Cancellation of Non-Qualified Plan Deferral Election Due to a Coronavirus-Related Distribution

In general, a participant must make a deferral election to a non-qualified deferred compensation plan before the beginning of the plan year and the election must remain in effect for the entire plan year. Participants made their deferral elections by December 31, 2019 to calendar year plans, before anyone knew how impactful the COVID-19 virus would be on businesses and individuals’ incomes.

The regulations under Section 409A of the Internal Revenue Code (the “Code”) state that a plan may provide for the cancellation of a participant’s deferral election, or such a cancellation may be made, due to an unforeseeable emergency or a hardship withdrawal, as defined in the 401(k) regulations. Both an unforeseeable emergency and a hardship withdrawal generally require the participant to have suffered a financial detriment, such as unreimbursed medical expenses, a casualty loss, or funeral expenses. As such, a decrease in income, standing alone, would not generally be sufficient to allow a participant to cancel his/her deferral election to a non-qualified plan.

IRS Notice 2020-50 (issued June 19, 2020) provides that if the participant is a qualified individual as defined in the CARES Act, and takes a coronavirus-related distribution (“CRD”) from an eligible retirement plan, that distribution will be deemed to be a hardship withdrawal for purposes of the Section 409A regulations, and the participant may be able to permissibly cancel his/her deferral election to the non-qualified plan.

The cancellation may be automatic under the terms of the non-qualified plan, or the participant may need to make an affirmative election to cancel the deferral election. Note that the deferral election must be actually cancelled, not merely postponed or delayed. Any subsequent deferral election would have to comply with the general timing rules under the non-qualified plan and Code Section 409A; therefore, if the deferral election is cancelled, the participant may need to wait until 2021 to make a new deferral election to the non-qualified plan.

The IRS interpretation in Notice 2020-50 is welcome relief by making it easier for participants who are experiencing adverse financial consequences as a result of the COVID-19 virus, such as those who are furloughed, laid off, or working on a reduced hour schedule with a related reduction in pay, to cancel their deferral elections to a non-qualified deferred compensation plan.

Implications for 401(K) Plans in the Secure Act

As part of the 2020 appropriations act, Congress passed the SECURE Act (Setting Every Community Up for Retirement Enhancement Act of 2019), which was signed into law by the President on December 20, 2019. The SECURE Act has a number of implications for 401(k) plans, a summary of which follows.

  1. Increase in Maximum Automatic Deferral. The maximum “automatic” deferral that can be made to a 401(k) plan that is a qualified automatic contribution arrangement is increased from 10% of compensation to 15% of compensation.  This change is effective for plan years beginning after December 31, 2019.
  2. Notice Requirements for Safe Harbor Plans. A “safe harbor” 401(k) plan that satisfies the safe harbor through non-elective employer contributions at least equal to 3% of the employee’s compensation is no longer required to provide the annual safe harbor notice at least 30 days before the beginning of the plan year.  Safe harbor plans that satisfy the safe harbor through matching contributions are still subject to the annual notice requirements. This change is effective for plan years beginning after December 31, 2019.
  3. Timing of Adoption of Safe Harbor Status. A 401(k) plan can be amended to become a safe harbor plan providing a 3% non-elective contribution by the day before the 30th day before the end of the plan year (December 1 for a calendar year plan.)  Alternatively, the plan can be amended to become a safe harbor plan providing a 4% non-elective contribution by the last day of the following plan year.  This change gives employers another tool to correct a 401(k) plan that fails the ADP test. For example, if a non-safe harbor plan fails the ADP test for the plan year ending December 31, 2020, in lieu of distributing excess contributions to highly compensated employees, the plan can be amended by December 31, 2021 to add a 4% non-elective contribution for the 2020 plan year.  The SECURE Act does not state when the non-elective contribution must be made to the plan for the 2020 plan year.  These amendments may not be adopted if the 401(k) plan is a safe harbor plan that satisfies the safe harbor through matching contributions.  This change is effective for plan years beginning after December 31, 2019.
  4. No Loans Through Credit Cards or Similar Arrangements. Some 401(k) plans made plan loans available to participants through what was essentially a credit card.  Each use of the card constituted a new loan; the participant received a bill, and made monthly payments to the plan.  Effective December 21, 2019, loans from a 401(k) plan through the use of a credit card or similar arrangement are not allowed under Section 72(p) of the Internal Revenue Code (the “Code”).  Any such loans would be treated as a taxable distribution from the plan.
  5. In-Service Distribution of Annuity Contracts. 401(k) plans may offer an annuity or similar contract providing for lifetime income as an investment option.  These contracts may have surrender charges if they are liquidated, for example, if the investment is no longer available as an investment option under the plan.  Effective for plan years after December 31, 2019, a 401(k) plan may allow participants to take an in-service distribution of such annuity contract within 90 days before the date on which the annuity contract is no longer authorized to be held as an investment option under the plan, even if the participant is not otherwise entitled to a distribution under the plan.  The distribution must be in the form of a direct trustee-to-trustee transfer to an IRA or other qualified retirement plan or as a distribution of the annuity contract to the participant.
  6. Elective Deferrals by Long-Term Part-Time Employees. A “long-term part-time” worker must be allowed to make elective deferrals to a 401(k) plan.  A long-term part-time worker is an employee who is at least age 21 and has completed three consecutive years of service with at least 500 hours of service in each such year.  Such an employee must enter the plan on the earlier of (a) the first day of the plan year after meeting the age and service requirements; or (b) the date that is six months after the date on which the employee satisfied the age and service requirements.

