Reprinted with permission from Leimberg Information Services, Inc. (LISI).
By Christopher Denicolo, Alan Gassman and Brandon Ketron
The Coronavirus Aid, Relief, and Economic Security Act, better known as the “CARES Act,” has been law since its enactment on Friday, March 27, 2020. In addition to introducing the wonderfully complicated (and often confounding) Paycheck Protection Program, the CARES Act sets forth a number of taxpayer-friendly provisions with respect to IRAs and Retirement Plans, for the purpose of providing much needed tax-advantaged opportunities to taxpayers who might need to tap into their IRAs and Retirement Plans to access assets during the recent unprecedented economic situation as a result of the COVID-19 pandemic.
The changes include the elimination of required minimum distributions for 2020, the ability for certain taxpayers to borrow from a retirement plan on more favorable terms, and the opportunity for certain taxpayers to receive a “coronavirus-related distribution” from his or her IRA or retirement plan, with the flexibility to decide how such distribution will be taxed (or if it will be treated like a loan), and without having to worry about the 10% early distribution tax.
On June 19, the IRS released Notice 2020-50 to provide guidance with respect to these provisions, primarily aimed at expanding the number of Americans who qualify for the coronavirus-related distribution and increased borrowing opportunity benefits, and addressing the technical reporting requirements associated therewith.
The CARES Act enables certain “qualified individuals” who are harmed by the SARS-CoV-2 coronavirus to have until September 22, 2020 to borrow from retirement plans that enable borrowing up to the lesser of (a) $100,000 (up from the former $50,000 limit on borrowing); or (b) “The present value of the non-forfeitable accrued benefit of the employee under the plan.”
Previous law limited this to being the lesser of $50,000 or one-half of the present value of the non-forfeitable accrued benefit.
In addition, the CARES Act provides relief to taxpayers who have borrowed from their retirement plans by suspending payments that would otherwise by owed between March 27, 2020 and December 31, 2020. Any such suspended payments will cause adjustments of the amounts owed as a result of interest accrued in the interim.
Loans from IRAs are not permitted, so IRAs are not impacted by this change.
Additionally, qualified individuals may also take a “coronavirus-related distribution” of up to $100,000 in withdrawals from an IRA or retirement plan between January 1, 2020 and December 30, 2020. Coronavirus-related distributions are not subject to the 10% excise tax that normally applies to distributions taken by an IRA owner/plan participant under age 59½. Further, the qualified individual has the choice of paying the distribution back within (a) three years of the date of the distribution, so that it will be treated as if it essentially were a tax-free loan, or (b) having the distribution be considered to be taxable income either (I) all in 2020, or (II) as taxable income one-third in 2020, one-third in 2021, and one-third in 2022. The distribution will be subject to income tax unless the Taxpayer elects to have it treated as a loan.
The CARES Act provisions for pension and IRA liberalization were very well written, and balanced, but many questions and much detail had to be added to make the provisions whole and workable. The IRS did an excellent job with this by issuing Notice 2020-15, especially when compared to the mass confusion and lack of clarity that has plagued the PPP loan program rules that have been promulgated by the Small Business Administration and will lead to many years of litigation and harm from uncertainty to the business community.
Expanding the definition of “qualified individual”
The increased borrowing and coronavirus-related distribution opportunities are available only if the taxpayer is a “qualified individual.” Under the CARES Act, a qualified individual is a person who meets one or more of the following circumstances, which are expanded upon under the Notice (see See Sec. 2202(a)(4)(A)(i), H.R. 748, CARES Act, 116th Congress (2020):
1-He or she experiences adverse financial consequences in 2020 as the result of any of the following five coronavirus-related circumstances due to COVID-19:
A. Being quarantined;
B. Being furloughed, laid off, or having work hours reduced by an employer;
C. Being unable to work due to lack of childcare;
D. Closing or reduced hours of a business owned or operated by the Qualified Individual; or
E. Other factors as determined by the Secretary of the Treasury (or the Secretary’s delegate).
2-The individual, or his or her spouse or dependent, has been diagnosed with SARS-CoV-2 or COVID-19 by a test approved by the Centers for Disease Control and Prevention (“CDC”).
It appears that an individual may marry someone with the diagnosis by December 31, 2020 in order to qualify, assuming that the individual does not otherwise qualify under any of the five circumstances mentioned above. Dating services with “I have had the virus” banners and doctor certifications have proliferated as a result of this.
