Friday, April 17, 2020
The CARES Act: A Summary and Planning Strategies
Anthony C. Kure, CFP®

Anthony C. Kure, CFP®

Managing Director of Northeastern Ohio Market, Senior Portfolio Manager, Principal
Management Team, Wealth Management Services, Cleveland - Akron

The CARES Act: A Summary and Planning Strategies

The outbreak of COVID-19 has impacted us all, and millions of Americans are suffering financially as a direct result. In response, Congress recently passed the CARES Act, a $2-trillion stimulus package designed to alleviate the financial stress on individuals and business owners associated with the economic shutdown.  Support is being supplied through a combination of tax relief, loan programs, revisions to existing loan terms, and direct cash to most taxpayers. 

Here is a brief summary of some of the provisions:

  • Federal government “recovery rebates” to most taxpayers (see details below)
  • “Corona-related distributions” allowing for penalty-free distributions from tax-deferred accounts for hardship related to the virus
  • Required Minimum Distributions (RMDs) not required in 2020 (see detail below)
  • Changes to charitable donation limits (see detail below)
  • Relief for small-business owners in the form of forgivable loans and grants for those negatively affected by the shutdown. These include the Paycheck Protection Program, Employee Retention Credit, and Economic Injury Disaster Loan
  • Supplementing states’ unemployment insurance with a federal program
  • Loosening of 401(k) loan restrictions
  • Temporary relief for paying student loans

While there are many details and other programs in this 880-page law, the three most relevant are the cash rebates, changes to charitable donation limits, and the suspension of 2020 RMDs.  

Recovery Rebates

These payments are refundable tax credits to be mailed or direct-deposited in May 2020 and are estimated to benefit up to 90% of taxpayers. Single taxpayers will receive a credit of up to $1,200 while married couples filing jointly will receive a payment of up to $2,400.  For each child in the household under 17 years of age, the benefit increases $500. Those with higher incomes are either partially or completely ineligible. The phase-outs begin when adjusted gross income is higher than $75,000 (Single) and $150,000 (Married Filing Jointly). The total benefit is reduced 5% for each $1,000 of income over the threshold. The AGI used to calculate this benefit is based on 2019 tax returns if already filed, but if the 2019 return has yet to be filed the IRS will use the 2018 tax return.

Changes to Charitable Donation Limits for 2020

One of the lesser-known elements of the CARES Act is the changes to charitable donation restrictions, in effect for 2020 only.

  • All taxpayers are now eligible to contribute up to $300 in cash to a qualified charity as an “above the line” deduction.  This means even if they do not itemize deductions on their tax return in 2020, they will still be able to deduct this contribution. These $300 contributions cannot be made to a Donor-Advised Fund.
  • The deductible limit on cash contributions to charity has been increased from 60% of AGI to 100% of AGI.
  • IRA owners in RMD status can still make Qualified Charitable Distributions (QCDs) up to the $100,000 annual limit.

Even though RMDs are not required in 2020, QCDs may still be a valuable way to make charitable donations. Tax-free distributions out of the IRA reduce its value, which results in lower taxable distributions in subsequent years. These provisions will provide support to the nonprofit sector which has been severely impacted by this crisis, and we are encouraging clients to accelerate their annual charitable gifts in this time of need.

RMDs Suspended in 2020

This could be the most impactful provision for those in RMD status. For those with non-IRA assets to live on, the ability to forego some or all of the RMD is likely to save significant federal and state taxes. The main points of this provision are:

  • Virtually all tax-deferred accounts are eligible for this exclusion including IRAs, 401(k)s, SEP IRAs, 403(b)s and 457(b)s
  • Inherited IRAs are eligible if taxpayers are “stretching” the distribution, per the pre-SECURE Act law from late December 2019. Inherited IRA owners subject to the SECURE act (those who inherited an IRA from a non-spouse who died on January 1, 2020 or after), still do not have to take the RMD this year (as defined by the SECURE Act). However, 2020 still counts as one of the 10 years on the “clock” by which time they will need to have emptied this account.
  • Taxpayers can “roll back” one RMD distribution if they took all or a portion of it this year. This requires careful consideration because there are detailed provisions to abide by:
    • If the RMD was taken within the last 60 days, the distribution can be rolled back into the IRA but only if the owner has not utilized the 60-day rollback provision within the last twelve months. The IRS has not clarified whether a taxpayer can roll back multiple distributions, or just one. We urge all taxpayers to consult with a trusted tax preparer for the recommended course of action.
    • If the RMD was taken more than 60 days ago, taxpayers need to “qualify” and prove they were impacted by the coronavirus (i.e. diagnosed, caring for someone who is, suffering “adverse financial consequences,” own a business that was closed, etc.). If they were not adversely affected, they cannot roll back the RMD beyond the 60-day window.
    • Inherited IRA distributions already taken in 2020 are not permitted to roll back.

Planning Strategies Related to Suspension of RMDs

Strategy #1:  Evaluate Capital Gains and Losses in Taxable Accounts

The first step is to determine whether the IRA distributions are needed to fund living expenses. If not, taxpayers can choose to suspend future distributions or forego them altogether if none have been taken. This will lower the federal and state tax liability and could provide a valuable opportunity to pay less or no taxes on capital gains incurred in taxable accounts.

While a detailed tax projection and portfolio analysis is highly recommended, the absence of the RMD could lower the capital-gains tax bracket from 20% to 15%, or even to 0%. Recent losses in the stock market also provide an opportunity to evaluate existing holdings for potential tax-loss harvesting. As a result, this year could be a golden opportunity to realign the investment portfolio while paying less capital-gains tax.

Strategy #2:  Consider a Roth Conversion

The suspension of RMDs may also provide a valuable opportunity to convert some of a Traditional IRA to a Roth IRA, known as a Roth conversion. Taxes are due on the IRA distribution, but once funds are in the Roth IRA they benefit from tax-free growth going forward. In addition, Roth IRAs are not subject to RMDs. Roth IRA heirs also benefit from tax-free distributions (but are subject to RMDs).

While 2020 presents a great opportunity to evaluate this tax-diversification strategy, it must be carefully evaluated. There are potential unintended consequences from converting too much to a Roth. Adding too much to taxable income could:

  1. Push a taxpayer into a higher capital-gains tax bracket (the inverse of Strategy #1), from 0% to 15% or even 20% on long-term capital gains
  2. Increase the amount of Social Security income that would be taxed (from 50% up to 85%)
  3. Incur Income-Related Monthly Adjustment Amount (IRMAA) surcharges on Medicare Part B and Part D premiums

We will continue to monitor events and provide updates to the extent it provides financial relief and opportunities going forward.

Find more practical advice on a wide variety of wealth management topics by exploring our JIC Blog: Beyond the Numbers library.