Processing Distributions in 2020

[Gilmore]

I guess I'm asking a question of other TPAs that primarily partner with recordkeepers.

And maybe I'm being overly paranoid, which is very likely.

It seems that the majority of the recordkeepers we work with have special forms for processing CRDs and CRLs, and if the plan sponsor does not "opt in" to using these forms they will process distributions in the "normal" manner regardless of the participant's status as a qualified individual.

We have some clients that feel their plans offer sufficient distribution options already and do not want a new special inservice distribution option, so they don't want to "opt-in".

Now a participant who terminated 5 years ago wants to take a distribution as a qualified individual under the CARES Act because they were laid off from their current employer.  Being savvy enough to know that they should be permitted to waive out of the withholding are told by the recordkeeper that because the plan sponsor did not opt in to allow CRDs, they will be subject to 20% mandatory withholding. 

At this point it should not be the plan sponsors decision, should it? 

I understand that the Plan would need to be amended to permit a qualified individual who would not otherwise have a distributable event under the current plan provisions to take a distribution if say for example they are still employed with reduced hours and are 30 years old. 

But does the Plan have to be amended to permit a qualified individual who has a distributable event to be able to waive out of the withholding?  Isn't that expressly permitted in the Act?

Are other TPAs telling their clients just to opt in so that qualified individuals are treated correctly under the Act?  Could a qualified individual who does not have their withholding applied correctly make an issue for the plan and require a penalty to be paid for not being able to waive out of the withholding?

Thanks.

[Bill Presson]

The plan sponsor elects whether to allow the specific distributions. If a participant is eligible, but the plan hasn't made the election, the participant can still be eligible for the CRD tax treatment, but the participant can't force the plan to do something that isn't part of the plan.

[Gilmore]

Thanks Bill.  II get what your saying.

If the plan didn't allow for any other distributable event, then the participant can't make the plan amend to allow a CRD, which would be a new type of distributable event.

But if the participant has a distributable event under current provisions, the distribution should be treated as a CRD for tax purposes if they are a qualified individual.

The issue we are running into is that many of the recordkeepers forms are only available if the plan sponsor "opts in" and most of the forms have some sort of certification that the plan will be amended or are permitting any kind of CRD.  Taking it a step further, for some recordkeepers, once the sponsor "opts in" they are processing CRDs for any participant that self certifies, even if the plan sponsor did not intend to allow an "inservice CRD". 

So either every qualified individual gets the special tax treatment, even if the plan was not intended to allow for a new distribution option, or no qualified individual gets special tax treatment.

And in this context I'm only concerned about how the withholding is done.  I know the QI has all the other tax benefits when they do their taxes.

[Peter Gulia]

To “determin[e] whether any distribution is a coronavirus-related distribution”, the statute allows an eligible retirement plan’s administrator to rely on a claimant’s certification.  CARES Act § 2202(a)(4)(B).

 

Could a recordkeeper put on a form for an ordinary distribution, in a part in which a distributee may specify a withholding choice for a distribution not an eligible rollover distribution, a § 2202(a)(4)(A)(ii) certification—to be relied on only for tax-reporting (if the IRS later sets a 1099-R code) and tax-withholding?

 

To the extent that a plan’s directed trustee or other payer may rely on the plan’s administrator’s instructions to support tax-reporting and tax-withholding, could a payer rely on an administrator’s instruction (perhaps a standing instruction) that a distributee who completed that certification gets coronavirus withholding treatment?

[Kevin C]

A recent article from Ferenczy Benefits Law Center discusses withholding for distributions if the plan sponsor doesn't elect to make any CARES Act changes.  It was in the news section a few days back.

https://ferenczylaw.com/flashpoint-the-cares-act-do-we-have-to/
 

Quote

 

However, what is the appropriate action by the Plan Administrator of a plan that is not affirmatively permitting CRDs but has a participant payout that nonetheless qualifies as a CRD for tax purposes? And how is the Plan Administrator to know that the participant is a QI so that the distribution is a CRD?

