While COVID-19 impacted just about every aspect of our lives, it especially affected our wallets. Some of us even had to dig into our retirement savings just to make ends meet. Fortunately, the COVID-19 Relief Bill helped make that a little easier.  In this article, we’ll take a look at the rules for COVID-19 special distributions and how a small business CPA like us can help you use those rules to save on taxes. Let’s dive in.

What Are COVID-19 Special Distributions?

For many of us, our savings are tied up in a tax-advantaged retirement account like an IRA or a 401(k). While these accounts provide all kinds of benefits (if you don’t have one, you should), if you pull out funds before you turn 59 ½, you’ll have to pay a 10% penalty.

Then the COVID-19 pandemic hit. Suddenly, we were losing our jobs or getting sick and we had to turn to retirement savings to pay the bills – not a good situation.
Luckily, Congress had our backs on this one. While most people noticed the 00 relief checks, the COVID relief bill – or CARES act – also created special tax rules that took the sting out of retirement account distributions taken in 2020.

If you follow the rules – and your CPA prepares your taxes properly – you can avoid the 10% penalty, reduce taxes by spreading the income out over three years, and pay back the funds without affecting your yearly contribution caps.

What Are the COVID-19 Special Distribution Rules?

It’s the IRS, so of course, there will be specific rules! To avoid the 10% penalty, our retirement account distributions needed to meet four specific criteria:

1. Must Be Related to COVID-19
The funds had to be used for one of the following reasons:
Paying for medical expenses related to COVID-19
Covering any other financial hardship brought on by COVID-19
So, pretty much everyone on planet earth qualifies. And this is a self-report situation, so as long as you can justify your need for funds in the context of the pandemic, you’re all set.

2. Must Come from Qualified Accounts
The funds needed to come from a qualified retirement account. These accounts include:
Traditional and Roth IRA
401(k) and 401(a)
403(a) and 403(b)
457(b)

3. Must Be Distributed in 2020
Withdrawals had to be made between January 1, 2020, and December 31, 2020. And while the distribution will count as income, you don’t have to take the tax hit entirely for 2020. You can spread it out over three years – 2020, 2021, and 2022.

4. Must Be $100,000 or Less
Your total withdrawal had to be $100K or less. If you had several retirement accounts, you could withdraw from all of them, but only up to $100K total is exempt from the 10% penalty.

Can You Still Benefit from COVID-19 Special Distributions?

Ok, sounds great. But it’s almost 2023. Can you still benefit from these rules? Yes, there are a few tricks a CPA can do to optimize your tax situation. Returns can be amended to accommodate the following:
1. Include Special Distributions on Your 2020 Return
If you withdrew retirement funds in 2020 for COVID-related reasons but didn’t realize you could be spared the 10% penalty, you can still amend your 2020 return to get that money back. Talk to a CPA to learn more.

2. Spread Out Special Distributions Over 3 Years
Early or not, distributions from retirement accounts are typically taxed as income. This could be a problem if you took a significant special distribution in 2020.
Fortunately, the CARES Act includes a provision that allows you to spread out that income over three years, reducing the tax burden. If you didn’t know this at the time, a tax preparer can amend your previous tax returns to accommodate this change.

3. Replace Funds Without Affecting Yearly Limits
Retirement accounts limit how much money you can contribute per year. However, replacing your special distribution doesn’t affect your yearly cap. You can max out your retirement accounts as usual plus you can replace the funds you withdrew.

You just need to make sure this is correctly documented in your tax returns. Talk to a CPA to learn more.

How Can We Help?

While COVID-19 was a disaster for the world, it doesn’t have to be a disaster for your finances. Davidov & Associates, a CPA firm in Alexandria VA can help you amend your 2020 or 2021 tax returns to make sure you’ve saved every possible penny.

If you need a CPA and you’re near Alexandria, Falls Church, Arlington, McLean, or anywhere in Fairfax county or the greater Washington DC area, please give us a call or send a message so we can figure out how to help you.