IRS Expands Favorable Treatment on COVID-Related Retirement Plan Distributions

(Parker Tax Publishing July 2020)

The IRS expanded the list of qualified individuals who are eligible for favorable tax treatment with respect to coronavirus-related retirement plan distributions. The guidance is intended to assist employers and plan administrators, trustees and custodians, and qualified individuals in applying changes made in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), including by providing guidance on how plans may report coronavirus-related distributions and how individuals may report such distributions on their individual federal income tax returns. Notice 2020-50.

Background

Under Code Sec. 402(c)(8), an eligible retirement plan includes an individual retirement arrangement (IRA) under Code Sec. 408(a) or (b), a qualified plan under Code Sec. 401(a), an annuity plan under Code Sec. 403(a), a Code Sec. 403(b) plan, and a governmental deferred compensation plan under Code Sec. 457(b). Distributions from these plans generally are includible in the distributee's gross income in the year of the distribution. Individuals must begin taking required minimum distributions from any eligible retirement plan, including IRAs and annuities, once the individual turns 72.

As a result of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which was signed into law on March 27, numerous taxpayer-favorable changes were made to the rules on distributions from, and contributions to, eligible retirement plans. Under Section 2202 of the CARES Act, qualified individuals receive favorable tax treatment with respect to distributions from eligible retirement plans that are coronavirus-related distributions.

Section 2202(a)(4)(A) of the CARES Act defines a coronavirus-related distribution as any distribution from an eligible retirement plan made on or after January 1, 2020, and before December 31, 2020, to a qualified individual. Section 2202(a)(2) of the CARES Act limits the amount of aggregate distributions from all eligible retirement plans that can be treated as coronavirus-related distributions to no more than $100,000.

A coronavirus-related distribution is not subject to the 10 percent additional tax under Code Sec. 72(t) (including the 25 percent additional tax under Code Sec. 72(t)(6) for certain distributions from SIMPLE IRAs), is generally includible in income over a three-year period, and, to the extent the distribution is eligible for tax-free rollover treatment and is contributed to an eligible retirement plan within a three-year period, is not includible in income. Section 2202 of the CARES Act also increased the allowable plan loan amount under Code Sec. 72(p) and permits a suspension of payments for plan loans outstanding on or after March 27, 2020, that are made to qualified individuals.

Under the CARES Act, a qualified individual is one:

(1) who is diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (i.e., COVID-19) by a test approved by the Centers for Disease Control and Prevention (including a test authorized under the Federal Food, Drug, and Cosmetic Act);

(2) whose spouse or dependent (as defined in Code Sec. 152) is diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention (including a test authorized under the Federal Food, Drug, and Cosmetic Act); or

(3) who experiences adverse financial consequences as a result of: (i) the individual being quarantined, being furloughed or laid off, or having work hours reduced due to COVID-19; (ii) the individual being unable to work due to lack of childcare due to COVID-19; or (iii) closing or reducing hours of a business owned or operated by the individual due to COVID-19.

Expansion of Individuals Eligible to Tax Favorable Treatment

In Notice 2020-50, the IRS expanded the list of individuals eligible for tax-favorable treatment with respect to coronavirus-related distributions to include any individual who experiences adverse financial consequences as a result of:

(1) the individual having a reduction in pay (or self-employment income) due to COVID-19 or having a job offer rescinded or start date for a job delayed due to COVID-19;

(2) 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 childcare due to COVID-19, having a reduction in pay (or self-employment income) due to COVID-19, or having a job offer rescinded or start date for a job delayed due to COVID-19; or

(3) closing or reducing hours of a business owned or operated by the individual's spouse or a member of the individual's household due to COVID-19.

Expansion of Distributions Eligible for Tax Favorable Treatment

In Notice 2020-50, the IRS states that the definition of a coronavirus-related distribution under Section 2202(a)(4) of the CARES Act does not limit such distributions to amounts withdrawn solely to meet a need arising from COVID-19. Thus, Notice 2020-50 provides that, for an individual who is a qualified individual as a result of experiencing adverse financial consequences, coronavirus-related distributions are permitted without regard to the qualified individual's need for funds, and the amount of the distribution is not required to correspond to the extent of the adverse financial consequences experienced by the qualified individual.

In general, a distribution from an employer retirement plan made on account of hardship is not a coronavirus-related distribution eligible for tax-free rollover treatment. However, if the distribution satisfies certain requirements in Notice 2020-50, then, except as otherwise provided in the notice (relating to nonqualified deferred compensation plans), the distribution is not treated as made on account of hardship for purposes of Notice 2020-50 and, thus, any portion of the distribution is permitted to be recontributed to an eligible retirement plan.

The total amount of distributions treated by an employer as coronavirus-related distributions under all its retirement plans with respect to a qualified individual cannot exceed $100,000. For purposes of this rule, the term "employer" means the employer maintaining the plan and those employers required to be aggregated with the employer under Code Sec. 414(b), (c), (m), or (o). However, in Notice 2020-50, the IRS states that a plan will not fail to satisfy any requirement under the Code merely because a qualified individual's total coronavirus-related distributions exceed $100,000 taking into account distributions from IRAs or other eligible retirement plans maintained by unrelated employers.