CARES does not address this issue.  There have been other times that the IRS permitted similar penalty-free distributions to victims of hurricane disasters (e.g., after Katrina). In those circumstances, the IRS provided guidance that an employer that chose not to affirmatively provide such distributions did not have to comply with the alternate withholding and notice rules.  (See, e.g., Notice 2005-92.)

Assuming that the IRS follows this practice for CARES, Plan Administrators that make distributions from plans that do not specifically adopt the CRD rules may continue to withhold on those distributions at the 20% rate.

 

 

[Larry Starr]

18 hours ago, Gilmore said:

Thanks Bill.  II get what your saying.

If the plan didn't allow for any other distributable event, then the participant can't make the plan amend to allow a CRD, which would be a new type of distributable event.

But if the participant has a distributable event under current provisions, the distribution should be treated as a CRD for tax purposes if they are a qualified individual.

The issue we are running into is that many of the recordkeepers forms are only available if the plan sponsor "opts in" and most of the forms have some sort of certification that the plan will be amended or are permitting any kind of CRD.  Taking it a step further, for some recordkeepers, once the sponsor "opts in" they are processing CRDs for any participant that self certifies, even if the plan sponsor did not intend to allow an "inservice CRD". 

So either every qualified individual gets the special tax treatment, even if the plan was not intended to allow for a new distribution option, or no qualified individual gets special tax treatment.

And in this context I'm only concerned about how the withholding is done.  I know the QI has all the other tax benefits when they do their taxes.

The plan  sponsor is not required to adopt any part of the CRD scheme.  However, let's reiterate: that doesn't mean the participant can't claim CRD treatment on their own tax form. You have identified the "glitch", which is that the 20% withholding WILL apply (participant has no right to waive it). Payee has to live with those results.

[Gilmore]

Appreciate all of the responses.  Just a bit more clarification, then I will relent, and I do appreciate everyone's insight.

If I am a QI and I request a distribution from a plan in which I have a distributable event without the plan needing to be amended for CRDs (like a termination distribution), and I want to waive the 10% withholding that the CARES Act says would apply, and I'm told that I'm subject to 20% mandatory withholding because the plan sponsor didn't "opt-in" to whatever process the recordkeeper put in place, and the $1000 that I thought I was distributing to pay my rent is now only $800, and I complain to the IRS, DOL, and anyone else who will listen, is there a chance that the plan sponsor would be dinged $100 for not allowing me to wave the withholding?

Separate issue, with John Hancock for example.  If I have a client using John Hancock and they do intend to amend their plan to allow CRDs, and I have a terminated QI requesting a distribution, are other TPAs using the John Hancock form for CRDs even though it specifically says it's only for "Active Employees" and intended to be used as an inservice distribution?

Sorry to beat this to death but we're trying to strike the right balance between the spirit of the Act for the participants, and providing the right guidance to the client.

Thanks!

[Peter Gulia]

I assumed one need not change tax-withholding, and is (at least) permitted to withhold 20%.

 

I’m asking whether a withholding-only recognition of a coronavirus-related distribution is permissible and feasible.

 

Is it as easy as putting one more paragraph in a form?  (And perhaps one more switch in the computer system.)

 

Or am I missing something?

 

If a service provider can help a distributee get lower or no tax-withholding without imposing a risk on plan fiduciaries (and with not too much burden on the service provider), might doing so be a nice courtesy?

[Larry Starr]

11 minutes ago, Gilmore said:

Appreciate all of the responses.  Just a bit more clarification, then I will relent, and I do appreciate everyone's insight.

If I am a QI and I request a distribution from a plan in which I have a distributable event without the plan needing to be amended for CRDs (like a termination distribution), and I want to waive the 10% withholding that the CARES Act says would apply, and I'm told that I'm subject to 20% mandatory withholding because the plan sponsor didn't "opt-in" to whatever process the recordkeeper put in place, and the $1000 that I thought I was distributing to pay my rent is now only $800, and I complain to the IRS, DOL, and anyone else who will listen, is there a chance that the plan sponsor would be dinged $100 for not allowing me to wave the withholding?

