IRS guidance for the CARES Act is worth the wait

A plan may permit a qualified individual to elect one or more of the following CARES Act provisions:

• Take a CRD on or after January 1, 2020, through December 30, 2020
• Take a loan with increased dollar limits during the period beginning on March 27, 2020, and ending on September 22, 2020
• Suspend loan repayments due for the period beginning March 27, 2020, through December 31, 2020 

The notice expands relief under the CARES Act and formalizes the previously released “Coronavirus-related relief for retirement plans and IRAs questions and answers.” In addition, it provides useful information that not only assists plan sponsors and service providers with the administration of CRDs and CARES Act loan provisions, but also helps qualified individuals understand the tax benefits of CRDs by providing scenarios for the options available for income inclusion, recontributions, and reporting. 

Specifically, the notice:

1. Expands the definition of “qualified individual” for purposes of CRDs, increased loan limits, and loan suspensions
2. Permits reliance on certifications made by a qualified individual (and provides sample language)
3. Explains the special tax treatment afforded to qualified individuals and repayments of CRDs
4. Addresses the reporting and recontributions of CRDs (for payers and individuals)
5. Provides a safe harbor for loan suspensions and repayments
6. Permits the cancellation of deferral election under nonqualified deferred compensation plans

1 The notice expands the definition of qualified individual

In response to numerous requests, the IRS expanded the conditions to determine if an individual is a qualified individual. The term now includes not only an individual who experiences adverse financial consequences related to the following factors, but also the individual’s spouse or household member (provided they have the same principal residence):

• Being quarantined, being furloughed or laid off, or having work hours reduced due to COVID-19;
• Being unable to work because of a lack of childcare due to COVID-19;
• Closing or reducing hours of a business that they own or operate due to COVID-19;
• Having pay or self-employment income reduced due to COVID-19; or
• Having a job offer rescinded or start date for a job delayed due to COVID-19.

Note that the last two bullets above are new qualifying events.

As a reminder, a qualified individual also includes an individual who is or whose spouse or dependent is diagnosed with COVID-19 by a Centers for Disease Control and Prevention (CDC)-approved test (this condition is unchanged).

While this expansion of the definition of a qualified individual is good news to many individuals, it has caused concern among some plan sponsors. On the one hand, the addition of the new events (i.e., a reduction in pay or self-employment income and a rescinded or delayed job offer) and the inclusion of the employment status of the individual’s spouse for determining adverse financial consequences will be helpful, especially for families that depend on two incomes; however, the expansion to include an individual’s household member who shares the same principal residence appears to go beyond the intent of the CARES Act—and, perhaps, unintentionally opens the floodgates to retirement funds. 

2 Reliance on self-certification

The notice reiterates that, unless a plan administrator has actual knowledge to the contrary, the plan administrator may rely on an individual’s certification that they’re qualified and eligible to receive a CRD. But the notice goes a step further by:

• Explicitly stating that the actual knowledge requirement doesn’t mean that a plan administrator has an obligation to check the validity of the certification, and
• Including an example of an acceptable certification that can be used by plan administrators. 

As anticipated, the notice extends the above self-certification conditions to CARES Act loan provisions, not just CRDs, which appears to have been unintentionally omitted from the CARES Act.

Interestingly, the sample certification provided by the IRS only requires that a qualified individual provide a blanket statement that they meet one of the COVID-19 conditions—it doesn’t require that the qualified individual specify the applicable condition that’s satisfied. Although plan sponsors may rely on the individual’s self-certification, absent actual knowledge to the contrary for plan purposes, individuals should be aware that the notice cautions that only an individual who’s actually qualified is eligible for favorable tax treatment as described below.

3 Favorable tax treatment of CRDs

CRDs are exempt from the 10% penalty tax that generally applies to retirement funds received prior to age 59½. In addition, CRDs provide options for qualified individuals to reduce the tax impact normally associated with such distributions.

• CRDs may be included in income pro rata over a three-year period or alternatively included in the year of receipt.
• Qualified individuals have the option to recontribute all or a portion of the CRD to an IRA or a retirement plan that accepts rollovers within three years following the date the CRD was received (certain exceptions apply).

Even if a plan sponsor chooses not to offer CRDs, a qualified individual may be able to treat most 2020 distributions up to an aggregate amount of $100,000 as CRDs (certain exceptions apply, such as corrective refunds) and obtain the favorable tax benefits. While all recipients of CRDs may take advantage of certain tax benefits, such as the inclusion of the taxable income pro rata over three years, certain distributions not otherwise eligible for direct rollover may not be recontributed. See “Accepting recontributions of CRDs” below for rules and exceptions.

4 Addresses the reporting and recontributions of CRDs

Tax reporting on CRDs

Payors must report a CRD on Form 1099-R. If no other appropriate code applies, a payor may use either distribution code 2 (early distribution, exception applies) or code 1 (early distribution, no known exception) in box 7.

This flexibility is appreciated by payers whose system limitations would otherwise require manual processing or reprogramming. Note that the CRD is required to be reported on an individual’s Form 1099-R, even if the individual recontributes it to the distributing IRA or retirement plan in the same year.

