Seyfarth Synopsis: As discussed in more detail in our prior blog post, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") provided certain relief to defined contribution plan participants, provided they were “qualified individuals”, making it easier for them to access retirement plan money in light of the COVID-19 pandemic. While the CARES Act provided welcome relief for retirement plan participants, some open questions remain with respect to the administration of these provisions, and we have been eagerly awaiting guidance from the IRS, which arrived in the form of Notice 2020-50 (the “Notice”) on June 19, 2020.
As a reminder, under the CARES Act, a qualified individual may be entitled to take a tax-favored “coronavirus-related” withdrawal (“CV Distribution”) from defined contribution plans of up to $100,000, free from the 10% penalty that normally applies to early withdrawals. An individual can elect to include the distribution in taxable income ratably over a three-year period and/or re-contribute the distribution to an eligible retirement plan. The CARES Act also permits a qualified individual to take a loan for up to $100,000 (“CV Loan”).
The Notice provides detailed guidance related to the CARES Act for employers, all eligible retirement plan providers, and individuals. The Notice comes as much needed direction, and makes the benefits of the CARES Act even more accessible. In the Notice, the IRS:
- Expands the group of individuals who can be "qualified individuals" to whom CV Distributions and CV Loans are available;
- Clarifies what amounts are available for CV Distributions;
- Provides guidance regarding the maximum amount that may be distributed and reliance on participant certifications of eligibility for CV Distributions;
- Provides guidance relating to the tax reporting of CV Distributions and the mechanics of re-contributing CV Distributions to an eligible retirement plan; and
- Expands the terms for providing CV Loans.
These items are each discussed in more detail below.
Expansion of the Definition of “Qualified Individual”
Under the CARES Act, a "qualified individual" is someone who:
- Is diagnosed with either the SARS-CoV-2 virus or with coronavirus disease 2019 (COVID-19);
- Has a spouse or dependent who is diagnosed with the virus or disease; or
- Experiences adverse financial consequences as a result of:
- Being quarantined, furloughed or laid off, or having their work hours reduced due to COVID-19;
- Being unable to work due to a lack of childcare due to COVID-19; or
- Closing or reducing hours of a business owned or operated by the individual due to COVID-19.
Read strictly, this initial definition of qualified individual left many adversely impacted participants on the sidelines and ineligible for a CV Distribution or CV Loan. For example, while the participant’s position or salary may not have been affected by the pandemic, if the participant’s spouse had his or her salary cut or was laid off or furloughed, the participant was not entitled to a CV Distribution or CV Loan.
The Notice addresses this gap and others by expanding the definition of a “qualified individual” to include individuals that experience 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 a start date for a job delayed due to COVID-19;
- Their spouse or a member of the individual’s household:
- being quarantined, furloughed, laid off or having work hours reduced due to COVID-19,
- being unable to work due to COVID-19 due to lack of child care,
- having a reduction in pay (or self-employment income) due to COVID-19, or
- having a job offer rescinded or a start date for a job delayed due to COVID-19; or
- The closing or reduction-in-hours of a business owned or operated by the individual’s spouse or a member of the individual’s household due to COVID-19
Note: The Notice provides that a member of the individual’s household is someone who shares the individual’s principal residence.
Clarification of Amounts Available for a CV Distribution
The Notice clarifies that a CV Distribution does not need to be limited to the amount necessary to meet the need arising from COVID-19 (unlike the requirements that apply to a hardship withdrawal). It also clarifies certain plan sources that are available/not available to be taken in a CV Distribution, as shown in the list below:
YES: Amounts Available for CV Distribution
- Elective Deferrals
- Qualified Nonelective Contributions
- Qualified Matching Contributions
- Safe Harbor Contributions (nonelective or matching)
NO: Amounts NOT Available for CV Distribution
- Corrective distributions on account of exceeding the Code Section 415 limitations
- Excess elective deferrals distributed to a participant
- Excess contributions and excess aggregated contributions distributed to a participant
- Loans treated as deemed distributions
- Dividends paid on applicable securities
- The costs of current life insurance protection
- Prohibited allocations treated as deemed distributions under Code Section 409(p), which sets forth the rules regarding allocations for any disqualified person in an Employee Stock Ownership Plan.
- Distributions that are permissible withdrawals from an EACA
- Distributions of accident or health insurance under Treas. Reg. Section 1.402(a)-1(e) (1)(i), which provides that an employer’s payments for such insurance is generally a taxable distribution to participants.
Note: This list is not an exhaustive list of items that may be included or excluded for the purpose of a CV Distribution.
