On March 27, 2020, President Trump signed H.R. 748, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act” or the “Act”). The CARES Act makes significant changes tax related employment and employee benefits changes in the form of a number of relief provisions designed to mitigate the negative economic consequences of the novel coronavirus or “COVID-19” pandemic. The Act complements prior relief legislation, the Families First Coronavirus Response Act (PL 116–127, H.R. 6201). Due to the unusual speed of the legislative process, the CARES Act may contain technical issues or drafting errors that may have to be addressed in future legislation.
This blog post summarizes several of the most significant employment and employee benefits tax changes for businesses and individuals. A separate blog post containing a more detailed review of the other tax and accounting changes is available here. The Kean Miller Tax Group will post additional updates as the situation develops.
In addition to the tax changes, the CARES Act contains provisions designed to provide relief to small businesses, large businesses, and changes designed to support the U.S. health care system.
Section 2202 – Special Rules for Use of Retirement Funds –
Section 2202(a) – Tax Favored Withdrawals from Qualified Plans
The CARES Act provides for tax favored withdrawals from qualified plans. Under the Act, Internal Revenue Code (“IRC”) Section 72(t) shall not apply to any “Coronavirus related distribution”. IRC Section 72(t) imposes a 10% penalty on any premature distribution from a qualified plan. This relief provision applies broadly to eligible retirement plans, including individual retirement accounts and annuities, plans qualified under IRC Section 401(a) and 403(a), tax sheltered annuities under IRC Section 403(b) or governmental deferred compensation plans under IRC Section 457(b). A distribution is considered to be a coronavirus related distribution if it is made between January 1, 2020 and December 31, 2020 to an individual that satisfies one of the following criteria:
- An individual diagnosed with COVID-19 virus by a test approved by the Centers for Disease Control and Prevention (the “CDC”); or
- An individual whose spouse or dependent is diagnosed with COVID-19 virus; or
- An individual who has incurred adverse financial conditions resulting from quarantine, furlough, layoff, or reduction of hours associated with COVID-19; or
- An individual that is unable to work due to lack of childcare resulting from COVID-19; or
- An individual who is unable to work as a result of the closing of a business owned or operated by the individual due to the COVID-19 virus.
The plan administrator of a qualified plan may rely on a certification from the employee that he or she meets the conditions of an individual entitled to such a distribution.
The amount of the Coronavirus related distribution may not exceed $100,000 for any taxable year with respect to an individual. Notwithstanding this, the employer sponsor of a qualified plan is permitted to make a distribution from the plan to a particular individual provided that all such distributions from all such plans maintained by the employer and any members of the employer’s controlled group to that individual do not exceed $100,000 in the aggregate.
The consequences of a distribution being a Coronavirus related distribution are that: (1) the distribution is permitted under a plan notwithstanding the other limitations on distributions from the plan for 401(k) distributions, or distributions by 403(b) or 457 plan; (2) the distribution is not subject to penalty under IRC Section 72 (t) of 10% of the amount of the early distribution; (3) although the distribution is taxable, the income from the distribution is spread ratably over three years, unless the employee elects to have it taxed in the year of the distribution; (4) the distribution is exempt from withholding; and (5) the distribution may be repaid in whole or in part (thereby avoiding income taxation to the employee/distributee) at any time within three years from the date of the distribution. The repayment may be made to any eligible plan, in which case it is treated as a rollover within 60 days from the date of distribution; that is, it is not taxable. The amount of the distribution to be repaid may not exceed the amount of the distribution.
If a plan sponsor chooses to allow Coronavirus related distributions, the sponsor must amend its plan to do so. Specifically, employers have until the last day of the plan year beginning on or after January 1, 2022 to make an amendment to their plan incorporating these provisions, provided that the amendment is consistent with the CARES Act, the plan is operated in accordance with the amendment, and the amendment is retroactive.
