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Self-certification of Coronavirus-related distributions and plan loans

Plan sponsors can rely on participants to ‘self-certify’ they are qualified individuals who are eligible to take advantage of special rules for Coronavirus-related distributions (CRDs) and plan loans. Can you explain what it means to self-certify? Is a plan sponsor required to obtain formal documentation?

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 Massachusetts is representative of a common inquiry related to self-certification.

Highlights of the Discussion

The IRS explained what self certification for purposes of CRDs and plan loans means in IRS Notice 2020-50, Section 2 E.

The administrator of an eligible retirement plan may rely on an individual’s certification that the individual satisfies the conditions to be a qualified individual in determining whether a distribution is a coronavirus-related distribution, unless the administrator has actual knowledge to the contrary.

The notice goes on to explain that having “actual knowledge to the contrary” does not mean the plan administrator must inquire whether an individual has satisfied the conditions to be a qualified individual, but need only possess information that is sufficiently accurate to judge the certification as truthful.

While the notice did not specify that the certification be “in writing,” retaining evidence of the certification is part of a good plan governance and administration process. To that end, the IRS included an example of an acceptable certification on pages 9 and 10 of Notice 2020-50 (reproduced below).

Name: _______________________ (and other identifying information requested by the employer for administrative purposes).

I certify that I meet at least one of the following conditions: (1) I was diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (referred to collectively as 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) my spouse or my dependent was 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) I have experienced adverse financial consequences because: (i) I, my spouse, or a member of my household was quarantined, furloughed or laid off, or had work hours reduced due to COVID-19; (ii) I, my spouse, or a member of my household was unable to work due to lack of childcare due to COVID-19; (iii) a business owned or operated by me, my spouse, or a member of my household closed or reduced hours due to COVID-19; or (iv) I, my spouse, or a member of my household had a reduction in pay (or self-employment income) due to COVID-19 or had a job offer rescinded or start date for a job delayed due to COVID-19.

Signature: ______________________

The above certification, or one similar to it, can be used to authorize the

  • Taking of a CRD;
  • Recontribution (or rollover) of a CRD within three years to an eligible retirement plan; and
  • Application of the special rules for coronavirus-related loans.

If a plan offers CRDs, accepts CRD rollovers and/or applies the special rules for coronavirus-related plan loans, the sponsor should check with its recordkeeping service providers to verify appropriate procedures related to the self-certification process are in place.

Conclusion

While not required to do so, qualified retirement plans can offer CRDs and implement special coronavirus-related loan rules. Only qualified individuals may take advantage of these temporary rules if their work-place retirement plan offers them. To ease the determination as to whether a person is a qualified individual, plan sponsors can follow the self-certification guidance of IRS Notice 2020-50.

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Qualified plan loans and Coronavirus-related distributions

If a qualified plan participant defaults on a plan loan, can he/she treat the distribution as a Coronavirus-Related Distribution (CRD), even if the plan does not offer CRDs?”  

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 Arizona is representative of a common inquiry related to CRDs.

Answer:  Potentially, if there is a loan offset.  If a retirement plan reduces, or offsets, a participant’s account balance by the unpaid portion of a defaulted loan, the IRS considers such amount an actual distribution, which could be treated as a CRD, provided the plan participant otherwise meets the definition of a CRD-qualified individual. (See definition below). A recipient of a CRD can take advantage of special tax rules that allow him/her to pay back the amount within three years (2020, 2021 and 2022); and/or spread the taxation of any amounts retained over three years. Loans treated as “deemed distributions” may not qualify as CRDs (Notice 2020-50).

When a participant fails to meet the repayment requirements of a plan loan and cannot payoff the loan in full, the loan is in default. The plan administrator must handle the outstanding loan balance in one of two ways: 1) as a loan offset or 2) as a deemed distribution.

Loan offset

A loan offset occurs when, in conjunction with the loan default, a participant has a distribution triggering event under the terms of the plan. In this case, the plan administrator will use the participant’s remaining account balance to pay off (offset) the loan amount. The plan reports the offset on IRS Form 1099-R; coded as an actual distribution based on the age of the recipient, and uses special code M to signify “loan offset.”

