Increased Penalties under the SECURE Act

The SECURE Act created many new ways to help both individuals and employers save for retirement, including creating extra flexibility for safe harbor plans, extending the deadline to initially adopt a qualified plan, eliminating the maximum age for IRA contributions, and delaying the age at which required minimum distributions commence. However, from Congress’ point of view, each additional dollar that is saved in a qualified retirement plan or IRA represents lost tax revenue. Therefore, the SECURE Act also includes some revenue raisers to offset the cost of the expanded retirement benefits. One of these provisions is Section 403 which increases (by a factor of 10) the penalties for several types of failures related to retirement plans.

Form 5500

The first and most notable increase comes under section 403(a) of the SECURE Act, regarding the penalty under IRC section 6652(e) for failure to file Form 5500. Form 5500 is the annual return for employee benefit plans which is due 7 months after the end of the plan year (July 31 for a calendar plan year). The deadline can be extended by an additional 2½ months (to October 15 for a calendar plan year) if an extension request is filed with the IRS. If the Form 5500 is not filed by the deadline, the IRS imposes a fine on the plan administrator for each day that the filing is late. If an extension was filed, it is disregarded when applying this penalty; the fine is calculated retroactive back to the original due date of the Form 5500. Prior to the SECURE Act, the fine was $25/day, with a maximum of $15,000 for a single Form 5500. After the SECURE Act, the penalty is now $250/day, with a maximum of $150,000 for a single Form 5500.

Of course, IRS penalties alone do not tell the whole story when it comes to Form 5500. The Department of Labor imposes its own fines on top of those levied by the IRS. The DOL can charge a plan administrator who fails to file a Form 5500 up to $2,233 per day, with no maximum. This fine was not increased under the SECURE Act, but is adjusted annually for inflation. Fortunately for plan administrators, the DOL offers a way to get plans caught up at a much lower cost. Under the Delinquent Filer Voluntary Compliance Program (DFVCP), a Form 5500 can be filed late at a cost of $750 per filing, or a maximum of $1,500 per plan when filing multiple forms at once, as long as the plan has fewer than 100 participants. Higher fees apply for larger plans. The DVFCP may only be used for a voluntary submission by a delinquent filer; if the filing is in response to a government notice regarding the delinquency, the DVFCP may not be used.

Form 8955-SSA

Section 403(b) of the SECURE Act increased the penalties for failing to register or report certain changes in status under IRC section 6652(d). This actually includes two separate penalties. The first, under section 6652(d)(1), is for failure to file Form 8955-SSA. This is the form used to report terminated participants with a deferred vested benefit. Previously the penalty was $1 per day for each participant required to be reported on the form, with a maximum penalty of $5,000. Now the penalty is $10 per day per participant, with a maximum of $50,000.

Plan Changes Reported to the IRS

The second increase added under SECURE section 403(b) is the penalty under IRC section 6652(d)(2), for failure to notify the IRS of a change in the name of the plan, a change in the name or address of the plan administrator, the termination of the plan, or a merger or division of the plan. These changes do not require a separate form to notify the IRS; they are noted on the Form 5500. However, if a plan administrator fails to file a Form 5500, and any of the required items apply, they could be subject to both the penalties under 6652(e) and 6652(d)(2). Prior to the SECURE Act, the penalty was $1 per day with a maximum penalty of $1,000; the penalty has increased to $10 per day with a maximum of $10,000.

Participant Distribution Notice

Finally, section 403(c) of the SECURE Act increased the penalty under IRC 6652(h) for failure to provide the notice required under IRC 3405(e)(10)(B). This section describes the notice that is required to be given to anyone receiving a distribution which is not an eligible rollover distribution, informing them that they may elect to waive federal income tax withholding. The notice must be provided no earlier than 6 months before payments commence, and not later than the time that would give the payee reasonable time to make an election without delaying payment. Prior to the SECURE Act, the penalty for failure to provide this notice was $10 for each failure, not to exceed $5,000 for a single payor in a calendar year. The penalty has been increased to $100 for each failure with a calendar year maximum of $50,000. Note that the penalty for failure to provide the section 402(f) notice for eligible rollover distributions was already $100 per failure with an annual maximum of $50,000 under SBJPA 1996; SECURE brought the penalty for non-rollover eligible distributions into line with the penalty for rollover eligible distributions.

While the SECURE Act opened many new opportunities to save for retirement, the increased penalties mean it is more important than ever to make sure your plan is operated in strict compliance. If you have any questions about your compliance requirements, please contact us.

