Exception of 10% penalty for early withdrawal from traditional IRA

[Terry53029]

Would like the opinion of the community on the new exception of the 10% penalty, because of COVID 19. A client of mine asked if she would qualify for the exception, because she started a new business this year, and feels she did not make as much profit because of the virus. I was thinking that she might be a qualifying person based on this from the new guidance in   Notice 2005-92

• You experience adverse financial consequences as a result of closing or reducing hours of a business that you own or operate due to SARS-CoV-2 or COVID-19.

My concern is being a new part time business (she has a full time well paying job with no lose of income this year) How can we show that the virus cost her income? Would appreciate any input that anyone would like to share.

Thanks

[rbynaker]

What kind of business?  Was it ordered closed by the state?

We're in uncharted territory but if her AGI in 2020 is at least as much as it was in 2019 I'm not sure you have much of a leg to stand on.  Was there a business plan with income projections?

It's a "self-certification" process and I doubt anyone is going to look at it but I wouldn't be comfortable excluding the penalty unless there was at least some fact in her favor.

How old is she?  There's still time run out to a crowded bar with no mask on. 🙂  I had the 'Rona for about 2 1/2 weeks and it was really only bad for 2-3 days.

Rick

[qbteachmt]

You should be following Notice 2020-50.

Not making as much Profit as planned isn't being harmed. Not being able to operate as planned is a type of harm. Make sure the client "gets the story straight."

"I had the 'Rona for about 2 1/2 weeks and it was really only bad for 2-3 days."

That doesn't really apply. Some people are dead, too. They've been impacted.

[sjrcpa]

@rbynaker  Oh my! I'm sorry to hear. At least you seem to have had a mild case.

[Just-Lisa-Now-]

I "think" Rick was saying HE had the virus...not to use it as this clients reason.

[rbynaker]

Just a poor attempt at humor on my part.

If the client tests positive for COVID-19 (or SARS-CoV-2) it's a get-out-of-jail-free card for the 10% penalty.  Then we don't have to debate the meaning of vague terms in the CARES Act like "adverse financial consequences" or wonder if there might be more guidance coming on "other factors as determined by the Secretary of the Treasury."

[qbteachmt]

Sorry; I get a PTSD reaction to flippant comments regarding the severity of the covid-19 illness and its potential. You don't know what it feels like to be that sick, unless you get that sick; and then you consider yourself one of the lucky ones that didn't die from it. I have empathy for anyone who gets ill.

I don't think anyone will care that someone wants to leverage removing their own investments from their retirement account now, and hopes to skip the penalty. Because reducing their own retirement funds only really impacts their future and not ours. This client can decide to do whatever they want; I doubt the IRS will show up with a lie detector.

[itonewbie · Accepted solution]

Hey, Rick, long time no see!  Glad to hear that you did not spend time with Rona at all.

My take is that Congress and the Treasury intend for the application of these exceptions to be sufficiently broad without strings of quantitative or qualitative conditions attached, recognizing that the economic impact of the pandemic is far and wide.

Sec. 1(B) of Notice 2020-50 simply restates Sec. 2202(a)(4)(A)(ii), which stipulates that "coronavirus-related distributions" are generally distributions made during 2020 to an individual:

• (I) who is diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (referred to collectively in this notice as COVID-19) by a test approved by the Centers for Disease Control and Prevention (including a test authorized under the Federal Food, Drug, and Cosmetic Act);
• (II) whose spouse or dependent (as defined in section 152 of the Code) is diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention (including a test authorized under the Federal Food, Drug, and Cosmetic Act; or
• (III) who experiences adverse financial consequences as a result of:
  • the individual being quarantined, being furloughed or laid off, or having work hours reduced due to COVID-19;
  • the individual being unable to work due to lack of childcare due to COVID-19; or
  • closing or reducing hours of a business owned or operated by the individual due to COVID-19.

Reliant on the authority given the Treasury by subparagraph (a)(ii)(III) to prescribe "other factors", Notice 2020-05 further expands the application, in a similar vein, to:

• individuals who, due to COVID-19, have their pay (or self-employed income) reduced, job offer rescinded, or start date for a job delayed; and
• the individual's spouse or a household member who meet the same conditions.

While it is true that the clause "who experiences adverse financial consequences as a result of" the various conditions places the burden of proof on the taxpayer, IMHO, it should merely be read that adverse financial consequences are presumptive so long as the individual meets any of the criteria outlined.