The Notice also clarifies that the CV Distribution relief is optional for plan sponsors; plan sponsors are not required to make them available. Further, even if a distribution would have qualified as a CV Distribution, if not made available under a particular plan, a participant is still permitted to treat an otherwise permissible in-service distribution (e.g., a hardship distribution), as a CV Distribution (eligible for 3 year inclusion in income, not subject to the 10% early distribution excise tax, and eligible to be re-contributed to a plan or IRA). As a result, it is possible for employers and qualified individuals to treat the distribution differently for tax reporting purposes.
Guidance Relating to Amount that May be Distributed and Reliance on Self-Certification for CV Distributions
The Notice answers common questions employers have had about how to administer CV Distributions. First, it clarifies how employers are to determine the maximum amount that may be distributed to a qualified individual in a CV Distribution. The CARES Act provided that CV Distributions must be limited to no more than $100,000 per taxpayer, but that’s in the aggregate. So for employers within a large control group that maintains more than one plan, the employer will need to establish a procedure for monitoring the other plans within the control group to ensure compliance with the $100,000 limit. However, the Notice clarifies that a plan will not fail to satisfy the requirements because a qualified individual’s total CV Distributions exceed $100,000 taking into account distributions from IRAs or other eligible retirement plans maintained by unrelated employers.
Second, the Notice clarifies that plan administrators may rely on a participant’s certification that he or she is a qualified individual unless the administrator has actual knowledge that the individual’s certification is not accurate, and administrators are not obligated to inquire into the veracity of the certification. Given the expansion of the definition of a qualified individual, actual knowledge will be a very high bar. The Notice even provides a sample of an acceptable individual certification, which may be used for CV Distributions or CV Loans.
Guidance on Tax Reporting and Re-contribution of CV Distributions
The Notice generally provides that CV Distributions that are eligible for tax-free rollover treatment may be re-contributed to an eligible retirement plan, and such re-contributions will be treated as a trustee-to-trustee transfer to such plan. The Notice makes it clear, however, that certain CV Distributions are not available for re-contribution (e.g., a CV Distribution made to a qualified individual as beneficiary).
The Notice provides guidance for both plan sponsors and qualified individuals with respect to the reporting, tax treatment and re-contributions of CV Distributions, as follows:
- Tax Reporting of CV Distributions. Payors of CV Distributions are to report such distributions on Form 1099-R using distribution code 2 (“early distribution, exception applies”) in box 7 of Form 1099-R, so long as there is no other more appropriate code. Payors may also use distribution code 1 (early distribution, no known exception) in box 7 of Form 1099-R.
A qualified individual is to use Form 8915-E, Qualified 2020 Disaster Retirement Plan Distributions and Repayments, to designate a distribution as a CV Distribution (the form is also used to elect out of three-year ratable income inclusion, as described below). Form 8915-E is also used by a qualified individual to report re-contributions, if they are made (as described in more detail below). The 2020 Form 8915-E is expected to be issued by the end of the year, but is not yet available. Forms 8915-E have been issued by the IRS in the past to report penalty-free distributions (and re-contributions) related to prior disaster relief.
A qualified individual may treat a CV Distribution as income ratably over a three-year period beginning in the year of the distribution, or include the entire amount of the distribution in income beginning the day after the date of the CV Distribution.
- Accepting Re-contributions of CV Distributions. Plans may accept re-contributions if the plan administrator reasonably concludes the amounts are eligible for direct rollover treatment under the CARES Act. Plan administrators also may rely on employee certifications, as described above, to make the determination that such amounts are eligible for re-contribution.
In addition to providing guidance regarding the reporting of CV Distributions, the Notice details the tax treatment of re-contributions, depending on whether the individual chooses to include the entire amount of the distribution in income for 2020, or ratably over a three year period. The Notice offers several examples of various re-contribution scenarios.
In one example, a defined contribution plan participant takes a $15,000 CV Distribution on March 30, 2020. The participant chooses to include the entire amount of the CV Distribution in income for 2020, electing out of the three-year ratable income inclusion on Form 8915-E that is used to report the CV Distribution. In 2022, the participant re-contributes $15,000 to the plan. To report this re-contribution, the participant will need to file an amended 2020 tax return reporting the re-contribution and reducing his or her gross income by $15,000.
