January 21, 2021
IRA Owners: How Tax Season Will be Different in 2021
By: Pacific Premier Trust
The 2020 tax year was a year unlike any other. As the coronavirus pandemic shuttered businesses and affected reduced staffing at the IRS, the government postponed the traditional April 15 Tax Day by three months, extending the federal tax filing deadline to July 15, 2020.
Tax Day 2021 is currently scheduled to fall on its standard April 15 date. But given coronavirus relief legislation enacted in 2020, many Americans may be filing tax returns that look much different than prior years. For IRA owners, the start of Tax Season 2021 means it’s time to ensure you understand how IRA-related rules changed last year and what may be different as you prepare to file your 2020 taxes.
Required Minimum Distributions
In a typical year, traditional IRA owners are required to start taking a Required Minimum Distribution (RMD) after reaching the age of 72. But in 2020, the CARES Act—the coronavirus relief legislation passed by Congress in March—waived the requirement that traditional IRA owners take an RMD. The IRS allowed investors who took a 2020 RMD from a traditional IRA before the passage of the CARES to roll the money back into their retirement account.
The CARES Act means that many IRA owners do not have to worry about paying taxes on a 2020 required minimum distribution this tax season. But If you did take an RMD in 2020 and did not roll it back into your retirement account, taxes are still due on that income.
RMDs are not waived for 2021, so the usual RMD rules—and taxes—apply.
The CARES Act also allowed “qualified individuals”—investors facing COVID-related hardships—to withdrawal up to $100,000 from their IRAs in 2020 without facing typical taxes and penalties. For instance, the 10% tax on early distributions does not apply to coronavirus-related distributions.
Investors are also not required to pay tax on the entire sum of their coronavirus-related withdrawal on their 2020 tax return. Instead, investors can spread out the tax payments on COVID-related distributions over three years, ending with the 2022 tax year. The IRS provides the following example of how investors can treat COVID-related distributions:
If you receive a $9,000 coronavirus-related distribution in 2020, you would report $3,000 in income on your federal income tax return for each of 2020, 2021, and 2022. However, you have the option of including the entire distribution in your income for the year of the distribution.
IRA owners who took a COVID-related distribution can also avoid paying income taxes on the withdrawal if they return part or all of the entire sum to their IRA within three years. Here is an IRS example of how this might work:
If … you receive a coronavirus-related distribution in 2020, you choose to include the distribution amount in income over a 3-year period (2020, 2021, and 2022), and you choose to repay the full amount to an eligible retirement plan in 2022, you may file amended federal income tax returns for 2020 and 2021 to claim a refund of the tax attributable to the amount of the distribution that you included in income for those years, and you will not be required to include any amount in income in 2022.
Qualified charitable distributions
Retirement savers can fund their annual charitable donations by using their IRA to make qualified charitable distributions (QCDs)—which are also called IRA charitable rollovers. Using a QCD, eligible IRA owners who are 70½ or older can directly transfer up to $100,000 of IRA assets a year to an eligible charity. In a typical year, QCDs can be used to fulfill an IRA owner’s annual required minimum distribution.
But 2020 was not a typical year, and the requirement to take an RMD was waived. Although QCDs could not be used to offset RMDs, IRA owners who made QCDs can use those distributions to reduce their 2020 taxable income.
One thing that hasn’t changed for Tax Season 2021 is your window for making annual contributions to a Roth or traditional IRA. If you haven't already funded your retirement account for 2020, you have until Tax Day 2021 to make your contribution. And remember: Contributions to your traditional IRA may be tax deductible.
Approach 2021 Tax Season with patience—and professional help
As I said at the start of this blog, we are facing a tax season unlike any other we’ve experienced in recent memory. Not only may your financial picture look drastically different than it did a year ago, but rules and regulations governing IRAs have also changed. The media is already warning that Tax Season 2021 could be “messy” and “ugly” as regulatory changes, stimulus payments, and unemployment benefits add complexity to 2020 tax returns.
When it comes to taxes, especially in a year complicated by COVID and tax changes, it is a good idea to work with a trusted financial professional who can ensure your taxes will be filed correctly and on time. It’s an even better idea for self-directed IRA investors to work with a tax advisor who is up-to-date on IRA rules and regulations and understands the nuances of investing in alternative assets with an IRA.
Pacific Premier Trust is here if you have questions regarding your self-directed IRA, the CARES Act, and taxes. You can call our Client Services team at 1.800.962.4238 Monday through Friday, 7 a.m.-5 p.m. MT.
1The SECURE Act, which went into effect on January 1, 2020, changed RMD rules by raising the age at which investors must take their first required minimum distribution from 70½ to 72. Investors who turned 70½ in 2020 or after are now required to take their first RMD by April 1 of the year they reach 72. After that, each yearly RMD must be taken by December 31.
© 2021 Pacific Premier Trust, a Division of Pacific Premier Bank.
Pacific Premier Trust performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. Pacific Premier Trust is not affiliated with any financial professional, investment sponsor, or investment, tax or legal advisor.
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