CARES Act favorable tax treatment for distributions to eligible individuals (10% early distribution penalty, ability to pay income tax over three years (when elected), and waiver of the 20% mandatory withholding otherwise applicable to employer-sponsored plans) applies to federal income tax only. State income tax treatment may vary depending on particular state’s decision whether or not to align with the applicable federal income tax regime. This often varies from state to state, and states may selectively “decouple” assorted federal tax code provisions. Thus for instance, depending on a particular state, CRD withdrawals may or may not be subject to state income tax and/or early penalty.
For example, while the State of California announced that it would follow the CARES Act and provide relief from its customary 2.5% (6% for SIMPLE IRAs) penalty on early retirement account withdrawals,* the State of New York became the first state to take action to decouple from the CARES Act, including the three-year ratable income inclusion for coronavirus-related distributions from retirement plans.**
As always, individuals should consult with their tax and/or legal advisor on application of state income tax rules applicable in their specific circumstances.
* COVID-19 frequently asked questions for tax relief and assistance, California Franchise Tax Board. Retrieved on May 7, 2020 from https://www.ftb.ca.gov/about-ftb/newsroom/covid-19/help-with-covid-19.html#General .
** New York budget bill passes legislature, Eversheds Sutherland. Retrieved on May 7, 2020 from https://us.eversheds-sutherland.com/NewsCommentary/Legal-Alerts/230842/New-York-budget-bill-passes-legislature .