The IRS addressed Frequently Asked Questions (“FAQs”) this week on the new coronavirus-related distribution (“CRD”) available from eligible retirement plans added by the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”).
As background, the CARES Act allows certain retirement plans to provide a special in-service distribution option in 2020 to participants affected by COVID-19 (“Qualified Individuals”). These distributions, which can be up to $100,000 in the aggregate, will not be subject to the 10% additional income tax for early withdrawal or the mandatory 20% federal income tax withholding. Additionally, a CRD is generally included in the participant’s taxable income over a three-year period, but the participant may choose to repay the distribution to the plan or have the entire distribution included in his or her taxable income in the year in which it is received.
A participant is a Qualified Individual if: (i) the participant, the participant’s spouse or the participant’s dependent (as defined in Code Section 152) is diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (COVID-19) or (ii) the participant experiences adverse financial consequences as a result of:
- a furlough, lay-off, or reduction of work hours due to SARS-CoV-2 or COVID-19;
- inability to work due to lack of child care due to SARS-CoV-2 or COVID-19;
- the closing or reducing of hours of a business owned or operated by the individual due to SARS-CoV-2 or COVID-19; or
- other factors as determined by the Secretary of the Treasury.
The IRS plans to issue additional guidance in the form of an IRS Notice, following many of the same principles that applied to qualifying distributions that were permitted after Hurricane Katrina.
The FAQs provide the following clarifications:
Plan Responsibilities with Respect to CRDs
- Plan Changes are Optional. Employers are not required to adopt the distribution rules under the CARES Act. An employer may choose whether, and to what extent, to amend its plan to provide for CRDs. Since the CARES Act affects the tax treatment of CRDs, even if an employer does not treat a distribution as coronavirus-related, a Qualified Individual may still treat a distribution that otherwise meets the requirements to be a CRD as coronavirus-related on his or her federal income tax return. It is also important to remember that plan amendments relating to CRDs are generally not required until the end of the 2022 plan year, provided the plan is operated in accordance with the terms of the CARES Act.
- In-Service Withdrawals. A CRD is treated as meeting the distribution restrictions for a 401(k) plan, 403(b) plan, or governmental 457(b) plan even if the distribution would occur before an otherwise permissible distribution event (e.g., severance from employment, disability, or attainment of age 59½). The CARES Act specifically permits these eligible retirement plans to offer in-service CRDs; it does not otherwise change the limits on when plan distributions are permitted to be made from other employer-sponsored retirement plans. For example, the CARES Act does not create a right for a defined benefit plan or money purchase pension plan to permit an in-service withdrawal.
- Distributions Post Severance from Employment. While much of the focus of discussions on CRDs has been on the new in-service withdrawal opportunity, the CARES Act provides that the 10% additional tax under Section 72(t) does not apply to any distribution that qualifies as a CRD, even if not received under the new withdrawal feature. In addition to the 10% additional tax that may apply to in-service withdrawals before a participant attains age 59½, the 10% additional tax may also apply when a participant takes a distribution following separation from service before age 55. Employers and participants should consider whether other distributions, including those from defined benefit plans and money purchase pension plans following separation from service, may be treated as CRDs.
- Communicating to Participants. Distributions made from January 1, 2020 to December 30, 2020 may be treated as a CRD. This means that a distribution made on the last day of the year will not qualify, but a distribution may retroactively qualify as a CRD even if made before the declaration of the COVID-19 national emergency or the date on which the CARES Act became law. Therefore, caution should be taken in communicating to plan participants the available timeframe for taking CRDs.
- Self-Certification. A plan administrator may rely on a participant’s certification that he or she satisfies the conditions to be a Qualified Individual, unless the administrator has actual knowledge to the contrary.
- Repayments. While the CARES Act permits participants to repay a CRD within three years from the date of distribution and therefore, treat the distribution and subsequent repayment as a tax-free rollover, a plan that does not accept rollover contributions is not required to be amended to accept repayments of CRDs.
- Reporting. The payment of a CRD must be reported by the eligible retirement plan on Form 1099-R even if the Qualified Individual repays the CRD in the same year. Remember, distributions made during 2020 prior to the passage of the CARES Act may qualify for CRDs. Plan administrators should track distributions taken during 2020 to identify which ones are CRDs. More guidance is expected from the IRS later this year.
Income Tax Treatment
- Treatment as a CRD. A participant may treat a distribution as a CRD on his or her federal income tax return even if the participant’s employer plan does not treat the distribution that way. However, the participant must meets the eligibility requirements to be a Qualified Individual. Although, as stated above, a plan administrator may rely on an individual’s eligibility certification when making and reporting a distribution as a CRD, the individual is only entitled to treat the distribution as a CRD for purposes of the individual’s federal income tax return if the individual actually meets the eligibility requirements under the CARES Act. A participant should carefully assess whether he or she meets the definition of Qualified Individual. For example, a participant who experiences a reduction in wages that is not in connection with a furlough, lay-off, or reduction of work hours or one of the other qualifying reasons would not be a Qualified Individual.
- Income Inclusion. The default income inclusion-timing rule is that CRDs are included in income ratably over three years, beginning with the year in which the distribution is made. Alternatively, the participant may choose to include the entire amount of the distribution in taxable income for the year of the distribution.
- Reporting Repayments. A participant must file IRS Form 8915-E (which is expected to be available before the end of 2020) to report any repayment of a CRD and to determine the amount of any CRD that is includible in income for a year.
- Claiming a Refund. Let’s assume a participant takes a CRD in 2020 and chooses to include the distribution amount in income over three years (2020, 2021, and 2022). Then, in 2022, the participant repays the full amount of the distribution to an eligible retirement plan. The participant may file amended federal income tax returns for 2020 and 2021 to claim a refund of the tax attributable to the amount of the distribution that was included in income for those years, and the participant will not be required to include any amount in income in 2022.
- Repayments Made Prior to Filing Tax Return. Using the prior example, assume the participant repays the full amount of the CRD on March 1, 2021. Because the repayment is made before the participant files his or her federal income tax return for 2020, no amount needs to be included in income with respect to the distribution on the participant’s 2020 federal income tax return. It is important to recall, however, that the CRD must still be reported by the plan on Form 1099-R even if the CRD is repaid.
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