July 22, 2020

New IRS Guidance Expands Eligibility for 401(k) Plan COVID-19 Related Distributions and Loans

On June 19, 2020, the Internal Revenue Service (“IRS”) issued Notice 2020-50, along with a related news release, that provides official guidance on “coronavirus-related distributions” and temporarily expanded loans taken from 401(k) plans due to the COVID-19 crisis. The Notice expands the eligibility criteria for such distributions and loans, thereby potentially increasing the number of 401(k) plan participants able to take advantage of these features.

Background. In response to the global pandemic, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was signed into law by President Trump on March 27, 2020. Among other things, 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 Congress Passes CARES Act in Response to COVID-19 Crisis, Contains 401(k) Ease-of-Access and Other Provisions for details.)

On May 4, 2020, the IRS issued Q&As which generally expanded upon and clarified the rules set forth in the CARES Act establishing the new coronavirus-related distribution and loan provisions. (See our previous blog entitled IRS Issues Q&As Under CARES Act on COVID-19 Related 401(k) Plan Distributions and Loans for details.) In addition to the clarifying provisions, the Q&As promised that further guidance would soon be forthcoming.

Notice 2020-50 Represents the Next Step. As promised, Notice 2020-50 moves things another step forward. Briefly stated, Notice 2020-50 expands the definition of “qualified individual” for purposes of both coronavirus-related distributions and the temporarily increased loan limits, now taking into account additional factors such as reductions in pay, rescissions of job offers, and delayed start dates. In addition, certain adverse financial consequences due to the impact of the COVID-19 that directly impact the individual’s spouse or household member (as defined below) are also now taken into account.

The guidance also addresses how employers and qualified individuals should report the tax treatment of coronavirus-related distributions and increased loans on their federal income tax filings, and contains certain other clarifying provisions.

NOTE: This article is not intended to detail all the rules regarding coronavirus-related distributions and expanded loan provisions, but merely to highlight the new guidance contained in Notice 2020-50. For a more complete explanation of the topic, please refer to the earlier blogs previously referred to above.

Expanded Definition of “Qualified Individual.” In a significant extension of eligibility for the enhanced distribution and loan provisions, Notice 2020-50 expands the definition of “qualified individual” to include a participant who:

  • Experiences a reduction in pay (or self-employment income) due to COVID-19, or has a job offer rescinded, or an employment start date delayed, due to COVID-19;
  • Has a spouse or “household member” (defined as an individual who shares the participant’s principle residence) who:
    • Has been quarantined, furloughed, or laid off;
    • Has had his or her work hours reduced due to COVID-19,
    • Is unable to work because of the lack of child care,
    • Had a reduction in pay (or self-employment income) due to COVID-19, or
    • Had a job offer rescinded, or start date delayed, due to COVID-19;
  • Had a business owned or operated by the individual’s spouse or household member that had to close, or reduce hours, because of COVID-19.

COMMENT: Unlike traditional 401(k) hardship withdrawals see 401(k) Plan Distributions and Vesting for details, the amount of the coronavirus-related distribution or loan does not have to demonstrably correspond to the direct financial impact the pandemic has had on the individual. Accordingly, it appears that, as long as the participant meets the definition of “qualified individual” for these purposes, the money may be used for any reasonable purpose.

Tax Reporting of Coronavirus-Related Distributions and Loans. The Notice also addresses how employers and qualified individuals should report the tax treatment of these distributions and loans on their federal income tax filings. Specifically:

  • An eligible retirement plan must report the payment of a coronavirus-related distribution to a qualified individual on Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
  • This reporting is required even if the qualified individual later recontributes the coronavirus-related distribution to the same eligible 401(k) retirement plan in the same year. (See IRS Issues Q&As Under CARES Act on COVID-19 Related 401(k) Plan Distributions and Loans for further details.)
  • If the employer is treating the payment as a coronavirus-related distribution and no other appropriate code applies, then the employer should use distribution code 2 (early distribution, exception applies) in box 7 of Form 1099-R.
  • Finally, the employer also is permitted to use distribution code 1 (early distribution, no known exception) in box 7 of Form 1099-R, in lieu of distribution code 2.

Additional Provisions. Notice 2020-50 also contains certain other noteworthy provisions (this list is not meant to be exhaustive):

  • The Notice clarifies that plan sponsors may choose whether to implement either or both of the coronavirus-related distribution and loan rules, and provides that qualified individuals can claim the tax benefits of the coronavirus-related distribution rules even if the plan’s provisions are not amended.
  • The guidance clarifies that plan administrators may rely on an individual’s certification that the individual is a qualified individual. (Although the Q&As previously released also made this point, Notice 2020-50 goes a step further by providing a sample certification that may be used for this purpose.)
  • The Notice provides employers with a safe harbor procedure for implementing the suspension of loan repayments that would otherwise be due through the end of calendar year 2020 (but also notes that there may be other reasonable ways to administer these rules).
  • Under the safe harbor, a qualified employer 401(k) plan will be treated as satisfying the CARES Act requirements if a qualified individual’s obligation to repay a plan loan is suspended for any period beginning not earlier than March 27, 2020, and ending not later than December 31, 2020 (the “suspension period”).
  • The loan repayments must resume after the end of the suspension period, and the term of the loan may be extended by up to one year from the date the loan was originally due to be repaid.
  • If a qualified employer 401(k) 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.
  • Interest accruing during the suspension period must be added to the remaining principal of the loan.
  • Further specific details are spelled out in the Notice.

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.

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