Newly issued IRS Notice 2020-50 has expanded eligibility for coronavirus-related distributions (CRDs) and answered questions about the application of the CRD and loan rules.
Definition of Qualified Individuals
The Coronavirus Aid, Relief and Economic Security (CARES) Act defines a participant eligible to receive a CRD or loan as a “qualified individual” and authorized the IRS to expand the group of eligible individuals. The statutory definition makes a participant eligible for CRDs if the participant or the participant’s spouse or tax dependent is diagnosed with COVID-19 or if the participant is personally affected by certain financial events, defined as a quarantine, layoff, furlough, a reduction in work hours or inability to work due to lack of child care as a result of COVID-19. The new rules expand the list of financial events and make a participant eligible if a spouse or any person who shares the participant’s primary residence (a “household member”) is affected by them.
“Qualified individuals” now also include:
- Those experiencing a new group of adverse financial events. Individuals qualify if they, their spouses or household members have experienced a reduction in pay or self-employment income, or had a job offer delayed or rescinded due to COVID-19;
- Individuals whose spouses or household members are quarantined, furloughed, laid off, have had work hours reduced due to COVID-19 or are unable to work due to lack of child care; and
- Individuals whose spouses or household members have had to close or reduce the hours of a business owned or operated by them.
These new rules should make many additional individuals eligible for the CARES Act relief.
Which Distributions Are CRDs?
The IRS has confirmed that most distributions of up to $100,000 made to qualified individuals are eligible for the special CRD tax treatment. This allows recipients to elect to take the amount into federal taxable income ratably over a three-year period and permits the distributions to be recontributed to an eligible retirement plan within three years. CRDs include distributions that would otherwise have been required minimum distributions (RMDs) or hardship distributions, even though these are usually not eligible rollover distributions, and offsets of unpaid loan amounts. However, corrective distributions, such as refunds of excess contributions when plans fail nondiscrimination testing, deemed distributions on loan default and taxable costs of current life insurance protection cannot be CRDs.
Plan sponsors and administrators have no duty to investigate eligibility for CRDS and, unless they have actual knowledge to the contrary, which should be rare, may rely on a participant’s certification of eligibility when making CRD distributions and loans and accepting recontributions. A sample distribution certification in which the distributee simply states that one of the listed requirements has been satisfied has been provided in the notice. No proof of hardship is required. The IRS also confirmed that nonspouse beneficiaries, who may not make indirect rollovers, are also prevented from recontributing CRDs.
Further Guidance on Taxes
The IRS previously indicated that it would generally follow the same tax rules that applied to special distributions after Hurricane Katrina. The new guidance largely confirms that, says that no 20% withholding or 10% early distribution penalty applies to CRDs and gives examples of the federal tax treatment both when the recipient takes the entire distribution into federal income in the year of distribution and where an election has been made to take the distribution ratably into federal income over three years. Distributions and recontributions will be reported on new Form 8915-E. The relief indicates that:
- If the entire distribution is taken into income in the year of distribution, repayment reduces income for that year. If full repayment is made before the federal tax return for the year of distribution has been filed, no portion of the distribution needs to be taken into income. If repayment is made after the federal return for the year of distribution has been filed, an amended return for the year of distribution must be filed;
- If inclusion in federal income over three years has been elected, repayments will first reduce income in the year of repayment. To the extent the repayment exceeds the amount of the distribution taken into income in the year of repayment, the excess may be carried forward or carried back; and
- Repayments may be made up to the filing of a tax return for a tax year within the three-year period.
State tax treatment may differ from the federal tax treatment.
As was expected, there is no special code required to be used on Form 1099-R to identify CRDs. A plan sponsor or payer that wants to treat a distribution as a CRD can use Code 2 (early distribution, exception applies). However, it is also permissible to use Code 7 (early distribution, no known exception). The requirement to report the distribution on Form 1099-R applies even if the entire distribution is repaid to the plan before the tax return for the year of distribution has been filed. A qualified individual is not bound by the 1099-R reporting when filing the individual’s tax return.
Loan Safe Harbor
The CARES Act permits, but does not require, plan sponsors to adopt an optional “one-year suspension” of loan repayments by qualified individuals during the period from March 27 to December 31. There has been confusion about how the one-year suspension would be applied, and when repayments must resume after the suspension. The IRS has announced a safe harbor for plan sponsors.
Under the safe harbor:
- Loan repayments will resume when the suspension ends. This means they will resume as of January 2021 if the suspension goes through December 31;
- The term of the loan may be extended up to one year after the date the loan was originally due even if it would cause the loan term to exceed five years or any longer term permitted for a loan to purchase a principal residence; and
- The loan, including additional interest on the unpaid balance, must be reamortized as of January 1, 2021, to the new due date.
Other reasonable methods will also be acceptable. For example, the IRS says if the suspension began on April 1, the loan may be reamortized as of April 1, 2021, provided repayments are made from January through March 2021. One year would still be added to the original loan term.
While Notice 2020-50 didn’t answer all of our questions, and, in particular, it is not clear what happens if a plan sponsor does not implement the loan suspension and there is a default, the new rule clarifications will assist plan sponsors who are still trying to decide whether or not to adopt the CARES Act relief.
Carol Buckmann is a co-founding partner of Cohen & Buckmann P.C. As a highly regarded employee benefits and ERISA [Employee Retirement Income Security Act] attorney, Buckmann deals with the foremost issues in ERISA, including pension plan compliance, fiduciary responsibilities and investment fund formation.
She has 40 years of practice in this area of the law and a depth of experience on complex pension law and fiduciary problems. She regularly shares her thoughts on new developments in the benefits industry on Insights, Cohen & Buckmann’s blog, and writes and speaks on ERISA topics. Buckmann has been recognized by Martindale-Hubbell as an AV Pre-eminent Rated Lawyer, was selected for inclusion in the Best Lawyers in America and was named one of the Super Lawyers in Employee Benefits.This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Institutional Shareholder Services or its affiliates.
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