CARES Act Loan Provisions - Ambiguities

[Luke Bailey]

The CARES Act provision for COVID-19 distributions is different from the provision liberalizing the loan rules. The provision for distributions merely describes what a plan can do and not violate the qualification rules, as well as the tax treatment for the participant of Covid-19 distrributions. Clearly, the employer must implement the distribution provisions through an amendment or through a policy change eventually backfilled by an amendment in order for the distribution provisions to apply to a participant.

However, the CARES Act loan provision regarding the 1-year payment extension (Section 2002(b)(2) of CARES Act) can be read as a command regarding the administration of a loan. It does not say the equivalent of, "Hey employer, if you want to change your loan policy, you can do the following without having a distribution under 72(p)," but rather it says,

"(A) if the due date pursuant to subparagraph (B) or (C) of section 72(p)(2) of such Code for any repayment with respect to such loan occurs during the period beginning on the date of the enactment of this Act and ending on December 31, 2020, such due date shall be delayed for 1 year..." [emphasis supplied].

The problem is that loan payments aren't really due pursuant to the referenced subparagraphs of Section 72(p)(2), but rather pursuant to the loan's legal documentation, which presumably complies with 72(p). So you can interpret this (or not) as meaning that to the extent the loan documents incorporate 72(p), they are overridden as to the one-year extension. Moreover, the CARES Act loan provisions for the 1-year suspension say nothing about amending loan documents or policies, although I guess you could argue that Congress thought plan documents contained loan rules, which obviously is not typically the case, and therefore would need to be amended for the suspension.

Another ambiguity, I think, is regarding what payments have a "due date." Suppose a participant who qualifies for the COVID provisions terminated a month or two before 3/27/2020 and under the terms of his or her participant loan, the remaining balance is accelerated and due as a lump sum 3/31/2020, or it will be distributed as an offset? Is the lump sum repayment suspended for a year? If it isn't and a loan offset distribution occurs, is that distribution a COVID-related distribution qualifying for the 3-year averaging, extended rollover, etc.? What if the employee has not terminated, but payment could not be made by withholding for some reason beginning in the fourth quarter of 2019, so that 3/31/2020 was the last day of his/her grace period. (Again, assume the participant does qualify as a COVID-19-affected individual.) If you don't buy my first argument that the requirement to bring the loan current as of 3/31/2020 is suspended for a year, is the resulting "deemed distribution" a COVID-19 distribution?

 

[RatherBeGolfing]

Luke,

The same language in KETRA has been interpreted as optional due to language in Notice 2005-92.  Notice 2005-92 also included a safe harbor method for delayed repayments

 

katrina_act_text.pdf not200592.113005.end.pdf

[Luke Bailey]

48 minutes ago, RatherBeGolfing said:

Luke,

The same language in KETRA has been interpreted as optional due to language in Notice 2005-92.  Notice 2005-92 also included a safe harbor method for delayed repayments

 

katrina_act_text.pdf 99.58 kB · 1 download not200592.113005.end.pdf 51.12 kB · 1 download

RatherBeGolfing, thanks. I just reviewed Notice 2005-92. So assuming IRS issues similar guidance for CARES and that CARES does not create substantive rights enforceable by the participant beyond the Code (both of which are safe assumptions, I think), the answers to my questions are:

• The CARES Act loan extension for qualifying participants would only apply if and to the extent that the plan sponsor/administrator chooses to apply it,
• A "deemed" distribution of a defaulted loan to a participant who is a COVID-19 affected participant, but who is not eligible for a distribution, e.g. because still employed, would not be a CARES Act distribution.
• A "loan offset" distribution to a participant with a defaulted loan who is entitled to receive a distribution would be a CARES Act distribution eligible for the CARES tax benefits (inclusion over 3-year period, no 10% premature distribution penalty, and rollover permissible through end of 3-year period).

I do not see anything in Notice 2005-92 that addresses the issue of whether the payment that would need to be made by a COVID-19 affected participant to make current/avoid default on a loan that was delinquent, but that had not yet defaulted under the plan's cure period, could be extended under the CARES Act. Is that your reading as well? Is it obvious to you that the IRS would think that such a payment is just a loan payment, and so would potentially benefit from the extension if the plan sponsor/administrator chooses to treat it that way?