Section 2202(b) – Increase to Limits on Loans Made from Qualified Plans
The CARES Act increases the limits on loans that are permitted to be made from qualified plans to certain “qualified individuals” without tax. Qualified plans for this purpose include plans qualified under IRC section 401(a), 403(a) and 403(b), as well as governmental plans. The dollar limit is increased from $50,000 to $100,000, and the percentage of the participant’s vested accrued benefit that can be loaned is increased from 50% to 100%. The loan may be made during the 180 day period beginning on the date of enactment; after that date, the old limits will apply to any new loans.
Example: Employee C, who has been diagnosed with COVID-19 virus, has accrued a vested benefit under his employer’s defined benefit pension plan that has a present value of $150,000 as of April 1, 2020. He may borrow $100,000 from the plan as of that date.
In addition, if any payment is due on any loan to a qualified individual (including pre-existing loans outstanding on March 27, 2020) between March 27, 2020 and December 31, 2020, the payment may be delayed for one year. Subsequent payments will be adjusted to reflect the delay and interest accrued during the period of the delay. In determining the 5-year period during which the loan is required to be paid, the period from March 27, 2020 to December 31, 2020 is disregarded; that is, the 5-year period is extended by that period of time. A qualified individual is an individual that satisfies one of the criteria required for an individual to receive a coronavirus related distribution (see above).
The employer sponsoring the plan is permitted to amend the plan to allow for such loans by the end of the plan year beginning on or after January 1, 2022, provided that the plan is operated in accordance with the CARES Act, is operated as if the amendment had been made, and the amendment is retroactive.
Section 2203 – Temporary Waiver of Required Minimum Distribution Rules For Certain Retirement Plans and Accounts – The CARES Act provides for the elimination of the required minimum distributions (“RMDs”) due in 2020 from certain defined contribution plans (including plans qualified under IRC Section 401(a), annuity plans under IRC Section 403(a), tax sheltered annuities under IRC Section 403(b), as well as governmental 457(b) plans) and individual retirement accounts and annuities. For persons who turned 70 1/2 before 2019, the RMD due for 2020, is not required. For persons who turned 70 1/2 during 2019 and who did not take the RMD during 2019, the required beginning date is April 1, 2020; That is, the April 1, 2020 RMD has been eliminated by the CARES Act, as well as the second RMD otherwise due for 2020 by December 31, 2020. The elimination of the RMD, however, does not apply to defined benefit plans, including cash balance plans.
It may be possible for persons who have taken an RMD during 2020 to treat the distribution as a rollover under the 60-day rollover rules and recontribute it to an eligible retirement plan within 60 days of the original distribution date. It may also be possible to treat the distribution as a coronavirus related distribution, in which case it may be recontributed over a 3-year period.
Example: Employee D participates in a cash balance plan and a 401(k) plan with his employer. He also has a separate IRA. Employee D turned age 70 1/2 during 2019 and did not take any RMD distribution from the qualified plans or from the IRA during 2019. Employee D will not have to take an RMD from the 401(k) plan or from the IRA during 2020, including the 2019 distribution that was due by April 1, 2020. However, Employee D will have to take the 2019 RMD from the cash balance plan by April 1, 2020 and continue to take distributions from the cash balance plan under the payment method selected under the cash balance plan. If Employee D chooses to take a lump sum distribution from the cash balance plan and roll over to an IRA by April 1, 2020, he will not be able to roll over the value of the RMD payments required for 2020 and he will be able to roll over the remainder to the IRA. During 2021, he will be required to take an RMD from the rollover IRA in an amount based on the IRA balance at December 31, 2020.
The Act also permits the extension of the 5-year period applicable to a beneficiary of a deceased participant who dies before RMDs have begun, which beneficiary does not elect to commence RMDs within the year following the date of death. Such beneficiary will have an additional year to take the full amount of the distribution, i.e., the year 2020 is disregarded in determining the end of the 5-year period.
