On March 30, 2020, we issued a First Alert describing the provisions of Section 2202 of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) providing liberalized rules and tax relief with respect to certain distributions and loans from eligible retirement plans to “qualified individuals” (as defined below) impacted by COVID-19. In general, these provisions are as follows:
- Permit plan distributions in 2020 of up to $100,000 to qualified individuals (“Coronavirus Distributions”), without a 10% early withdrawal penalty and allow the individuals to spread the federal income taxes on the distributions over three years and repay the distributions within three years;
- Increase the limit on the plan loans that a qualified individual may receive without being taxed from $50,000 to $100,000 for any loan made within 180 days after enactment of the CARES Act (“Coronavirus Loans”); and
- Allow payments due for the remainder of 2020 on outstanding plan loans to be delayed for up to one year without the qualified individual being taxed on the loan amount
(“Coronavirus Loan Suspensions”).
On May 4, 2020, the IRS issued its initial guidance on these provisions in the form of 14 FAQs. This Alert describes some of the highlights of the FAQs and flags certain issues that remain open. The IRS also indicated it is working on more detailed guidance, which it anticipates will reflect the principles of Notice 2005-92 regarding the plan distribution and loan relief Congress enacted for victims of Hurricane Katrina, to the extent the statutory provisions are similar (which they generally appear to be).
Must plans offer the Coronavirus Distributions, Loans and Loan Suspensions?
No. The FAQs indicate that plan sponsors may decide whether, and to what extent, to amend their plans to offer any one or a combination of Coronavirus Distributions,
Coronavirus Loans and Coronavirus Loan Suspensions. For example, a plan may permit Coronavirus Loan Suspensions without permitting Coronavirus Distributions and Coronavirus Loans or vice versa. There are a variety of factors a plan sponsor may want to consider regarding whether to permit them, including the extent to which their workforces are impacted by the coronavirus and may need the distributions, loans or loan suspensions, the potential for “leakage” of retirement assets, and whether repayment of large loans may create hardship for participants in later years.
May qualified individuals treat plan distributions as Coronavirus Distributions even if plans do not designate them as Coronavirus Distributions?
Yes. The FAQs indicate that even if a plan
does not specifically offer Coronavirus Distributions or designate a distribution as a Coronavirus Distribution, a qualified individual may elect on their income tax return to treat up to $100,000 of distributions received between January 1, 2020 and December 31, 2020 from all eligible plans (such as qualified plans, 403(b) plans, 457 plans and IRAs) as Coronavirus Distributions and receive the tax-favored treatment on them. Thus, a qualified individual impacted by the coronavirus may treat distributions received during 2020 for any reason (such as hardship or termination of employment) from such plans as exempt from the 10% early distribution tax penalty and spread the income over three years for federal income tax purposes and may do so independently of how the distribution was treated
by the plan.
Who are qualified individuals?
The FAQs indicate that a “qualified individual” is a plan participant (1) who is diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (COVID-19) based on a CDC-approved test, (2) whose spouse or dependent is so diagnosed with a CDC-approved test, or (3) or who experiences adverse financial consequences as a result of being quarantined, furloughed or laid off, having work hours reduced (or having to close or reduce the work hours of a business the individual owns or operates) or being unable to work due to lack of childcare, due to SARS-CoV-2 or COVID-19.
As currently written, these factors would not include situations in which a participant experiences adverse financial
consequence due to a spouse being quarantined, furloughed, laid off, or forced to close the business the spouse owns or operates. Nor would these include cases in which a participant who has been presumed to be positive for COVID-19 by a medical professional based on symptoms but, due to lack of test supplies or other reasons, a CDC-approved test was not actually conducted. IRS and Treasury have the authority, however, to expand the list of factors taken into consideration in determining if someone is a qualified individual by reason of experiencing adverse financial consequences, and the FAQs indicate, without further details, that expanding the list of factors is under consideration.
Proof a participant is a qualified individual
indicate that a plan administrator may rely on the individual’s certification that the individual is impacted by the coronavirus and meets the criteria for receiving a Coronavirus Distribution, absent actual knowledge to the contrary. The FAQs do not expressly indicate whether a plan may rely upon such a certification in determining that said individual is eligible for a Coronavirus Loan or Coronavirus Loan Suspension, however, but hopefully future guidance will permit that.
Are plans required to accept repayment of Coronavirus Distributions?
The FAQs state that “it is anticipated that eligible retirement plans will accept repayments” of Coronavirus Distributions and that such repayments are to be treated as rollover contributions. The FAQs also note,
however, that plans generally are not required to accept rollover contributions, so the FAQs indicate that a plan that does not accept any rollover contributions will not be required to change its terms or procedures to accept these repayments.
Which restrictions on plan distributions does the CARES Act lift for Coronavirus Distributions?
A Coronavirus Distribution is treated as not violating the distribution restrictions generally applicable to 401(k) plan, 403(b) plans and 457 plans. For example, a 401(k) plan may make a Coronavirus Distribution to a qualified individual even if the individual has not terminated employment, become disabled, attained age 59-1/2 or had a hardship. The FAQs clarify that the CARES Act does not, however, relax
any other distribution restrictions otherwise applicable to plans. Thus, pension plans, such as money purchase plans or defined benefit plans, generally may not make Coronavirus Distributions to participants prior to termination of employment (or when they become disabled or attain age 59-1/2). In addition, the IRS made clear that the CARES Act does not provide any exception to the joint and survivor annuity rules. For example, a pension plan would have to make any Coronavirus Distribution to a married participant as a joint and survivor annuity unless the participant elects otherwise with spousal consent.
Tax reporting of Coronavirus Distributions
A distribution designated as a Coronavirus Distribution by the plan is to be reported on Form
1099-R. More detail about what code to use for the distribution is anticipated later this year, although the Katrina guidance permits the plan to use one of the codes for “early distribution.” Whether or not the plan recognizes a distribution as a Coronavirus Distribution, a qualified individual is to report the distribution on his income tax return ratably over three years, unless he elects to include the entire distribution in income for 2020.
If a Coronavirus Distribution is repaid to an eligible plan, it is to be treated as a direct rollover, and the individual will report the repayment on Form 8915-E, which is in development. In addition, an individual who timely repays a Coronavirus Distribution is permitted to amend any prior tax returns to treat the Coronavirus
Distribution as not taxable.
Coronavirus Loans and Loan Suspensions
The FAQs indicate that the increased limits on Coronavirus Loans apply to loans made to eligible individuals from March 27, 2020 to September 22, 2020. In addition, regarding the Coronavirus Loan Suspensions, the FAQs provide that if a participant who is a qualified individual has an outstanding loan with a repayment due during the period beginning on the March 27, 2020, and ending December 31, 2020, such repayment due date may be delayed for up to one year without the loan defaulting or becoming taxable.
The FAQs also indicate that any payments after the suspension period will
be adjusted to reflect the delay, including the interest that will accrue during the suspension period. The FAQs cross reference relevant procedures in Notice 2005-92. Although not entirely clear, we anticipate that these provisions may permit recordkeepers to restart plan loan repayments on a reamortized basis in January 2021, but further guidance may clarify whether repayment may be delayed for a full 12 months.
What should plan sponsors do now?
Plan sponsors should continue to work with their ERISA counsel and recordkeepers and stay alert for further guidance as they move forward with determining whether to permit and how to implement Coronavirus Distributions, Coronavirus Loans, and/or Coronavirus Loan Suspensions for impacted
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