1099-R - Early Withdrawal - Coronavirus

[Cookie2021]

I have a 53-year old client who withdrew $100K from his 401K and his 58-year old wife withdrew $50K from her 401K.  The work hours were reduced and were told by their employer that they did not have to pay federal, state or 10% penalty since the withdrawal was related to Coronavirus.

My understanding is that the 10% penalty for early withdrawal is waived for Coronavirus disaster.  However, federal and state taxes still apply.  Is this not correct?

I'm completing the 1099-R Worksheet - section Qualified Disaster Distribution Smart Worksheet. Selected A: 2020 Coronavirus Related Distribution......and added the $100K for taxpayer and $50K for spouse under B:  Amount of Qualified Distribution.  After doing so, there was no federal tax or 10% penalty calculated. 

Is this correct? I feel like I'm doing something wrong.

[The-Tax-Lady]

Yes it's taxable for the IRS, Your state I don't know about. You need to pull up Form 8915 if you want to defer the taxes over 3 years. Was there Federal withholding on the 1099Rs?

[Just-Lisa-Now-]

Look at the 8915E's that wer generated once you checked those disaster boxes on the 1099R worksheet....it defaults to a 3 year spread of the income, which may be why it looks like no fed tax is being computed....you should see 1/3 of the income on the front page of the 1040 as taxable.

The 8915E takes away the early withdrawal penalties.

[qbteachmt]

"and were told by their employer that they did not have to pay federal, state or 10% penalty since the withdrawal was related to Coronavirus."

Well, that's sort of the tax rule. But not really.

They have up to three years to repay it to that account, and if they do so, they can amend any year(s) they reported and paid income tax on it, and it's as if the income never happened. Otherwise, if they keep it, it's taxable to the extent that any distribution from that sort of account is taxable (given no basis and not Roth 401(k), as examples).

Which is why their employer should not be doing tax returns.

[Cookie2021]

Yes, 10% was withheld in Federal taxes.  $10K for taxpayer and $5K for spouse. That's not enough to cover their taxes if the entire amount is taxable.  So does the 10% penalty still apply? or can that be spread out in the 3 years?  I will check Form 8915.

[qbteachmt]

This is Two Different provisions: "So does the 10% penalty still apply? or can that be spread out in the 3 years?"

The distribution has to meet the disaster eligibility. That covers the 10% penalty.

Of course this distribution is taxable, unless they have basis or this is Roth 401(k). The disaster provision gives the taxpayer the ability to spread the reportable income over three years, so that spreads out the taxable amount. Or, optionally report it all as 2020 income and pay the full tax for 2020.

Withholding and estimates are all part of the pool of funds prepaid for the tax year. There is no spreading their payment over three years. It's already prepaid in against the entire result of the 1040.

Read the qualification information for the 8915-E for covid distribution to confirm they each qualify and their distributions qualify.

[Slats]

Form 8915-E will remove the penalty only. The distribution is still taxable. Just now spread over the 3 years. Seems like you had it right. Program should show the 1/3 taxable amount in 2020, although you may need to adjust any refund to be carried over to satisfy the liability that is forthcoming in 2021 and 2022. Don't leave your clients hanging on the end of the limb like a little pinecone............fixing to fall hard. 

[qbteachmt · Accepted solution]

All of the forms 8915 are for various disasters, identified by year (the suffix) and all provide for a three-year spread for reporting the taxable income; they also have the option on this form to report all of it in the year of the payout. The -E is specifically for 2020 disasters.

The waiver for the early distribution penalty is part of the 1099-R worksheet in the tax prep programs; it also is on the form 5329 when exceptions apply.

A declared disaster is typically given consideration for special rules applying for distributions. But the rules vary. You have to read what applies to the situation at hand.