Section 2206 – Exclusion for Certain Employer Payments of Student Loans – The CARES Act provides for the exclusion from the employee’s income of employer payments of student loans on behalf of an employee. The exclusion applies to payments by employers made after March 27, 2020 (the date of enactment) and before January 1, 2021 and made by the employer on behalf of the employee of payments on principal and interest on a “qualified education loan”. IRC Section 221(b)(1). The education loan must have been incurred by the employee for education expenses, e.g., the cost of attendance at an eligible education institution as well as eligible fees, books, supplies and equipment. The exclusion from income is pursuant to IRC Section 127(c)(1) and means that the employee does not pay income taxes on the amount of the loan payment, but also that payroll taxes do not apply. The employer, in turn, may take a deduction. Payments may be made of both principal and interest, but the maximum amount of the exclusion is $5,250.00. The employer may pay the lender directly on behalf of the employee, but may also pay the employee the amount to be paid to the lender and the employee must use the funds to pay to the lender..
Section 2301 – Employee Retention Credit for Employers Subject to Closure Due to COVID-19 – The CARES Act provides an employee retention credit to employers, based on wages (and a proportionate amount of qualified health plan expenses) paid to employees. The credit is limited to 50% of wages paid between March 12, 2020 and December 31, 2020 and cannot exceed $10,000 per employee. An eligible employer is a nongovernmental employer that carried on a trade or business during 2020 and that meets either of the following tests:
- Operation of the business was fully or partially suspended due to government orders limiting commerce, travel or group meetings due to COVID-19; or
- The business experienced a reduction in gross receipts (determined quarterly as compared with the prior year) of at least 50%, with the credit continuing until the gross receipts in a quarter exceed 80% of prior year levels.
The credit applies to wages paid to employees by the employer, with respect to which the employee is not performing services (for an employer with over 100 employees in the prior year), to wages paid during the period of suspension (for employers with fewer than 100 employees and which are subject to suspension order), and to wages paid with respect to an employee in the calendar quarter during which the substantial reduction in gross receipts applies (for an employer with fewer than 100 employees and which had a 50% decline in gross receipts). Affiliated employers are considered a single employer for purposes of the 100 employee determination. Self-employed persons may also claim the credit for their self-employment income. Tax exempt employers are eligible for the credit.
Wages credited under the Paid Sick Leave or Paid Family and Medical Leave provisions of the Families First Coronavirus Recovery Act are not included. Employers taking a small business interruption loan are not eligible for the credit. In addition, an employee for which the employer retention credit is taken is ineligible for purposes of the work opportunity tax credit in IRC Section 51.
The credit is claimed by the employer by reducing the employment taxes payable for all of its employees. If the credit exceeds the employment taxes, then the employer can claim a refund, which is payable by Treasury under the refund rules for excess employment tax payments.
Section 2302 – Deferral of Payment of Employer Payroll Taxes – The CARES Act provides that the payment of “applicable employment taxes” for the “payroll tax deferral period” is not due until a later date. Applicable payroll taxes include Social Security and Medicare as well as self-employment taxes. In the case of self-employment taxes only 50% of the self-employment taxes may be delayed. The payroll tax deferral period is the period from the date of enactment (March 22, 2020) to December 31, 2020. One-half of the taxes must be paid by December 31, 2021 and the remainder must be paid by December 31, 2022. The delayed payment of payroll taxes may not apply to the employer if the employer made a small business loan that is the subject of debt forgiveness under CARES Act Sections 1106 or 1109.
Sections 3201-3203 – Diagnostic Testing and Preventative Services – Section 3201(a)(1) requires that health plans cover the cost of an in vitro diagnostic test for the detection of the coronavirus that causes COVID-19, if the test: (1) is approved by the Food and Drug Administration (the “FDA”); (2) has been requested for emergency use by the developer and certain other conditions are met; (3) has been developed in and authorized by a stateafter notice is given to DHHS; or (4) otherwise approved for use under appropriate guidance. Health plans and health insurance issuers are required to reimburse the provider of the diagnostic testingat a prenegotiated or for no more than the price of the testing, as published on the provider’s website..
