The Internal Revenue Service (IRS) recently issued Notice 2020-50 to provide retirement plans with guidance under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The extensive guidance provides helpful clarification to plan sponsors and individuals on the enhanced distribution and loan suspension provisions under the CARES Act. Some of the highlights of the guidance are discussed below.
As described in our earlier article, under section 2202 of the CARES Act, qualified individuals receive favorable tax treatment for distributions from eligible retirement plans that are coronavirus-related distributions (CRDs). Generally, a CRD is not subject to the 10% additional tax on early distributions, is includible in income over a three-year period, and, to the extent the distribution is eligible for tax-free rollover treatment and is contributed to an eligible retirement plan within a three-year period, will not be includible in income. Section 2202 also increases the allowable plan loan amount under the Internal Revenue Code and permits a suspension of payments for plan loans outstanding on or after March 27, 2020, that are made to qualified individuals.
Expanded Definition of Qualified Individuals
To receive a CRD, the recipient must be a “qualified individual” as defined under the CARES Act, which authorizes the Secretary of Treasury to state additional adverse financial factors that may cause a person to become a qualified individual. The guidance expands the definition of a qualified individual by adding that the definition also includes:
- An individual who experiences adverse financial consequences as a result of having a reduction in pay (or self-employment income) due to COVID-19 or having a job offer rescinded or start date for a job delayed due to COVID-19;
- An individual whose spouse or whose member of his or her household (as defined below) experiences adverse financial consequences as a result of:
- Being quarantined, being furloughed or laid off, or having work hours reduced due to COVID‑19;
- Being unable to work due to lack of childcare due to COVID-19;
- Having a reduction in pay (or self-employment income) due to COVID-19;
- Having a job offer rescinded or start date for a job delayed due to COVID-19; or
- Closing or reducing hours of a business owned or operated by the spouse or member of the individual’s household due to COVID-19.
For purposes of the additional factors, a member of the individual’s household is someone who shares the individual’s principal residence.
Example: John’s spouse, Mary, was offered a job on April 1, 2020. However, due to COVID-19, Mary’s prospective employer rescinded the job offer on April 15, 2020. John is a qualified individual under the expanded definition. Mary is also a qualified individual.
Plan and Participant May Differ on CRD Treatment
The guidance explains that a plan sponsor has discretion in whether to allow CRDs, so long as the treatment of any distributions as CRDs is consistent. The guidance also notes that a qualified individual may treat a distribution as a CRD on his or her federal tax return regardless of whether a distributing plan recognizes the distribution as a CRD.
Example: In addition to the facts above, John is a participant in the Employer, Inc. 401(k) Plan, which permits rollover balances to be distributed at any time. On April 30, 2020, John takes a distribution of $25,000 from his rollover account in the Employer, Inc. 401(k) Plan. The Employer, Inc. 401(k) Plan does not recognize CRDs and therefore does not specially report the distribution. When filing his federal income taxes for 2020, John may treat the distribution from the Employer, Inc. 401(k) Plan as a CRD and take advantage of the associated tax benefits.
CRDs Do Not Have to Correspond to a Financial Need
The guidance clarifies that the CARES Act does not limit CRDs to amounts withdrawn solely to meet a need arising from COVID-19. In other words, if an individual is a qualified individual, he or she may take a CRD up to the maximum permitted amount regardless of any financial need.
Example: In addition to the facts above, John took the distribution of $25,000 because he wanted to buy a new ski boat. John may still treat the distribution from the Employer, Inc. 401(k) Plan as a CRD.
No Duty to Investigate Qualified Individual Certifications
The CARES Act states that a retirement plan administrator may rely on a participant’s certification that he or she is a qualified individual. In later guidance provided by the IRS in the form of FAQs posted on its website, the IRS stated that an administrator may rely on a participant’s certification only if the administrator does not have actual knowledge to the contrary. Notice 2020-50 clarifies that an administrator does not have a duty to inquire further when presented with an employee’s certification. Rather, actual knowledge for this purpose means that the administrator does not already possess “sufficiently accurate information to determine the veracity of the employee’s certification.”
Example of Acceptable Qualified Individual Certification
The guidance provides the following example of an acceptable certification:
Name: _______________________ (and other identifying information requested by the employer for administrative purposes).
I certify that I meet at least one of the following conditions: (1) I was diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (referred to collectively as COVID-19) by a test approved by the Centers for Disease Control and Prevention (including a test authorized under the Federal Food, Drug, and Cosmetic Act); (2) my spouse or my dependent was diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention (including a test authorized under the Federal Food, Drug, and Cosmetic Act); or (3) I have experienced adverse financial consequences because: (i) I, my spouse, or a member of my household was quarantined, furloughed or laid off, or had work hours reduced due to COVID-19; (ii) I, my spouse, or a member of my household was unable to work due to lack of childcare due to COVID-19; (iii) a business owned or operated by me, my spouse, or a member of my household closed or reduced hours due to COVID-19; or (iv) I, my spouse, or a member of my household had a reduction in pay (or self-employment income) due to COVID-19 or had a job offer rescinded or start date for a job delayed due to COVID-19.
The guidance also notes that, although an administrator may rely on such a certification for making and reporting a CRD, the individual may treat the distribution as a CRD for federal income tax purposes only if the individual actually meets the definition of a qualified individual.
Safe Harbor for Delayed Loan Repayments
The CARES Act provided that a retirement plan may provide that the repayment due dates occurring from March 27, 2020, through December 31, 2020, for a plan loan to a qualified individual may be “delayed for 1 year.” To satisfy the repayment requirements, the guidance provides a safe harbor under which a loan with delayed repayments is reamortized (including any accrued interest) beginning with the first payment date occurring in 2021 up to the date that is one year after the original loan repayment date.
Example: In addition to the facts above, on April 1, 2020, John received a loan from the Employer, Inc. 401(k) Plan of $20,000 to be repaid in monthly payments of $368.33 over five years through payroll withholding. John makes payments for three months through June 30, 2020. Employer, Inc. suspends payroll withholding repayments for the period from July 1, 2020, through December 31, 2020, for loans to qualified individuals that are outstanding on or after March 27, 2020. Because John is a qualified individual, no further repayments are made on his loan until January 1, 2021 (when the balance is $19,477). At that time, repayments on his loan resume, with the amount of each monthly installment reamortized to be $343.27 in order for the loan to be repaid by March 31, 2026 (which is the date the loan originally would have been fully repaid, plus one year).
The guidance recognizes that there are additional ways that the delayed loan repayments could be administered and provides an example in which payments resume under the original amortization schedule beginning January 1, 2021, but are not reamortized to include the delayed payments until the first delayed payment is due.
Cancellation of Deferral Elections under Nonqualified Deferred Compensation Plans
Pursuant to regulations under Code Section 409A, a nonqualified deferred compensation plan subject to Code Section 409A may provide for a cancellation of a service provider’s deferral election, or such a cancellation may be made due to an unforeseeable emergency or a hardship distribution. The guidance provides that if a service provider receives a distribution from an eligible retirement plan that constitutes a CRD that distribution will be considered a hardship distribution. As a result, a nonqualified deferred compensation plan may provide for a cancellation of the service provider's deferral election, or such a cancellation may be made, due to a CRD. The guidance emphasizes that the deferral election must be cancelled – not merely postponed or otherwise delayed.
If you have any questions about the guidance or the CARES Act, please contact one of the attorneys in the Employee Benefits and Executive Compensation Practice Group at Bradley.