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2021 Qualified Charitable Distributions from IRAs

“The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 changed the age for taking requirement minimum distributions (RMDs) to age 72.  Did it also change the age for making Qualified Charitable Distributions (QCDs)?”

 

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from Alabama is representative of a common inquiry related to charitable giving.

Highlights of the Discussion

  • No, the SECURE Act did not change the eligibility age for making a QCD; it remains at 70½. So, any “eligible IRA owner or beneficiary” (defined below) can make a QCD up to $100,000 for 2021 by December 31, 2021.  The contributor must keep records to prove the amount of the QCD  (see Substantiation Requirements in IRS Publication 526, Charitable Contributions).
  • Those who make QCDs before reaching age 72 will not have the added benefit of counting them towards their RMDs, but the QCDs still will be excludable from taxable income and go towards supporting good causes. Because a QCD reduces taxable income, other potential benefits may result, for example, a person may be able to avoid paying higher Medicare premiums. Note that for those who make both QCDs and deductible IRA contributions[1] in the same year may need to limit the portion of a QCD that is excluded from income.
  • An eligible IRA owner or beneficiary for QCD purposes is a person who has attained age 70½ or older, and has assets in traditional IRAs, Roth IRAs, or “inactiveSEP IRAs or savings incentive match plans for employees (SIMPLE) IRAs. Inactive means there are no ongoing employer contributions to the SEP IRA or SIMPLE IRA. A SEP IRA or a SIMPLE IRA is treated as ongoing if the sponsoring employer makes an employer contribution for the plan year ending with or within the IRA owner’s taxable year in which the charitable contribution would be made (see IRS Notice 2007-7, Q&A 36).
  • A QCD is any otherwise taxable distribution (up to $100,000 per year) that an eligible person directly transfers to a “qualifying charitable organization.” QCDs were a temporary provision in the Pension Protection Act of 2006. After years of provisional annual extensions, the Protecting Americans from Tax Hikes Act of 2015 reinstated and made permanent QCDs for 2015 and beyond.
  • Generally, qualifying charitable organizations include those described in §170(b)(1)(A) of the Internal Revenue Code (IRC) (e.g., churches, educational organizations, hospitals and medical facilities, foundations, etc.) other than supporting organizations described in IRC § 509(a)(3) or donor advised funds that are described in IRC § 4966(d)(2). The IRS has a handy online tool Tax Exempt Organization Search, which can help taxpayers identify organizations eligible to receive tax-deductible charitable contributions. Note that a QCD contributor would not be entitled to an additional itemized tax deduction for a charitable contribution when making a QCD.
  • Where an individual has made nondeductible contributions to his or her traditional IRAs, a special rule treats amounts distributed to charities as coming first from taxable funds, instead of proportionately from taxable and nontaxable funds, as would be the case with regular distributions.
  • Be aware there are special IRS Form 1040 reporting instructions that apply to QCDs.
  • Section IX of IRS Notice 2007-7 contains additional compliance details regarding QCDs. For example, QCDs are not subject to federal tax withholding because an IRA owner that requests such a distribution is deemed to have elected out of withholding under IRC § 3405(a)(2) (see IRS Notice 2007-7 , Q&A 40).
  • There are other charitable giving options aside from QCDs. For example, the Consolidated Appropriations Act extended two temporary tax changes through the end of 2021 to encourage charitable giving by individuals (see Covid Tax Tip 2021-143). They include 1) a limited deduction (up to $600 for married couples) for charitable cash contributions for individuals who do not itemize deductions; and 2) a deduction of up to 100 percent of the taxpayer’s adjusted gross income for certain charitable cash contributions (if properly elected on their 2021 Form 1040 or Form 1040-SR) by those who itemize their deductions.
  • As one can see, the options for charitable giving are many and can be confusing, making consultation with a tax professional a recommended course of action.

Conclusion

Eligible traditional and Roth IRA owners and beneficiaries, including those with inactive SEP or SIMPLE IRAs, should be aware of the benefits of directing QCDs to their favorite charitable organizations.  Law changes and extensions have enhanced other giving options, making professional tax advice essential when making a gifting decision.

 

[1] The SECURE Act also eliminated the maximum age limit for making traditional IRA contributions.

