IRS issues guidance on retirement plan CARES Act distributions and loans

On June 19, 2020, the Internal Revenue Service provided additional guidance for plan sponsors implementing the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) retirement plan relief. Notice 2020-50 expands the scope of participants eligible for relief, describes the process for and taxation of recontributions, provides a safe harbor for reamortizing loans following suspension, and addresses the impact on nonqualified deferred compensation programs, in addition to other clarifications.

Background

A key component of the CARES Act provides increased access to retirement funds and favorable tax treatment for certain distributions made to qualified individuals. The CARES Act also gives plan sponsors the option to relax retirement plan loan rules.

Specifically, the CARES Act provides that qualified individuals can take “coronavirus-related distributions” of up to $100,000 in the aggregate from their retirement accounts between January 1, 2020 and December 30, 2020. Additionally, plans can offer qualified individuals increased loan limits of up to $100,000 (or 100% of their vested account balance, if less) for a six-month period following the effective date of the CARES Act, and the opportunity to suspend loan payments due between March 27, 2020 and December 31, 2020.

Implementing these changes is voluntary, though many plan sponsors have made the relief available to their workforces.

Coronavirus-related distributions

The Notice clarifies and expands several aspects of the rules for coronavirus-related distributions (CRDs).

Expansion of definition of qualified individuals

Under the CARES Act, a “qualified individual” can take a CRD of up to $100,000 without paying a 10% early withdrawal penalty. Additionally, federal income tax on the CRD can be spread over three years. The CARES Act specifically defines a “qualified individual” to include plan participants who:

• Have been diagnosed with COVID-19,
• Have a spouse or dependent who has been diagnosed with COVID-19, or
• Have experienced financial impacts as a result of specified COVID-19 events:
  • Being quarantined, furloughed, or laid off, or having work hours reduced due to COVID-19;
  • Being unable to work due to lack of childcare due to COVID-19; or
  • The closing or reducing of hours of a business owned or operated by the individual, due to COVID-19.

As authorized by the CARES Act, the Notice expands the definition of a “qualified individual” to include plan participants who experience adverse financial consequences due to COVID-19 as a result of:

• Reduction in pay (or self-employment income) or having a job offer rescinded or start date for a job delayed;
• A spouse or a member of the individual’s household being quarantined, being furloughed or laid off, or having work hours reduced, being unable to work due to lack of childcare, having a reduction in pay (or self-employment income), or having a job offer rescinded or start date for a job delayed; or
• Closing or reducing hours of a business owned or operated by the individual’s spouse or a member of the individual’s household.

Eversheds Sutherland Observation: The Notice’s expanded definition responds to calls for the relief to cover situations in which an employee’s or spouse’s pay is reduced, or a spouse or member of the household experiences various triggering events.

Definition of coronavirus-related distribution

The Notice clarifies that a CRD is not limited to amounts required to meet a specific need arising from COVID-19. Instead, qualified individuals (as described above) can receive a CRD regardless of whether they have a financial need for the distribution, and the CRD may be in excess of any COVID-19 related financial need.

The Notice also confirms that qualified individuals who are otherwise eligible to take a retirement plan distribution can treat a qualifying distribution as a CRD when filing their own federal income tax return, regardless of whether the plan formally provided for CRDs.

Administration and certification

The Notice confirms that implementing these provisions is optional. Plan sponsors can decide whether to offer CRDs and the loan relief under their plans – for example, they can choose to only permit CRDs and not the loan relief, or vice versa.

The Notice also confirms that direct rollover, § 402(f) notice, and 20% withholding requirements are not applicable to CRDs.

The CARES Act provides that a plan administrator can rely on a participant’s certification regarding eligibility, unless the plan administrator has “actual knowledge” to the contrary. Plan administrators have questioned whether this standard requires some level of due diligence on their part. The Notice helpfully states that there is no obligation for the plan administrator to investigate whether the participant’s certification is accurate; the “actual knowledge” standard only takes into account information already in the administrator’s possession. The Notice also includes a sample certification.

Recontributions

CRDs can be recontributed to an eligible retirement plan within three years of the initial distribution, and the distribution and recontribution will be treated as a non-taxable plan-to-plan rollover. In response to plan sponsor concerns that accepting recontributions could put the plan at risk, the Notice provides that even an invalid recontribution will not disqualify the plan, provided the plan administrator (1) reasonably concludes that the recontribution is eligible for direct rollover treatment, and (2) distributes any amounts, with earnings, that are later determined to be invalid. Plan administrators may rely on a participant’s certification, as described above, in making the determination regarding recontribution eligibility.

The Notice provides a methodology under which participants who make a recontribution can make an adjustment to their tax returns such that they do not pay tax on the original distribution. This may involve amending prior tax returns if the recontribution occurs in 2021 or 2022. The methodology is essentially the same as that used for Hurricane Katrina distributions in 2005 as described in Notice 2005-92.

The Notice also clarifies that non-spouse beneficiaries who receive a CRD are not allowed to make a recontribution.

Eversheds Sutherland Observation: The Notice indicates that it is expected that retirement plans will generally allow recontributions, which are treated the same as rollovers. The Notice acknowledges that plans are not required to accept rollovers, and it gives an example of a plan that does not accept any type of rollover, including recontributions. However, the Notice does not address whether a plan could refuse to accept only recontributions, or specific categories of recontributions, while allowing all other types of rollovers.

Loans

The Notice clarifies several issues in the administration of the CARES Act plan loan relief.

Suspension of loan payments

The Notice provides a safe harbor for satisfying the loan suspension rules. Under this safe harbor, loan repayments may be suspended through December 31, 2020. Following the suspension period, the remaining loan (plus additional interest that accrues during the suspension period) is reamortized over the original loan period plus one year. This extension will not cause the loan to be treated as a deemed distribution even if an individual’s reamortized loan period extends beyond the five year term. The Notice also states that other reasonable methods of implementing the loan suspension are permissible.

Certifications

Similar to the guidance for CRDs discussed above, plan administrators can rely on a participant’s certification that he or she is a qualified individual and qualifies for the CARES Act plan loan provisions, unless the plan administrator has actual knowledge to the contrary.

Cancellation of nonqualified deferred compensation plan elections

Generally, nonqualified deferred compensation (NQDC) plans can allow employees and other service providers to cancel their deferral election due to an unforeseeable emergency or a hardship distribution under the 401(k) rules. The Notice provides that NQDC plans are permitted, but not required, to treat CRDs as hardship distributions for purposes of determining whether employees or other service providers can cancel their deferral elections. Note that the deferral election has to be cancelled, and not simply postponed or delayed.

_____

If you have any questions about this legal alert, please feel free to contact any of the attorneys listed under Related People/Contributors or the Eversheds Sutherland attorney with whom you regularly work.