Summary of the Changes Made by Section 403 of the SECURE Act

  • Failure: Did not file Form 5500

    • Old penalty: $25 per day, maximum $15,000

    • New penalty: $250 per day, maximum $150,000

  • Failure: Did not file Form 8955-SSA

    • Old penalty: $1 per day per participant, maximum $5,000

    • New penalty: $10 per day per participant, maximum $50,000

  • Failure: Did not notify IRS of change in plan name or sponsor address, plan merger or division, or plan termination

    • Old penalty: $1 per day, maximum $1,000

    • New penalty: $10 per day, maximum $10,000

  • Failure: Did not provide the required notice to a participant receiving a distribution not eligible for rollover regarding their right to waive federal income tax withholding

    • Old penalty: $10 per failure, maximum $5,000

    • New penalty: $100 per failure, maximum $50,000

Coronavirus Relief Part VI - IRS Guidance on RMD Rollovers

On June 23, 2020, the IRS published Notice 2020-51 which provides additional guidance related to Section 2203 of the CARES Act which waived Required Minimum Distributions for 2020 for certain plans and IRAs. For our previous coverage of Section 2203, see Coronavirus Relief Part III - RMD Waivers. The notice also provides an update on the RMD changes made by the SECURE Act.

Deadline Extended

The CARES Act was signed into law on March 27, 2020, and effective on that date, there were no more RMDs for 2020 (for participants in defined contribution plans and holders of IRAs). This was a great relief for anyone who had not yet taken their 2020 RMD, as they would no longer be required to take a distribution during the volatile market environment. However, many individuals who were subject to 2020 RMDs might have already taken their distributions prior to the enactment of the CARES Act.

Once the CARES Act became law, any distribution taken between January 1, 2020 and March 27, 2020 which had been classified as an RMD was now considered an eligible rollover distribution. Generally, an eligible rollover distribution which is not directly rolled over may still be paid to an IRA or to the trustee of an eligible retirement plan and be excluded from income, as long as the payment happens within 60 days of the distribution. Individuals who received RMDs in February or March 2020 would still have had some time after the enactment of the CARES Act to take advantage of this 60-day rollover period. However, those who took their RMDs in January 2020 would have missed the window to pay back their RMD.

Notice 2020-51 provides relief. The IRS officially extended the 60-day rollover window to August 31, 2020, to roll over any RMD payment (other than from a defined benefit plan) made in 2020 to an eligible retirement plan or IRA. Thanks to this relief, participants who took an RMD at any time in 2020 now have until August 31, 2020 to repay the amount of their RMD and exclude it from income in 2020.

Exception to One-Rollover-per-Year-Rule

Ordinarily, the holder of an IRA is not permitted to make more than one rollover contribution in any 12-month period. Notice 2020-51 provides an exception to this rule with respect to the re-contribution of amounts which were distributed as RMDs as described in the previous section. Therefore, an amount which was distributed as an RMD during 2020 may be repaid to an IRA at any time up through August 31, 2020, regardless of whether the account holder has made (or will make) another rollover contribution within a year.

Plans not Required to Treat 2020 RMDs as Eligible for Rollover

The SECURE Act increased the age at which RMDs must begin from 70½ to 72, effective for individuals attaining age 70½ in 2020 or later. However since the SECURE Act was passed very late in 2019, it did not give much time for recordkeepers and other service providers to update their systems and procedures before the new rule took effect. As a result, some distributions may have been paid out during 2020 and treated as RMDs, even if they were no longer actually RMDs.

A distribution which is not an RMD is generally eligible for rollover. The administrator of a plan which makes an eligible rollover distribution must comply with certain requirements, including providing a special tax notice to the participant, and withholding 20% for federal income tax purposes.

If a distribution was made during 2020 and was treated as an RMD by the payor, but after the application of the SECURE Act and/or the CARES Act, it would no longer be an RMD, and therefore could be an eligible rollover distribution. However the plan would have failed to comply with the notice and withholding requirements by treating the distribution as an RMD.

Notice 2020-51 provides relief, by allowing payors to treat distributions, which would have been RMDs for 2020 if not for the provisions of the SECURE Act and the CARES Act, as if they were not eligible rollover distributions, with respect to the notice and withholding requirements.

If you have any questions about your RMD obligations for 2020 or beyond, please contact us.

Coronavirus Relief Part V - Expansion of Qualifying Factors, and Clarification from IRS

We are pleased to return to the topic of section 2202 of the CARES Act. For previous discussion of section 2202, see Part I - Coronavirus-Related Distributions and Part II - Loans of our Coronavirus relief series.

On June 19, 2020 the IRS released Notice 2020-50. This notice takes advantage of the provision in the CARES Act which permits the Treasury Department to provide additional factors to consider when determining who is a qualified individual for purposes of Coronavirus-related distributions and loans. The notice additionally provides some clarification on certain issues related to section 2202, including the suspension of loan payments for a qualified individual.