A qualified individual is permitted to designate any eligible distribution as a coronavirus-related distribution provided the total amount treated by the individual as coronavirus-related distributions from all eligible retirement plans does not exceed $100,000.

Example: If a qualified individual receives a distribution of $50,000 in August of 2020 and a distribution of $75,000 in September of 2020 and both distributions satisfy the definition of a coronavirus-related distribution, only $100,000 of the $125,000 received by the qualified individual can be treated as a coronavirus-related distribution. Thus, the individual can only treat $100,000 of the August and September distributions as coronavirus-related distributions on the individual's 2020 federal income tax return. Assuming no Code Sec. 72(t)(2) exception applies, the remaining $25,000 of the distribution is an early distribution that is subject to the 10 percent additional tax. This amount must be included on the individual's 2020 federal income tax return and is not eligible for the three-year recontribution to an eligible retirement plan.

There are two methods for a qualified individual to include the taxable portion of a coronavirus-related distribution in income:

(1) ratably over a three-year period that begins in the year of the distribution; or

(2) electing out of the three-year ratable income inclusion and including the entire amount of the taxable portion of the distribution in income in the year of the distribution.

Compliance Tip: This election cannot be made or changed after the timely filing of the individual's federal income tax return (including extensions) for the year of the distribution. All coronavirus-related distributions received in a tax year must be treated consistently (either all distributions must be included in income over a three-year period or all distributions must be included in income in the current year).

Example: John receives a $30,000 distribution from his IRA on October 1, 2020. John is a qualified individual and elects to treat the distribution as a coronavirus-related distribution. John uses the three-year ratable income inclusion for the $30,000 distribution. John 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.

If a coronavirus-related distribution is eligible for tax-free rollover treatment, a qualified individual is permitted, at any time in the three-year period beginning the day after the date of a coronavirus-related distribution, to recontribute any portion of the distribution, but not an amount in excess of the amount of the distribution, to an eligible retirement plan. A recontribution of a coronavirus-related distribution is not treated as a rollover contribution for purposes of the one-rollover-per-year limitation under Code Sec. 408(d)(3)(B).

If a qualified individual elects to include all coronavirus-related distributions received in a year in gross income for that year and recontributes any portion of the coronavirus-related distributions to an eligible retirement plan at any time during the three-year recontribution period, then the amount of the recontribution will reduce the amount of the coronavirus-related distribution included in gross income for the year of the distribution. The qualified individual will report the amount of the recontribution on Form 8915-E (which will be filed with the individual's federal income tax return, if applicable).

Observation: Form 8915-E is a new form that the IRS expects to be available before the end of 2020.

If a qualified individual includes a coronavirus-related distribution in gross income in the year of the distribution and recontributes the distribution to an eligible retirement plan after the timely filing of the individual's federal income tax return for the year of the distribution (that is, after the due date, including extensions), the individual must file an amended federal income tax return for the year of the distribution. The qualified individual will need to file a revised Form 8915-E (with his or her amended federal income tax return) to report the amount of the recontribution and should reduce his or her gross income by the amount of the recontribution, but not in an amount exceeding the amount of the coronavirus-related distribution.

Example: Brenda receives a $45,000 distribution from a Section 403(b) plan on November 1, 2020. She is a qualified individual and treats the distribution as a coronavirus-related distribution. Brenda receives no other coronavirus-related distribution from any eligible retirement plan and recontributes $45,000 to an IRA on March 31, 2021. Brenda reports the recontribution on Form 8915-E and files the 2020 federal income tax return on April 10, 2021. For Brenda, no portion of the coronavirus-related distribution is includible as income for the 2020 tax year.

If a qualified individual includes a coronavirus-related distribution ratably over a 3-year period and the individual recontributes any portion of the coronavirus-related distribution to an eligible retirement plan at any date before the timely filing of the individual's federal income tax return (that is, by the due date, including extensions) for a tax year in the three-year period, the amount of the recontribution will reduce the ratable portion of the coronavirus-related distribution that is includible in gross income for that tax year.

Example: Denise receives $75,000 from a 401(k) plan on December 1, 2020. She is a qualified individual and treats the $75,000 distribution as a coronavirus-related distribution. Denise uses the three-year ratable income inclusion method for the distribution. Denise makes one recontribution of $25,000 to the 401(k) plan on April 10, 2022. She files the 2021 federal income tax return on April 15, 2022. Without the recontribution, Denise should include $25,000 in income with respect to the coronavirus-related distribution on each of her 2020, 2021, and 2022 federal income tax returns. However, as a result of the recontribution to the 401(k) plan, Denise should include $25,000 in income with respect to the coronavirus-related distribution on the 2020 federal income tax return, $0 in income with respect to the coronavirus-related distribution on the 2021 federal income tax return, and $25,000 in income with respect to the coronavirus-related distribution on the 2022 federal income tax return.

For a discussion of the tax treatment of coronavirus-related distributions, see Parker Tax ¶131,560.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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