 

[RatherBeGolfing]

40 minutes ago, Luke Bailey said:

The CARES Act loan extension for qualifying participants would only apply if and to the extent that the plan sponsor/administrator chooses to apply it,

Agreed

51 minutes ago, Luke Bailey said:

A "deemed" distribution of a defaulted loan to a participant who is a COVID-19 affected participant, but who is not eligible for a distribution, e.g. because still employed, would not be a CARES Act distribution.

Agreed

51 minutes ago, Luke Bailey said:

A "loan offset" distribution to a participant with a defaulted loan who is entitled to receive a distribution would be a CARES Act distribution eligible for the CARES tax benefits (inclusion over 3-year period, no 10% premature distribution penalty, and rollover permissible through end of 3-year period).

Agreed

52 minutes ago, Luke Bailey said:

I do not see anything in Notice 2005-92 that addresses the issue of whether the payment that would need to be made by a COVID-19 affected participant to make current/avoid default on a loan that was delinquent, but that had not yet defaulted under the plan's cure period, could be extended under the CARES Act. Is that your reading as well? Is it obvious to you that the IRS would think that such a payment is just a loan payment, and so would potentially benefit from the extension if the plan sponsor/administrator chooses to treat it that way?

My reading of 2202(b)(2)(A) is that the due date of the payment (per the amortization schedule) would need to fall during the suspension period.  I wouldn't count the cure period as a "due date" that could be extended.  It can probably be argued the other way as well, but that is how Im looking at it for now.

[Larry Starr]

11 minutes ago, RatherBeGolfing said:

 

 

1 hour ago, Luke Bailey said:

 

• A "deemed" distribution of a defaulted loan to a participant who is a COVID-19 affected participant, but who is not eligible for a distribution, e.g. because still employed, would not be a CARES Act distribution.

 

I  love what you guys have analyzed. However, I'm not sure that I agree with this response, but I have to admit I haven't absorbed all the rules yet and we have VERY FEW loans in our plans (yeah, I know.... you all wish you could do that!!!?).  Here's the issue. 

While the plan might not treat that distribution as a CRD, the participant is, I think, free to treat it as such on his tax return.  We clearly are allowed to have different plan treatment and 1040 tax treatment with these distributions.  Am I wrong? 

[RatherBeGolfing]

17 minutes ago, Larry Starr said:

 

I  love what you guys have analyzed. However, I'm not sure that I agree with this response, but I have to admit I haven't absorbed all the rules yet and we have VERY FEW loans in our plans (yeah, I know.... you all wish you could do that!!!?).  Here's the issue. 

While the plan might not treat that distribution as a CRD, the participant is, I think, free to treat it as such on his tax return.  We clearly are allowed to have different plan treatment and 1040 tax treatment with these distributions.  Am I wrong? 

I think it comes down to whether a deemed distribution is in fact a distribution, or just a taxable event.  An offset is clearly a distribution, one that could even be rolled over, so that is a CRD if all other requirements are met.     

EDIT: Im going to send this one to Derrin  to see if he can include it it on his "Fireside chat" webcast next week...

[Larry Starr]

17 minutes ago, RatherBeGolfing said:

I think it comes down to whether a deemed distribution is in fact a distribution, or just a taxable event.  An offset is clearly a distribution, one that could even be rolled over, so that is a CRD if all other requirements are met.     

EDIT: Im going to send this one to Derrin  to see if he can include it it on his "Fireside chat" webcast next week...

Got it!  Yeah, I'm not willing to make that call at this point; maybe Derrin will have wise words!  If it is determined that it is NOT a distribution, just a taxable event (and I'm not quite sure that those aren't definitions without distinction in this situation), what's to stop the employee from still treating it as a CRD and handling their 1040 appropriately, including the ability to pay it back into, say, his IRA over the three years?

[Luke Bailey]

1 hour ago, RatherBeGolfing said:

My reading of 2202(b)(2)(A) is that the due date of the payment (per the amortization schedule) would need to fall during the suspension period.  I wouldn't count the cure period as a "due date" that could be extended.  It can probably be argued the other way as well, but that is how Im looking at it for now.

From a policy perspective, someone who can't afford to repay his/her loan because of COVID-19 for a year is probably in the same place as someone who takes a new loan because of COVID-19, so if I were IRS, given that the language literally supports it and that the employer would have to implement and could put reasonable guard rails around it, I would probably permit it.

 

1 hour ago, Larry Starr said:

  love what you guys have analyzed. However, I'm not sure that I agree with this response, but I have to admit I haven't absorbed all the rules yet and we have VERY FEW loans in our plans (yeah, I know.... you all wish you could do that!!!?).  Here's the issue. 

