The Internal Revenue Service has issued frequently asked questions (FAQs) clarifying the special distribution options and loan relief provisions applicable to eligible retirement plans and IRAs found in section 2202 of the CARES Act.
The following is a high-level overview of the clarifications detailed in the FAQs. A more in-depth analysis of the CARES Act can be found here.
The CARES Act permits employers to amend their eligible retirement plans to allow qualified individuals (QIs) to receive Coronavirus-Related Distributions (CRDs) from their retirement savings between January 1, 2020, and December 31, 2020. CRDs are available in amounts of up to $100,000, and are not subject to the 10 percent early distribution penalty tax that would otherwise apply. Additionally, CRDs will not be treated as eligible rollover distributions, so the mandatory 20 percent withholding also does not apply.
CRDs generally are includible in income ratably over a three-year period starting in 2020. The FAQs illustrate that if a QI receives a $15,000 CRD in 2020, $5,000 in income would be reported on his or her federal income tax return for each of 2020, 2021, and 2022. Alternatively, the QI could elect to include the entire distribution in income in 2020.
QIs also may choose to repay the CRDs to an eligible retirement plan or IRA; however, plans are not required to permit repayment. If a CRD is repaid within three years of receipt, the QI will not be assessed federal income taxes on the CRD amount. The FAQs clarify that if taxes have already been paid when the repayment is made, the QI can file amended returns to obtain a refund of the overpaid taxes. For example, if the QI elects to include the CRD amount in income over three years (2020, 2021, and 2022) and then later decides to repay the full amount of the CRD in 2022, the QI can file amended federal income tax returns for 2020 and 2021 to claim a refund of the tax already paid on the CRD for those years. Also, the QI would not be required to include any amount of the CRD in income in 2022.
The FAQs also clarify that defined benefit pension plans are permitted to offer CRDs. However, the CARES Act did not otherwise change the restrictions on the timing and form of payment of distributions from defined benefit plans. Thus, to obtain a CRD from a defined benefit plan, the plan must offer lump sums, the QI generally cannot be actively employed by the plan sponsor or its affiliates, and if the QI is married, spousal consent generally would be required.
The FAQs provide that plans must report CRDs by issuing Forms 1099-R, even if the QIs repay the CRD amounts in the same year. Even if an employer does not treat a distribution as a CRD, a QI may elect to treat the distribution as a CRD on his or her individual federal income tax return. The IRS expects to provide further guidance on how plans should report these distributions.
Increased Loan Amounts and Repayment Options
The CARES Act permits employers to amend their eligible retirement plans to permit QIs an additional year for repayment of plan loans, provided that the repayments otherwise would be due on or after March 27, 2020, through December 31, 2020. The CARES Act also allows employers to increase the loan limit for QIs to the lesser of $100,000 or 100 percent of the account balance for new loans taken during the six months following enactment of the CARES Act (through September 27, 2020). The FAQs clarify that the loan rules, like the CRD provisions, are completely optional. An employer may, for example, decide to amend its plan to offer CRDs but not to change its loan provisions.
The Treasury Department and the IRS are formulating further guidance under the CARES Act that will apply the same principles as set forth in IRS Notice 2005-92, which clarified the tax-favored treatment of plan distributions under the Katrina Emergency Tax Relief Act of 2005. Additionally, the FAQs indicate that guidance expanding the definition of a QI is on the horizon.
Ballard Spahr LLP’s attorneys in the Employee Benefits and Executive Compensation practice group can assist plan sponsors and employers in structuring their retirement plans to reflect the changes under section 2202 of the CARES Act.