On May 4, 2020, the Internal Revenue Service (IRS) issued a series of questions and answers to address the new rules affecting retirement plans and IRAs under the Coronavirus Aid, Relief and Economic Security Act (CARES Act). The recent guidance provides additional clarity on how the newly enacted CARES Act distribution and loan changes apply in practice. (Our prior alert (available here) explained the other retirement plan changes available under the CARES Act.)
The CARES Act provides special treatment for coronavirus-related distributions in several respects: First, such distributions are exempt from the 10% penalty for early distribution, which otherwise may apply to any qualified plan, 403(b) plan, or IRA. Second, the in-service distribution prohibitions are waived for 401(k), 403(b), and 457(b) plans—but they are not waived for other qualified plans, such as pension plans. Third, such distributions are not subject to 20% mandatory federal income tax withholding that otherwise applies to cash lump sum distributions from qualified, 403(b), and governmental 457(b) plans.
The CARES Act authorizes Section 401(k), 403(b), and 457(b) plans to make otherwise impermissible in-service coronavirus-related distributions of up to $100,000 from January 1, 2020 to December 30, 2020 to a "qualified individual" who:
- Has been diagnosed with SARS-CoV-2 or coronavirus disease 19 (collectively, coronavirus) by a test approved by the CDC;
- Has a spouse or dependent who has been diagnosed with coronavirus by such a test; or
- Has experienced adverse financial consequences as a result of being quarantined, furloughed, or laid off; having work hours reduced; a loss of child care due to the coronavirus; or certain other factors.
If a distribution meets these requirements, it receives favorable tax treatment in at least three ways. First, although the coronavirus-related distribution will be subject to income tax, it will not be subject to either the 10% penalty tax for early withdrawals or the 20% withholding requirement on rollover distributions. Second, unless a qualified individual elects otherwise, such distributions will be included in the qualified individual's taxable income ratably over a three-year period. Third, a qualified individual who receives a coronavirus-related distribution may repay the amount of the distribution to the retirement plan or IRA in the three-year period after the distribution is received, in which case the distribution will not be subject to income tax.
Coronavirus-Related Plan Loans
The CARES Act also authorized retirement plans to make changes to the participant loan rules for qualified individuals as described above. For those individuals, retirement plans may:
- Increase the maximum participant loan limit for loans granted between March 27, 2020 and September 22, 2020 from (i) the lesser of $50,000 or 50% of the participant's vested account balance, to (ii) the lesser of $100,000 or 100% of the participant's vested account balance; and
- Delay any repayments of outstanding loans due from March 27, 2020 to December 31, 2020 for a period of up to one year, after which the loan would be adjusted to reflect the delay and the interest accruing during that period.
New IRS Guidance
While the CARES Act provisions above provide much-needed assistance to participants affected by the coronavirus, they raise a number of questions about how the rules apply in practice. The new IRS guidance provides clarity on the following points:
- Optional Nature of CARES Act Changes—The guidance confirmed that the CARES Act distribution and loan changes are optional, and plan sponsors may decide whether and to what extent to adopt them.
- Participant Self-Certification—A plan sponsor may rely on a participant's self-certification of eligibility (unless the plan sponsor has actual knowledge to the contrary).
- Qualified Individuals—The guidance indicates that the IRS is considering expanding the list of factors that would make a person a "qualified individual" eligible for a coronavirus-related distribution or the loan changes.
- Repayment of Coronavirus-Related Distribution—The guidance clarifies the mechanics for repaying coronavirus-related distributions. As discussed above, unless a qualified individual elects otherwise, such distributions are to be included in the qualified individual's taxable income ratably over a three-year period. Distributions and/or repayments will be reportable by the individual on a Form 8915-E with his or her tax return. If the qualified individual repays part or all of a coronavirus-related distribution in a year after a tax year in which it is included in taxable income, the individual may file an amended tax return to claim a refund for the repayment.
- Requirement to Accept Repayments—Repayment is made by means of a rollover to an IRA or eligible retirement plan that accepts rollovers. The guidance suggests that a plan which otherwise accepts rollover contributions will need to accept repayments of coronavirus-related distributions.
- Distributions from Pension Plans—The guidance clarifies that the CARES Act does not permit pension plans (including money-purchase pension plans) to make coronavirus-related distributions before an otherwise permissible distributable event, or to make distributions without spousal consent (if otherwise required).
- Treatment of Coronavirus-Related Distributions on Tax Return—The guidance clarifies that a retirement plan participant may treat a distribution as a coronavirus-related distribution on his or her tax return, regardless of whether the plan sponsor has adopted coronavirus-related distributions in an eligible retirement plan. The qualified individual must otherwise be eligible for a distribution from the plan (such as upon employment termination or in-service on or after age 59½).
- Distribution Reporting—The guidance states that the payment of coronavirus-related distributions must be reported on Form 1099-R, even if the qualified individual repays the coronavirus-related distribution in the same year.
- Loan Repayment Deferral—By reference to Hurricane Katrina guidance, the guidance suggests that there may be a safe harbor (deemed compliance, but not the only means of compliance) if loan repayments between March 27, 2020 and December 31, 2020 are suspended, and the loan is re-amortized as of January 1, 2021 to include accrued interest and reflect the repayment suspension period.
According to the IRS, it expects to issue additional and more formal guidance on the CARES Act provisions discussed above. Until then, if you have any questions about the information above, please feel free to contact the authors or any member of the Employee Benefits and Executive Compensation team at Venable LLP.