While the plan might not treat that distribution as a CRD, the participant is, I think, free to treat it as such on his tax return.  We clearly are allowed to have different plan treatment and 1040 tax treatment with these distributions.  Am I wrong? 

Larry, the Notice that RatherBeGolfing pointed to (2005-92) specifically said that a loan offset distribution was a "distribution" and therefore got the seemingly identical KETRA tax benefit.

 

40 minutes ago, Larry Starr said:

Got it!  Yeah, I'm not willing to make that call at this point; maybe Derrin will have wise words!  If it is determined that it is NOT a distribution, just a taxable event (and I'm not quite sure that those aren't definitions without distinction in this situation), what's to stop the employee from still treating it as a CRD and handling their 1040 appropriately, including the ability to pay it back into, say, his IRA over the three years?

Larry, I think the fact that the participant has to provide plan administrator with self-certification that the distribution meets the requirements implies a role for the employer to at least receive that certification and keep it on file. Besides, presumably there will be a code for 2020 1099-R's to show how treated and that is where rubber will hit road.

[Larry Starr]

15 minutes ago, Luke Bailey said:

From a policy perspective, someone who can't afford to repay his/her loan because of COVID-19 for a year is probably in the same place as someone who takes a new loan because of COVID-19, so if I were IRS, given that the language literally supports it and that the employer would have to implement and could put reasonable guard rails around it, I would probably permit it.

 

Larry, the Notice that RatherBeGolfing pointed to (2005-92) specifically said that a loan offset distribution was a "distribution" and therefore got the seemingly identical KETRA tax benefit.

 

Larry, I think the fact that the participant has to provide plan administrator with self-certification that the distribution meets the requirements implies a role for the employer to at least receive that certification and keep it on file. Besides, presumably there will be a code for 2020 1099-R's to show how treated and that is where rubber will hit road.

I don't think the failure to provide a notice to the employer will eliminate the ability to declare you are eligible and treat the distribution on your personal return as a CRD.  Also, I don't believe there will be a special code now (there wasn't for Katrina).  I had previously suggested a separate code but I don't think we will get it OR that it is necessary. There will be some sort of identification process with the personal return in order to treat it as a CRD and get the spreading of the taxation benefit.  Of course, we might all be surprised by whatever they ultimately tell us to do, so keep an open mind on this stuff.

[RatherBeGolfing]

9 minutes ago, Luke Bailey said:

From a policy perspective, someone who can't afford to repay his/her loan because of COVID-19 for a year is probably in the same place as someone who takes a new loan because of COVID-19, so if I were IRS, given that the language literally supports it and that the employer would have to implement and could put reasonable guard rails around it, I would probably permit it.

 

100% agree new loan or old loan doesn't matter.  I'm saying the payment you want to delay has to have a due date that occurs during the suspension period (3/27/20-12/31/20).  If you are on year three of a loan and you didnt make your 2/28/20 payment, I'm not sure I see that the language supports delaying that payment.  Is the due date of a loan payment its scheduled payment date or the cure date?

 

[RatherBeGolfing]

6 minutes ago, Larry Starr said:

I don't think the failure to provide a notice to the employer will eliminate the ability to declare you are eligible and treat the distribution on your personal return as a CRD.  Also, I don't believe there will be a special code now (there wasn't for Katrina).  I had previously suggested a separate code but I don't think we will get it OR that it is necessary. There will be some sort of identification process with the personal return in order to treat it as a CRD and get the spreading of the taxation benefit.  Of course, we might all be surprised by whatever they ultimately tell us to do, so keep an open mind on this stuff.

Agreed.  The employee would only need to certify that he/she is a qualified individual for the purpose of a CRD as a distributable event.  Other than that, it would be handled on the employees tax return.

[RatherBeGolfing]

1 hour ago, Larry Starr said:

what's to stop the employee from still treating it as a CRD and handling their 1040 appropriately, including the ability to pay it back into, say, his IRA over the three years?

The 1099 for loan offset is the same as any other distribution.  The 1099 for a deemed distribution without an offset uses code L in addition to 1,2, or 7.  That signals that it is not rollover eligible.

So, if my interpretation is correct, I believe the 1099 would prevent the employee from treating it as a CRD for tax purposes.