The employer is not required to make any matching or non-elective contributions to a long-term part-time employee who is making elective deferrals under this special rule.  If the employer makes matching or non-elective contributions on behalf of a part-time worker, he or she will earn a year of vesting service for every year in which the worker has at least 500 hours of service.

A long-term part-time worker who becomes a full-time employee will no longer be treated as a long-term part-time worker as of the first day of the plan year following the plan year in which the employee completes 1000 hours of service.

For testing purposes, an employer may elect to exclude long-term part-time employees for the purposes of:

  • Non-discrimination testing under Code Section 401(a)(4)
  • ADP testing
  • Safe harbor contributions
  • Automatic contribution arrangements
  • ACP testing
  • Coverage testing under Code Section 410(b)

Further, such employees may be excluded for purposes of minimum benefits and vesting under the top-heavy rules.

These new rules do not apply to collectively bargained employees.

The new participation rule for long-term part-time workers applies to plan years beginning after December 31, 2020, except that for purposes of determining whether the three consecutive year period has been met, 12-month periods beginning before January 1, 2021 will not be taken into account.

  1. Qualified Birth or Adoption Distributions. A 401(k) plan may allow an in-service distribution of up to $5,000 for a “qualified birth or adoption distribution.” This is a distribution made within the one year period following the birth or legal adoption of a child. Such a distribution may be repaid to the plan by the participant.  A qualified birth or adoption distribution is exempt from the 10% early distribution tax under Code Section 72(t)(2). This provision is effective for distributions made after December 31, 2019.
  2. Lifetime Income Stream Disclosure. At least once in every 12-month period, the participant’s benefit statement must disclose the “lifetime income stream equivalent” of the participant’s account balance. A lifetime income steam equivalent means the monthly payments the participant would receive if his or her account balance were used to provide a qualified joint and survivor annuity and a single life annuity.  The Department of Labor (“DOL”) is directed to issue a model lifetime income disclosure, appropriate assumptions and interim final rules by December 20, 2020. No plan fiduciary or plan sponsor will have any liability under ERISA if it provides the lifetime income equivalents in accordance with the DOL’s assumptions consistent with explanations contained in the model lifetime income disclosure.  This disclosure will apply to benefit statements furnished more than 12 months after the latest of the issuance by the DOL of the interim final rules, the model disclosure or the assumptions.
  3. Fiduciary Safe Harbor for Selection of Lifetime Income Provider. The SECURE Act sets out a safe harbor for a fiduciary who selects a guaranteed annuity contract providing lifetime income to a participant.  The fiduciary will be protected from fiduciary liability under ERISA if it evaluates the financial capability of the insurer and the cost of the contract, and receives certain written representations from the insurer.  The fiduciary must satisfy these responsibilities at the time of selection of an insurer for a participant or beneficiary. This means if the insurer is unable to meet its payment obligations in the future under the contract, the fiduciary is not liable for any losses that affect the participant.
  4. Required Beginning Date Increased to Age 72. The required beginning date for purposes of required minimum distributions is increased from age 70½ to age 72.  This applies to distributions required to be made after December 31, 2019 with respect to individuals who attain age 70½  after that date. Required minimum distributions based on age 70 ½ due April 1, 2020 must still be made.
  5. RMD Rules Revised. If an employee dies before receiving his or her entire account balance, the required minimum distribution (RMD) rules are revised to provide that the entire benefit must be distributed within 10 years.  A beneficiary (other than certain “eligible designated beneficiaries”) is no longer permitted to receive distributions over his or her lifetime. An eligible designated beneficiary who is permitted to receive distributions over his or her lifetime includes a surviving spouse and a person who is not more than 10 years younger than the employee.  This change is generally effective for distributions with respect to employees who die after December 31, 2019.

