A Rare Opportunity to Benefit From a Tax Do-Over! (Undoing 2020 Required Minimum Distributions)

Not many of us get a second chance to essentially go back and change the results of a previous action – in essence, undo a decision that was, at the time, irreversible. It is rarer still that we get a “do-over” when it comes to making a tax decision. One might rightfully conclude the US tax system does not promote many opportunities for individuals to reverse a transaction once it is executed. For example, a prior tax law exception with regard to re-characterizing a Roth IRA “conversion” provided individuals with an election to reverse a prior year Roth conversion. This was an available planning strategy up until the Tax Cuts and Jobs Act of 2017 (TCJA 2017) made Roth IRA conversions, completed on or after January 1, 2018, irrevocable. A re-characterization (“do-over”) of a Roth IRA conversion was one of the more advantageous planning strategies available to individuals prior to its elimination by the TCJA 2017 law change. However, certain individuals may once again have a “do-over” opportunity this summer.

2020 Required Minimum Distribution Relief

So, enough with tax law history – what does a tax “do-over” have to do with Required Minimum Distributions? Individuals can no longer benefit from a Roth IRA conversion “do-over.” However, certain individuals have a limited window of time this summer to benefit from a Required Minimum Distribution (RMD) “do-over” strategy. Once again, but only for a short period of time, individuals will have an option to undo a prior tax transaction. In this instance, a particular group of individuals, those who have already taken their 2020 RMD, will have an opportunity to return their RMD to their retirement account. In so doing, they will be able to reduce their 2020 taxable income and replenish their retirement savings account. (Whether or not this is an advisable tax strategy is a topic that will be addressed at the conclusion of this discussion.)

Who Qualifies and Who Doesn’t

Having the option to rollover a 2020 RMD might not be groundbreaking news to those individuals who already qualified for 2020 RMD relief. However, it is an especially “big deal” and a welcome reprieve for a select group of individuals who originally did not qualify for 2020 RMD relief under an earlier IRS announcement in April. Individuals who had taken their 2020 RMD after January 31, 2020 were already permitted to rollover these amounts (back into their retirement account) for 2020. This was the result of a combination of actions taken by both Congress (passing the CARES Act) in March 2020 and the Internal Revenue Service (issuing Notice 2020-23) in April. The CARES Act suspended RMDs for 2020. Subsequently, the IRS issued Notice 2020-23 which stated that 2020 RMDs (post January 31, 2020 RMDs) would be eligible for rollover if completed by July 15, 2020.

Notice 2020-23 was especially important because it extended RMD relief to an individual who had taken a 2020 RMD but had exceeded the 60 day rollover period. Nonetheless, there was still a group of individuals (see below) who did not qualify for 2020 RMD relief under either the CARES Act or IRS Notice 2020-23. Recognizing this inequity, the IRS issued an additional announcement on June 23rd to address the needs of those remaining individuals who would not otherwise receive 2020 RMD relief.

2020 RMD Relief Extended to More Individuals

Before we get into the specifics of the June 23rd IRS announcement (IRS Notice 2020-51), it is important to identify the particular class of “new” individuals who now qualify for the additional 2020 RMD relief. If you are an individual who falls into one of the following categories, you have until August 31, 2020 to benefit from an IRS permitted RMD “do-over” for 2020:

  • Individuals who took their 2020 RMD prior to February 1, 2020
  • Individuals who have taken monthly RMDs during 2020 (rather than one lump-sum)
  • Non-spouse beneficiaries receiving RMDs from inherited IRAs

If you are among the above group of individuals, July and August is an extremely time-sensitive two month period for you. The deadline for the RMD do-over is August 31st; therefore, if you wish to rollover your 2020 RMD back into your retirement account, you have a narrow window of time to make a decision.

2020 Planning Opportunities and Considerations

IRS Notice 2020-51 is important for a number of reasons. First, it placed the January 2020 “early-bird” RMD recipients on equal footing with the post January 2020 RMD recipients; in other words, the folks who were provided initial RMD relief under the CARES Act. Perhaps more importantly, IRS Notice 2020-51 provides relief to a new group of RMD recipients who previously could not rollover RMDs under normal circumstances. This includes individuals who exceeded the 60 day rollover period and individuals who received RMDs from inherited IRAs.

In addition, the Notice stated that RMD repayments would not count for purposes of the once-per-year rollover rule. This is very helpful, for example, in the case of beneficiaries who take monthly distributions from their qualified plans or IRAs. In the absence of this relief, only one 2020 distribution would be contributed back into the qualified plan or IRA.

The RMD relief is only for 2020 and action must be completed no later than August 31st. Some commentators have already noted the significance of IRS Notice 2020-51, especially in terms of its precedent to provide RMD relief to individuals who would not otherwise qualify under current tax law. The COVID-19 pandemic has caused unprecedented circumstances in all facets of our lives; IRS Notice 2020-51 is an example of how it has impacted current year tax law.

Summary

Finally, even though individuals have an opportunity to avoid taxation in 2020, the decision to do so should be carefully evaluated. As previously mentioned, RMDs are suspended for 2020 per legislation contained within the CARES Act and, for those who have already taken a 2020 RMD, IRS Notices 2020-23 and 2020-51 provide a tax “do-over” opportunity if utilized no later than August 31st.

Tax advisors are genuinely intrigued to explore tax strategy options for clients considering different 2020 RMD planning scenarios. On one hand, it is generally advantageous to defer taxes, especially when the tax deferral occurs within a tax-deferred retirement account such as an IRA or 401(k) account. On the other hand, individuals need to consider their current and future tax brackets. Even by including their 2020 RMD, individuals may find they are firmly entrenched within the 10% or 12% tax bracket for 2020. A 10% or even 12% tax rate is difficult to pass up, especially if one’s future tax rate is anticipated to be significantly higher.

Therefore, if one is “comfortable” paying a 10%-12% tax rate on their 2020 RMD, it might be best to pass on the 2020 federal “do-over” opportunity that resulted from the COVID-19 pandemic legislation. (State tax law consideration should also be included in any RMD analysis.) Bottom line, July and August will be a critical two month period for individuals to speak with their tax advisor and determine whether or not a tax “do-over” is in their best interest for 2020.

For more information or a discussion on how this may impact you, please contact James Guarino or your BNN advisor at 800.244.7444.

Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.