On June 19, 2020, the IRS issued guidance on the CARES Act’s coronavirus-related distribution and loan provisions in Notice 2020-50. This Notice provides some helpful administrative detail and expands coronavirus-related distributions in several important ways.
Background on the CARES Act. As discussed in our March 30, 2020 Client Alert, the CARES Act permits plan sponsors to allow “qualified individuals” to:
- Take coronavirus-related distributions of up to $100,000 during 2020, with (i) no early withdrawal 10% additional income tax, (ii) income tax spread over 3 years, and (iii) all tax liability on the coronavirus-related distribution avoided if the distribution is repaid within 3 years;
- Take loans from their plan accounts between March 27, 2020 and September 23, 2020, of up to 100% of their account balances or, if less, $100,000; and
- Delay loan repayments due between March 27, 2020 and December 31, 2020 by one year, with the maximum 5-year repayment period extended accordingly.
The CARES Act defines “qualified individuals” as those individuals who (i) are diagnosed with COVID-19; (ii) have a spouse or tax dependent who is diagnosed with COVID-19; or (iii) experience adverse financial consequences as a result of: (a) being quarantined due to COVID-19, (b) being furloughed or laid off or having work hours reduced due to COVID-19, (c) being unable to work due to lack of child care due to COVID-19, or (d) the closing or reduction in hours of a business owned or operated by the individual due to COVID-19.
The CARES Act also authorizes the Secretary of Treasury to expand the definition of “qualified individual”. In a letter to the Secretary of Treasury, dated April 15, 2020, the SGR Employee Benefits and Executive Compensation Department asked that he expand the definition of “qualified individual” to include individuals who experience a reduction in pay. The expanded definition of “qualified individual” under Notice 2020-50 responds to this request.
New Guidance under Notice 2020-50. The IRS guidance provided in Notice 2020-50 addresses several open questions, including:
Expanded Eligibility. The categories of individuals who are eligible to benefit from the CARES Act’s distribution and loan provisions have been expanded. The definition of “qualified individual” now includes:
- An individual who is diagnosed with Coronavirus by a test approved by the U.S. Centers for Disease Control and Prevention;
- An individual whose spouse or dependent is diagnosed with Coronavirus by such a test; or
- An individual who experiences adverse financial consequences as a result of:
- The individual, his/her spouse or someone who shares the individual’s principal residence being quarantined, furloughed or laid off, or having work hours reduced, due to Coronavirus;
- The individual, his/her spouse or someone who shares the individual’s principal residence being unable to work due to lack of child care, due to Coronavirus;
- The closing or reducing hours of a business owned or operated by an individual, his/her spouse or someone who shares the Participant’s principal residence, due to Coronavirus;
- The individual, his/her spouse or someone who shares the individual’s principal residence having a reduction in pay or self-employment income, due to Coronavirus;
- The individual, his/her spouse or someone who shares the individual’s principal residence having a job offer rescinded or start date of a job delayed, due to Coronavirus; or
- Other factors as determined by the U.S. Secretary of the Treasury (or his or her delegate).
Distributions That May Qualify as Coronavirus-Related Distributions. The CARES Act permits 401(k) plans and some similar plans to make in-service coronavirus-related distributions to qualified individuals who might not otherwise be eligible for an in-service distribution.
- The Notice confirms that most other distributions made during 2020, and not merely distributions taken pursuant to a special in-service distribution right added under the CARES Act, will qualify as coronavirus-related distributions.
- However, not every coronavirus-related distribution will be eligible for all of the favorable tax treatment under the CARES Act.
- For example, only rollover eligible distributions and hardship withdrawals made between January 1, 2020, and December 30, 2020, to a qualified individual are eligible for repayment.
- Periodic payments made during this period are eligible for 3-year income inclusion, but they are not eligible for repayment because they are not otherwise eligible to be rolled over.
- Interestingly, although hardship distributions are not normally eligible to be rolled over and therefore would seem to be ineligible for repayment, Notice 2020-50 treats hardship distributions that qualify as coronavirus-related distributions as rollover eligible and therefore eligible for repayment.
Plan Sponsor Flexibility. Plan sponsors may adopt some, but not all, of the CARES Act coronavirus-related distribution and loan provisions. In addition, plan sponsors may adopt reasonable procedures for identifying distributions that are to be treated as coronavirus-related distributions.
Reliance on Participant Certifications. Plan sponsors may rely on a participant’s certification that he/she is a qualified individual as long as the plan sponsor does not already possess information that the participant’s certification is untrue. The IRS also provided a sample participant certification.
Tax Reporting and Withholding by Retirement Plans. The IRS explains how plans should report coronavirus-related distributions on Form 1099-R and provides that the rules for eligible rollover distributions, including the mandatory 20% withholding tax on amounts not rolled over, do not apply to coronavirus-related distributions. An individual may elect voluntary tax withholding with respect to a coronavirus-related distribution.
Tax Reporting by Individuals. Even if the plan does not treat the distribution as a coronavirus-related distribution, a qualified individual may treat a distribution that qualifies as a coronavirus-related distribution as such on his/her individual income tax return. In addition, the IRS explains how individuals should report coronavirus-related distributions on their individual income tax return and Form 8915-E, including how to report the repayment of coronavirus-related distributions.
Plan Sponsor Administration of Repayments. Plan sponsors should treat a participant’s repayment of a coronavirus-related distribution as a rollover contribution.
Plan Sponsor Administration of Loans. Plan sponsors may take advantage of a safe harbor detailed in Notice 2020-50 for implementing delayed loan repayments and the extended loan repayment period. The safe harbor requires that interest accruing during the suspension of loan repayments be added to the remaining principal amount of the loan, with the loan reamortized on January 1, 2021, and repaid in substantially level installments during the remaining repayment period (which may be extended by an additional year). The Notice acknowledges that there may be other ways to implement the delay in loan repayments, although those alternatives could be difficult to administer.
Impact on Nonqualified Plans. Under Code Section 409A, a nonqualified deferred compensation plan may provide that an individual’s deferral elections are cancelled if the individual takes a hardship withdrawal from a 401(k) plan sponsored by the employer. Importantly, the 409A regulations provide that this cancellation may not be at the election of the individual.
Notice 2020-50 provides that a coronavirus-related distribution can be treated as a 401(k) hardship withdrawal for purposes of cancelling a 409A deferral election. However, given the breadth of distributions that may qualify as coronavirus-related distributions and the fact that cancellation cannot be at the election of the individual participant, it may be difficult to implement such cancellations in practice.
For more information on the retirement plan relief provided in the CARES Act, please contact your Employee Benefits and Executive Compensation Counsel at Smith, Gambrell & Russell, LLP.