Plans must be amended to incorporate the changes made by the SECURE Act by the last day of the first plan year beginning on or after January 1, 2022 (or a later date prescribed by the IRS), and must be operated in accordance with the provisions of the SECURE Act as of the applicable effective date.  As many of these changes are effective for plan years beginning after December 31, 2019, plan sponsors should evaluate the changes, determine the impact on the operation of their plan and communicate the changes to participants.

If you have any questions about the SECURE Act, please contact Cynthia A. Moore at 248-433-7295, or any other member of Dickinson Wright’s Employee Benefits and Executive Compensation Group.

IRS Announces 2020 Annual Adjustments for Qualified Retirement Plan Limits

The IRS has announced the annual limits that will apply to qualified retirement plans in 2020. The key 2020 limits, as compared to the 2019 limits, are:

For 401(k) plans, the maximum deferral limit increases by $500 to $19,500 for a participant who is under age 50. A participant who is age 50 or older will be able to defer a maximum of $26,000 ($19,500 + $6,500 catch-up), a $1,000 increase from 2019.

If you have any questions or would like more information, please contact Cynthia A. Moore in the Troy, Michigan office at 248-433-7295.

IRS General Counsel Opinion on Deductibility of Health Insurance Premiums Paid for Family Members of S Corporation Shareholders

The IRS recently issued a Chief Counsel Memorandum clarifying when a family member of a 2% shareholder in an S corporation is entitled to a deduction under Section 162(l) of the Internal Revenue Code (the “Code”) for health plan insurance premiums paid for coverage provided to the family member by the S corporation. Chief Counsel Memorandum 201912001 (March 22, 2019).

Background. For benefit plan purposes, a 2% or more shareholder of an S corporation is treated like a partner in a partnership. Therefore, if the 2% shareholder-employee is covered by a health plan of the S corporation, the S corporation will include the health insurance premiums paid in the shareholder’s income and they will be reported as income on Form W-2. To give the 2% shareholder equivalency with common law employees, the 2% shareholder is allowed to take an “above the line” deduction on his or her individual Form 1040 for the amounts paid by the S corporation for health insurance coverage for the shareholder-employee and his or her family members.

To meet the requirements for the deduction under Code Section 162(l), the health plan must be established by the S corporation. The plan is considered to be established by the S corporation if either:

  • The S corporation makes the premium payments for the health insurance policy; or
  • The 2% shareholder makes the insurance premium payments and the S corporation reimburses the shareholder upon receipt of proof of payment.

Issue Addressed by the IRS. The question posed to the IRS was whether a family member, who is deemed to own stock under the family attribution rules, is entitled to the deduction under Code Section 162(l) for the amount of the health insurance premiums paid on his or her behalf by the S corporation. The family attribution rules provide that an individual is deemed to own stock owned, directly or indirectly, by or for his or her spouse, children, grandchildren and parents.

For example, assume Father owns 100% of an S corporation. Daughter is employed by the S corporation and, under the family attribution rules, is deemed to own 100% of Father’s stock. Daughter is, therefore, considered to be a 2% shareholder. The S corporation provides a group health plan to all employees, including Daughter. The premiums paid by the S corporation on behalf of Daughter for the health plan coverage will be included on her Form W-2 as income.

In the Chief Counsel Memorandum, the IRS concluded that, if the conditions of Code Section 162(l) are met, Daughter is entitled to take a deduction on Form 1040 for the health plan premiums paid by the S corporation on her behalf.

This conclusion in the Chief Counsel Memorandum is welcome news for family members who work for S corporations owned by another family member, as they will be permitted to take the deduction for insurance premiums paid for health plan coverage that is included in their income.

