclusion

The IRS’s added factors for identifying adverse financial consequences means that people can qualify on a household basis rather than solely on an individual basis.  It also means that a lost or delayed new job, reduced wages, and lost self-employment income can count as well.

By James Solheim, J.D.

Wolters Kluwer is by your side to help you stay up-to-date with tax and compliance changes and support your ability to work remotely. Please visit our Coronavirus (COVID-19) Resource Page for Tax & Accounting Professionals.

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