Repaying a COVID-Related Distribution

Do you remember a tax break in 2020 that allowed you to take (up to) $100,000 from your IRA or your employer retirement plan? These were called “coronavirus-related distributions,” or CRDs in the lingo. In and of itself, the provision was not remarkable. What was remarkable is that one was allowed three years to return some, all, or none of the money to the IRA or employer plan, as one wished.

I was thinking recently that I do not remember seeing 2021 individual returns where someone returned the money.

Granted, we have a flotilla of returns on extension here at Galactic Command. I may yet see this beast in its natural state.

Let’s go over how this provision works.

To make it easy, let’s say that you took $100,000 from your 401(k) in 2020 for qualifying COVID-related reasons.

You had an immediate binary decision:

·      Report the entire $100,000 as income in 2020 and pay the taxes immediately.

·      Spread the reporting of the $100 grand over three years – 2020, 2021 and 2022 - and pay taxes over three years.

There was no early-distribution penalty on this distribution, which was good.

You might wonder how paying the tax immediately could be preferable to paying over three years. It could happen. How? Say that you had a business and it got decimated by COVID lockdowns. Your 2020 income might be very low – heck, you might even have an overall tax loss. If that were the case, reporting the income and paying the tax in 2020 might make sense, especially if you expected your subsequent years’ income to return to normal levels.

What was a COVID-related reason for a distribution?

The easy ones are:

·      You, a spouse or dependent were diagnosed (and possibly quarantined) with COVID;

·      You had childcare issues because of COVID;

·      You were furloughed, laid-off or had work hours reduced because of COVID.

Makes sense. There is one more:

·      You experienced other “adverse financial consequences” because of COVID.

That last one has an open-gate feel to me. I’ll give you an example:

·      You own rental cabins in Aspen. No one was renting your cabins in 2020. Did you experience “adverse financial consequences” triggering this tax provision?

You have – should you choose to do so – three years to put the money back. The three-year period starts with the date of distribution, so it does not automatically mean (in fact, it is unlikely to be) December 31^st three years later.

The money doesn’t have to return to the same IRA or employer plan. Any qualifying IRA or employer plan will work. Makes sense, as there is a more-than-incidental chance that someone no longer works for the same employer.

 Let’s say that you decide to return $50 grand of the $100 grand.

The tax reporting depends on how you reported the $100 grand in 2020.

Remember that there were two ways to go:

·      Report all of it in 2020

This is easy.

You reported $100 grand in 2020.

When you return $50 grand you … amend 2020 and reduce income by $50 grand.

What if you return $50 grand over two payments – one in 2021 and again in 2022?

Easy: you amend 2020 for the 2021 and amend 2020 again for the 2022.

Question: can you keep amending like that – that is, amending an amended?

Answer: you bet.

·       Report the $100 grand over three years.

This is not so easy.

The reporting depends on how much of the $100 grand you have left to report.

Let’s say that you are in the second year of the three-year spread and repay $30,000 to your IRA or employer plan.

The test here is: did you repay the includable amount (or less) for that year?

If yes, just subtract the repayment from the includable amount and report the difference on that year’s return.

In our example, the math would be $33,333 - 30,000 = $3,333. You would report $3,333 for the second year of the spread.

If no, then it gets ugly.

Let’s revise our example to say that you repaid $40,000 rather than $30,000.

First step: You would offset the current-year includable amount entirely. There is nothing to report the second year, and you still have $6,667 ($40,000 – 33,333) remaining.

You have a decision.

You have a year left on the three-year spread. You could elect to carryforward the $6,667 to that year. You would report $26,666 ($33,333 – 6,667) in income for that third and final year.

You could alternatively choose to amend a prior year for the $6,667. For example, you already reported $33,333 in 2020, so you could amend 2020, reduce income by $6,666 and get an immediate tax refund.

Which is better? Neither is inherently better, at least to my thinking. It depends on your situation.

There is a specific tax form to use with spreads and repayments of CRDs. I will spare us the details for this discussion.

There you have it: the ropes to repaying a coronavirus-related distribution (CRD).

If you reflect, do you see the complexity Congress added to the tax Code? Multiply this provision by however many times Congress alters the Code every year, and you can see how we have gotten to the point where an average person is probably unable to prepare his/her own tax return.

 

Your 2020 Tax Return and the Stimulus Payments

 

Let’s talk about your 2020 personal tax return and the two stimulus payments that you (may have) received.

