Are coronavirus CARES Act 401k withdrawals subject to an early withdrawal penalty in the state of Arkansas?

[KathrynG3]

No, there is not an early withdrawal penalty in the state of Arkansas because there is no penalty on the federal return.

For more information, see: 

2020 AR 1000F and AR1000NR Instructions, page 12, 3rd column, Line 18B, and page 13, 3rd column, Line 31.

Arkansas Individual Income Tax Lump-Sum Distribution Averaging

What is Form 8915-E Qualified 2020 Disaster Retirement Plan Distributions and Repayments?

Can I make a hardship withdrawal from my 401(k)?

[s-sifford]

I used form 8915-E for the federal return and it handled that correctly but on the Arkansas return the covid distribution was reported on line 16 as a nonqualified distribution (subject to penalty) instead of a qualified distribution on line 18. It gave me a 10% penalty on line 32.  I am filing on paper and will make a manual correction.

[pamharter]

I'm told that Arkansas does not allow the taxing of the CARES Act retirement distribution to be averaged over three years like the federal government does. Is there something official and in writing showing that Arkansas DOES NOT ALLOW the three year spread of tax liability? Neither HB1361 nor Act 248 are any help.  

However, HB1361 states in Section 4 "Arkansas should conform its income tax laws to the federal tax treatment of these loans, payments, and expenses to enable Arkansas taxpayers to receive the full benefit of the tax laws...[etc]" which sounds like they WOULD allow the three year split.

I intend to repay these funds into my retirement plan this year to replenish my retirement savings. When I withdraw them again when I retire, will Arkansas tax this money again? The agent at the DFA told me that YES, Arkansas will tax those funds a second time. I have a hard time believing that. Please confirm.  [Perhaps there was a miscommunication. It would depend on whether there's a tax credit/refund given for repayment. Nevertheless, this shouldn't be double taxed.] 

[AmyC]

Arkansas covid treatment is here. The state offers coverage of taxes in  Moving to Arkansas. It looks like you paid tax on the full amount in 2020 on your state return. Arkansas does not use the federal AGI, it is state specific with no mention of the federal treatment.

On the federal, you can input how much you have repaid and deduct that from your tax bill. Arkansas will benefit by taxing the money again when you withdraw it unless the state determines a policy to allow handling of the issue at the state level for repaid amounts.

The final word, Update and Answers to Questions on Federal CARES Act.

@pamharter

[pamharter]

@AmyC,  thank you so much for your quick and detailed reply! That’s the most information anyone has given me so far. But I still have questions.

Your first link re AR covid treatment only talks about loan forgiveness under PPP, SBA, EIDL and CFAP. No mention of individual income tax treatment, unless I’m missing something.

You said that “Arkansas does not use the Federal AGI, it is state specific with no mention of the federal treatment.” How do you explain the language in the House Bill that states in Section 4: (underline mine)

“...that Arkansas should conform its income tax laws to the federal tax treatment of these loans, payments, and expenses to enable Arkansas taxpayers to receive the full benefit of the tax laws so that they can continue to provide jobs for Arkansans and avoid higher rates of unemployment and financial distress; and that this act is immediately necessary because the 2020 tax return season is underway and immediate conformity to the federal tax laws will assist the state with its economic recovery and will enable businesses to continue providing jobs that are necessary to the public peace, health, and safety.”

I’m still looking for something definitive in writing that says we cannot spread tax liability over three years. Arkansas doesn't use the federal AGI as a general practice or in this situation?

For federal treatment of repayment, you said that we can repay less than the full amount in any of the years and deduct that from the tax bill. Thank you for mentioning that! What would be considered an eligible retirement plan? My plan at work doesn’t accept direct contributions, only what I have withheld from my paycheck. Should I set up a regular IRA?

What’s concerning to me is that Arkansas COULD “benefit by taxing the money again” unless and until a policy is in place to change that. Of course, not directed at you, Amy, but... in what world is it okay to pay income tax twice on the same money? Retirement money, no less!

The last link you provided only addresses the 10% penalty not being assessed for early distributions under the CARES Act.

Thanks again, Amy!

[AmyC]

All questions should be answered by reading the AR1000F and AR1000NR Instructions.  Page 10 describes withdrawals and there is no place for spreading payments. It is not allowed in AR.

Some states begin with the federal AGI and make adjustments. AR does not do that. AR has state specific income so it starts from scratch, not the federal.

Since AR has taxed the money once already, you would have the taxed portion as a basis to not be taxed in the future. Keep track of all records, the taxation, and the repayment to be able to prove later.

While there may be a house bill suggesting changes, it is not in the 2021 instructions for preparing your tax forms. The state can change the laws at any time and make them retroactive going back to 2020 or farther. In which case, you could amend your tax returns.

I hope this helps!

[pamharter]

@AmyC, yes that is so helpful, thank you! I'm so glad you understand my questions. It's been frustrating trying to find something online that speaks to this issue. 

So I've learned that Arkansas is one of several states that doesn't conform to the federal tax code (interesting!), and that I *should* only be taxed on the portion that wasn't taxed the first time, and I totally get that. You've helped so much. Thanks again!