Spreading the Income Tax Due on the COVID-19 Solo 401k Distribution Over 3 Years

A COVID-19 qualifying distribution from your self-directed solo 401k plan processed during 2020, which is a maximum of $100,000, can be repaid tax free over 3 (three) years.

Form examples and to listen to a recorded webinar CLICK HERE.

The Start of the 3 (Three) Year Clock

The 3 (three) year period starts the next day after the solo 401k distribution was received.

Example: Ted took a $70,000 coronavirus-related distribution (CRD) from his self-directed solo 401k on February 20, 2020 and receive the check on March 1, 2020. The three year period to return the funds back to his solo 401k or to an IRA starts on Mach 2, 2020; therefore, Ted must return the funds by March 2, 2023.

The 3 (Three) Year Clock to Return the Funds Back to the Solo 401k Plan or to an IRA

While federal taxes are not required to be withheld at time of the CRD related solo 401k distribution, the federal taxes due on the distribution have to be paid back at minimum equally over 3 years or can be paid sooner. This three year period begins in 2020, the year the distribution was taken. The amount of taxes due on the distribution is based on your total earned income for the year, and distributions from solo 401k plans are taxed at earned income rates.

Example: Jane took a CRD related $90,000 solo 401k distribution on April 15, 2020. Jane can include the full $90,000 distribution as earned income for 2020, or she can spread it over a three-year period ($30,000 in income for 2020, $30,000 in income for 2021, and $30,000 in income for 2022). Per question 7 of the following IRA link https://www.irs.gov/newsroom/coronavirus-related-relief-for-retirement-plans-and-iras-questions-and-answers, See more examples in Sections 4.D, 4.E, and 4.F of Notice 2005-92

If Jane later decides to return the $90,000 distribution back to the solo 401k plan or to an IRA by the end of the 3 (three) year clock so by April 16, 2023 (assuming she originally received the the solo 401k distribution on April 15, 2020), Jane will have to file amended tax returns for all three years (2020, 2021 and 2022) to get back the taxes already paid on the solo 401k distribution.

File Amended Tax Returns

For those who return the the solo 401k funds distributed due to COVID-19 to the solo 401k or to an IRA, the participant will need to file amended Form 1040 tax returns to recover the taxes paid since the taxes due on the distribution have to be spread out at minimum over a three year period.

Can’t Overpay

The amount repaid to the solo 401k or the the IRA cannot exceed the amount that was distributed.

Direct Rollover

The amount repaid to the solo 401k or the IRA will be fall under the non-taxable direct-rollover umbrella.

Not Deemed a 60 Day Rollover

The once per 12 month rollover rule does not apply.

No 10% Early Distribution Penalty to Pay Back

There is no 10% early distribution penalty for those under age 59 1/2 to pay back because the 10% early distribution is waived for COVID-19 qualifying solo 401k distributions.

Reporting the Coronavirus Related Distributions

Solo 401k participants who took coronavirus related distributions (CRDs) will report CRDs when they file their individual income tax return. In addition to the 1040 series return itself, the taxpayer will file new Form 8915-E (the 8915 series reports certain disaster-related tax events) to determine the amount of any CRD included in income for the year, and to report CRD repayments.

The solo 401k plan provider will report the distribution on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit Sharing Plans, IRAs, Insurance Contracts, etc.

Age 59 1/2 QUESTION:

I am considering a withdrawal per the Cares Act provision and have a question. I will be 55 years old this September. As I will be past the age of 59 1/2 when the withdrawal is due, would I still have to pay it back given that I will have met the minimum age requirement?

Federal taxes are always due on distributions of pretax solo 401k funds. The CARES Act did not exempt the payment of the Federal tax that applies to the withdrawal of pretax solo 401k funds. Instead, it delayed having to make the full federal tax payment in the first year by allowing it to be spread over three years commencing with the 2020 distribution–the year the distribution was first processed. Therefore, unless the distributed funds are returned to the solo 401k or to an IRA by the third year, you will not be able to recoup the federal taxes paid on the pretax solo 401k distribution.

Don’t confuse the 10 percent early distribution penalty which is a separate tax altogether and generally applies to distributions made from IRAs and solo 401k plans before age 59 1/2 unless the IRS provides an exception. The CARES Act created such an exception by waiving the 10% early distribution penalty on coronavirus related distributions (CRD) up to $100,000.

Deadline to Return the 2020 CARES ACT Distribution from Solo 401k QUESTION:

I made a $50,000 Cares act withdrawal from my solo 401k to help pay for taxes and college tuition. I am hoping to be able to pay some, if not all, of it back. I want to pay as much back as I can in time for the 2020 tax return filing. What is the latest date that I can make a repayment for it to decrease the total withdrawal amount on the 2020 tax return that I file next year if I file an extension?

As long as you return the 2020 Cares Act related distribution to an IRA or to the solo 401k by your personal tax return (Form 1040) due date in 2021 plus timely filed extension, you won’t owe income tax for 2020 on the amount distributed. The IRS has posted a Q and A on this topic and is question 7. Click here to view the IRS page. That same IRS page also references more examples surrounding the return of the COVID-19 related distribution found in Notice 2005-92 Sections 4.D, 4.E and 4.F.

Depositing Distribution Taken from Day-Time Job Employer 401k QUESTION:

My wife has an employer 401k plan which we are eligible to withdraw 100k due to the CARES Act. I would like to know, if we may repay that 100k to our solo 401k instead of her employer-sponsored plan?

If she is also self-employed and meets the solo 401k eligibility requirements, yes the CARES Act (COVID-19) distribution amount may be redeposited to another qualified plan including a solo 401k plan and even an IRA.

Is there a default option for repaying/returning the funds QUESTION:

Do I get to choose when to return the coronavirus related distribution that I took from my solo 401k plan ?

The CARES Act allows the taxable income due on the CRD from the solo 401k or an IRA for that matter to be spread ratably over 2020, 2021 and 2022. The default is this 3 (three) year period. The other option is for the participant to choose to include the full amount of the CRD as taxable income for 2020. If this election is made, it must be done using IRS Form 8915-E by the individuals May 17, 2021 tax return due date or October 15, 2021 if an extensions is filed. It is important to note, however, that once this election is made it cannot be changed.

Form 1099-R for Each Year 401k QUESTION:

For the 2nd and 3rd year of declaring the 1/3 income portions of the 2020 CRD, will a 1099-R need to be issued, presumably indicating $0 Box 1 Gross Distribution but 1/3 the 2020 CRD in the Box 2a Taxable Amount?”]

ANSWER:

No, as just one Form 1099-R is issued for the year in which the full coronavirus related distribution occurred. For example, if you distributed the full allowed amount of $100,000 in 2020 which was the maximum amount allowed under the rules, then a Form 1099-R would have been issued in early 2021 by the solo 401k plan provider to report the full $100,000 CRD amount. You can still spread the taxes due on the full $100,000 distribution over three years, however.