Notice 2020-50 expanded the definition of a “qualified individual” to include an individual who experiences adverse financial conditions as a result of any one or more of the following:
1. the individual having a reduction in pay (or self-employment income) due to COVID-19 or having a job offer rescinded or start date for a job delayed due to COVID-19;
2. the individual’s spouse or a member of the individual’s household (as defined below) being quarantined, being 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, having a reduction in pay (or self-employment income) due to COVID-19, or having a job offer rescinded or start date for a job delayed due to COVID-19; or
3. closing or reducing hours of a business owned or operated by the individual’s spouse or a member of the individual’s household due to COVID-19.
The Notice states that, for purposes of applying these additional factors, a member of the individual’s household is someone who shares the individual’s principal residence, but does not provide further guidance with respect to this. Apartment and house sharing advertisements may make mention of the advantages of sharing a residence with a person having one or more of these circumstances, which must be occurring while the circumstances are applicable, or thereafter if the roommates marry. Worse reasons to marry have been known to apply, including the need to share Leimberg Information Services accounts.
Additional Guidance on Coronavirus-Related Distributions
The Notice confirms an important point: a qualified individual is entitled to designate that a distribution from an IRA or retirement plan is a coronavirus-related distribution (assuming he or she otherwise qualifies), regardless of whether the plan treats the distribution as so qualifying.
Therefore, a distribution that would have been a required minimum distribution, but for the fact that the CARES Act eliminated required minimum distributions for 2020, or that where such distribution has been made from a Plan that does not treat the distribution as a coronavirus-related distribution, nevertheless can qualify as a coronavirus-related distribution.
Note, however, the following distributions do not qualify as coronavirus-related distributions per the Notice: corrective distributions of elective deferrals and employee contributions that are returned to the employee (together with the income allocable thereto) in order to comply with the IRC § 415 limitations, excess elective deferrals under IRC § 402(g), excess contributions under IRC § 401(k), and excess aggregate contributions under IRC § 401(m); loans that are treated as deemed distributions pursuant to 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 pursuant to IRC § 409(p); distributions that are permissible withdrawals from an eligible automatic contribution arrangement within the meaning of IRC § 414(w); and distributions of premiums for accident or health insurance under IRC § 1.402(a)-1(e)(1)(i).
Moreover, the Notice indicates that a qualified individual need not use coronavirus-related distributions for a need arising from COVID-19. Accordingly, so long as he or she is a qualified individual as a result of experiencing adverse financial consequences as described above, coronavirus-related distributions are permitted without regard to the qualified individual’s need for funds, and the amount of the distribution may greatly exceed the amount or value of the adverse financial consequences that have been experienced by the qualified individual.
The Notice also indicates that the administrator of an eligible retirement plan may rely upon the plan participant’s certification that her or she is a qualified individual in determining whether a distribution is a coronavirus-related distribution, unless the administrator has “actual knowledge” to the contrary. The administrator has no duty to inquire as to whether the individual qualifies, unless the administrator possesses sufficiently accurate information to determine the lack of veracity of a certification. A sample certification is provided in the Notice.
Nevertheless, the individual is only entitled to treat the distribution as a coronavirus-related distribution on his or her federal income tax return if the individual actually meets the eligibility requirements to be considered as a qualified individual, regardless of whether the individual provides a duly signed certification to the administration.
As stated above, the qualified individual has three options as to the tax treatment of a coronavirus-related distribution:
1. Recognize all income from the distribution in 2020 (without being subject to the 10% excise tax under IRC § 72(t));
2. Elect to recognize one-third of the tax associated with the distribution in each of 2020, 2021, and 2022 (again, without being subject to the 10% excise tax under IRC § 72(t)); or
3. If eligible, treat the distribution in whole or in part as an interest-free loan from the IRA or retirement plan that is considered to be a “trustee to trustee” rollover to the IRA or Plan, so long as it is recontributed by the third anniversary of the distribution. If the election is in part, then the unrepaid amount will be subject to the election as between 1 and 2 above, with allocation as further described below.
The Notice states that a qualified individual is permitted to designate any qualifying distributions as a coronavirus-related distribution on the qualified individual’s timely filed 2020 Form 1040 federal income tax return (including extensions).
The Notice also provides that the election of whether: (a) to recognize all income associated with the coronavirus-related distribution in 2020; or (b) to recognize income associated with the coronavirus-related distribution one-third in each of 2020, 2021 and 2022, must be made on the qualified individual’s timely filed 2020 Form 1040 federal income tax return (including extensions), and on a Form 8915-E that is filed with the return. The election must apply consistently to all coronavirus-related distributions received in 2020, so a taxpayer cannot treat one such 2020 distribution as being taxable one-third in each of 2020, 2021, and 2022, while treating another such distribution as being fully taxable in 2020 or as a loan. Further, the election is irrevocable once it is made on such timely filed tax return.