The first round of stimulus checks was up to $1,200 for each spouse and $500 for each qualifying child.

The second round was up to $600 for each spouse and qualifying child.

So, if you have two qualifying kids and qualified for the maximum, you would have received $5,800 ($3,400 plus $2,400) between the two rounds.

How do you not qualify for the maximum?

One way is easy: you had too much income.

The second way is nonintuitive: the child was over age 16. A qualifying child means a child under the age of 17. Seems odd to me to exclude a high school senior, but there it is.

Let’s talk about the first non-qualification: income.

Let’s use a married couple with two qualifying children as our example.

The income limit for marrieds is $150,000. Past that point the stimulus check goes away by a nickel on the dollar. The maximum for two spouses is $2,400, so we can calculate this as follows:

                      $2,400 divided by .05 = $ 48,000

                      $150,000 plus 48,000 = $198,000

All right, the stimulus for marrieds burns-out at $198,000, right?

Nope.

Why?

Because of the qualifying children.

Each of the kids adds another $10,000 to the phaseout range.

We have two kids. That means $20,000 added to the $198,000, totaling $218,000 before we burn-out of stimulus altogether.

Are we stilling phasing-out at a nickel on the dollar?

Let’s check.

           $218,000 – 150,000 = $68,000

           $3,400 divided by 68,000 equals $0.05.

Yep, nickel on the dollar.

You received the first stimulus check in April, 2020. Remember that tax returns were automatically extended until July 15, 2020 because of COVID. The odds were extremely good that the IRS was not basing its calculations on your 2019 return, because your 2019 return had not been prepared, much less filed. For most of us, the IRS was looking at our 2018 tax return.

Let’s continue.

You received your second stimulus check very late in December, 2020 or (more likely) January, 2021 – but the income phaseout range was the same.

What did change was the tax year the IRS was looking at. By December, 2020 you would have filed your 2019 tax return (let’s skip paper filings that may not have been processed by then, or we are going to drive ourselves crazy).

If your income went up from 2018 to 2019, you would have climbed the phaseout range. You might have received a first stimulus check, for example, but not qualified for a second one. It could have gone the other way, of course, if your income went down in 2019. 

Now your 2020 tax return lands on my desk and we need to settle-up on the stimulus.

How do we settle-up?

We run through the income phaseout range … again.

Using your 2020 tax return this time.

Did you notice we are doing the calculation three times using income from three different tax years?

Yep, it’s a pain.

Mind you, if you have modest income, I know that you received the maximum stimulus.

Conversely, if you made bank, I know that you received no stimulus.

Fall in between – or have wildly varying income – and I you need to tell me the amount of your stimulus checks.

Let’s go through a quick example, using our married couple with two qualifying children.

Their 2018 adjusted gross income was 201,000.

Here is the first stimulus:

phaseout start			150,000.00
phaseout end		198,000.00
add: 2 children		20,000.00
			218,000.00
				68,000.00
2018 AGI			201,000.00
				51,000.00
First stimulus		2,400.00
		1,000.00
			3,400.00	times	51,000.00	=	2,550.00
					68,000.00
			(2,550.00)
			850.00

They would have received $850.

Their 2019 adjusted gross income was $320,000.

Way over the income limit. There was no second stimulus.

Their 2020 tax return lands on my desk. Their adjusted gross income is $104,000.

Way below the income limit. Full stimulus.

Two qualifying kids. The maximum over two rounds of stimulus would be $3,400 plus $2,400 = $5,800.

They already received $850 per above.

That means a $4,950 credit on their 2020 individual tax return. I look like a hero.

But why? After all, their 2019 income was over $300 grand – way above the range for receiving any stimulus.

The quirky thing is that the stimulus is based on one’s 2020 tax return. Congress however wanted the money out as fast as possible. The stimulus had an income test, though, so the first option was to do the calculation on one’s 2019 tax return. When that option proved unworkable, the second option was to use 2018. It was messy but quick, and one would settle-up when filing the 2020 tax return.

Congress realized that settling-up could mean repaying some of the stimulus money. Since that somewhat negated the purpose of a stimulus, Congress decided that the gate would only swing one way. If one did not receive enough stimulus, then one could claim the shortfall on the 2020 return. If one was overpaid, well … one got to keep the money. 

It was a win:win.

Not so much for the accountant, though.