Seyfarth Synopsis: As Seyfarth has blogged about on multiple occasions [here and here], the CARES Act provides participants in tax-qualified retirement plans the opportunity to request distributions on a tax-favored basis by self-certifying that they have been adversely impacted by COVID-19. Seyfarth has also blogged about the IRS’s recent guidance on these distributions under Notice 2020-50 [here]. In the final substantive section of Notice 2020-50, the IRS issued relief for non-qualified deferred compensation plans as well. Specifically, if a participant self-certifies and receives a CARES Act distribution from a tax-qualified retirement plan, the participant may also cancel the participant’s deferral elections under any non-qualified deferred compensation plan. This opportunity raises interesting questions for plan sponsors and participants.
Historically, if a participant elected a hardship distribution under a 401(k) plan, the participant generally was prohibited from making any deferrals for at least six months under the 401(k) plan or all other plans maintained by the employer, including any non-qualified deferred compensation plans. To align with this requirement, Code Section 409A permits the cancellation of non-qualified plan deferral elections following a 401(k) plan hardship distribution. The Bipartisan Budget Act of 2018 removed the requirement for a participant to suspend 401(k) plan deferrals following receipt of a hardship distribution, but (intentionally or not) it did not amend Code Section 409A to remove the opportunity to cancel nonqualified plan deferral elections following a 401(k) plan hardship distribution. As a result, non-qualified plans can still permit the cancellation of deferral elections following a 401(k) plan hardship distribution.
With Notice 2020-50, the IRS has blessed the cancellation of non-qualified plan deferrals following a CARES Act 401(k) plan distribution. Specifically, the Notice piggybacks on the Code Section 409A cancellation rule described above by providing that a CARES Act distribution is treated as a 401(k) plan hardship distribution for purposes of such rule.
As noted above, CARES Act distributions may be based solely on self-certification by the participant. Effectively then, a participant could elect a $1 CARES Act distribution by self-certifying that COVID-19 adversely impacted the participant and in doing so, cancel potentially significant remaining non-qualified plan deferrals. While the relief afforded by Notice 2020-50 should protect non-qualified plan sponsors that authorize the cancellation of non-qualified deferrals following a CARES Act distribution, participants should be cautious before taking advantage of this relief. For example, if the IRS later disagrees with a participant’s self-certification during an individual audit, the IRS could determine that the cancellation of the nonqualified plan deferral election was a Code Section 409A violation and subject the entire plan benefit to immediate taxes, plus a 20% excise tax and premium interest (i.e., not just against the amount of the cancelled deferrals but against the entire nonqualified plan account balance). (Presumably, the impact on the qualified plan tax treatment of a non-compliant self-certification may be remedied through a repayment of the CARES Act distribution or through a 10% excise tax on the amount of the CARES Act distribution.)
After taking into consideration the above noted caution, the non-qualified plan may still permit the cancellation if allowed under its written terms (or even be required to cancel the deferrals). So, as always, please check your plan terms before moving forward with a cancellation of non-qualified plan deferrals based on a CARES Act distribution. Finally, and with stakes this high, plan sponsors should make certain that the non-qualified deferred compensation plan includes 409A tax and penalty indemnification language, and may wish to seek an additional acknowledgement or indemnity from a participant covering any potential adverse Code Section 409A tax consequences before permitting the cancellation.