Coronavirus Aid, Relief, And Economic Security Act - Coronavirus Related Distributions
Coronavirus Aid, Relief, And Economic Security Act
Coronavirus Related Distributions
The coronavirus pandemic has triggered profound public health and financial crises in the U.S. and around the globe. Some taxpayers may be in temporary need of dipping into their qualified [e.g., 401(k)] or non-qualified [e.g., Traditional IRA] retirement account in order to meet current expenses. In normal circumstances, penalties deter taxpayers from dipping into retirement accounts. Under the Corona Virus Aid, Relief, and Economic Security Act (CARES Act, Pub. L. 116-136, 134 Stat. 281 (2020)), some of those penalties have been suspended.
Summary
? The CARES Act provides “qualified individuals” with favorable tax treatment with respect to distributions from eligible retirement plans that are coronavirus-related distributions (CRDs).
? CRDs will not be subject to the 10% penalty imposed by IRC §72(t).
? Ordinary income taxes payable related to a CRD may be spread over a three-year period of time.
? If a CRD is eligible for tax-free rollover treatment and is contributed to an eligible retirement plan within a 3-year period, a CRD will not be includible in taxable income.
? The CARES Act increases allowable qualified retirement plan loan amounts and permits a suspension of loan payments related to qualified individuals accruing on or after March 27, 2020 through Dec. 31, 2020.
Any taxpayer who needs or has taken money from their retirement plan this year should consult with their tax advisor immediately in order to plan for the tax treatment of that withdrawal for the next tax year.
The following is intended to highlight the key components of the CARES Act in relation to retirement plan Covid-related distributions. For a detailed understanding of how the CARES Act affects you or your employees, please consult with your tax advisor or attorney.
Normal Qualified and Non-Qualified Retirement Plan Rules
Retirees over age 65 or age 67 (depending on the retiree’s year of birth) must take minimum required distributions annually. These distributions are generally subject to ordinary income taxation in the year received.
Distributions from certain retirement plans (IRAs, §401(a) qualified plans, §403(a) annuity plans, §403(b) public school and tax-exempt organization plans, and §457 government employee deferred compensation plans) to taxpayers under age 59? are generally includible in the taxpayer’s ordinary income and are generally subject to an additional 10% early withdrawal penalty under IRC §72(t)(1).
Numerous exceptions exist to tax inclusion, such as distributions made on or after age 59?, distributions to a beneficiary due to the employee’s death, disability distributions, distributions that are part of substantially equal periodic payments made over the employee’s life or life expectancy, rollovers to another retirement plan within 60-days, plan loans, and IRC §72(p) plan loan distributions.
Example: A healthy traditional IRA holder age 50 receives a one-time distribution of $50,000 from her plan. That withdrawal would subject the taxpayer to ordinary income tax on the distribution in the year the distribution was made and she would also have to pay an additional 10% early withdrawal penalty. However, two weeks after the distribution, the taxpayer transfers the funds to her IRC §401(k) plan at work. In this scenario, the taxpayer does not pay ordinary income tax on the distribution or the 10% early withdrawal penalty.
Covid-Related Distributions
Under the CARES Act, there are numerous rules pertaining to individuals, employees, and employers when managing retirement plans. For example, how an individual is permitted to treat a Covid-Related Distribution (CRD) can be different than how an employer (e.g., an IRC §401(k) plan) treats a CRD. However, in general, where an early distribution from certain retirement plans is considered a CRD, the CARES Act provides exceptions (see CARES Act §2202(a)) to the normal early withdrawal rules:
? The 10% penalty is waived;
? The taxpayer is permitted to spread the ordinary income tax payment over three-years; and
? Extends the rollover period from sixty-days to three years; and
? Minimum Required Distributions (MRDs) may also be treated by a qualified individual as a CRD
Qualified Covid-Related Individuals
A qualified CRD (see CARES Act §2202(a)(4)(A)(ii)) is one where the individual, the individual’s spouse, the individual’s dependent (see IRC §152), or a member of the individual’s household (i.e., someone who shares the individual’s principal residence).
? Was diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention (CDC) or a test authorized under the Federal Food, Drug, and Cosmetic Act);
? Experienced adverse financial consequences as a result of being quarantined, being furloughed or laid-off, or having work hours reduced due to COVID-19;
? Was unable to work due to lack of childcare due to COVID-19;
? Had to close or reduce hours of a business owned or operated by the individual due to COVID; or
? Had a reduction in pay (or self-employment income) due to COVID-19.
CRDs are permitted without regard to the qualified individual’s need for funds. Also, the amount of the distribution is not required to correspond to the extent of the adverse financial consequences experienced by the qualified individual.
Qualified Covid-Related Distributions
A CRD is any distribution from an eligible retirement plan made on or after January 1, 2020 and before December 31, 2020 to a qualified individual. The CARES Act limits the amount of aggregate CRD distributions to no more than $100,000.
Example 1: A qualified individual receives a distribution of $50,000 in August of 2020 and a distribution of $75,000 in September of 2020 and both distributions satisfy the definition of a CRD. The individual can only treat $100,000 of the August and September distributions as CRDs on the individual’s 2020 federal income tax return. Assuming no §72(t)(2) exception applies, the remaining $25,000 of the distribution is an early distribution that is subject to the 10% additional tax. This amount must be included on the individual’s 2020 federal income tax return and will not be eligible for 3-year recontribution to an eligible retirement plan.