 

[Luke Bailey]

49 minutes ago, Larry Starr said:

I don't think the failure to provide a notice to the employer will eliminate the ability to declare you are eligible and treat the distribution on your personal return as a CRD.  Also, I don't believe there will be a special code now (there wasn't for Katrina).  I had previously suggested a separate code but I don't think we will get it OR that it is necessary. There will be some sort of identification process with the personal return in order to treat it as a CRD and get the spreading of the taxation benefit.  Of course, we might all be surprised by whatever they ultimately tell us to do, so keep an open mind on this stuff.

OK, thanks, Larry. I was not that deeply interested in the issue at time of KETRA, so was not aware of that. Perhaps they will do it same way this time. Pretty much everyone who would have a loan or need a distribution in the relevant time period will be negatively affected by COVID, so maybe not worth IRS's bothering about it.

[Luke Bailey]

47 minutes ago, RatherBeGolfing said:

100% agree new loan or old loan doesn't matter.  I'm saying the payment you want to delay has to have a due date that occurs during the suspension period (3/27/20-12/31/20).  If you are on year three of a loan and you didnt make your 2/28/20 payment, I'm not sure I see that the language supports delaying that payment.  Is the due date of a loan payment its scheduled payment date or the cure date?

 

OK. I see your point. CARES Act references IRC sec. 72(p)(2)(B) and (C). (B) does not seem relevant, but (C) probably slightly supports the argument that is the regular payment that must be missed in the relevant time frame, because being referred to in CARES Act. On the other hand, looking at 72(p)(2)(B) and (C) together, and along with the regs, I think one could easily justify that any payment within the cure period is a "payment due" for purposes of CARES. IRC sec. 72(p) and its regs are basically telling you the payments you need to make to avoid having to treat the loan as a distribution, and that scheme includes the cure period and a payment during the cure period that would be sufficient to avoid deeming of loan. Gee, they're giving $2 trillion plus away, you think they would cut a break to a guy or gal who might have cured his or her loan delinquency, but for getting hit by COVID. At no cost to Treasury. But we will see.

[Luke Bailey]

1 hour ago, RatherBeGolfing said:

100% agree new loan or old loan doesn't matter.  I'm saying the payment you want to delay has to have a due date that occurs during the suspension period (3/27/20-12/31/20).  If you are on year three of a loan and you didnt make your 2/28/20 payment, I'm not sure I see that the language supports delaying that payment.  Is the due date of a loan payment its scheduled payment date or the cure date?

 

By the way, if you go the route of saying that only the scheduled payment, not a permissible cure payment, is what has to fall within the CARES Act period, then it's a bright line, right? If the payment was due 3/15/2020, but not made, you would be just as ineligible for the one-year delay as if the missed payment was in fourth quarter of 2019, right?

And do you see a distinction with respect to an employee who terminates employment at a time when the loan is current, but with a balance, and the plan's loan policy is to accelerate on termination if the remaining balance is not repaid within a short period, the end of that short period falls during the CARES Act period? If the loan is not repaid, the resulting distribution will be a loan offset that can be treated as a CARES Act distribution (assuming the participant qualifies as COVID-affected), and that treatment would be better in most cases than getting the one-year repayment extension, but assuming the employer wanted to adopt the CARES Act loan relief to the limit, the participant would probably have a choice, right? On the other hand, if the employer decides to only view regular payments under the loan's original amortization schedule as eligible for the CARES Act relief, it would appear to be able to do that if IRS applies same rules as did for KETRA.

[RatherBeGolfing]

36 minutes ago, Luke Bailey said:

By the way, if you go the route of saying that only the scheduled payment, not a permissible cure payment, is what has to fall within the CARES Act period, then it's a bright line, right? If the payment was due 3/15/2020, but not made, you would be just as ineligible for the one-year delay as if the missed payment was in fourth quarter of 2019, right?

For that specific payment, yes.

 

1 hour ago, Luke Bailey said:

And do you see a distinction with respect to an employee who terminates employment at a time when the loan is current, but with a balance, and the plan's loan policy is to accelerate on termination if the remaining balance is not repaid within a short period, the end of that short period falls during the CARES Act period?

Probably.  Such a policy is usually there because a participant no longer has payroll to withhold from.  If the plan's loan policy is require payment within  2 weeks of termination, that could be considered the due date.  Payment hasn't been missed yet, so its not a cure payment. 