Preventive services and vaccines are also required to be covered by group health plans and health insurance issuers offering group or individual health insurance. Such plans or policies are required to cover, without cost sharing, any qualified coronavirus preventive services. Qualified coronavirus services include an item, service, or immunization to prevent or mitigate coronavirus as approved or recommended by testing facilities and CDC. The effective date of the coverage is 15 business days after the recommendation date. The coverage must be provided, without cost sharing, by group health plans, health insurance issuers and individual health insurance issuers.
Sections 3601-3606 – Technical Corrections to the Family First Coronavirus Response Act (“FFCRA”) – The CARES Act makes several technical corrections to the limitations that apply per employee to paid leave and emergency paid sick leave under the FFCRA. Section 3604 provides that the Office of Management and Budget may waive paid family and paid sick leave for certain federal executive branch employees.
Section 3605 of the CARES Act clarifies the FFCRA by providing that re-hired employees are to be eligible for the Family and Medical Leave. In particular, eligible employees include persons who are employed at least 30 calendar days by the employer from whom leave is requested, who are laid off by the employer not earlier than March 1, 2020, who had worked for the employer for at least 30 of the last 60 days before the layoff and who are rehired by the employer.
CARES Act Section 3606 provides for the advanced refund of credits due under the FFCRA. In particular, the CARES Act permits treasury to issue rules whereby the credit is refundable and the manner under which the refund may be issued. It also states that the emplpoyer making late deposits will not be penalized if the failure to make the deposit is done in anticipation of the allowance of the credit. This is consistent with the allowance by Internal Revenue Service of employers to withhold all payroll taxes of employer and employee and federal income tax withholding payments to the treasury in anticipation of the allowance of the credit, see IR 2020-57.
Section 3608 – Single-Employer Plan Funding Rules – The CARES Act provides for funding relief for single employer defined benefit pension plans. IRC Section 430(a) and Employee Retirement Income Security Act of 1974 (“ERISA”) Section 303 are modified to permit the minimum required contribution due under IRC Section 430(j), including quarterly contributions, to be deferred during calendar year 2020. The due date for such amounts that would have been required to have been made during 2020 shall be extended to January 1, 2021. The amount of the required contribution will be increased by interest.
Section 3701 – Exemption for Telehealth Services – The Act provides for an exemption from the deductible and co-pay requirements for high deductible health plans associated with health savings accounts in the case of telehealth services. The exemption applies for plan years beginning on or before December 31, 2021. If a health plan fails to impose the deductible on telehealth expenses and other remote services, the plan shall not lose its status as a high deductible health plan. The effective date of the change is the date of enactment.
Section 3702 – Inclusion of Certain Over-the-Counter Medical Products As Qualified Medical Expenses – The CARES Act provides that certain over-the-counter medical products can qualify as qualifying medical expenses so as to be payable by a health savings account, an Archer medical savings account, or a health flexible spending account under IRC Section 125. The medical products include amounts paid for menstrual care products such as tampons, liners, etc. The change is effective for amounts paid after December 31, 2019 and is a permanent change in the law.
The CARES Act contains an unprecedented economic stimulus and the tax provisions are designed to facilitate getting cash to individuals and businesses as soon as possible. In general, there is not much downside to permitting qualified plans to offer the distributions and loans to employees. Most of the other employee and benefit provisions are favorable to both employees and employers and it is desirable for both to become aware of the benefits of these provisions. . As noted above, employers should review their unique situation as well as their employee benefits plans to determine whether and to what extent to amend sponsored plans in light of the changes in the CARES Act. For other provisions, such as employee retention credits, it is necessary to consider whether to take advantage of the credit or to use another option, such as SBA loans that may be forgiven, because they are mutually exclusive
For additional information, please contact the Kean Miller Tax Group:
Robert Schmidt at (225) 382-4621; Jaye Calhoun at (504) 293-5936; Kevin Curry at (225) 382-3484; Jason Brown at (225) 389-3733; Angie Adolph at (225) 382-3437; J. Mark Miller at (318) 562-2701; Phyllis Sims at (225) 389-3717; or Willie Kolarik at (225) 382-3441.