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George F. Bearup, J.D. Senior Legal Trust Advisor

23-Jun-20

Distributions from Retirement Plans Under the CARES Act – Some Answers

Notice 2020-50.

Background:  The CARES Act authorizes qualified individuals to receive favorable tax treatment with respect to distributions from eligible retirement plans that are coronavirus-related distributions. Such a distribution is not subject to the 10% early distribution excise tax [IRC 72(t)] or the 25% penalty for early distributions from a SIMPLE IRA [IRC 72(t)(6).] The CARES Act also permits the income tax on the retirement plan distribution to be reported over three years, starting with the year in which the distribution takes place. If the distribution is eligible for a tax-free rollover treatment and is contributed to an eligible retirement plan within a 3-year period, it will not be included in the distributee’s income. The CARES Act also increased the allowable plan loan amount made to qualified individuals. Notice 2020-50 answers some of the questions that have surfaced with these temporary changes authorized by the CARES Act.

Qualified Individual: You will recall that this definition is tied to someone who is diagnosed with COVID-19, or their spouse or dependent with that diagnosis. The definition also includes a person who experiences adverse financial consequences as a result of quarantine, furlough or lay-off (including a self-employed individual who experiences a reduction in pay), or being unable to work due to a lack of childcare. This was further expanded in Regulations to include situations where the individual’s spouse or ‘member of their family’ was quarantined, furloughed, laid-off, or having their work hours reduced due to COVID-19. The Notice clarifies that a ‘member of the individual’s household is someone who shares the individual’s principal residence.’

  • Example: A 24 year old child who lives at home with his parents is furloughed. The living-in-the-same-household child’s furlough would result in the father being a qualified individual.

Coronavirus-Related Distribution: This is any distribution from an eligible retirement plan, including an IRA, that is made between January 1, 2020 and December 31, 2020 to a qualified individual. The qualified individual designates by a certification that the distribution is coronavirus-related. The amount of this distribution is limited to $100,000. The coronavirus-related distribution is available even if the qualified plan administrator does not treat the distribution as coronavirus-related.

  • Example: A plan participant age 55 who had terminated employment and who is taking substantially equal periodic payments from the qualified plan (thus avoiding the 10% early distribution penalty) is eligible to treat those periodic payments a coronavirus-related.
  • Example: A participant has obtained a plan loan from his account balance; he is using a plan-offset to repay the loan. The participant is permitted to treat the plan-offset as coronavirus-related.
  • Example: An individual is a participant in several qualified plans. So long as the employer-sponsors of those qualified plans are unrelated, the participant can take up to $100,000 as a coronavirus-related distribution from each plan, i.e. more than $100,000 can be distributed to the multi-plan participant as coronavirus-related distributions.
  • Example: The $100,000 coronavirus-related distribution limit can also be exceeded if a coronavirus-related distribution is taken from an IRA and also a comparable distribution is taken from a qualified plan in which the individual is a participant. [This is a very loose interpretation of a couple of passing comments in the IRS’s Notice. I would be very uncomfortable advising someone that they can withdraw $100,000 from their $401(k) account and another $100,000 from their IRA account in the same year, penalty-free. The same concerns would be with regard to a plan participant in two 401(k) plans, taking $100,000 from each of the two plans.]
  • Example: On December 20,2020, Pat takes a $35,000 distribution from her 401(k) account. Pat meets the definition of a qualified individual. On the same day, Pat takes a $15,000 distribution from her IRA. Pat is permitted to treat both the $35,000 distribution and the $15,000 distribution as coronavirus-related distributions on her 2020 Form 1040 tax return.
  • Amount of Coronavirus-Related Distribution:  While the CARES Act limits the maximum distribution amount to $100,000 it does not limit such distributions to amounts withdrawn solely to meet a need arising from COVID-19.
  • Example: Melinda, who is a qualified individual as a result of experiencing adverse financial consequences, can take coronavirus-related distributions without regard to her actual need for the funds, nor is the amount of the distribution required to correspond to the extent of Melinda’s adverse financial consequences experience. In short, Melinda does not need to justify the amount that she takes as a coronavirus-related distribution.

Reporting a Coronavirus-Related Distribution:  A coronavirus-related distribution can be included in the distributee’s income ratably (equal installments) over 3 years, and will not be subject to the 10% early distribution excise tax. Alternatively, the distribution can all be reported and included in the distributee’s income in the year of the coronavirus-related distribution. The individual can elect-out of paying the tax ratably over the three year period, however this election cannot be made or changed after a timely filed individual income tax return in the year of the distribution.