The participant does not have the right to waive the 10%, because the mandatory 20% applies if the plan is not "doing" CRDs.  It's 20% because that is the law.  What was done is correct; no one will listen to your complaint, except for a lawyer who will be happy to charge you large sums (much greater than your 20% withholding) and then tell you that you have no valid complaint.

[Larry Starr]

4 minutes ago, Peter Gulia said:

I assumed one need not change tax-withholding, and is (at least) permitted to withhold 20%.

 

I’m asking whether a withholding-only recognition of a coronavirus-related distribution is permissible and feasible.

 

Is it as easy as putting one more paragraph in a form?  (And perhaps one more switch in the computer system.)

 

Or am I missing something?

 

If a service provider can help a distributee get lower or no tax-withholding without imposing a risk on plan fiduciaries (and with not too much burden on the service provider), might doing so be a nice courtesy?

Peter, I don't see how a plan that does not plan to adopt CRD option has a choice on the 20% withholding. It will require (eventually) an amendment to the plan to match what is being done.  I don't see this as a "courtesy"; it is a significant plan change and it affects all participants during this period of time.  I wouldn't suggest my client do it.

[Gilmore]

I am apparently incorrectly disassociating the two aspect of a CRD.  One creates a special inservice type of distribution for participants who are QI and would not otherwise have a distribution option under the plan. 

The other is the tax treatment that is afforded to ANY distribution made in 2020, even those made prior to the Act's enactment which I understand cannot be undone from a withholding standpoint, but I assumed (incorrectly it seems) would apply to any distribution thereafter for a QI including the ability to waive withholding.

It's definitely easier for us to follow along with the 20% withholding, so I appreciate that I am not correct.

Thanks for the responses.

[Peter Gulia]

Larry Starr, thank you for helping me think this through.

 

I’m imagining the possibility that what a plan paid as an ordinary distribution could nonetheless be a coronavirus-related distribution within § 2202(a)(4) that gets the tax-withholding treatment of § 2202(a)(6)(A).

 

Would your outlook be different if the trustee or other payer acts on its own without asking anything from the plan’s administrator (relying only on the distributee’s certification)?

[RatherBeGolfing]

1 hour ago, Peter Gulia said:

I’m imagining the possibility that what a plan paid as an ordinary distribution could nonetheless be a coronavirus-related distribution within § 2202(a)(4) that gets the tax-withholding treatment of § 2202(a)(6)(A).

Peter, I'm not comfortable advising my clients to do this either.  At least not without some sort of guidance  from the IRS.

While it is the participants responsibility to pay taxes, it is the plans responsibility to withhold taxes.  The proposed tax treatment is essentially asking a non adopting plan to somehow adopt just the tax portion of 2202(a).  

Let's look at it from a different angle.  Do you agree that if you cannot amend for the tax treatment alone, this could create a plan defect?  Further, if you cannot amend for tax treatment alone, could the trustee or plan admin be seen as making determination as to the participants eligibility for tax treatment under CARES?

[Peter Gulia]

RatherBeGolfing, thank you for helping me think this through, especially the reasoning.

The situation is a nice reminder about not letting a good impulse overtake careful thinking and sound judgment.

[Gilmore]

Well put Peter.  I was thinking until further guidance I'll just go with the herd, but your response was much better.

[Kevin C]

4 hours ago, Larry Starr said:

Peter, I don't see how a plan that does not plan to adopt CRD option has a choice on the 20% withholding. It will require (eventually) an amendment to the plan to match what is being done.  I don't see this as a "courtesy"; it is a significant plan change and it affects all participants during this period of time.  I wouldn't suggest my client do it.

