The CARES Act, signed into law on March 27, 2020, allows employees affected by COVID-19 greater access to money set aside for them in employer retirement plans.  As often happens, many details of this new law were not immediately clear.  We found ourselves saying to clients on a number of occasions, “We think this is how the law is going to work, but we’ll need to wait for guidance.”

That guidance arrived last month in the form of IRS Notice 2020-50, entitled “Guidance for Coronavirus-Related Distributions and Loans from Retirement Plans Under the Cares Act,” and Notice 2020-51, “Guidance on Waiver of 2020 Required Minimum Distributions.”  This article summarizes the new information set forth in Notice 2020-50.  Notice 2020-51 will be addressed in a future article.  Basic information about the CARES Act and retirement plans can be found at the end of this article.

Coronavirus-Related Distributions

Under the CARES Act, you qualify for a coronavirus-related distribution (CRD) if you or your spouse has COVID-19 or if you experience financial consequences as a result of quarantine, furlough, layoff, reduced work hours, inability to work because of lack of childcare, or closing or reduction of hours of a business you own or operate.  Notice 2020-50 adds three more criteria for being a “qualified individual”:

• Reduction in pay, rescission of job offer, or delayed start date.
• Spouse or member of household suffers the financial consequences referenced above.
• Closing or reduction of hours of business owned or operated by spouse or member of household.

The Notice clarifies that certain distributions can qualify as CRDs:  (i) distributions that would have been required minimum distributions (RMDs) if not for the CARES Act, (ii) distributions a qualified individual receives as a beneficiary (rather than as the employee), (iii) reduction or offset of account balance in order to repay a loan, including qualified plan loan offsets.  On the other hand, a number of amounts cannot be CRDs, including corrective distributions of 401(k) deferrals and deemed distributions of loans.

If you’re a qualified individual, your CRD does not have to be limited to the amount of financial loss you’ve suffered as a result of COVID-19; your distribution can be more than that if you want.  It is possible that an employer may not designate a distribution as a CRD, but the employee may designate that same distribution as a CRD for tax purposes.  On the flip side, there are instances where an employee might not designate a distribution as a CRD that the employer did so designate.

When it comes to recontributing a CRD to an eligible retirement plan, the CRD must have been eligible for tax-free rollover treatment when originally made.  A beneficiary may not recontribute a CRD.  Whereas hardship distributions are not normally eligible rollover distributions, such a distribution that qualifies as a CRD may be recontributed.

Guidance for Plans Making CRDs

In normal times, certain monies may not be paid from a plan until there has been a distributable event such as severance from employment, disability, or attainment of age 59½.  The CARES Act allows distributions of deferrals, QNEC, QMAC, or safe harbor contributions even when there has not otherwise been a distributable event.  Pension plans (money purchase and defined benefit plans) are not allowed to make distributions before a distributable event even if the distribution is a CRD.  In addition, if the qualified joint and survivor annuity rules apply, spousal consent still must be obtained even if the distribution is a CRD.

A plan does not have to offer the rollover option for a distribution that is a CRD, nor provide a rollover notice, nor withhold 20% federal taxes as is normally required.  However, voluntary withholding requirements apply.

An employer can choose the extent to which it adopts the CARES Act rules.  A plan could have CRDs but not expand the loan provisions for qualified individuals, or vice versa.  An employer can develop reasonable procedures for deciding which distributions are treated as CRDs under its plans, if all such distributions aren’t.  However, if any distributions of salary deferrals are treated as CRDs, the plan must be consistent in how it treats similar distributions. 

An employer may treat up to $100,000 of distributions to an employee as CRDs.  “Employer” means all the companies within the controlled group.  If distributions from IRAs or plans of other employers cause an employee to exceed $100,000 of would-be CRDs, an employer will not be in trouble as long as that employer limits the amounts it is treating as CRDs to $100,000 per employee.

One of the hallmarks of the CARES Act is that an employee may self-certify his eligibility for CRDs.  An employer may refuse to make a CRD if it has “actual knowledge” that the employee doesn’t qualify.  This doesn’t mean the employer needs to poke around and verify that the employee is telling the truth, just that it can refuse the CRD if it already knows the employee doesn’t qualify.  (Given issues with medical privacy, I wonder how often an employer will actually know an employee doesn’t qualify.)  While an employer may rely on the employee’s word for purposes of paying the distribution, the employee must truly qualify for a CRD to be eligible for the favorable tax treatment.  Presumably, the employee would need to produce evidence for the Tax Person should he ever be audited.

Plans are allowed to pay CRDs not currently permitted under the plan’s terms and then amend the plan later to conform with how the plan was operated.  For non-government plans, the deadline to do these amendments is the last day of the plan year that begins in 2022, so not for a while.