Accepting recontributions of CRDs

Under the CARES Act, qualified individuals are permitted to recontribute all or a portion of a CRD (that’s eligible for tax-free rollover) within a three-year period to an IRA or retirement plan that accepts rollovers. The notice clarifies that a plan administrator should obtain evidence to reasonably conclude that the recontribution is eligible for direct rollover under the CARES Act. For this purpose, the plan administrator may rely on the individual’s certification that they’re qualified—and that the 2020 distribution qualified as a CRD—unless the plan administrator has actual knowledge to the contrary.

Generally, CRDs may be recontributed, but only to the extent the CRD would otherwise have been eligible for a direct rollover. The notice, however, provides for a few notable exceptions. For example, the notice permits a qualified individual to designate a hardship distribution as a CRD, even for recontribution purposes. This is surprising because, generally, a hardship distribution is ineligible for direct or indirect rollover. The notice also reiterates that the recontribution of a CRD to an IRA isn’t subject to the one-rollover-per-year IRA limitation rule. The notice doesn’t, however, permit a nonspousal beneficiary to recontribute any amounts attributable to a CRD.   

Although the notice offers some insight on recontributions of CRDs, it doesn’t provide clarity regarding whether a plan sponsor will be required to accept recontributions of CRDs. It may have, in fact, clouded the issue by stating “it is anticipated that eligible retirement plans will accept recontributions of coronavirus-related distributions, which are to be treated as rollover contributions.” This raises the question of whether a plan that accepts rollover contributions will be required to accept recontributions of CRDs and, if so, whether a plan can impose restrictions—such as only accepting CRD recontributions that were originally distributed from the receiving plan. In any event, considering the amount of retirement funds withdrawn for CRDs, plan sponsors should be encouraged to accept recontributions of CRDs, with possible reasonable restrictions.

Guidance for individuals receiving and reporting CRDs

The notice provides great depth on reporting CRDs. Generally, qualified individuals report CRDs on their 2020 federal income-tax return and on Form 8915-E, Qualified 2020 Disaster Retirement Plan Distributions and Repayments (the IRS anticipates that Form 8915-E will be available before the end of 2020).

As mentioned, a qualified individual has a choice to either include the taxable portion of the CRD in income pro rata over a three-year period that begins in the year of distribution or include the entire amount in the year of distribution; however, once the individual’s federal income-tax return (including extensions) has been filed, the decision can’t be changed. Also, qualified individuals must treat all CRDs consistently—a qualified individual who receives multiple CRDs must recognize the taxable portion as income for all CRDs over a three-year period or in the year of receipt. 

The notice provides many examples that show the flexibility a qualified individual has when using the three-year method for purposes of recontributions. But it also demonstrates where the one-year method may be appropriate—for example, when qualified individuals intend to recontribute the entire CRD before filing their 2020 tax return.  

5 CARES Act safe harbor for 401(k) loan suspensions and repayments

Prior to the issuance of the notice, there were differing opinions among retirement plan practitioners on acceptable procedures for handling suspended loans under the CARES Act (ranging from loan repayment restarts and/or reamortization dates, to the effect of varying loan suspension periods). While most CARES Act provisions parallel KETRA relief, there’s one key difference relating to the loan suspension provision—the length of the suspension period. 

Thankfully, we now have our answer, as the notice provides a practical safe harbor method for plan sponsors who adopted the loan suspension provision. Under the safe harbor: 

• Loan repayments resume at the end of the suspension period (no later than January 1, 2021).
• Loan due dates may be extended for a period of up to one year.
• Interest accrues on the outstanding loan during the suspension period.
• The loan (including accrued interest) is reamortized over the extended loan period (i.e., the original period of the loan, plus one year) on January 1, 2021, and adjusted loan repayments begin in accordance with the new schedule. 

Although the notice provides a practical safe harbor to treat loan suspensions and repayments, it also acknowledges that there may be “additional reasonable, if more complex, ways” to administer loan suspensions. It appears that the more complex methods will involve different loan restart dates and/or varying extension periods that needlessly create more work, room for error, and confusion for plan participants. For these reasons, it’s anticipated that most plan sponsors will opt to use the safe harbor method.

6 Cancellation of deferral election permitted in nonqualified deferred compensation plan

Lastly, the notice provides a surprise bonus with respect to CRDs and nonqualified deferred compensation plans. As background, a nonqualified plan (NQ plan) subject to Internal Revenue Code Section 409A may permit the cancellation of an individual’s deferral election in the event of an unforeseeable emergency or a hardship distribution from an eligible retirement plan. Under the notice, a CRD received from an eligible retirement plan will be considered a hardship distribution for this purpose, thus permitting the cancellation of the deferral elections in some NQ plans. 

Employers should check their NQ plan document to determine if it contains this provision; if it doesn’t, they should consider adding it.

The 19-page notice provides valuable, detailed guidance, supported by examples that can help plan sponsors, service providers, and participants understand the rules and options relating to CRDs and loan provisions under the CARES Act; however, the notice also reiterates that these CARES Act provisions are optional.

Plans that implement CARES Act provisions should maintain an operational checklist. This will be helpful when preparing the CARES Act amendment, which must, generally, be adopted no later than the last day of the 2022 plan year—or 2024 for governmental plans. The CARES Act, however, gives the IRS the authority to extend these deadlines in future guidance.