Treasury Issues Favorable CARES Guidance--With a Tight Deadline

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In late June 2020, the IRS issued guidance on the one-year suspension of required minimum distributions (IRS Notice 2020-51, June 22, 2020) and on coronavirus-related distributions (IRS Notice 2020-50, June 20, 2020). Both notices provide very liberal and participant-friendly interpretations of the CARES Act’s tax relief for retirement-plan owners, though one provision comes with a short two-month deadline for taxpayers who need its help.

If you already took your RMD--you can pay it back!

We already knew that, thanks to the CARES Act, RMDs were suspended (not required) for calendar-year 2020. And we knew that, because CARES was not enacted until the end of March 2020, many clients had already taken their 2020 RMD (in full or in part) before CARES even existed. We knew that some people could reverse those distributions with a standard rollover, and that a few people would even be able to treat their 2020 RMDs, which were no longer required, as coronavirus-related distributions, or CRDs, with a three-year rollover deadline.

Advisors and their clients hoped for more relief from the Treasury to help those who took required distributions--which turned out not to be required--but for one reason or another could not use the standard rollover or CRD path. The IRS has now delivered generous relief. Almost everyone who took a 2020 RMD who didn’t need to can eliminate the tax on the unwanted distributions by rolling them over via one of the three paths recognized in Notice 2020-51:

Repayment of IRA distribution by Aug. 31, 2020. This one is brand new: Anyone who received an IRA distribution in 2020, which would have been a required minimum distribution if CARES had not been enacted, can pay that distribution back into the IRA it came out of by Aug. 31, 2020, and thereby eliminate the otherwise taxable distribution. This even applies to recipients who cannot use the regular rollover provisions, namely nonspouse beneficiaries of inherited IRAs (who normally cannot roll over ANY distribution from the inherited IRA) and IRA owners for whom a rollover would violate the once-per-12-months limit on IRA-to-IRA rollovers. Advisors must act very fast to help their clients take advantage of this relief--especially the nonspouse beneficiaries of inherited IRAs who have no other option for reversing a distribution already taken. Unfortunately, this repayment relief applies only to IRAs--it's not applicable for distributions from other types of plans such as 401(k) and 403(b) plans.

Regular rollover. Since any RMD distributed in 2020 is actually not an RMD (thanks to CARES), it is automatically an eligible rollover distribution (except for nonspouse beneficiaries, of course). Thus, the recipient can generally roll it over to any eligible retirement plan within 60 days. The IRS has extended the deadline to Aug. 31, 2020, for these rollovers, if that is later than the 60-day deadline (for example, someone who received the distribution in January 2020 now has until Aug. 31, 2020, to roll it over). These regular types of rollovers are subject to the usual limits, such as the once-per-12-months limit on IRA-to-IRA rollovers, and the prohibition against rollovers by nonspouse beneficiaries of inherited plans.

Coronavirus-related distribution. A coronavirus-related distribution can be rolled over anytime within three years after the distribution is received, and it is not subject to the once-per-12-months limit on IRA-to-IRA rollovers. The IRS, in Notice 2020-50, expanded the categories of "qualified individuals" whose 2020 retirement-plan distributions can be treated as CRDs (see below). So, these qualified individuals will have three years to eliminate the tax on a 2020 RMD, which is no longer required, by rolling it over into the same or another retirement plan. This path is not available to nonspouse beneficiaries of inherited retirement benefits--a nonspouse beneficiary can receive a CRD but cannot roll it over (except via the repayment path discussed above).

Expanded Categories of Coronavirus-Related Distributions As explained in my May column, a CRD receives three special tax breaks: The 10% tax on distributions prior to age 59.5 does not apply; the recipient can elect to spread the income tax over three years, instead of paying it all in the year of the distribution; and the recipient (if eligible to make rollovers) can roll over the CRD for up to three years after the distribution, instead of the usual 60 days. Much of IRS Notice 2020-50 is devoted to the complicated guidance needed if an individual who elects the three-year tax spread ends up rolling all or part of the distribution over during the three-year period, thereby retroactively reducing or erasing the tax liability they had incurred.

In defining a CRD, the CARES Act specified certain categories of qualified individuals, such as an individual who was diagnosed with COVID-19 (or whose spouse was so diagnosed), or an individual who suffered adverse financial effects due to being furloughed or laid off as a result of the pandemic. CARES allowed the Treasury to expand the definition of CRD by adding other types of virus-triggered situations that could cause adverse financial effects, and the IRS has done so in Notice 2020-50. Significantly, the IRS added reduced pay and hours to the list, and also expanded the work-related cutbacks, lack of child care, and so on, to include not just the retirement plan owner but also his or her spouse and household members.

With this expanded, more-generous definition of coronavirus-related distributions, it appears that most workers will qualify to receive CRDs, since few occupations were left untouched by the virus-triggered shutdowns. However, since the categories are mostly work-related, a retiree will likely qualify for CRD treatment only if he (or his spouse) is actually diagnosed with the virus or shares a house with an essential worker.

The Treasury’s generous and liberal interpretation of the CARES Act relief provisions should provide substantial flexibility and options for our retirement-plan-owning clients. And as a reminder, one of those provisions (allowing repayment of IRA distributions) requires very fast action by advisors whose clients need its relief due to its fast-approaching Aug. 31, 2020, deadline.

Natalie Choate is an estate planning lawyer in Boston with Nutter McClennen & Fish LLP. Her practice is limited to consulting regarding retirement benefits. The new 2019 edition of Choate's best-selling book, Life and Death Planning for Retirement Benefits, is now available through her website, www.ataxplan.com, where you can also see her speaking schedule and submit questions for this column. The views expressed in this article may or may not reflect the views of Morningstar.