I disagree with your first sentence here, although I'm inclined to agree with your last sentence. Is there something you see that indicates a plan that doesn't allow for the new distributable event is prevented from applying voluntary withholding to a CRD?  One of the questions in Derrin's Q&A follow-up to the recent COVID-19 session is: 

Quote

 

Q. Is the 20% withholding waived only if the plan permits these distributions?

No.

 

It's on page 5.  http://www.erisapedia.com/static/Covid19Webcast2020_04Questions.pdf

Section 2202(a)(6)(A) says "For purposes of sections 401(a)(31), 402(f), and 3405 of the Internal Revenue Code of 1986, coronavirus-related distributions shall not be treated as eligible rollover distributions."  That could be read as requiring voluntary withholding for a CRD, since the definition of CRD in 2202(a)(4)(A) is not limited to just distributions made under the new distributable event.  The article I linked above points out that with similar provisions in the hurricane relief laws, IRS guidance said the decision of voluntary withholding vs 20% was up to the Plan Administrator. 

 

Quote

 

2202(a)(6) (A) CORONAVIRUS-RELATED DISTRIBUTION.—Except as provided in paragraph (2), the term ‘‘coronavirus-related distribution’’ means

any distribution from an eligible retirement plan made—

(i) on or after January 1, 2020, and before December 31, 2020,

(ii) to an individual—

   (I) who is diagnosed with the virus SARS–CoV–2 or with coronavirus disease 2019 (COVID–19) by a test approved by the Centers for

Disease Control and Prevention,

  (II) whose spouse or dependent (as defined in section 152 of the Internal Revenue Code of 1986) is diagnosed with such virus or disease by such a

test, or

  (III) who experiences adverse financial consequences as a result of being quarantined, being furloughed or laid off or having work hours reduced due to such virus or disease, being unable to work due to lack of child care due to such virus or disease, closing or reducing hours of a business owned or operated by the individual due to such virus or disease, or other factors as determined by the Secretary of the Treasury (or the Secretary’s delegate).

 

 

[G8Rs]

Seems like there are 2 aspects of this that are being combined. First, does the plan permit a distributable event? In your situation, the answer is no. Then you go to the second part - does the plan want to treat the distribution being made (which is being made for other reasons), as a CRD? I assume the answer is also no, but these are two different decisions for a plan sponsor to make.  

If the plan treats it as a CRD, then it's subject to 10% voluntary withholding. If the plan doesn't treat it as a CRD, then it's subject to 20% withholding. 

The plan has this choice per Notice 2005-92 (and there's no reason to believe the IRS would reach a different interpretation of the exact same language that was used in KETRA).

C. Treatment of distributions as Katrina distributions. An employer is permitted to choose whether to treat distributions under its plans as Katrina distributions. Further, the employer (or plan administrator) is permitted to develop any reasonable procedures for identifying which distributions are treated as Katrina distributions under its retirement plans. However, if an employer retirement plan treats any distribution of an amount subject to § 401(k)(2)(B)(i), 403(b)(7)(A)(ii), 403(b)(11) or 457(d)(1)(A) as a Katrina distribution, the plan must be consistent in its treatment. Thus, the amount of the distribution must be taken into account in determining the $100,000 limit on Katrina distribution payments made under the retirement plans maintained by the employer.

 

 

[Gilmore]

Circling back to my original question, many of our plans are not afforded a choice of differentiating the new distributable event from the tax treatment of a CRD.  The decision is being made by the recordkeeper's forms and procedures.  Either you opt-in and permit CRDs or you don't get to use a CRD distribution form and normal 20% withholding applies.

My two concerns for asking the question were, is this what the law intended, or was the intent to allow ANY distribution to a QI to be afforded the ability to waive withholding, and if so, does the penalty for not treating the distribution to the QI as a CRD for tax purposes have the potential to result in a $100 penalty to the plan sponsor?