Example 2: An IRC §401(k) plan distributes $35,000 to a qualified individual on December 1, 2020. The qualified individual also receives a distribution from her IRA on December 1, 2020 of $15,000. The individual is permitted to treat both the $35,000 from the plan and the $15,000 from the IRA as CRDs on her 2020 federal income tax return.
There are many rules pertaining to rolling over a CRD back into an eligible retirement plan within 3-years. Many of those rules and forms are put in place by the IRS.
Whether a distribution is a qualified CRD is generally up to the self-certification of the individual. For example, when taking an early CRD from a qualified retirement plan such as an IRC §401(k) plan, the individual could self-certify to her or his employer similar to the following:
Employee Name _______________________
I certify that I meet at least one of the following conditions: (1) I was diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (referred to collectively as COVID-19) by a test approved by the Centers for Disease Control and Prevention (including a test authorized under the Federal Food, Drug, and Cosmetic Act); (2) my spouse or my dependent was diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention (including a test authorized under the Federal Food, Drug, and Cosmetic Act); or (3) I have experienced adverse financial consequences because: (i) I, my spouse, or a member of my household was quarantined, furloughed or laid off, or had work hours reduced due to COVID-19; (ii) I, my spouse, or a member of my household was unable to work due to lack of childcare due to COVID-19; (iii) a business owned or operated by me, my spouse, or a member of my household closed or reduced hours due to COVID-19; or (iv) I, my spouse, or a member of my household had a reduction in pay (or self-employment income) due to COVID-19 or had a job offer rescinded or start date for a job delayed due to COVID-19.
Signature: ______________________
Minimum Required Distributions
An offshoot effect of the CARES Act is that Minimum Required Distributions (MRDs) are eligible to be treated as CRDs. Meaning, a taxpayer could treat his or her MRD (if received in calendar year 2020) as a CRD and spread the ordinary income tax payment over three years.
Distributions that are Not CRDs
The following amounts are not permitted to be treated as CRDs:
? Corrective distributions of elective deferrals and employee contributions that are returned to the employee in order to comply with the IRC §415 limitations;
? Excess elective deferrals under IRC §402(g);
? Excess contributions under IRC §401(k);
? Excess aggregate contributions under § 401(m);
? Loans that are treated as deemed distributions under IRC §72(p);
? Dividends paid on applicable employer securities under IRC §404(k);
? The costs of current life insurance protection;
? Prohibited allocations that are treated as deemed distributions under IRC §409(p);
? Distributions that are permissible withdrawals from an eligible automatic contribution arrangement under IRC §414(w); and
? Distributions of premiums for accident or health insurance under Treas. Reg. §1.402(a)-1(e)(1)(i).
CRDs Pertaining to Qualified Retirement Plan Loans
Special rules apply to a loan made from a qualified employer plan to a qualified individual on or after March 27, 2020 and before September 23, 2020. For these loans, the CARES Act (see §2202(b)(1)) changes the limits under IRC §72(p)(2)(A).
Normally, a qualified plan may not loan to a plan participant an aggregate amount more than $50,000 or 50% of the employee’s vested accrued plan benefit (see IRC §72(p)(2)(A)(i)). Under the CARES Act, those limits have been increased to $100,000 and 100% of the employee’s vested accrued plan benefit.
In addition, the CARES Act modifies the normal loan repayment rules (see IRC §72(p)(2)(B)) and permits an employer to provide a one-year delay on loan payments falling between March 27, 2020 and December 31, 2020. If an employer permits these loan payment delays, those delayed loan payments will not be a deemed (taxable) distribution to the employee.
Each repayment that becomes due during the period March 27, 2020 through December 31, 2020 may be delayed for up to one year and then be re-amortized over a period that is up to one year longer than the original term of the loan.
Example: On April 1, 2020, a participant with a non-forfeitable account balance of $40,000 borrowed $20,000 to be repaid in level monthly installments of $368.33 over 5 years (via payroll withholding). The participant makes payments for three months through June 30, 2020. The participant is a qualified (CRD) individual. The participant’s employer takes action to suspend payroll withholding repayments from July 1, 2020, through December 31, 2020 for loans to qualified (CRD) individuals that are outstanding on or after March 27, 2020. Because the participant is a qualified individual, no further repayments are made on the participant’s loan until January 1, 2021 (when the balance is $19,477). At that time, repayments on the loan resume, with the amount of each monthly installment re-amortized to be $343.27 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).
Conclusion
While the tax effects of the CARES Act are still being analyzed, implemented, and understood, some are coming into focus, such as those relating to distributions, loans, ordinary income taxation, and penalties. If you are an employer who has a qualified plan, it is critical to meet with your plan manager, tax advisor, or legal counsel to determine what effect these new rules will have on you and your employees. If you are an individual who is receiving Minimum Required Distributions from your plan, you need to meet with your tax advisor to determine how you should treat those distributions occurring in tax year 2020.
Lastly, if you have taken a distribution from your IRA or retirement plan at work due to Covid, it is critical you meet with your tax advisor to determine how to treat those distributions on your 2020 federal income tax return.