The IRS recently issued frequently asked questions (FAQs) regarding retirement plan distribution and loan relief under the Coronavirus Aid, Relief and Economic Security (CARES) Act. This relief applies to qualified individuals affected by the novel coronavirus (COVID-19) pandemic. It expanded distribution options and favorable tax treatment, increased plan loan limits and delayed repayment of outstanding plan loans.
The FAQs explain that the IRS plans to release further guidance under Internal Revenue Code Section 2202 “in the near future.” It will apply principles originally articulated in Notice 2005-92, which interpreted distribution and loan relief enacted in response to Hurricane Katrina. Meanwhile, here are some highlights of the CARES Act FAQs:
Optional relief. Employers may choose whether to amend their plans to provide the Sec. 2202 distribution and loan relief, which includes allowing qualified individuals to delay repayment of outstanding plan loans for up to one year. They may also adopt some portions of the relief but not others — for example, the distribution relief but not the plan loan rules or loan repayment schedules.
Waived distribution restrictions. COVID-19-related distributions are treated as meeting certain restrictions ordinarily applicable to 401(k) plans and certain other plans — for example, the requirement that 401(k) plans prohibit the distribution of elective deferrals before specified events. But other distribution limits (for instance, the spousal consent rules) aren’t waived simply because the distribution, if made, could qualify as a COVID-19-related distribution.
Tax treatment of distributions. COVID-19-related distributions are generally taxable, though not subject to the 10% tax on early distributions. They’re reported as income ratably over a three-year period, unless the individual reports the full amount as income for 2020. Qualified individuals who receive a distribution that meets the requirement for a qualified distribution may treat the distribution as such on their federal income tax returns, regardless of how an employer or plan reports or characterizes the distribution.
Reporting of distributions. Plans must report COVID-19-related distributions on Form 1099-R, even if the individual repays the distribution in the same year. More information about reporting such distributions will be provided “later this year,” according to the IRS.
No obligation to accept repayments. The FAQs affirm that plans generally aren’t required to accept rollovers of COVID-19-related distributions.
Tax treatment of repayments. Distributions repaid to an eligible retirement plan within three years are treated as rollovers (and, thus, not taxable). An example in the FAQs shows how to handle repayment of a COVID-19-related distribution in 2022 (after one-third of the distribution has been reported as income in each of the two preceding years) for federal income tax purposes. The Katrina notice provides additional examples. Qualified individuals must report repayments on Form 8915-E, which will be issued later this year.
Plan loans. If loan repayments are suspended, payments after the delay must be adjusted to reflect the delay and any interest accrued during the delay.
It’s important for employers to understand how the CARES Act relief and these FAQs affect plan administration and what plan amendments may be required. Please contact us for assistance.