Tax Reporting and Recontributions

A plan must report a CRD on Form 1099-R in the year made, even if the employee recontributes the CRD to the same eligible retirement plan in the same year.  (Eligible retirement plans are employer plans and IRAs.)  Distribution Code 2 (early distribution, exception applies) may be used in Box 7 of the 1099.  Code 1 (early distribution, no known exception) may also be used.

If an employee receives a CRD that was eligible for tax-free rollover, then any part or all of it may be recontributed to any eligible retirement plan that wants to accept CRD recontributions, whether that be the plan the money originally came out of or another plan.  A plan administrator must reasonably conclude that the recontribution is eligible for direct rollover treatment; again, the plan may rely on the employee’s word unless it has actual knowledge to the contrary.

The favorable tax treatment for CRDs consists of (i) no 10% early withdrawal penalty, (ii) qualified individuals may recontribute the CRD to an eligible plan within the three-year period starting the day after the distribution was received, and (iii) income may be spread ratably over three years.  The decision to spread out the income must be made by the time the tax return for the year of distribution is filed and cannot be changed after that date.  There will be a new Form 8915-E on which an employee will report CRDs and recontributions.  This may either be filed as part of the federal tax return or filed separately.

An employee may designate up to $100,000 in distributions as CRDs.  This can come from any combination of employer plans and IRAs.  Any amount exceeding $100,000 will not be eligible for the favorable tax treatment.

When recontributing a CRD that was wholly or partially taxed in a prior year, an employee may have to file an amended tax return for one or more of those prior years.  If the employee receives a CRD in 2020 but recontributes the whole CRD either in 2020 or in 2021 before the 2020 tax return is filed, then the CRD is not taxable in 2020 (or ever).  If the CRD is recontributed after the 2020 tax return is filed, then the employee will need to file an amended 2020 tax return to reflect the recontribution and get a refund on the tax paid.

If an employee has elected to spread the tax ratably over three years, then any recontributions will serve to offset the tax owed on the tax return to be next filed (that is, the prior year tax return if it hasn’t been filed yet; otherwise, the current year tax return to be filed in the following year).  If a recontribution is greater than the ratable portion of taxable income from the CRD that will be reflected on the return to be next filed, the employee has two choices:  (i) carry forward the remainder and use it to offset next year’s ratable portion of taxable income, or (ii) carry back the remainder to a prior year and file an amended tax return.

Participant Loans

Between March 27, 2020 and September 22, 2020, a plan participant affected by COVID-19 may borrow up to $100,000, up from the usual $50,000 limit.  Such participants may borrow 100% of their vested accrued benefit rather than the usual 50%.  This is if the employer chooses to allow these increased limits, of course.  It doesn’t have to.

The CARES Act said that any loan repayments due between March 27, 2020 and December 31, 2020 for qualified individuals could be delayed by a year.  Subsequent repayments were to be adjusted to reflect the delay in due date for these 2020 payments and the interest accruing thereon.  If the extension on repayments caused the term of the loan to exceed the usual five-year limit, that was okay.

There were questions about how to put this rule into practice.  Would the repayments that were extended by a year be due at the same time as and on top of the payments that were already due a year later?  Was there any extension on payments due in 2021?  Would the January 2021 payment be due sooner than the July 2020 payment which had been extended by a year?  How would the interest accrual be calculated?

Notice 2020-50 gave an example of how to apply the rule on extending loan payments.  It’s a safe harbor, meaning you’re allowed to do it that way but don’t have to.  Here’s how it says you can handle it under Notice 2020-50:

• Determine the outstanding balance as of the date repayments will first be suspended in 2020.
• Accumulate this balance with interest to the date of the first payment due in 2021.
• Reamortize the loan through the original loan payoff date plus one year.

The example in the Notice was a five-year loan of $20,000 made on April 1, 2020 with 4.00% interest and monthly repayments of $368.33.  Payments were made at the close of each of the next three months.  Payments due at the end of July 2020 through December 2020 were suspended.  Payments resumed January 31, 2021.  Interest was accumulated from June 30, 2020 through January 31, 2021.  The loan was reamortized to have payments of $343.27 per month ending on March 31, 2026 – one year later than the loan was originally scheduled to end.  The monthly payment went down because, even though only six payments were skipped, the Notice allows the loan to be extended by a full year anyway.  Sixty-six payments will ultimately be made instead of the usual 60 monthly payments made on a five-year loan, so each payment is smaller.

In another example, the IRS says you can suspend the 2020 payments, make the payments due in the first three months of 2021 as regularly scheduled, then reamortize the outstanding balance as of April 1, 2021 so that the loan ends a year after it was originally due.  The IRS didn’t put any numbers behind this example and basically suggests you’re on your own if you try to do something more complex than the safe harbor they gave.

Anyone looking for details on COVID-19 distributions or loan relief may wish to read Notice 2020-50 or talk to someone who spends a lot of time working on this sort of thing.