IRS Issues Q&As Under CARES Act on COVID-19 Related 401(k) Plan Distributions and Loans
On May 4, 2020, the Internal Revenue Service (“IRS”) issued Q&As under the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, providing guidance to 401(k) plan administrators and participants regarding coronavirus-related distributions and enhanced participant loans for covered employees who are affected by the pandemic. The Q&As generally expand upon and clarify the rules set forth in the CARES Act establishing the new plan distribution and loan provisions.
Generally stated, the CARES Act:
- Ushered in new “coronavirus-related distributions” of up to $100,000 from 401(k) plans; and
- Temporarily increased the limits on 401(k) plan participant loans for qualified individuals from (i) $50,000 to $100,000; and (ii) 50 percent of a participant’s 401(k) plan balance to 100 percent of his or her 401(k) plan balance.
See our previous blog entitled “Congress Passes CARES Act in Response to COVID-19 Crisis, Contains 401(k) Ease-of-Access and Other Provisions” for details.
The Q&As state that the IRS intends to release further guidance under each of these CARES Act provisions “in the near future.”
Highlights of the Q&As applicable to 401(k) plans appear below:
“Qualified Individual” Defined. For purposes of both the expanded 401(k) plan distribution rules and the temporarily increased participant loan limits, the term “qualified individual” means:
- An individual diagnosed with the virus SARS-CoV-2, or with coronavirus disease 2019 (COVID-19), by a test approved by the Centers for Disease Control and Prevention (“CDCP”);
- An individual whose spouse or dependent is diagnosed with SARS-CoV-2 or with COVID-19 by a test approved by the CDCP;
- An individual who experiences adverse financial consequences as a result of being quarantined, being furloughed or laid off, or having his or her work hours reduced due to SARS-CoV-2 or COVID-19;
- An individual who experiences adverse financial consequences as a result of being unable to work due to a lack of child care due to SARS-CoV-2 or COVID-19; or
- An individual who experiences adverse financial consequences as a result of the closing of, or reduction of hours of, a business that he or she owns or operates due to SARS-CoV-2 or COVID-19.
The Q&As state that the IRS might expand the above list in future guidance, in response to comments from the public regarding additional qualifying factors.
“Coronavirus-Related Distribution” Defined. A “coronavirus-related distribution” is a distribution that is made from a 401(k) plan to a qualified individual from January 1, 2020, to December 30, 2020, up to an aggregate limit of $100,000. If an individual is covered by more than one 401(k) plan (or if he or she takes a similar distribution from an individual retirement account (“IRA”)), then all such plans are consolidated for purposes of the aggregate limit.
Coronavirus-Related Distribution Not Subject to the 10-percent Penalty Tax. The Q&As specify that the 10% additional tax on early distributions does not apply to coronavirus-related distributions.
Income Taxation of Coronavirus-Related Distributions. A coronavirus-related distribution is subject to regular income tax, which is generally imposed ratably over a three-year period, beginning with the year in which the individual receives the distribution. However, taxpayers have the option of being taxed on the entire amount of the distribution during the year in which it is received (i.e., 2020).
EXAMPLE: Georgia receives $9,000 from her 401(k) plan as a coronavirus-related distribution in 2020. She would report $3,000 as income on her 2020 Federal Form 1040, and also report $3,000 as income for each of the years 2021 and 2022 – unless she elects to report all $9,000 as income on her 2020 Form 1040.
Repayments of Corornavirus-Related Distributions. A qualified individual may repay all or part of the amount of a coronavirus-related distribution to an eligible retirement plan, so long as the repayment is completed in full within the three-year period following the date on which the distribution was received. The Q&As clarify that, if the amount is fully repaid, then the recipient does not owe federal tax on the distribution, since it is then treated as a direct trustee-to-trustee transfer to the plan.
NOTE: The Q&As further clarify that a participant who paid taxes on the amount of a coronavirus-related distribution may file an amended tax return to claim a refund of the tax attributable to the distribution, if later he or she repays the amount of the distribution within the three-year period.