New Qualifying Factors

The text of the CARES Act provides that an individual is eligible for the special distribution and loan provisions if they suffered “adverse financial consequences” due to COVID-19. These consequences include being quarantined, being furloughed or laid off, being unable to work due to lack of childcare, a reduction in hours worked, or the closing or reduction in hours of operation of a business that they owned. However all of these only applied to the participant themselves. Notice 2020-50 expanded all of these factors to also include the individual’s spouse, and members of their household (defined as anyone sharing the same principal residence).

In addition, two entirely new qualifying factors were added. An individual is now qualifying if they, their spouse or member of their household experienced a reduction in pay or self-employment income due to COVID-19. An individual is also now qualifying if they, their spouse or member of their household had a job offer rescinded or start date delayed due to COVID-19.

To recap, a qualifying individual is one:

  • Who is diagnosed with SARS-CoV-2 or the coronavirus disease 2019 (collectively referred to as "COVID-19");

  • Whose spouse or dependent is diagnosed with COVID-19; or

  • Who experiences adverse financial consequences as a result of any of the following, or whose spouse or a member of whose household experiences adverse financial consequences as a result of any of the following due to COVID-19:

    • Being quarantined, laid off, or furloughed;

    • Having work hours reduced;

    • Being unable to work due to lack of child care;

    • Closing or reduction in hours of operation of a business that they own;

    • Reduction in pay or self-employment income; or

    • Having a job offer rescinded, or start date delayed.

Participant Self-Certification of Qualifying Status

The IRS reaffirmed in Notice 2020-50 that a Plan Administrator may rely upon a participant’s certification that they meet the definition of a qualified individual when determining whether to allow a coronavirus-related distribution or loan. However, they may not rely upon the participant’s certification if they have actual knowledge to the contrary. The Plan Administrator is not required to investigate the veracity of the participant’s claim; they would only be required to deny it if they already possessed knowledge contradicting the claim.

The IRS also clarified that while the Plan Administrator may rely upon the certification without verifying it, the participant is not entitled to treat the distribution as a coronavirus-related distribution on their personal tax return (with respect to the waiver of the excise tax under sec. 72(t) and the spread of income over a 3-year period) unless they actually are a qualified individual.

Suspension of Loan Payments

One of the more puzzling pieces in the text of section 2202 regards the suspension of loan payments. There was some confusion because the wording of the Act permits a qualified individual to suspend, for a one year period, loan payments which were scheduled to be due between March 27, 2020, and December 31, 2020.  This is unclear because although it says payments are suspended for one year, the range of dates for which it says payments may be suspended is itself less than one year. So the question is, what happens at the end of the year?

For example, if a payment was originally due on March 31, 2020, and was delayed for one year, it would now be due March 31, 2021. However, there was no suspension permitted in the law for a payment due in January 2021. If payments are required to begin in January, then the participant did not have their payments suspended for one year as the law seems to require. 

Furthermore, the Act says that the original term of the loan will be extended by the length of the suspension period. If payments resume 9 months after the suspension, is the term extended by 9 months or by the 1 year referenced in the Act?

Notice 2020-50 provides a safe harbor method for compliance with this section. Under the safe harbor, the suspension period must end on December 31, 2020 and payments must resume after that date, however the original term of the loan is extended by 1 year. The outstanding balance of the loan as of the beginning of the suspension period must be increased for interest through the end of the year, then amortized into level payments for the remainder of the term (including the 1 year extension).

The notice also recognizes that there may be other ways to comply with the loan suspension provision of the CARES Act, however they may be more complex than the safe harbor method. For example, the payments beginning in January 2021 may be made as originally scheduled, and then increased payments may be required to begin only starting on the anniversary of the original suspension date. In this case, the outstanding balance would be computed as of the 1-year anniversary of the start of the suspension period, taking into account accrued interest during the suspension period, but also taking into account the payments made between January 1, 2021 and the anniversary date. That balance would then be amortized into level payments over the remaining term of the loan, including a 1-year extension.

In any case, it is clear that repayments must begin again on the first repayment date after December 31, 2020. It is not permissible to wait until one full year after the loan suspension date to begin repayments.

Other Items

The notice grants that, for a participant in a Section 409A Nonqualified Deferred Compensation Plan, if the participant receives a Coronavirus-Related Distribution from an eligible retirement plan, that distribution will be considered a hardship distribution for purposes of permitting a cancellation of the participant’s deferral election under the nonqualified plan. The election may only be cancelled, not postponed or delayed.

The notice also discusses the impact on various individual income tax scenarios of making repayments of Coronavirus-related distributions. Since these affect individual tax planning, and not retirement plan design or administration, they have not been covered here. However, if you have questions about it, or anything else related to the CARES Act, please don’t hesitate to contact us.