How do I treat a 401(k) COVID withdrawal on my tax return?

March 10, 2021

Q. I took a $33,500 Cares Act withdrawal in 2020. I had 20% federal and 10% state tax withheld. I am planning to spread the taxes over three years. I am filing married jointly and our total household income will be roughly $180,000, not including the 401(k) withdrawal. We have two kids and rent a home, and we work at home so maybe we have more deductions, but I have no idea how to treat the 401(k) withdrawal.

— Unsure

A. As you noted, there are special rules for distributions taken in 2020.

You could take up to $100,000 and pay the taxes owed over three years if you qualify, rather than pay it all in one year, said Michael Karu, a certified public accountant with Levine, Jacobs & Co. in Livingston.

He said in order to qualify, you must meet one of the following requirements:

  • You, your spouse or a dependent were diagnosed with COVID-19;
  • You experienced adverse financial consequences as a result of being quarantined, furloughed, laid off, or having your hours reduced as a result of COVID-19;
  • You experienced adverse financial consequences as a result of not being able to work due to a lack of child care as a result of COVID-19; or
  • You experienced adverse financial consequences as a result of a business closing that you own or operate as a result of COVID-19.

There are other rules that allow for the distribution to be repaid to the plan, Karu said, but if that was not done in 2020, you would have to include no less than one-third of the distribution on your 2020 tax return. You could later amend the return after the repayment is completed, he said.

“If you repay it in 2022, then you would be required to include no less than one-third in each of the 2020 and 2021 tax years, and amend both years,” he said. “Any tax withheld would be reported on your 2020 income tax return.”

Karu said because you are a cash-basis taxpayer, you are taxed in the year in which the distribution is taken.

“Having federal and state income tax withheld at the time of the distribution doesn’t change the taxability of the distribution, it just lessens the amount you would owe when you file your return,” he said.

On your other deductions, unless you are self-employed, it is unlikely that you will be itemizing your deductions, he said. Moreover, it is most likely that you will not be able to deduct home office expenses, he said.

“If you receive a W-2, you are not self-employed and any home office expenses incurred, if allowable, would have been treated as Employee Business Expenses, which are only allowable if you fall into one of four categories – Armed Forces Reservist, Qualified Performing Artists, Fee-Basis State of Local Government Officials, or Employees with Impairment Related Work Expenses,” he said.

Regardless, the standard deduction for married filing jointly is $24,800 and increases depending on age.

“Depending on the ages of your children, you will be able to get a child tax credit up to a maximum of $2,000 per child,” he said. “You also may be able to take child care credits, which have specific guidelines.”

If you’re confused about your taxes, consider using a qualified tax preparer.

Email your questions to Ask@NJMoneyHelp.com.

Karin Price Mueller writes the Bamboozled column for NJ Advance Media and is the founder of NJMoneyHelp.com. Follow NJMoneyHelp on Twitter @NJMoneyHelp. Find NJMoneyHelp on Facebook. Sign up for NJMoneyHelp.com’s weekly e-newsletter.