IRS Expands CARES Act Tax Breaks On Retirement Plan Distributions, Loans

IRS Expands CARES Act Tax Breaks On Retirement Plan Distributions, Loans

The IRS expanded the number of taxpayers who qualify to tap into their retirement plans using the generous provisions of the CARES Act. The IRS also answered questions about details of distributions and loans under the CARES Act that have been asked by employers, employees, and plan administrators.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act allows people adversely affected by the coronavirus pandemic to take cash out of retirement plans and accounts with fewer restrictions and penalties than usual. The law also offers easier terms for paying taxes on distributions.

One provision of the CARES Act waives the 10% penalty on an early distribution from a retirement plan when the distribution is taken for coronavirus-related reasons. The penalty ordinarily is imposed when a retirement plan participant takes a distribution before age 59½ and the distribution doesn’t qualify for one of the existing exceptions to the penalty.

Even when the 10% penalty is avoided, the distribution is included in gross income. But under the CARES Act retirement plan distributions may be included in income over a three-year period instead of all in the year of the distribution.

Also, a distribution normally can’t be deposited to the same or another retirement plan, unless that is done within 60 days of the distribution. Otherwise, a return of a distribution would be an excess contribution to the plan. But under the CARES Act, the coronavirus-related distribution can be re-contributed to the plan within three-years in lieu of including it in gross income over three years. The distribution can be re-contributed to the same plan from which it was withdrawn or contributed to another plan of which the individual is a participant at the time of the re-contribution. Annual retirement plan contribution limits won’t apply to a re-contribution.

Now, the penalty is waived when the distribution was taken for coronavirus-related reasons.

This provision applies to IRAs as well as 401(k)s and other defined contribution retirement plans.

In another CARES Act provision, the amount that can be borrowed from a retirement plan is increased. (Loans can’t be taken from IRAs, only from employer retirement plans.)

The normal maximum amount of a retirement plan loan is the lesser of $50,000 or 50% of the participant’s vested account balance. That limit was increased for the 180 days that began with March 27, the day the CARES Act became effective.

The maximum loan amount is doubled to the lesser of $100,000 or 100% of the participant’s vested account balance.

There’s an additional benefit for anyone who had an outstanding retirement plan loan as of March 27, 2020. Payments due on those loans through December 31, 2020, can be deferred for one year at the plan sponsor’s option.

In the CARES Act, someone adversely affected by the pandemic is defined as someone who was diagnosed with the COVID-19, has a spouse or dependent diagnosed with it, or experienced adverse financial consequences as a result of being quarantined, furloughed, laid off, having work hours reduced, or being unable to obtain work because of a lack of child care, a business closing, or hours being reduced.

The CARES Act empowers the IRS to expand the list of qualified individuals. In Notice 2020-50, the IRS expands the list of adversely-affected taxpayers to include those who:

  • had a reduction in pay or self-employment income because of COVID-19 or had a job offer rescinded or start date delayed due to COVID-19;
  • had a spouse or household member who has been quarantined, furloughed, or laid off, or had work hours reduced due to COVID-19, or is unable to work because of lack of child care, had a reduction in pay or self-employment income due to COVID-19, or had a job offer rescinded or start date delayed because of COVID-19; or
  • had a business owned or operated by the individual’s spouse or household member that had to close or reduce hours because of COVID-19.

For many people the most important additions to the list are that more of the effects of the pandemic on a spouse or member of the household are examined to determine if an individual was adversely-affected.

Another important feature of the Notice is that, unlike a traditional hardship withdrawal, the amount of the distribution or loan doesn’t have to correspond to the direct financial impact of the pandemic on the individual. Plan members don’t have to prove the extent to which they were adversely affected, and plan administrators don’t have to sort through an employee’s bills, invoices and receipts to determine the qualifying amount of a loan of distribution.

The Notice also gives employers and plan administrators detailed guidance on how to report on next year’s 1099 forms the loans and distributions that qualify for CARES Act relief.

Employees should know that an employer or other plan sponsor can choose whether to adopt the CARES Act changes on loans and distributions. The Notice makes clear that employers aren’t required to adopt the provisions and make them available to employees.

This article was originally published by on June 23, 2020.

This information is provided with the understanding that Payroll Partners is not rendering legal, accounting, or other professional advice or service. Professional advice on specific issues should be sought from an accountant, lawyer, or other professional.