The IRS considers a loan offset as an eligible rollover distribution, assuming the recipient can come up with the amount out of pocket to complete the rollover in a timely manner. Further, if the plan loan offset is due to plan termination or severance from employment, instead of the usual 60-day rollover period, the individual has until the due date, including extensions, for filing his/her Federal income tax return to complete the rollover. IRS Notice 2020-50 confirms that an offset of a qualified individual’s plan account balance in order to repay a plan loan is permitted to be treated as a CRD, if the recipient is otherwise eligible, regardless of whether the plan allows for CRDs.

EXAMPLE

As a result of a workforce reduction, Cameron was let go from his employer. He has an outstanding 401(k) plan loan which he cannot pay back at this point. Since Cameron has a distribution trigger (i.e., separation from service) the plan administrator will offset his account balance by the outstanding loan amount, and report the distribution on Form 1099-R using code M. Cameron is CRD-eligible, but his 401(k) plan does not allow CRDs. Nonetheless, the IRS allows Cameron to treat the loan offset as a CRD, and take advantage of the special three-year tax treatment rules.

Loan as deemed distribution

In contrast, a deemed distribution of a loan balance occurs when a participant does not have a distribution triggering event under the terms of the plan at the time of the loan default, and no other way to pay back the loan. In this situation, the plan reports the loan amount as distributed using a special code “L” for deemed distribution on Form 1099-R. The participant must include the deemed distribution in taxable income for the year; subject to an early distribution penalty tax (unless an exception applies). A deemed distribution cannot be treated as a CRD, and is not eligible for rollover.

Who qualifies for a CRD?

The definition of a CRD-qualified individual was updated as a result of IRS Notice 2020-50 to include

1)   An individual, his or her spouse, beneficiary or a dependent who is officially diagnosed with COVID– 19;

2)   An individual, his or her spouse, beneficiary or member of the household (i.e., someone who shares the individual’s principal residence) who experiences adverse financial consequences as a result of Covid-19 because of

  • Furlough,
  • Lay off,
  • Job offer rescission;
  • Start date delay;
  • Reduced work hours or pay (including self-employment income);
  • Lack of child care, or
  • A closure or reduction in the hours of a business owned or operated by the individual.

Conclusion

Pursuant to Notice 2020-50, CRD-qualified individuals who experience a loan offset may treat such amounts as CRDs, regardless of whether the plan offers CRDs. Deemed distributions of defaulted loans, in contrast, may not be treated as CRDs, and are not eligible for rollover.

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Reporting Coronavirus-Related Distributions

“With the creation of Coronavirus-Related Distributions (CRDs) and the ability to pro rate the taxation and pay the withdrawal back within three years, how will retirement plan and IRA administrators, as well as individuals, report these transactions to the IRS? Won’t it be a big mess?”

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 Washington is representative of a common inquiry related to CRDs.

Highlights of the Discussion

While we do not have definitive reporting guidance yet, we anticipate the IRS’s reporting procedures for CRDs will be similar to those the agency already has in place for “qualified disaster distributions” (QDDs). It seems we’ve been here before.

For CRDs, the IRS will waive the 10% early distribution penalty for the first $100,000 taken from an eligible retirement plan due to Coronavirus. Distribution recipients may pay back the amount within three years (2020, 2021 and 2022); and taxation can be spread over three years. The term ‘‘eligible retirement plan’’ includes an IRA (as well as an IRA-based plan), qualified plan, qualified annuity plan, governmental 457(b) plan or 403(b) plan.

Like CRDs, QDDs, were tax-favored withdrawals and repayments from certain retirement plans for taxpayers who suffered economic losses as a result of disasters like those for Hurricanes Harvey, Irma and Maria, and the California Wildfires. The most recent IRS Publication 976, Disaster Relief and Forms 8915-A, 2016 Qualified Disaster Retirement Plan Distributions and Repayments and 8915-B Qualified 2017 Disaster Retirement Plan Distributions and Repayments and their instructions (Instructions to Form 8915-A and Instructions to Form 8915-B) give us a pretty good idea of what the IRS will expect for CRDs with respect to reporting. No doubt there will be some “tweaks” needed to these materials to encompass CRDs, but at least we know we are not starting from scratch!

Conclusion

When and how much of a CRD a recipient pays back (rolls over) within the next three years will dictate his or her precise reporting protocol. Reporting will not be the same for everyone. It may involve filing amended tax returns, but rest assured there will be a manageable process for plan and IRA administrators, as well as IRA owners and plan participants to account for CRDs.

© Copyright 2020 Retirement Learning Center, all rights reserved