1 hour ago, Luke Bailey said:

If the loan is not repaid, the resulting distribution will be a loan offset that can be treated as a CARES Act distribution (assuming the participant qualifies as COVID-affected), and that treatment would be better in most cases than getting the one-year repayment extension, but assuming the employer wanted to adopt the CARES Act loan relief to the limit, the participant would probably have a choice, right?

I would assume participant would have a choice.

 

[Luke Bailey]

15 hours ago, RatherBeGolfing said:

For that specific payment, yes

OK. I'm pretty sure we're in agreement, but let me take it out a few more steps. If the 3/15 payment is made up, after 3/15, then the 3/30 payment (assuming semimonthly amortization) falls in the period. So a loan that would otherwise default based on a missed payment the date for which fell before the beginning of the COVID-19 period, if the delinquency is not cured, can be brought into the COVID-19 relief by making up (before the end of the cure period) all of the payments that were missed before the beginning of the cure period. Then all the payments after that get the one-year extension. Agreed?

[RatherBeGolfing]

2 minutes ago, Luke Bailey said:

OK. I'm pretty sure we're in agreement, but let me take it out a few more steps. If the 3/15 payment is made up, after 3/15, then the 3/30 payment (assuming semimonthly amortization) falls in the period. So a loan that would otherwise default based on a missed payment the date for which fell before the beginning of the COVID-19 period, if the delinquency is not cured, can be brought into the COVID-19 relief by making up (before the end of the cure period) all of the payments that were missed before the beginning of the cure period. Then all the payments after that get the one-year extension. Agreed?

Agreed.

I think there may be a workaround that would allow for more participants to benefit from the relief though.  Lets say that you haven't made your semimonthly payments at all for 2020, so you are 5 payments behind with no ability to make those payments up at the moment.  

Rev Proc 2019-19 allows for self-correction of certain loan failures by a single lump sum payment, re-amortization, or a combination of the two.  If the missed loan payments are corrected by re-amortizing, and the first payment falls in the suspension period, we have effectively managed to delay payments scheduled before the suspension period.  Do you agree? 

[RatherBeGolfing]

19 hours ago, Luke Bailey said:

Larry, the Notice that RatherBeGolfing pointed to (2005-92) specifically said that a loan offset distribution was a "distribution" and therefore got the seemingly identical KETRA tax benefit.

@Larry Starr Having just re-read Notice 2005-92 it actually goes a step further and specifically says that deemed distributions are not permitted to be treated as a Katrina distribution. 

Quote

However, any amount described in Q&A-4 of §1.402(c)-2 of the regulations is not permitted to be treated as a Katrina distribution. Thus, the following amounts are not Katrina  Distributions: corrective distributions of excess contributions under § 415, excess elective deferrals under § 402(g), excess contributions under § 401(k), and excess aggregate
contributions under § 401(m); loans that are treated as deemed distributions pursuant to § 72(p); dividends paid on applicable employer securities under § 404(k); and the costs of current life insurance protection.

  

[Luke Bailey]

2 hours ago, RatherBeGolfing said:

Agreed.

I think there may be a workaround that would allow for more participants to benefit from the relief though.  Lets say that you haven't made your semimonthly payments at all for 2020, so you are 5 payments behind with no ability to make those payments up at the moment.  

Rev Proc 2019-19 allows for self-correction of certain loan failures by a single lump sum payment, re-amortization, or a combination of the two.  If the missed loan payments are corrected by re-amortizing, and the first payment falls in the suspension period, we have effectively managed to delay payments scheduled before the suspension period.  Do you agree? 

RatherBeGolfing, yes. There is a lot of flexibility here, but requires a lot of sophistication and handholding by/of employer to make happen for participant. Could wear out patience of many employers to provide loan relief at maximum level. But the beauty of the Notice 2005-92 approach is that the employer can choose what it wants to do on the range of the possible (from not doing the extension at all to probing the maximum extent of the relief legislation), and be OK as long as it is consistent and nondiscriminatory.

 

55 minutes ago, RatherBeGolfing said:

@Larry Starr Having just re-read Notice 2005-92 it actually goes a step further and specifically says that deemed distributions are not permitted to be treated as a Katrina distribution. 

 Right. The notice draws a distinction between a "deemed loan," say to a current employee who revoked withholding for loan payments or otherwise has a default while in service, which would not, per IRS, qualify for the favorable KETRA (and likely CARES Act as well) tax treatment, and a "loan offset" distribution, say to an employee who is laid off and qualified for a distribution while a loan is defaulted, which would be treated favorably for tax purposes (at least for KETRA, probably also now for CARES).