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Privacy Notices and Retirement Plans

One of my clients who sponsors a 401(k) plan asked about the timing of sending a recordkeeper privacy notice to plan participants.  Does such a notice exist and, if so, when is the due date for delivery?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Oklahoma is representative of a common inquiry related to 401(k) plan notices.

Highlights of the Discussion

At this time, there is no federal requirement for recordkeepers of qualified retirement plans to issue privacy notices to plan participants. However, a similar requirement could be coming down the pike as regulators become more concerned over retirement plan cybersecurity issues. In practice, research has found that some third-party administrators (TPAs) who administer both health plans [regulated by the Health Insurance Portability and Accountability Act of 1996 (HIPAA)] and retirement plans (regulated by the Employee Retirement Income Security Act of 1974 (ERISA)] have adopted similar security protection practices for both areas, including sending out Privacy Notices.[1]

As you may know, HIPAA is the federal law that resulted in the creation of national standards for the protection of sensitive patient health information from being disclosed without the patient’s consent or knowledge. The HIPAA Privacy Rule requires health plans and covered health care providers (“covered entities”) to distribute a notice that provides a user-friendly explanation of an individual’s rights with respect to their personal health information and the privacy practices of the covered entities. Covered health care entities must give the notice at enrollment and send a reminder at least once every three years explaining that individuals may request the notice at any time. The Privacy Notice must appear on the entity’s website and be posted in a conspicuous location as well.

With respect to qualified retirement plans, the Department of Labor currently has not created definitive cybersecurity rules or regulations. Instead, in April of 2021, it issued cybersecurity tips and best practices for plan sponsors, recordkeepers and participants:

  • Tips for Hiring a Service Provider: This piece helps plan sponsors and fiduciaries prudently select a service provider with strong cybersecurity practices and monitor their activities, as ERISA requires.
  • Cybersecurity Program Best Practices: This piece assists plan fiduciaries and record-keepers in their responsibilities to manage cybersecurity risks.
  • Online Security Tips: This piece offers plan participants and beneficiaries who check their accounts online basic rules to reduce the risk of fraud or loss.

Despite the lack of formal directives from the DOL, there is an understanding under DOL Regulation Section 2520.104b-1(c) and other pronouncements related to the electronic delivery of plan information that a plan sponsor must ensure the plan recordkeeping system it uses keeps participants’ personal information relating to their accounts and benefits confidential.

Conclusion

Currently, there is no HIPAA-like Privacy Notice required for retirement plan participants at this time. DOL regulators continue their conversations over what rules

[1] Advisory Council on Employee Welfare and Pension Benefit Plans, “Privacy and Security Issues Affecting Employee Benefit Plans, 2011

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Establishing a Solo 401(k) under the New Rules

“My client is a sole proprietor and would like to set up a solo 401(k) plan for 2021. Are there any special considerations of which he needs to be aware?

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from Connecticut is representative of a common inquiry related to establishing a Solo 401(k) plan.

Highlights of the Discussion
• Yes, there are special considerations with respect to establishing and contributing to a solo 401(k) plan. For that reason, your client should work with his CPA, tax advisor and/or legal counsel to address all the issues.

• Three of the key consideration would include the following items, the

 Deadline for establishing the solo 401(k) plan,
 Deadline for making a salary deferral election, and
 Owner’s compensation for contribution purposes.

• In order to be able to make employee salary deferrals to the solo 401(k) for 2021, a sole proprietor would have to establish the solo 401(k) and execute a salary deferral election by December 31, 2021. Here’s why.

• Although the Setting Every Community Up for Retirement Enhancement (SECURE) Act, delayed the deadline for establishing a qualified retirement plan for a particular tax year until the business’s tax return due date, plus extensions, in practice, the delay only applies for facilitating the ability to make employer contributions (e.g., a profit-sharing contribution) for the prior year—not employee salary deferrals. Let’s take a look at an example.

EXAMPLE
The 2021 maximum contribution for an unincorporated business owner to a solo 401(k) plan with enough earned income could be as high as $58,000 (or $64,500 if he or she turns age 50 or older before the end of the year). Anthony, a 54-year-old sole proprietor who earns $400,000, would like to set up a solo 401(k) plan for 2021. If Anthony establishes the solo 401(k) by December 31, 2021, and executes a salary deferral election by the same date, his maximum contribution for 2021 would be $64,500.

