The Consolidated Appropriations Act, 2021 (the “CAA”) has provisions that are designed to provide tax relief for individuals and employers who have been adversely affected by one of the numerous federally declared “Qualified Disasters”.
These provisions of the CAA are found in Sections 301 through 306 of Title III, of Division EE, which is called “The Taxpayer Certainty and Disaster Relief Act of 2020” (the “2020 Tax Relief Act”).
In this blog post, we will focus on Sections 301 through 303 of the 2020 Tax Relief Act, which address (i) tax-qualified retirement plans, and (ii) employee retention tax credits for employers.
The beginning point in understanding this matter is digesting a few technical definitions that are used throughout the law.
First, there is a federal law called the Robert T. Stafford Disaster Relief and Emergency Assistance Act (the “Stafford Act”). The Stafford Act authorizes the delivery of federal technical, financial, logistical, and other assistance to states and localities during declared major disasters or emergencies. The Federal Emergency Management Agency (“FEMA”) coordinates administration of disaster relief resources and assistance to states.
Based on the provisions of the Stafford Act, Section 301 of the 2020 Tax Relief Act defines the following terms:
Qualified Disaster Area
This is an entire geographical area that, under the Stafford Act, has been declared by the President to be subject to a “major disaster” that occurred between December 28, 2019 and December 21, 2020.
Qualified Disaster Zone
This is a zone within a Qualified Disaster area that, under the Stafford Act, has been declared by the President as qualified for individual or individual and public assistance from the federal government, sometime between January 1, 2020 and February 19, 2021.
A Qualified Disaster is a Stafford Act “major disaster” that was declared by the President during the December 28,2019 – December 21,2020 time frame outlined above. However, it does not include any disaster declaration related solely to the COVID-19 pandemic.
The term Incident Period relates to a Qualified Disaster. It is supposed to be declared by FEMA. It presumably begins with the date of the Qualified Disaster. FEMA determines when the Incident Period of the Qualified Disaster ends.
* * *
There have been numerous major disaster declarations during 2020. A list can be found on the FEMA website: https://www.fema.gov. Search for “disaster declarations”.
Tax-Qualified Retirement Plan Rules
The retirement plan rules that pertain to Qualified Disasters are actually not that new. Similar rules have been put in place in the past to address various disasters (e.g., Hurricane Katrina).
These retirement plan rules also are similar to the special rules that were provided in the CARES Act for withdrawals and loans from tax-qualified retirement plans. In fact, the CARES Act rules were modeled on the earlier disaster relief laws.
Essentially, there are three special retirement plan rules in relation Qualified Disasters:
- A participant can receive “Qualified Disaster Distributions” up to $100,000
- A participant can receive loans up to $100,000 and delay loan payments
- A participant can repay a hardship withdrawal not used to buy a home
Qualified Disaster Distributions
Under Section 302(a) of the 2020 Tax Relief Act, an employer’s retirement plan can be amended to permit a participant to receive a “Qualified Disaster Distribution”, if the participant meets all of the following requirements:
- The participant’s principal abode was located within a Qualified Disaster Area during the Incident Period
- The participant suffered an economic loss by reason of the Qualified Disaster
- The distribution does not exceed $100,000
- The distribution is made before June 19, 2021
Retirement plans that are covered by this rule include:
- Defined contribution plans that are tax-qualified under Internal Revenue Code (“Code”) Section 401(a) (and 401(k)),
- Code Section 403(b) plans, and
- Governmental Code Section 457(b) plans.
Unlike the CARES Act, this law specifically states that withdrawals are permitted from “money purchase pension plans” that are tax-qualified under Code Section 401(a). Note that it does not appear that a withdrawal is permitted from a tax-qualified defined benefit pension plan (including a cash balance pension plan).
Likewise, this is not a rule that extends to any nonqualified deferred compensation plans (including supplemental executive retirement plans). However, it is possible that a participant in a nonqualified deferred compensation plan might have a right to a distribution under that type of plan on account of an “unforeseeable emergency”.
If a participant in a tax-qualified retirement plan has a pre-existing right to make a withdrawal (e.g., at age 59-1/2), such a withdrawal under the plan can be treated as a Qualified Disaster Distribution if the Participant meets the requirements noted above. If the Participant does not have a pre-existing right to a withdrawal, the Plan can be amended to permit the Participant to make the withdrawal, even if the Participant is an active employee.
An individual has a personal $100,000 withdrawal limit for each Qualified Disaster. However, an employer is only required to apply the $100,000 withdrawal limit in regard to an individual employee, insofar as it relates to the tax-qualified plans of that particular employer.
An employee who receives a Qualified Disaster Distribution has to pay tax on the distribution, but can spread the taxable income over three tax years. In addition, the Qualified Disaster Distribution is exempt from the 10% penalty tax that can apply for early distributions from tax-qualified plans (Code Section 72(t)).
A participant who receives a Qualified Disaster Distribution also has a right to repay it to the plan (or another employer’s tax-qualified retirement plan or an IRA of the participant that accepts rollovers) within three years of the date of the Qualified Disaster Distribution. Any amounts repaid are to be treated as tax-free rollovers. It appears that if a repayment is made after taxable income was previously reported, the employee will have to file an amended tax return to claim a refund of tax previously paid.