A Chief Counsel Memorandum is written advice issued by the Office of Chief Counsel in response to an internal request for guidance from the IRS. It is not considered substantial authority or binding precedent, but provides insight on the IRS position on a particular issue. We recommend that you consult with qualified tax counsel on this or similar issues.

If you have questions, please contact Cynthia A. Moore at 248-433-7295 or any other member of Dickinson Wright’s Employee Benefits and Executive Compensation group.

Determining Eligibility for the Employer Credit for Paid Family and Medical Leave

Section 45S of the Internal Revenue Code (“Code”), added to the Code by the Tax Cuts and Jobs Act of 2017, establishes a general business credit for an employer who provides paid family and medical leave to qualifying employees. The credit would partially offset the cost of the paid leave, however, it is available only for the 2018 and 2019 taxable years. To assist employers in determining whether they are eligible to claim the credit, the IRS provided guidance in Notice 2018-71, summarized below.

Calculating the Credit

The credit is generally equal to the applicable percentage of the wages paid to qualifying employees while on family and medical leave. The applicable percentage is 12.5% increased (but not above 25%) by 0.25 percentage points for each percentage point by which the rate of payment exceeds 50%. Notice 2018-71 provides further details on how to calculate and claim the credit.

Written Policy

As a prerequisite to claiming the credit, the employer must have a written policy that provides all “qualifying employees” with at least two weeks of paid family and medical leave (pro-rated for part-time employees) at a rate of at least 50% of the employee’s normal wages. The written policy may be in a single document or multiple documents.

For an employer’s first taxable year beginning after December 31, 2017, the written policy could be adopted with retroactive effect as long as retroactive leave payments were made by the last day of the taxable year. (December 31, 2018 for employers with a calendar year.) For subsequent taxable years, the written policy must be in place before the credit is taken. The policy is considered to be in place on the later of the policy’s adoption date or its effective date.

Therefore, if a calendar year employer determines in early 2019 that its current leave policy does not satisfy the IRS guidance, the employer can implement a new or updated policy and claim the credit on a prospective basis in 2019. The practical question is then whether to retain the policy when the credit expires at the end of the 2019 taxable year.

Family and Medical Leave

The types of leave eligible for the credit are leaves qualifying under the Family and Medical Leave Act (“FMLA”), typically for the birth or adoption of a child, the employee’s serious health condition, or caring for a spouse, child or parent with a serious health condition. The leave must be specifically designated for one or more FMLA purposes, may not be used for any other reason, and is not paid by a State or local government or required by State or local law. Thus:

  • PTO days that can be used for sickness, vacation, or personal reasons will not qualify (because the leave can be used for reasons other than FMLA purposes); and
  • To the extent paid leave is provided under State or local law, the federal credit cannot be claimed.

Short-term disability leave can qualify, whether it is insured or self-insured, as long as it meets all other requirements of family and medical leave under Code Section 45S.

Qualifying Employee

A “qualifying employee” is one who has been employed for one year or more and whose compensation is less than 60% of the amount under Code Section 414(q)(1)(B)(i) ($72,000 in 2018 and $75,000 in 2019.) No classification of employees may be excluded and a pro-rata amount of leave must be provided to part-time employees (working fewer than 30 hours per week.) Therefore, a paid leave policy benefiting only full-time employees will not qualify for the federal credit.

If an employer is using payments from a short-term disability (STD) insurance policy to satisfy the paid leave obligation, the employer should review the policy to determine if it has any pre-existing condition exclusions. If so, according to IRS Notice 2018-71, the employer will not be eligible for the credit for any employee because a qualifying employee with a pre-existing condition would not receive payments from the policy. This deficiency can be cured if the employer provides payments on a self-insured basis to any qualifying employee who is not eligible for payments under the STD policy due to a pre-existing condition.

Effective Date

The credit applies to wages paid in taxable years beginning after December 31, 2017 and before January 1, 2020.

The credit is useful in encouraging an employer to provide paid family and medical leave to employees. However, its usefulness is limited as the credit expires at the end of the 2019 taxable year. If an employer wishes to take advantage of the credit, it should carefully review its existing leave policy and STD policy and determine if modifications are necessary.

If you have any questions about the credit for paid family and medical leave, please contact Cynthia A. Moore at or any other member of the Dickinson Wright Tax or Employee Benefits group.