This article answers questions and provides information to guide clients who are hoping to receive their Economic Impact Payments (EIP) and wondering what to expect for next year’s tax return. It also addresses the new tax requirements for withdrawals, distributions, and loans against clients’ retirement accounts.
How are Economic Impact Payments Tied to Tax Filings?
Under the CARES Act, an EIP is an advance tax credit on a taxpayer’s 2020 taxes.
The payments are not considered income, and clients will not be required to pay the money back on their 2020 taxes. The federal government bases the initial amount each person or household receives on 2019 tax information (or on 2018 information if 2019 has not been filed).
If clients do not receive their full EIP, they may be eligible for more EIP once they file their 2020 tax returns if their income is significantly lower than in previous years. Final distribution of the tax credit is based on the filing of 2020 taxes, so if a client has a child, or if a client has a substantial drop in income, they will be eligible to receive additional tax credit (e.g., if income drops from $85,000.00 in 2018 to $72,000.00 in 2020, the client would get the remainder of the full EIP, but would pay nothing back if the situation were reversed).
If a client has not filed income taxes for 2018 or 2019 – due to low income or other reasons – the federal government as of April 11, 2020, has developed a tool for “non-filing persons” to apply for their relief checks electronically through the IRS website.
Clients should be aware there have been many reports of technical issues with the online tool. Thus, even if information is filed correctly, many clients may still encounter problems.
Alternatively, if a client has not yet filed taxes in 2018 or 2019 because they owe taxes from prior years, they will need to file their 2019 taxes as soon as possible. In doing so, they should not use the non-filing tool. Unless a client meets the requirements of not having to file, the IRS will likely be looking for a return to be filed, and will deny a claim for EIP using this non-filing tool.
The IRS will continue to process EIPs through the end of 2020. Clients in these situations may still be eligible for an EIP, despite owing back taxes, though they should be advised that it will take longer for them to receive their EIP.
How will Clients Receive their Economic Impact Payment?
If parties provided the IRS with direct deposit information on their most recent tax return, their EIP will be deposited directly into the bank account on file. All others will receive physical checks.
As of April 15, 2020, the IRS has opened a new “Get My Payment” tool for entering direct deposit information and tracking payments through this payment process. Parties using this tool will need to have their Social Security number, address on file, and most recent tax return information if they try to apply for direct deposit. The IRS allows taxpayers to change their account information if their EIP has not yet been processed or scheduled for distribution.
As of April 15, 2020, those who receive their payment via direct deposit can expect their EIPs once their account information is processed. If the IRS cannot process proper bank account information, a physical check will be mailed to the address on file.
If clients are receiving a physical check, they may be waiting until September 2020 to receive their payment. The IRS started sending out physical checks the week of April 20, 2020, and will continue to distribute them in waves of about 5 million checks per week, starting with those with lowest incomes first, and going in a “reverse ‘adjusted gross income’ order.”1 Those on Social Security or SSDI will automatically receive their EIP with through the same method they receive their current payment. You can find the IRS portal on the irs.gov website.
Where Will the Money Go for Divorced Couples Who Filed Jointly in 2018 or 2019?
Clients’ EIPs will be delivered to the address or bank account listed on the latest tax return. For couples who are recently divorced and filed jointly in either 2018 or 2019, only one party will receive a check.
Likewise, clients should be aware that the funds may be directed to a now-closed account. The IRS has no system in place to track a change in status, so parties will need to update their status on their own. If parties have not filed their 2019 taxes, they should file as soon as possible and inform the IRS of the change in status.
However, due to significant backup in the IRS’ processing abilities, the IRS may not process a change in status in time for it to make a difference where a client’s EIP money is distributed. Clients can use the “Get My Payment” tool to track their EIP distribution.
What If the Money Has Already Been Deposited or Scheduled to be Delivered?
Clients should speak with their ex-spouse to discuss a transfer of the money to split the EIP payments in advance.
What Happens with the Economic Impact Payments for Clients’ Children?
Whoever claimed the children as a dependent for Child Tax Credit purposes on the most recent tax return will receive the additional $500 per qualifying child.
Children ages 17-24 who are claimed as a dependent do not receive an EIP. Children born in 2020 may be claimed next year as well, and parties can receive the additional EIP amount for the child. However, parents claiming the child on their 2020 taxes will likely not receive an additional EIP next year, if an EIP was already received for that child.
Although EIPs are considered a tax credit, it may be more helpful to look at an EIP as a negative expense or a credit against variable expenses that should be split similar to that of any other variable expense. If efforts to fairly split the EIP fail, clients could bring an action in court, although clients and counsel should consider the cost benefit of doing so.
Will Economic Impact Payments be Garnished?
EIPs will not be garnished if clients owe back taxes, nor will they be garnished for child support orders. However, if a party is behind on child support, a client will have their EIP garnished and used to pay off any outstanding arrears for unpaid child support.
What does this Mean for Clients Currently Going through a Divorce?
Divorcing parties should include a provision regarding EIPs into their Marital Settlement Agreement (MSA), as the final amount is determined by 2020 income.
This can be addressed under the tax provisions of the MSA to include how to handle an EIP. Including language that provides for an exception for tax agreements for clients who qualify for a change in the 2020 EIPs helps to avoid returning to court next year over possible EIP-related refund disputes.
Are There Changes in Retirement Distributions?
There are also tax provisions that allow eligible parties tax breaks for “COVID-related distributions” through Dec. 31, 2020. Eligible parties must have been diagnosed with COVID-19 via a Centers for Disease Control and Prevention (CDC) approved test or had a spouse who was diagnosed.
Additionally, if clients have experienced financial consequences, such as being furloughed or laid off; working reduced hours due to a closing of a business, self-employed or otherwise; or being inability to work due to child care, the new distribution rules may also apply. Clients should retain records for proof of these hardships in the event the IRS requests it. There is also a provision for other factors which are at the discretion of the Secretary of Treasury when reviewing a claim.
In these situations, the CARES Act has waived minimum retirement distributions requirements for 2020. Additionally, the 10% tax penalty on 401(k) and IRA withdrawals is forgiven through Dec. 31, 2020. While distribution rollovers must typically be redeposited within a 60-day period, the CARES Act extends this to a three-year period.
Additionally, the CARES Act allows for an increase in the total amount of loan a client may take against their 401(k). Instead of a client being able to take a maximum of $50,000 or 50 percent of their total vested account balance (whichever amount is lower), the CARES Act allows for up to $100,000 or 100 percent. For 401(k) loans, repayment is also delayed for one year. Withdrawals are still taxed, but the taxes are now due within three years of removing funds.
As a general note, it is important that clients consider the option to withdraw from a retirement account very carefully, as it may have lasting effects on a client’s future retirement.
Due to the waiver of distribution penalties and the increased withdrawal amounts that the CARES Act permits, for those going through a divorce, simply withdrawing funds from a retirement account may be a viable alternative to using a QDRO. However, this is circumstantial, and there is no requirement that companies approve the new CARES Act provisions. Clients and counsel need to check with administration on the retirement account to review their own policies before moving forward with withdrawals.
TIFFANY L. HIGHSTROM