The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) provides sponsors of 401(k) and other tax-qualified retirement plans with tools to give their employees who are affected by COVID-19 greater access to their savings by temporarily allowing “coronavirus-related distributions” and doubling the limitations on plan loans. On June 19, the IRS issued Notice 2020-50, which provides guidance on these provisions of the CARES Act. In addition, Notice 2020-50 affords a special opportunity for participants of nonqualified deferred compensation (Section 409A) plans to cancel their deferral elections for the balance of 2020.
Under the CARES Act, a 401(k) or other tax-qualified retirement plan may allow qualified individuals (see below) the opportunity during the period March 23, 2020, through December 31, 2020, to withdraw up to $100,000 without being subject to the usual 10% penalty tax for distributions prior to age 59 ½ (a “coronavirus-related distribution”). A coronavirus-related distribution is generally includible in income over a three-year period, but income tax can be avoided to the extent that the distribution is repaid to a tax-qualified plan or IRA within the three-year period (the repayment is treated as a tax-free rollover). Note that a coronavirus-related distribution does not need to be used for only COVID-19-related needs provided the loan is taken by a qualified individual.
Notice 2020-50 provides guidance on how to report these distributions as well as any recontributions to the plan, including examples. A qualified individual who receives a coronavirus-related distribution can report the taxable portion in income either (i) ratably over three years or (ii) by irrevocably electing to include the entire amount in income in the year of distribution. A qualified individual who makes a recontribution to the plan would use Form 8915-E (which is expected to be available before the end of 2020) to report the recontribution and determine the amount of the coronavirus-related distribution to include in income. If such individual has already filed a tax return reporting the distribution and subsequently makes a recontribution to the plan, the individual will need to (i) file an amended tax return reporting the distribution and (ii) file a revised Form 8915-E to report the amount of the recontribution and reduce the gross income by the amount of the recontribution in an amount not exceeding the coronavirus-related distribution. Special rules for reporting income inclusion apply when utilizing the three-year income inclusion method if a recontribution to the plan exceeds the amount included in gross income for a tax year. These rules allow the recontribution to be carried forward or back to other tax years.
Increased Loan Limits; Delayed Loan Repayments
Under the CARES Act, 401(k) and other tax-qualified plans may increase the amount that a qualified individual may borrow against his or her account from $50,000 to $100,000 for loans taken between March 27 and September 23, 2020. The CARES Act also requires plans to allow qualified individuals to suspend for up to one year loan repayments otherwise due under plan loans during the period on or after March 27 through December 31, 2020 (the suspension period).
Loan repayments that are suspended during the suspension period and have the original term extended pursuant to the above will not incur a deemed distribution due to the suspension or extension. Notice 2020-50 provides employers with a safe harbor method for calculating loan repayments once they resume in January 2021. When payments resume, the safe harbor method allows for the remaining outstanding loan, plus interest, to be re-amortized and repaid in substantially level installments over the remaining loan term (including the one-year extension). Use of the safe harbor is not required. Notice 2020-50 provides that other reasonable methods to calculate loan payments may be utilized.
Canceling 409A Plan Deferral Elections
As a general rule, elections to defer compensation under a nonqualified (Section 409A) deferred compensation arrangement must be irrevocable for the year. Exceptions exist that allow for the cancellation of deferral elections due to an unforeseeable emergency or a hardship distribution from a 401(k) plan.
Notice 2020-50 now also allows a 409A plan to permit a participant who takes a coronavirus-related distribution (discussed above) from a 401(k) or other tax-qualified plan to cancel his or her deferral election for the balance of 2020. A participant who revokes a 409A plan deferral election cannot make a new deferral election under the 409A plan until the next plan year. Also, a deferral election cannot be reduced; it must either remain in place or be revoked entirely.
As indicated above, only a “qualified individual” is eligible for a coronavirus-related distribution, the special CARES Act plan loan opportunities discussed above, and the ability to revoke a 409A plan deferral election due to taking a coronavirus-related distribution.
Under the CARES Act, a qualified individual is generally defined as an individual:
- Who is diagnosed with COVID-19;
- Whose spouse or tax dependent is diagnosed with COVID-19; or
- Who experiences adverse financial consequences as a result of being quarantined, being furloughed or laid off, or having work hours reduced due to COVID-19; being unable to work due to lack of child care due to COVID-19; closing or reducing hours of a business owned or operated by the individual due to COVID-19; or other factors as determined by the Department of the Treasury.
Notice 2020-50 expands the definition of “qualified individual” to also include an individual who experiences adverse financial consequences as a result of:
- Having a reduction in pay (or self-employment income) due to COVID-19 or having a job offer rescinded or a start date for a job delayed due to COVID-19;
- The individual’s spouse or a member of the individual’s household being quarantined, being furloughed or laid off, or having work hours reduced due to COVID-19; being unable to work due to lack of child care due to COVID-19; having a reduction in pay (or self-employment income) due to COVID-19; or having a job offer rescinded or a start date for a job delayed due to COVID-19; or
- The closing or reduction of hours of a business owned or operated by the individual’s spouse or a member of the individual’s household due to COVID-19.
Notice 2020-50 provides that plan administrators may rely on a participant’s certification that the participant (or the participant’s spouse, dependent, or household member) is a qualified individual, absent actual knowledge to the contrary. The plan administrator has no obligation to make an inquiry regarding whether the certification is accurate, but the participant must actually meet the definition of a qualified individual to qualify for any favorable tax treatment. Notice 2020-50 provides a model certification that employers may use.
Our Employee Benefits and Executive Compensation Practice Group will continue to monitor COVID-19 guidance to keep clients informed of updates that may affect their administration of 401(k) or other tax-qualified plans and nonqualified deferred compensation arrangements. If you have any questions about Notice 2020-50 or any other provisions of the CARES Act relating to employees, employment-related taxes, or compensation matters, please contact one of the members of our Employee Benefits and Executive Compensation Practice Group.
To see our prior alerts and other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.