To Recontribute or Not to Recontribute?
Nevertheless, a qualified individual may recontribute any portion of the coronavirus-related distribution to his or her IRA or retirement olan at any time during the three-year period beginning the day after the date of such distribution, so long as the IRA or plan is an “eligible retirement plan.” For these purposes an “eligible retirement plan” includes an IRA, a qualified plan under IRC § 401(a), an annuity plan under IRC § 403(a), an IRC § 403(b) plan, and a governmental deferred compensation plan under IRC § 457(b). Any coronavirus-related distribution made to a qualified individual as a plan participant or an IRA owner (other than the surviving spouse of the employee or IRA owner) cannot be recontributed.
A recontribution made after 2020 by a qualified individual who has received a coronavirus-related distribution in 2020 will result in the need to amend his or her 2020 income tax return, if it has already been filed, and will be expected to result in a refund to be provided to the qualified individual if income tax resulting from the distribution has been paid. In addition to the amended income tax return, the qualified individual must file a Form 8915-E with his or her income tax return to report the reduction gross income by the amount of the recontribution. The Notice states that the Form 8915-E is expected to be available by the end of 2020.
For example, if a qualified individual has elected to recognize all income associated with a $50,000 coronavirus-related distribution that she received from her 401(k) in 2020, and later recontributes all $50,000 of such distribution to the 401(k) after her 2020 federal income tax return is filed, then she will need to file an amended 2020 federal income tax return and a revised Form 8915-E to report a reduction in her gross income by the $50,000 amount and receive a refund.
Where the individual has elected to have the income payable ratably over 2020, 2021, and 2022, the amount of the recontribution will first reduce the ratable portion of the coronavirus-related distribution that is includable in gross income for the year of repayment. Further, when a recontribution is made to an eligible retirement plan before the filing of the qualified individual’s federal income tax return for the previous year, then the amount of the recontribution will reduce the ratable portion of the distribution for that year.
For example, if a qualified individual receives a $75,000 coronavirus-related distribution from a 401(k) plan in 2020, elects the three-year tax deferral treatment on his 2020 federal income tax return, and recontributes $25,000 on April 10, 2022 (which is before his 2021 tax return was due), then the $25,000 recontribution will reduce the 2021 taxable income by $25,000, and the other two (2) years would not be affected.
If the same qualified individual had recontributed the $25,000 in December of 2022, then this would reduce the taxable income for 2022, instead of 2021.
Where a recontribution during any of the three years exceeds one-third (1/3) of the total amount, then the recontribution first reduces taxable income by one-third (1/3) of the total coronavirus-related distribution for the year of the recontribution, with any excess amount being carried forward or carried back as between the three-year period, as elected.
For example, if a qualified individual receives $90,000 as a coronavirus- related distribution from her IRA in 2020, elects three-year tax recognition on her timely filed 2020 federal income tax return, and recontributes $40,000 on November 10, 2021 (after her 2020 federal income tax return was due), then assuming that no other recontributions are made, she can elect to do one of the following:
a) Apply $30,000 against income reported on her 2021 federal income tax return, and carry the excess $10,000 forward to reduce taxable income for 2022 (which causes her to recognize only $20,000 of the income associated with the coronavirus-related distribution in 2022); or
b) Apply the $30,000 against 2021 income, in the same way as with option a) above, and carry the excess $10,000 back to reduce taxable income for 2020 by filing an amended 2020 federal income tax return (which reduces her 2020 income associated with the coronavirus-related distribution to $20,000, while not affecting her 2022 income associated with the coronavirus-related distribution).
Technical Coordination of the Law for Plan Loans
The increased ability to borrow from a retirement plan, and suspension of outstanding loan payments that would otherwise by owed between March 27, 2020 and December 31, 2020, as set forth under the CARES Act are also addressed by the Notice.
The Notice does not add much with respect to the increased borrowing capability described in the CARES Act, other than to provide that the
The Department of Labor has advised the Department of the Treasury and the IRS that it will not treat any person as having violated the provisions of Title I of the Employee Retirement Income Security Act (ERISA), including the adequate security and reasonably equivalent basis requirements in ERISA Section 408(b)(1) and 29 CFR 2550.408b-1, solely because the person made a plan loan to a qualified individual during the period beginning on March 27, 2020, and ending on September 22, 2020, in compliance with CARES Act Section 2202(b)(1) and the provisions of the Notice.
Further, the Notice provides a safe harbor for payments owed on outstanding loans from Retirement Plans. Because the CARES Act provides for a delay in outstanding payments owed under a loan made from a retirement plan, and for a resulting adjustment in amounts owed due to the delay and accrued interest, guidance was needed to avoid causing a loan to be treated as a distribution under IRC § 72(p)(2)(B) and (c) (requiring that Plan loans be repaid within five years and for level amortization of such loans).