If, under the new plan establishment rules, Anthony waits until sometime in 2022 before his extended tax filing deadline for 2021 (i.e., October 15, 2022) to establish a solo 401(k) for 2021, he could not make employee salary deferrals for 2021. Consequently, his maximum contribution in this scenario would be limited to $58,000 for 2021.

• In all cases, a salary deferral election must be made prior to the receipt of compensation Treasury Regulation (Treas. Reg.) 1.401(k)-1(a)(3)]. Pursuant to Treas. Reg. 1.401(k)-1(a)(6)(iii), for self-employed individuals (i.e., sole proprietors and partners), compensation is considered paid on the last day of the business owner’s taxable year (e.g., December 31, 2021 for 2021). Therefore, a self-employed person has until the end of his or her taxable year to execute a salary deferral election for “the plan.” Conservatively, that means the plan would have to be in place by December 31, 2021, as well to allow for the sole proprietor to make the salary deferral election.

• The definition of compensation for contribution purposes for an unincorporated business owner is unique IRC 401(c)(2)(A)(I). It takes into consideration earned income or net profits from the business but must be adjusted for self-employment taxes. Please refer to the worksheet for calculating contributions to a solo 401(k) plan for a self-employed individual in IRS Publication 560, Retirement Plans for Small Businesses

 

Conclusion
For self-employed individuals and their tax advisors, there are several special considerations with respect to setting up and contributing to solo 401(k) plans, including, but not limited to, the deadline for establishing a 401(k) plan, the deadline for making a salary deferral election, and the owner’s compensation for contribution purposes.

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“Disregarded Entities,” 403(b)s and 457(b)s

“How are subsidiaries and affiliates of an employer eligible to sponsor a 403(b) plan treated for plan participation purposes?”

Highlights of the Discussion

Generally, in order to offer an IRC §403(b) plan, the sponsor must be an “eligible employer” [e.g., a public school, church, or IRC §501(c)(3) organization as defined under Treasury Regulation (Treas. Reg) §1.403(b)-2(b)(8)(i)]. If the eligible 403(b) sponsor has a subsidiary or other affiliate; it, too, must be an eligible employer, in and of itself, in order to allow its employees to participate in the 403(b) plan [Treas. Reg. §1.403(b)-2(b)(8)(ii)].  There is an exception, however, for “disregarded entities” under Treas. Reg. §301.7701-3(b)(ii), including certain limited liability companies (LLCs) as explained in Chief Counsel Memorandum 201634021.[1] Memoranda are not formal guidance, but they do provide insight into how the IRS interprets and applies its rules and regulations.

In general, an LLC with a single owner may elect to be classified as either an association by filing Form 8832, Entity Classification Election or to be disregarded as an entity separate from its owner pursuant to Treas. Reg. §301.7701-3(b)(ii). If an entity is a disregarded entity, its activities are treated as those of a sole proprietorship, branch, or division of the owner under Treas. Reg. §301.7701-2(a). Consequently, a disregarded entity is treated as a branch or division of the 403(b) plan sponsor and not as a subsidiary or affiliate. Therefore, the employees of a disregarded entity are treated as employees of the entity sponsoring the 403(b), and must be allowed to make elective deferrals in order to satisfy the universal availability rule under Treas. Reg. § 1.403(b)-5(b).

The IRS applies similar reasoning to a governmental or tax-exempt, single-member LLC with a disregarded entity that sponsors a 457(b) plan. The disregarded entity is treated as a branch or division of the governmental or tax-exempt organization, so the employees of the disregarded entity are treated as employees of the governmental or tax-exempt organization and may, but are not required to, participate in the 457(b) plan.

Conclusion

In most cases, if a 403(b) sponsor has a subsidiary or other affiliate; it, too, must be an eligible employer, on its own, in order to allow its employees to participate in the 403(b) plan. There is an exception for certain disregarded entities. Employees of a disregarded entity are treated as employees of the entity sponsoring the 403(b), and must be allowed to make elective deferrals in order to satisfy the universal availability rule.

 

[1] Note:  General Counsel Memoranda are prepared by Chief Counsel attorneys and are intended primarily for IRS internal use. They are similar to standard attorney opinions and indicate the reasoning behind revenue rulings, private letter rulings, and technical advice memoranda.

 

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