On March 27, 2020, we wrote about provisions in the 2020 CARES Act, which expanded 401(k) loan eligibility and permitted funds to be drawn from IRAs without tax consequence, so long as the withdrawal was repaid by 2023. As we wrote this, there seemed to be some “too good to be true elements” to the package. As one might suspect, we now have additional “guidance” from the Joint Committee on Taxation. For those bypassed or still awaiting federally backed loans, the IRA strategy may be the only practical option, but here is what “MarketWatch” and the “Wall Street Journal” reported on May 4.
If you go the IRA route, you do actually report the withdrawal as income (the 10% penalty appears to be waived). It is reported over three years in equal tranches. Therefore, that does mean tax on $33,333 per year in 2020, 2021 and 2022. However, if you repay in 2023 you can get your tax payments credited or refunded by filing amended returns for the prior years in which you reported the withdrawal as income. In practical cash flow terms, this appears to signal that if you take the full $100,000, you need to remit $6,600 to $10,000 to Uncle Sam immediately and “reserve” an equal amount to pay similar payments in 2021 and 2022. Of course, you could “invest” the float money in your business or the stock market until the tax is due, but that wouldn’t be a prudent thing to do. The amount you need to set aside for taxes depends, of course, on your income in those years when it will have to be reported. This is why our estimated tax payments range from $6,600 to $10,000. Your accountant will benefit from having to prepare three amended returns. You can avoid that by repaying the entire distribution before your 2020 return is due, but what fun is that? The Journal also notes that once you take the distribution you need to develop a payback plan. That money is not going to fall from the sky in 2023.
On the 401(k) loan side, your plan is going to set a repayment amount and it will come out of your paycheck. The author of the Wall Street Journal article suggests you borrow half of what you think you will need. His reasoning is that we tend to overstate crises and he reminds us that money that is “out on loan,” is not invested and earning returns. The other risk is that you lose your job. That triggers a call of the loan and unless you can instantly repay. The amount you don’t tender back is treated as a distribution of income. I have not seen guidance on whether that involuntary distribution gets the same three-year look back treatment you can get from an IRA withdrawal. The loan maximum has doubled to $100,000 or 100% of the account balance. The loan repayment terms are the province of the retirement plan itself. Understand that you are not borrowing from your employer. You are borrowing your own money.
In the end, the CARES Act remedies given in March have been somewhat “taken” in May. However, the list of alternate resources to keep a business afloat or just put food on the table is not changing soon. If you were considering a loan or withdrawal, it would be wise to ring up your friendly accountant first, to explore which options makes the most sense for your situation.