Neither the text of the CARES Act nor Notice 2020-50 impose any additional requirements to qualify or quantify such "adverse financial consequences" other than to have the individual provide a simple self-certification on which plan administrators may rely upon unless they already possess sufficiently accurate information to determine the veracity of such a certification.

So long as the business owner can document and ascertain that the business was closed or that the operating hours were shortened in light of the pandemic, that may be sufficient ground for purposes of claiming the relief, in spite of her maintaining her full-time job.  This being a newly-founded business, I would think that making sure she is able to compare her business plan as well as projected financials against actual reduced operation and performance, if it becomes necessary, would be a good starting point.

[rbynaker]

Jensen,

Good to hear from you too.  I haven't been following the international news lately, how are things in your part of the world?

I agree with your analysis of the law.  But I didn't see anything specifically mentioned in Terry's post that met any particular qualification.  While I certainly agree that Congress set a pretty low bar on this, it's structured in a "deny, allow" order.  i.e. "you don't qualify for this exemption unless you meet one of the following criteria."

Terry's been a good contributor to the community and seems quite knowledgeable so I assume no one in the household was diagnosed with COVID-19, otherwise this would be a slam-dunk.

So that leaves us in the "adverse financial" box.  It sounds like Terry ruled out the "work hours reduced", at least at the "regular" job.  There was no mention of childcare.  So that leaves us with the "reducing hours" condition for a business with no prior history of hours to which we can compare.

If we can point to a state/governor's order that directly impacts this particular business (or even this general type of business) then we have a box to check on our "72(t) COVID-19 checklist".  i.e. "Taxpayer owned and operated an antique store which was deemed a non-essential business and ordered closed by the State Governor from x/x/20 to x/x/20.  This resulted in a reduction in business hours and adverse financial consequences."  File documented, job done.

So there could easily be facts out there that lead us to conclude this qualifies, but until Terry comes back tomorrow and gives them to us, I can't reach that conclusion with the limited facts presented.

Rick

[itonewbie]

Hi, Rick, agree with your views.  Terry definitely knows his stuff; we are happy to be his sounding board and I do enjoy these technical discussions (the little that I know 😅).

Let's just say things could be better, to put it mildly.  The untimely arrival of the pandemic didn't help either.  Sigh!

See you around.  Stay safe and take care.

[Terry53029]

Thanks to all for your response. The client is a single person, no children, and the business is on line sales. My first reaction was to tell her I don't think she qualifies, but thought I would run it by the community, and as always some very good insights, especially from Itonewrie. Had a hard time choosing which reply was the solution. Many thanks to all

[qbteachmt]

"I don't think she qualifies"

You have two things to consider.

If the individual qualifies or not as an impacted person: 2020-50 includes closing or reduced hours for a job or business, and delayed job start.

There is nothing in the code that states a person with a job cannot also be a business owner, and in fact, we have seen people getting PPP/EIDL for their S Corp and their Sole Proprietorship.

Also, the taking of the funds. From 2020-50:

"Thus, for example, for an individual who is a qualified individual as a result of experiencing adverse financial consequences as described above, coronavirus-related distributions are permitted without regard to the qualified individual’s need for funds, and the amount of the distribution is not required to correspond to the extent of the adverse financial consequences experienced by the qualified individual."

[Terry53029]

I agree with you Qbteachmt, and I found out today she is only going to take out $3000, so definitely not worth pushing the envelope. Thanks for your input

[Greta]

Do you think Form 5329 will add a code for Covid exception to penalty?

[Just-Lisa-Now-]

There will have to be something new, these COVID distributions can be paid back over 3 years, so they need a way to report that properly.

[qbteachmt]

I would expect a 1099-R worksheet to include provisions for whether the covid-19 exception applies or not, and then for each account and account type, for basis reporting and for repayment reporting. Sheesh; I don't want to think about it now.

[rbynaker]

At this point it looks like it will be Code 12 "Other", see page 4:

https://www.irs.gov/pub/irs-dft/i5329--dft.pdf

[qbteachmt]

Don't overlook that Notice 2020-50 explains the retirement plan administrator may or may not know or accept that this is a covid-related distribution, and that the individual still gets to treat it as such, and there will be a new form:

"A qualified individual receiving a coronavirus-related distribution is entitled to the following favorable tax treatment with respect to the distribution by reporting the distribution on the individual’s federal income tax return for 2020 and on Form 8915-E, Qualified 2020 Disaster Retirement Plan Distributions and Repayments (or if there is no federal income tax return for 2020, by filing just Form 8915-E)."

[Terry53029]

Thanks for the input @qbteachmt