Q. I took a $29,000 distribution from my 401(k) for COVID relief. I had $2,454 taxes withheld. Do I need to add that amount to my income when doing my 2020 tax return? If so, why do I have to spread the taxes over three years when they have already been withheld?
— Tax uncertain
A. There are a couple of things at play here.
First, the $29,000 401(k) distribution is an addition to your taxable income.
Because of COVID, for 2020, you have a choice, said Gail Rosen, a Martinsville-based certified public accountant.
You can either pay taxes on this distribution in 2020 or you can pay taxes on this distribution over a three-year period, she said.
She said the three-year period option is available to you if you meet the following requirements: you someone in your household had COVID-19 or someone experienced financial hardship due to the pandemic through job loss, reduction or delay, or if someone had childcare issues due to the virus in 2020.
“The $2,454 in taxes you had withheld from the $29,000 calculates to 8.5%, which you paid against the calculated tax liability,” she said. “Your final tax on this distribution depends upon your other income and expense items for 2020, and which marginal tax bracket you are in.”
Marginal tax brackets for 2020 peak at 37% for federal purposes and 10.75% for New Jersey purposes.
“I suggest you prepare your 2020 taxes and then carefully review your situation to determine if paying this tax over one year or three years will result in a lower tax liability for you,” she said. “Factors for you to consider include if your income is going up or down in the future and what your tax bracket will be.”
Then compare the amount of tax you will be paying on the distribution in one year versus over three years, she said.
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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.