Alternatively, the Notice provides an example where a participant chooses to include the CV Distribution in income ratably over three-years, and later re-contributes a portion of the CV Distribution. In the example, the participant takes a $75,000 CV Distribution. Without a re-contribution, the participant will include an additional $25,000 in income for each 2020, 2021 and 2022. However, if the participant makes a re-contribution in the three-year period, the amount re-contributed will reduce the ratable portion of the CV Distribution that is includible in gross income for that tax year. In the example, the participant re-contributes $25,000 on April 10, 2022 and files his 2021 tax return on April 15, 2022. The participant will include $25,000 in additional income for 2020, $0 in additional income for 2021 (because the re-contribution was made before the filing deadline for 2021), and the remaining $25,000 in additional income for 2022.
The Notice also addresses what happens if a participant re-contributes more than the amount that is otherwise includible in income for a particular tax year. In this case, the participant may choose to either carry the amount of the excess forward or back. If carried forward, the amount of the excess re-contribution is used to reduce the portion of the CV Distribution included in income in the next tax year in the three-year period. If carried back, the amount of the excess is used to reduce the portion of the CV Distribution included in income in the prior tax year in the three-year period. This is a little more complicated, as the participant will need to file an amended tax return to reduce - by the amount of the excess re-contribution - the amount included in income in the prior year as a result of the CV Distribution.
Guidance Regarding CV Loans
In addition to the guidance described above regarding CV Distributions, the Notice also provides guidance regarding the treatment of CV Loans. The CARES Act provides for increased loan limits and suspension of repayments of outstanding loans for qualified individuals from March 27, 2020 through September 23, 2020. The Notice further provides clarification to plan sponsors regarding the application of the revised loan terms under the CARES Act. Notably, the Notice clarifies that the loan provisions of the CARES Act are optional; plan sponsors are not required to provide for CV Loans.
As discussed in our prior blog post, in addition to increasing the amount that a qualified individual may borrow, the CARES Act also allows a qualified individual to delay certain repayments for plan loans outstanding on or after March 27, 2020. The language in the CARES Act led to some confusion about how the suspension period would be applied when loan repayments are to resume. Specifically, the CARES Act simply provides that the due date for any loan repayment otherwise due during the nine-month period from March 27, 2020, until December 31, 2020 (the “Suspension Period”) may be delayed “for 1 year” and that the one year delay is disregarded for purposes of applying the maximum loan term (e.g., 5 years for a general purpose loan).
Many plan sponsors have opted to allow participants to suspend loan repayments otherwise due during the Suspension Period, but because the Suspension Period was less than one year, there were open questions with respect to what needed to happen at the end of 2020/beginning of 2021, including the following:
(1) When loan repayments recommence on January 1, 2021, is the loan re-amortized at that point to account for the Suspension Period?
(2) Or, is the loan not re-amortized until one year after the date payments were suspended? Is each suspended loan repayment separately delayed for one year?
(3) Or, is an additional year just added to the end of the original term of the loan?
The Notice clarifies how the loan suspension period is intended to work and provides a safe harbor along with a helpful illustration. The safe harbor points to a combination of (1) and (3) above as the answer. Under the safe harbor, loan repayments are suspended through December 31, 2020, and resume in January 2021. When loan repayments resume on January 1, 2021, they are reamortized to account for the Suspension Period. The term of the underlying loan may then be extended by up to one year from the original due date. Interest accruing during the Suspension Period must be added to the remaining principal of the loan.
In the example provided by the IRS in the Notice, a plan participant borrowed $20,000 on April 1, 2020 to be repaid in level monthly installments of over five years by March 31, 2025. The participant makes loan repayments through June 30, 2020, at which time the participant’s employer suspends repayments for loans to qualified individuals for the period from July 1, 2020 through December 31, 2020. Participant is a qualified individual under the CARES Act, so his loan payments are suspended until January 1, 2021. On January 1, 2021, loan repayments resume, with the amount of each monthly installment re-amortized 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). As a result, in this example, each monthly payment starting in 2021 is actually lower than originally monthly amount due to the extended term even accounting for accrued but unpaid interest.
The Notice acknowledges that this method is merely a safe harbor, and that there are other reasonable, but perhaps more complex, methods to compliantly administer CV Loans. These could include suspending payments that would otherwise be due during the Suspension Period until the one year anniversary of the beginning of the Suspension Period. For example, for a Suspension Period starting on April 1, 2020, all suspended loan payments would be due on April 1, 2021, although non-suspended repayments would have to recommence in January 2021.
Reminder: Amendment Deadline
As a reminder, retirement plans (excluding governmental plans) must adopt amendments to reflect any CARES Act changes implemented by the last day of the first plan year beginning on or after January 1, 2022 (December 31, 2022 for non-governmental calendar year plans). Governmental plans must adopt amendments by the last day of the first plan year beginning on or after January 1, 2024. The deadlines for plan amendments also may be extended by the Secretary of Treasury in future guidance.