The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) provides various relief provisions for individuals, including provisions that benefit individuals in relation to their retirement plans and that provide an increase in allowable charitable deductions.
Income Taxation of Retirement Plans
10 Percent Additional Tax Waived for Coronavirus-Related Distributions
Generally, the IRS imposes ordinary income tax on retirement plan distributions. The IRS also imposes a 10 percent additional tax on retirement plan distributions that are included in the distributee’s gross income unless the distributee is over the age of 59½ or another exception is met.
The CARES Act waives this 10 percent additional tax for any “coronavirus-related distribution” up to $100,000. It is not necessary that the relevant plan allowed hardship distributions prior to the CARES Act. A coronavirus-related distribution is defined as any distribution from an eligible retirement plan, which includes IRAs, IRA annuities, qualified trusts, certain other retirement annuities, and specific deferred compensation plans, made during 2020 to an individual that meets one of the following criteria (“Qualified Individual”):
- He or she is diagnosed with SARS-CoV-2 or COVID-19 by a test approved by the CDC;
- His or her spouse or dependent is diagnosed with SARS-CoV-2 or COVID-19 by a test approved by the CDC; or
- He or she experiences adverse financial consequences as a result of being quarantined, being furloughed, laid off, or having work hours reduced due to such virus or disease, being unable to work due to lack of child care due to such virus or disease, closing or reducing hours of a business owned or operated by the individual due to such virus or disease, or other factors as determined by the Secretary of the Treasury.
The plan administrator may rely on the employee’s certification that the employee meets one of the above conditions to determine whether the distribution qualifies as a coronavirus-related distribution. For federal income tax return purposes, an employee’s certification alone is not sufficient; instead, the individual must actually meet the eligibility requirements.
Although the plan administrator has the option of whether or not to treat the distribution as a coronavirus-related distribution, a Qualified Individual may treat the coronavirus-related distribution as such on his or her federal income tax return regardless of how the plan administrator treats the distribution. The coronavirus-related distribution would be reported on a Form 8915-E.
Three-Year Rules Related to the Income Taxation of Coronavirus-Related Distributions
Although the 10 percent additional tax is waived when the foregoing requirements are met, the IRS will generally still impose income tax on distributions from an eligible retirement plan. To provide further relief, unless the Qualified Individual elects out of this treatment, the amount of the coronavirus-related distribution required to be included in gross income will be includable ratably over a three-year period beginning with the year of the distribution. In other words, the tax liability payments may be spread out over this three-year time period.
Further, a Qualified Individual may repay an amount up to the amount of the coronavirus-related distribution to the eligible retirement plan within the three-year period beginning with day after the date of the distribution. If the Qualified Individual repays the coronavirus-related distribution, then the Qualified Individual will be treated as transferring the repayment tax-free to the eligible retirement plan as a rollover contribution and the repayment will not affect the cap on retirement account contributions.
On May 4, 2020, the IRS provided FAQs for coronavirus-related relief under the CARES Act for retirement plans. These FAQs provide an example related to the repayment of the coronavirus-related distribution as follows:
“If, for example, you receive a coronavirus-related distribution in 2020, you choose to include the distribution amount in income over a 3-year period (2020, 2021, and 2022), and you choose to repay the full amount to an eligible retirement plan in 2022, you may file amended federal income tax returns for 2020 and 2021 to claim a refund of the tax attributable to the amount of the distribution that you included in income for those years, and you will not be required to include any amount in income in 2022.”
It is important to note, however, that plan administrators are not required to accept rollover contributions and will not be required to change their terms or procedures to accept such repayments. Therefore, if your plan currently does not accept rollover contributions, you likely will not be able to take advantage of this repayment option.
Loans from Qualified Employer Plans for Coronavirus-Related Relief
The CARES Act provides more flexibility for Qualified Individuals to take out loans from qualified employer plans, which includes a 401(a) plan, certain annuity plans, and certain 403(b) plans. Prior to the CARES Act, an individual could take out a loan without it being treated as a distribution from a qualified employer plan in the amount that was the lesser of $50,000 or one-half of the value of the account balance. For the 180-day period beginning on March 27, 2020, the plan administrator may allow a Qualified Individual to take out a loan up to the lesser of $100,000 (minus the individual’s outstanding plan loans) or the full value of the individual’s vested benefit under the plan.
Additionally, if a Qualified Individual has an outstanding loan from a qualified employer plan that is due between March 27, 2020 and December 31, 2020, the plan administrator may permit the due date to be delayed for one year; however, interest will accrue during such delay and payments following the one-year delay will be adjusted to account for the delayed time period. The one-year delay will not count toward the five-year requirement that a loan from a qualified employer plan be repayable within five years.
Temporary Waiver of Required Minimum Distribution Rules
For 2020, the required minimum distribution (“RMD”) requirements for certain defined contribution plans and individual retirement plans do not apply. This includes any RMD, including RMDs from 2019, that are required to be made in 2020 as long as it was not made before 2020. This includes RMDs that were required to begin in 2020 due to an owner turning 70½ in 2019.
Similar to the relief provided in 2009 as a result of the economic recession, amounts distributed in 2020 that would otherwise have been an RMD are eligible for rollover, subject to limitations.
There are also various provisions related to plan amendments.
The Treasury Department and IRS plan to release further guidance on the retirement plan aspect of the CARES Act in the near future.
For individuals who do not itemize deductions, the CARES Act provides a new above-the-line deduction for qualified charitable contributions up to $300 annually. To qualify, the contribution must be made in cash to a 170(b)(1)(A) organization, which does not include a 509(a)(3) supporting organization or a donor advised fund.
The CARES Act also provides benefits for individuals and corporations who itemize deductions when such taxpayers contribute cash to a 170(b)(1)(A) charitable organization (not including a 509(a)(3) supporting organization or a donor advised fund) and elect for such benefits to apply (“Qualified Contribution”). In the case of a partnership or S-corporation, the election for such benefits to apply must be made separately by each partner or shareholder.
For individuals who itemize deductions, the CARES Act removes the cap (which was 60 percent of adjusted gross income) for 2020 on the deduction for a Qualified Contribution. Thus, an individual who itemizes deductions may deduct a Qualified Contribution to the extent such contribution does not exceed the individual’s adjusted gross income. An individual may carry over and deduct the excess Qualified Contribution over the following five-year period.
For corporations, the CARES Act changes the limitation from 10 percent to 25 percent of the corporation’s taxable income on the deduction for a Qualified Contribution for 2020. The corporation will also be able to carry over and deduct the excess Qualified Contribution in the following five years, subject to limitations.
Finally, the CARES Act changes the limitation from 15 percent to 25 percent of net income on the deduction for a charitable contribution of food inventory from a trade or business during 2020.
Attorney Colton F. Castro contributed to this post.