Thus, the Notice states that a plan will be treated as satisfying IRC § 72(p) if a qualified individual’s obligation to repay a plan loan is suspended under the plan for any period beginning not earlier than March 27, 2020, and ending not later than December 31, 2020 (the “Suspension Period”).
Repayments of the loan must resume after the end of the Suspension Period, and the term of the loan may be extended by up to 1 year from the date the loan was originally due to be repaid. If a Plan suspends loan repayments during the suspension period, the suspension will not cause the loan to be deemed distributed even if, due solely to the suspension, the term of the loan is extended beyond five years; however, interest accruing during the Suspension Period must be added to the remaining principal of the loan, and the amortization schedule must be adjusted accordingly.
The Notice further states that a plan satisfies these rules if the loan is reamortized and repaid in substantially level installments over the remaining period of the loan. This means that a plan loan could be outstanding for as long as six years, so long as the outstanding balance is reamortized to account for accrued interest and the delay in the payments, which can be a benefit to a great many taxpayers who have had to borrow from their plans.
These updates from the IRS provide useful and logical guidance on once-murky provisions of the CARES Act. The full implications of this Notice have yet to be seen, but it will be interesting to see how many more coronavirus-related distributions are made after the significant expansion of the definition of “qualified individuals.” This expansion, which may effectively more than double the amount of eligible taxpayers, and make single people with certain issues seem attractive to be spouses or roommates could aid taxpayers in navigating the decision-making associated with coronavirus-related distributions, and will have lasting ramifications on a great many Taxpayers who will have access to their pension and IRA accounts in ways not possible before the age of COVID- 19.
It is often unwise to withdraw or borrow from pension and IRA accounts for a number of reasons, including unwise spending, asset protection planning, and the complexities of tax reporting and elections and options with respect thereto. For many taxpayers it will be much better to sell or borrow upon assets that are not protected from creditor claims, or that would best be sold to avoid maintenance and other expenses, and to enhance the chances of surviving the economic struggles and uncertainty faced by so many.
Source: LISI Employee Benefits & Retirement Planning Newsletter #740 (June 23, 2020) at http://www.leimbergservices.com.
About the authors
Christopher Denicolo, J.D., LL.M., is a partner at the Clearwater, Florida law firm of Gassman, Crotty & Denicolo P.A., where he practices in the areas of estate tax and trust planning, taxation, physician representation, and corporate and business law. He has co-authored several handbooks that have been featured in Bloomberg BNA Tax & Accounting, Steve Leimberg's Estate Planning and Asset Protection Planning Newsletters and the Florida Bar Journal. Mr. Denicolo is also the author of the Federal Income Taxation of the Business Entity Chapter of the Florida Bar's Florida Small Business Practice, Seventh Edition. Mr. Denicolo received his B.A. and B.S. degrees from Florida State University, his J.D. from Stetson University College of Law, and his LL.M. (Estate Planning) from the University of Miami. His email address is email@example.com.
Alan S. Gassman, J.D., LL.M. is a partner in the law firm of Gassman, Crotty & Denicolo, P.A., and practices in Clearwater, Florida. Alan is a frequent contributor to LISI, and has published numerous articles and books in publications such as BNA Tax & Accounting, Estate Planning, Trusts and Estates, and Interactive Legal and is coauthor of Gassman and Markham on Florida and Federal Creditor Protection and several other books on Estate and Estate Tax Planning, Trust Planning, Creditor Protection Planning, and associated topics. Alan and David Herzig will be presenting on “The Aftermath of PPP Loans and Other COVID-19 Concerns” at the 46th Annual Notre Dame Tax Institute which is taking place October 29-30 in South Bend, Indiana. You can contact Jerry Hesch at firstname.lastname@example.org for more information. Alan’s email address is email@example.com.
Brandon Ketron, CPA, JD, LL.M. is an associate at the law firm of Gassman, Crotty & Denicolo, P.A., in Clearwater, Florida and practices in the areas of Estate Planning, Tax and Corporate and Business Law.
Brandon is a frequent contributor to LISI and presents webinars on various topics for both clients and practitioners. Brandon attended Stetson University College of Law where he graduated cum laude, and received his LL.M. in Taxation from the University of Florida. He received his undergraduate degree at Roanoke College where he graduated cum laude with a degree in Business Administration and a concentration in both Accounting and Finance. Brandon is also a licensed CPA in the states of Florida and Virginia. His email address is firstname.lastname@example.org.