Journal of Financial Planning: December 2020
Randy Gardner, J.D., LL.M., CPA, RLP®, CFP®, is the founder of Goals Gap Planning, LLC, and the director of education for the Garrett Planning Network.
Julie Welch, CPA/PFS, CFP®, is the managing shareholder of Meara Welch Browne, P.C., an accounting firm in Leawood, Kan.
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There are three types of tax planning: long-term strategic planning, short-term tactical planning, and annual operational planning. IRS Notice 2020-50, issued by the Internal Revenue Service on June 19, 2020, offers excellent examples of all three types of tax planning.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act provides that:
- Qualified individuals may treat up to $100,000 in distributions made from their eligible retirement plans (including IRAs) between January 1, 2020, and December 30, 2020, as “coronavirus-related” distributions
- A coronavirus-related distribution is not subject to the 10 percent additional tax that otherwise generally applies to distributions made before an individual reaches age 591⁄2
- A coronavirus-related distribution can be included in income in equal installments over a three-year period
- An individual has three years to repay a coronavirus-related distribution to a plan or IRA and undo the tax consequences of the distribution.
Tax Treatment of Recontributed Amounts
Individuals have up to three years to recontribute qualified distributions. Recontributed dollars are not taxed; therefore, earlier returns may have to be amended if the individual reported the distribution as taxable income in an earlier year. The rules differ depending on whether the individual is recognizing income over three years or entirely in the year of distribution.
If a taxpayer includes all coronavirus-related distributions received in a year in gross income for the current 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: Bill receives a $45,000 coronavirus distribution from his employer plan on November 1, 2020. Bill recontributes $45,000 to an IRA on March 31, 2021. Bill reports the recontribution on to-be-issued Form 8915-E and files his 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 Bill timely requests an extension of time to file the 2020 federal income tax return and makes the recontribution on August 2, 2021, before filing the 2020 federal income tax return. Bill 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 Bill made the recontribution before the timely filing of the extended 2020 federal income tax return.
Planning observations: First, from a long-term strategic planning point of view, it is desirable for Bill to recontribute the withdrawn amounts to accomplish his long-term objective of saving for retirement on a tax-deferred basis.
Second, if Bill believes there is a chance he can return the withdrawn amounts in 2021, from an operational planning point of view, Bill should extend the filing of his 2020 tax return in order to take advantage of the withdrawn amounts for an additional six months and give himself time to gather the funds needed for the repayment.
Example 3: Carrie receives a $15,000 distribution from an employer plan on March 30, 2020. Carrie elects out of the three-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.
Carrie 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.
Planning observation: Carrie has up to three years to evaluate whether to recontribute the withdrawn amount to her long-term plan of saving for retirement and recover the taxes paid for 2020 on the withdrawn amount. Carrie may have needed the funds for her living needs during the three years or she may have engaged in a tactical short-term investment for the three years.
Recontributions: Income Reported 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: Don receives $75,000 from his employer plan on December 1, 2020. Don uses the three-year ratable income inclusion method. Don makes one recontribution of $25,000 to the plan on April 10, 2022. Don files his 2021 federal income tax return on April 15, 2022.
Without the recontribution, Don 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, Don 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
- $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 Don recontributes $25,000 to the plan on August 10, 2022. Don 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, Don 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
- $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 tax 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 tax 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: Eva receives a distribution of $90,000 from her IRA on November 15, 2020. Eva ratably includes the $90,000 distribution in income over a three-year period; without any recontribution, Eva will include $30,000 in income on each of the 2020, 2021, and 2022 federal income tax returns.
Eva includes $30,000 in income with respect to the coronavirus-related distribution on the 2020 federal income tax return. Eva then recontributes $40,000 to an IRA on November 10, 2021 (and makes no other recontribution in the three-year period). Eva may do either of the following:
- Option 1: Include $0 in income with respect to the coronavirus-related distribution on the 2021 federal income tax return, carry forward the excess recontribution of $10,000 to 2022, and include $20,000 ($30,000 – $10,000) in income with respect to the distribution on the 2022 federal income tax return.
- Option 2: Include $0 in income with respect to the coronavirus-related distribution on the 2021 tax return, $30,000 in income on the 2022 federal income tax return, and file an amended federal income tax return for 2020 to reduce the amount included in income as a result of the 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).
Planning observation: Think about the tactical planning opportunities presented by this sequence of examples from the IRS Notice, particularly Example 6 (Eva). If you take a coronavirus-related distribution in 2020, you can pay the tax on your 2020, 2021, and 2022 returns, determine which years are the high marginal tax rate years, recontribute all or part of the withdrawal before the extended due date of the return for 2022, and allocate the excess recontribution to the high tax years.
Example 7: The facts are the same as in Example 6, except Eva extended her 2021 income tax return. It is October 1, 2022, and Eva’s 2021 income tax return is due in two weeks. Usually, Eva is subject to a 30 percent (24 percent federal and 6 percent state) marginal income tax rate. However, because of the economic slowdown, her marginal tax rate in 2020 was 28 percent, is 38 percent in 2021 and, based on the first nine months in 2022, will be 30 percent in 2022. Her best tactical strategy appears to be to let the 2020 payment of tax stand because the marginal tax rate is lower than her anticipated future tax rate. Eva could recontribute $30,000 before the extended due date of her 2021 return to avoid tax on the withdrawal at a 38 percent tax rate, extend the due date for her 2022 return to give her the use of the funds until October 2022, and recontribute $30,000 before October 15, 2023, to avoid tax at the 30 percent marginal tax rate for 2022.
The coronavirus relief and stimulus packages offer numerous strategic, tactical, and operational planning strategies. There is still time in 2020 to take advantage of many of the provisions—and three years, in the case of coronavirus-related distributions—to evaluate how and when to recontribute retirement plan distributions.