[Peter Gulia]

Gilmore, the practical answers might come from some cautious lawyers in retirement-services businesses, especially big insurance and trust companies.

 

When I was inside counsel, the operations guys often reminded me that anything I said had to be functional across a dozen or more different computer systems (often, with no new or revised programming).

 

And I sometimes considered that even the slightest weakness in my legal reasoning (or just an unfortunate change in a regulator’s, arbitrator’s, or court’s appetite) could be magnified by tens of thousands of plans, with tens of millions of individuals, and hundreds of billions of dollars.

 

Further, a recordkeeper’s counsel has to manage these issues for a context in which all but the biggest plan sponsor/administrators have no lawyer but everyone must pretend that no one gives tax or legal advice to anyone beyond the recordkeeper itself.  Those facts of business life lead to doing what can be sourced to the government agency, with little or no room for interpretation.

 

Your originating post suggests your client plans are stuck with what the recordkeepers provide.  Don’t be surprised that a recordkeeper might give big-ship answers.

[Luke Bailey]

So are there three situations?

1. The plan adopts the CARES Act distribution rules, receives a certification, makes a distribution attributable to its CARES Act rules, and does not withhold. Right.
2. The plan does not adopt the CARES Act rules, but an individual has a right to a distribution and the plan accepts a certification from the individual and does not withhold? Seems right, but not as clear as 1.
3. Same as 2, but plan does not accept a certification. How does plan not withhold in this case?

[Gilmore]

Thanks again everyone.

[RatherBeGolfing]

16 hours ago, Luke Bailey said:

The plan does not adopt the CARES Act rules, but an individual has a right to a distribution and the plan accepts a certification from the individual and does not withhold? Seems right, but not as clear as 1.

Whether that will be possible in operation will depend on more than the trustee or plan admin though.  If the client is with a major platform recordkeeper like JH, American Funds, Ascensus, etc, the recordkeeper will make that decision.  

[Larry Starr]

On 4/17/2020 at 6:25 PM, Luke Bailey said:

So are there three situations?

1. The plan adopts the CARES Act distribution rules, receives a certification, makes a distribution attributable to its CARES Act rules, and does not withhold. Right.
2. The plan does not adopt the CARES Act rules, but an individual has a right to a distribution and the plan accepts a certification from the individual and does not withhold? Seems right, but not as clear as 1.
3. Same as 2, but plan does not accept a certification. How does plan not withhold in this case?

I just don't see option 2 being implemented in any of my plans.  We either allow CRD distributions (and appropriately amend to adopt those provisions eventually) or we don't. If we don't, it's 20% withholding, but the participant will be able to treat it as a CRD on his own tax return and split the taxes over 3 years.  The withholding is the withholding and he has to live with that.

[Bird]

7 hours ago, Larry Starr said:

I just don't see option 2 being implemented in any of my plans.  We either allow CRD distributions (and appropriately amend to adopt those provisions eventually) or we don't. If we don't, it's 20% withholding, but the participant will be able to treat it as a CRD on his own tax return and split the taxes over 3 years.  The withholding is the withholding and he has to live with that.

That's how I see it.  There may be some problems with the more obnoxious recordkeepers but most seem to be allowing either opting in or opting out.

[Gilmore]

Thank you Larry and Bird.

Bird, to your point regarding recordkeepers, do either of you have plans using John Hancock? 

The current John Hancock CRD form indicates on the form that it should only be used by active employees.  So I'm assuming, at least at the moment, that JH has determined that even if the plan amends for CRDs, 20% withholding should apply to a terminated QI.  I asked John Hancock about that and the rep said if the TPA or plan sponsor thinks the form should be used for other than inservice distributions they will process the form.  So it maybe sounds like they, like everyone else, rushed to put something out and maybe didn't think it through.

Question, would you use this form for a terminated QI if the plan is intending to adopt CRD provisions, and if so, do you see any issue on an audit (even a 5500 audit) due to the wording on the form?

Thanks once again.