Qualified Disaster Loans
Under Section 302(c) of the 2020 Tax Relief Act, an employer’s plan can be amended to permit a participant to receive a “Qualified Disaster Loan”, if the Participant meets both of the following requirements:
- The participant’s principal abode was located within a Qualified Disaster Area during the “Incident Period”
- The participant suffered an economic loss by reason of the Qualified Disaster
Normally, a plan loan cannot exceed $50,000, reduced by the highest outstanding loan balance within the past one year period. Nor can it exceed 50% of the participant’s vested account balance.
However, if the participant is eligible for a Qualified Disaster Loan, the maximum limit becomes $100,000, reduced by the highest outstanding loan balance within the past one year period. The loan also can be made up to 100% of the participant’s vested account balance.
In addition, if an eligible participant has an existing loan under the plan, the participant’s loan payments can be delayed if they are due between the first day of the Incident Period and 180 days after the end of the Incident Period.
The delay in payments can be until the later of (i) one year after the date the payment was due, or (ii) until June 19, 2021.
If payments are delayed, interest must continue to accrue on the balance, and the payments must be adjusted to account for the delay when they resume.
Finally, there generally is a five year maximum limit on a loan, unless it is used to purchase a principal residence. However, the maximum time period for repayment of the loan can be extended by the period of the delay in payments.
Repayment of Certain Plan Withdrawals
Under Section 302(b) of the 2020 Tax Relief Act, an employer’s retirement plan can be amended to permit a participant to repay certain hardship withdrawals that were obtained to build a home, but were not used to do so because of a Qualified Disaster.
To qualify for the repayment right, a participant has to meet both of the following requirements:
- The hardship withdrawal must have been obtained not earlier than 180 days before the Incident Period began and not later than 30 days after the end of the Incident Period.
- Repayment to the plan (or another employer’s tax-qualified retirement plan that accepts rollovers or to an IRA of the participant) must be made by June 19, 2021.
If an employer’s retirement plan requires amendments to provide for any of the foregoing rules, the plan is permitted to operate in compliance with the these rules. The plan amendment must be adopted by the last day of the first plan year beginning on or after January 1, 2022.
Employee Retention Credits
The Employee Retention Credit rules that pertain to Qualified Disasters are also not really new. Similar rules were enacted in the past to help employers whose businesses were adversely affected by various disasters (e.g., Hurricane Katrina).
These tax credit rules also are similar to the CARES Act employee retention credits that may be available to employers whose business operations were either suspended or greatly hindered by the pandemic. In fact, the CARES Act employee retention credits were modeled on the earlier disaster relief laws.
Under Section 303 of the 2020 Tax Relief Act, an employer may be able to claim a “2020 Qualified Disaster Employee Retention Credit”. To do so, the employer has to have a business within a Qualified Disaster Zone that became inoperable, and the employer has to have paid wages to an employee who had been employed within that Qualified Disaster Zone.
The credit is 40% of the wages paid to the employee, up to maximum of $2,400 of wages. Thus, the maximum tax credit is $960 per employee.
An employer is an “eligible employer” who may be able to claim the tax credit if both of the following requirements are met:
- During the Incident Period applicable to a 2020 Qualified Disaster, the employer had been conducting a trade or business within an area that became a Qualified Disaster Zone.
- At any time between the first day of the Incident Period and December 21, 2020, the trade or business within the Qualified Disaster Zone became “inoperable”, as a result of damage sustained by reason of the Qualified Disaster.
In relation to the 2020 Qualified Disaster Employee Retention Credit, an employee is an “eligible employee”, if the employee’s principal place of employment was in the Qualified Disaster Zone immediately before the Qualified Disaster.
The tax credit is available in relation to “qualified wages” that are paid to an eligible employee during the following period of time:
- Beginning on the date that the trade or business within the Qualified Disaster Zone became inoperable, and
- ending when “significant operations” of that trade or business have resumed within the Qualified Disaster Zone (but not later than 150 days after the end of the Incident Period).
All wages paid to an eligible employee are available for claiming the credit (up to the $2,400 limit), without regard to whether the employee was rendering services during the relevant period of time.
The term “wages” includes all compensation that is subject to federal unemployment tax under Code Section 3306. In addition, amounts paid by an employer to provide health coverage for an eligible employee also can be considered a qualified wages.
However, wages and health coverage payments cannot be taken into account if they are being used to claim loan forgiveness in relation to a PPP Loan. Nor can any such wages or health care payments be taken into account if they are being used to claim the employee retention credit under Section 2301 of the CARES Act (employee retention credits based on the business being suspended or greatly hindered because of the COVID-19 pandemic).
In addition, to the extent that wages are taken into account to claim the 2020 Qualified Disaster Employee Retention Credit, they cannot be taken into account to claim a tax deduction or certain other employee related tax credits.
Section 303(d) of the 2020 Tax Relief Act also permits certain tax-exempt organizations to claim the 2020 Qualified Disaster Employee Retention Credit.
In general, a tax-exempt organization may qualify if, absent its tax-exempt status, it would be considered to have been operating a trade or business with a Qualified Disaster Zone, and meets all other requirements of the law outlined above (e.g., the business became inoperable).
If a tax exempt organization is eligible to claim the 2020 Qualified Disaster Employee Retention Credit, the credit can be claimed to reduce the organization’s obligation to pay the employer “OASDI” social security tax (6.2% of wages for “Old Age, Survivors and Disability Insurance”).
State and Local Government Employers
State and local government employers are not eligible to claim the 2020 Qualified Disaster Employee Retention Credit.
However, an exception is made for colleges and universities that are tax-exempt organizations under Code Section 501(c), if the principal purpose of the organization is to provide medical or hospital care.