Notably, the Q&As also point out that 401(k) plans are not required to accept rollover contributions. If a plan does not accept any rollover contributions, then the plan is not required to change its terms or procedures to accept repayments of coronavirus-related distributions.
OBSERVATION: If the 401(k) plan does not accept any rollover contributions, then the participant would not be able to repay the coronavirus-related distribution and, thus, would have to pay tax on the entire amount. Fortunately, the vast majority of 401(k) plans do accept rollover contributions.
Participant Loan Repayments May Be Delayed for One Year. As explained above, the CARES Act temporarily increased the limits on 401(k) plan participant loans for qualified individuals. This expansion applies only for the 180-day period beginning on March 27, 2020 and ending on September 23, 2020, and it applies solely with respect to loans made to a “qualified individual,” as defined previously.
The Q&As reiterate the CARES Act rules stating that, if a participant loan is outstanding on or after March 27, 2020, and a repayment on the loan is due at any time from March 27, 2020 until December 31, 2020, then the due date of such repayment may be delayed for up to one year, as measured from the original due date. Any payments after the suspension period must be adjusted to reflect the delay. Importantly, interest on the loan continues to accrue during the delay period.
Expanded Distribution and Loan Provisions Are Optional. The Q&As also clarify that employers have the option to adopt, or to not adopt, the expanded distribution and/or participant loan rules. Therefore, an employer may choose to adopt either or both provisions, or neither of them. Further, a qualified individual may treat any distribution meeting the requirements of a “coronavirus-related distribution” accordingly on his or her federal income tax return, regardless of whether the 401(k) plan has been amended for that particular provision.
Plan Administrators May Rely on Employee Certifications. The Q&As permit 401(k) plan administrators to rely on an individual’s certification that he or she satisfies the conditions of a “qualified individual” in determining whether a distribution is a coronavirus-related distribution, unless the administrator has actual knowledge to the contrary.
Also, for tax purposes, an individual may treat a distribution as a “coronavirus-related distribution” only if the distribution, in fact, meets the eligibility requirements for such a distribution.
Reporting of Coronavirus-Related Distributions. Finally, 401(k) plans should report payments of coronavirus-related distributions to qualified individuals on Form 1099-R. This is true regardless of whether or not the qualified individual repays all or part of the coronavirus-related distribution to the plan.
Qualified individuals, on the other hand, should report a coronavirus-related distribution on their individual Form 1040s for 2020, declaring the taxable portion of the distribution as income ratably over the three-year period (i.e., 2020, 2021, and 2022, as explained previously), unless they are electing to include the entire amount in 2020.
The Q&As add that individuals should use IRS Form 8915-E (which is expected to be available before the end of 2020) to report any repayment of a coronavirus-related distribution, and to determine the amount of the coronavirus-related distribution that is includible in income for a particular year.
OTHER COVID-19 RESOURCES:
For more information about how the COVID-19 crisis may affect your 401(k) plan and health & welfare plan, please visit our previous blogs below:
- Departments Issue Further Guidance Expanding COVID-19 Relief for Health Plans
- DOL, IRS, EBSA Issue Guidance Further Expanding COVID-19 Relief for 401(k) Plans
- IRS Extends Various 401(k) Deadlines in Response to COVID-19 Crisis
- Families First Coronavirus Response Act, Impact on Employers
- Coronavirus (COVID-19) Regulatory Resources for Employee Benefit Plans
- 401(k) Plans in the Age of COVID-19: Hardship Withdrawals, Loans, and Other Issues
- Congress Passes CARES Act in Response to COVID-19 Crisis, Contains 401(k) Ease-of-Access and Other Provisions
- The CARES Act and its Impact on Health Plans
- HIPAA Reminders During COVID-19
- HIPAA IQ: “Work-From-Home” Edition
The information and content contained in this blog post are for general informational purposes only, and does not, and is not intended to, constitute legal advice. As always, for specific questions concerning your 401(k) retirement plan, or for help in operating your plan during the current COVID-19 crisis, please consult your own ERISA attorney or professional advisor.