  • Example: Kevin, a qualified individual, receives a $30,000 distribution from his IRA on October 1, 2020. Kevin elects to treat the distribution as a coronavirus-related distribution. Kevin uses the 3-year ratable income inclusion for the $30,000 distribution. Kevin should include $10,000 in income with respect to the coronavirus-related distribution on each of his 2020, 2021, and 2022 federal income tax returns.
  • Example: Karen, a qualified individual, takes a coronavirus-related distribution of $40,000 from her IRA in 2020. Karen may, at any time in the next successive years, beginning with the day she receives her coronavirus-related distribution, recontribute the $40,000 to an IRA or to an eligible retirement plan. Karen does a 60-day rollover of her IRA account in early 2022. Karen’s recontribution of her coronavirus-related distribution later in 2022 will not be treated as a rollover contribution for purposes of the one-rollover-per-year limitation. [IRC 408(d)(3)(B).]
  • Example: Corbin, a qualified individual, receives a $15,000 distribution from his IRA on March 30, 2020. Corbin elects to treat the $15,000 as a coronavirus-related distribution. Corbin elects-out of the 3-year ratable income inclusion by filing Form 8915-E. Corbin includes the entire $15,000 in his gross income for the 2020 taxable year. On December 31, 2022, Corbin recontributes the $15,000 to his IRA. Corbin will need to file an amended federal income tax return for the 2020 tax year to report the amount of his recontribution and reduce the gross income by $15,000 with regard to the coronavirus-related distribution included on his original 2020 federal income tax return. What if Corbin made his recontribution to his IRA on March 1, 2021, before he filed his 2020 federal income tax return? In that case, Corbin would report no portion of the coronavirus-related distribution as part of his 2020 income because he made the recontribution before his timely filing of his 2020 federal income tax return.

Tax-Free Rollover Treatment of a Coronavirus-Related Distribution: The CARES Act permits a coronavirus-related distribution to be treated as a tax-free rollover, if the withdrawn funds are recontributed to an eligible retirement plan. The recontribution will be treated as having been made in a trustee-to-trustee transfer to that eligible retirement plan. However, any coronavirus-related distribution, whether from an employer’s qualified plan or an IRA, that is paid to a qualified individual as a beneficiary of a plan participant or IRA owner (or than a surviving spouse of the deceased participant or IRA owner) is not available to be recontributed. If coronavirus-related distributions are timely recontributed to a qualified plan, then amended income tax returns for prior years when the distribution was reported as taxable income will have to be filed.

Hardship Distributions: Some qualified plans permit a hardship distribution. In general, a distribution from a qualified plan made on account of hardship is not eligible for the rollover distribution just described. If, however, the plan distribution satisfies the requirements of a coronavirus-related distribution, the distribution will not be treated as made on account of the participant’s hardship, and thus a portion of the distribution will be permitted to be recontributed to an eligible retirement plan.

Distributable Events: Some qualified plans restrict plan distributions to distributable events, such as severance from employment, disability, or attaining age 59 ½. A sponsoring employer can expand the distribution options under its qualified plan to allow an amount attributable to an elective, qualified nonelective, qualified matching, or ‘safe harbor’ contribution to be distributed as coronavirus-related, even if the distribution occurs before an otherwise distributable event described in the qualified plan. However, the CARES Act does not change the rules for when plan distributions are permitted to be made from a qualified plan.

  • Example: A money purchase pension plan is not permitted to make a distribution before an otherwise permitted distributable event described in the qualified plan merely because the distribution, if made, would qualify as a coronavirus-related distribution. Similarly, an ERISA covered qualified plan is not permitted to make a distribution in a distribution form other than a qualified joint and survivor annuity without a written spousal consent merely because the distribution, if made, could be treated as a coronavirus-related distribution.

Tax Withholding: A plan administrator, or payer, e.g. IRA custodian of a coronavirus-related distribution, is not required to withhold an amount equal to 20% of the distribution that normally is required. [IRC 3405(c)(1).] However, a coronavirus-related distribution is subject to the voluntary withholding requirements. [IRC 3405(b); 35.3405-1T.]

Conclusion: There are multiple answers, and examples, in this 20-page IRS Notice 2020-50 that are helpful. In addition, the Notice addresses the modification of rules with regard to qualified plan loans to a plan participant. A few comments also provide guidance to plan administrators and plan sponsors that may elect to not amend their qualified plans to adopt some of these more ‘liberalizing’ rules. It will be interesting to see if the interpretation of multiple $100,000 coronavirus-related distributions holds up if individuals attempt to abuse this ‘opportunity’, e.g. a plan participant rolls-out $100,000 from a qualified plan into an IRA, and then proceeds to take a $100,000 coronavirus-related distribution from each of their IRA and their qualified plan account. That result just seems to be too good to be true. Despite the implications in this Notice, I would bet that $100,000 means $100,000 from all sources, not each source.