Saturday 30th January 2021
In response to the COVID-19 pandemic, the United States Congress and the Puerto Rico Treasury Department (Hacienda) last year granted favorable tax treatment to coronavirus-related distributions (CRDs) and affiliate loans from U.S. Qualifying Plans and Puerto Rico. qualified plans. More recently, both jurisdictions have extended similar tax treatment to certain distributions, hardship withdrawals, and planning loans related to disasters outside of COVID-19.
US Civil Protection Rules
Section 302 of the Consolidated Appropriations Act (CAA) of 2021 provides special tax breaks to make it easier for participants to access funds from their tax-qualified pension plans to recover from disaster losses. Under the CAA, a “Qualified Disaster Area” is defined as any area in which the President declares a major disaster under the Stafford Act between January 1, 2020 and February 25, 2021 if the incident period begins between December 28, 2019 and December 27, 2020. The "incident period" is the "period that the Federal Agency for Disaster Protection has determined as the period in which the disaster occurred". A qualified disaster area does not include an area in which a major disaster has been reported solely due to the COVID-19 pandemic and the CAA does not extend the now expired CRD and the loan relief as part of the coronavirus aid, aid and economic security (CARES) Act.
Under the CAA, a Plan Participant is a "Qualified Person" entitled to relief if the Participant's primary residence is in a Qualified Disaster Area at any time during the Incident Period and the Participant has suffered economic loss as a result of the Disaster.
Plan sponsors are not obliged to adopt these disaster relief provisions. Plan sponsors who choose to adopt some or all of the CAA's relief provisions may initially administer their retirement plans in accordance with the provisions without first changing their qualifying plan records. However, the plans must be amended to reflect the relief provisions by the end of the plan year beginning on or after January 1, 2022 (i.e., December 31, 2022 for calendar plan year plans).
Qualified disaster distributions
A Qualified Retirement Plan may allow a Qualified Individual to perform Qualified Disaster Distribution (QDD) up to a maximum of $ 100,000 annually (reduced by the amount of the participant's previous QDDs). A QDD must be performed on or after the first day of the Incident Period and completed by June 25, 2021.
Much like CRDs under the CARES Act, QDDs are exempt from the 10 percent excise tax that is normally applied to early distributions from qualifying retirement plans. The participant may also choose to (1) include the QDD in taxable income on a pro-rata basis over the three tax years beginning with the year of distribution and / or (2) repay the QDD in whole or in part to the original plan Qualified Employer's plan or an individual retirement account (IRA) that accepts rollover, at any time during the three-year period beginning on the day after the date the QDD was created. QDD repayments are treated as tax-free rollover.
A Plan Sponsor may also increase the maximum limit on a loan to a Qualified Person to less than $ 100,000 or 100 percent of the participant's vested benefits balance.
A Qualified Person may be permitted to delay the repayment of any outstanding debt due between the first day of the relevant Incident Period and 180 days after the end of the Incident Period. These repayments may be delayed for up to a year or, if later, by June 25, 2021, even if the new repayment deadline exceeds the regular five-year term for loans for non-residential plans. However, subsequent repayments will need to be adjusted to reflect the delay and any interest accrued during the delay.
A participant who has applied for hardship to gain access to funds to buy or build primary residence in a qualifying disaster area may attribute hardship in whole or in part to the original plan, another employer's qualifying plan, or an IRA, the rollover will be accepted if the disaster ultimately resulted in no money being used to buy or build residential buildings. To be eligible for a refund, the hardship withdrawal must be completed in the period beginning 180 days before the first day of the Incident Period and ending 30 days after the last day of the Incident Period. Similar to QDD repayments, these repayments are also treated as tax-free rollover.
Rules for Disaster Relief in Puerto Rico
Section 1081.01 (b) (1) (D) of the 2011 Puerto Rico Internal Revenue Code (PRIRC) makes the favorable treatment of CRDs permanent through December 31, 2020 with respect to Disaster Distributions (DRDs). through Hacienda Circular Letters of Internal Revenue No. 20-23 and 20-29. However, there are no favorable tax treatment or special regulations for participant loans.
In principle, DRDs are flat-rate distributions after the separation of service and in-service hardship withdrawals – but not monthly pensions, regular installment payments or partial payments – that were paid to participants in a qualified plan in Puerto Rico due to a "declared disaster", whether a Puerto Rico-only qualifying plan or a dual qualifying plan, a defined benefit plan, or a defined contribution plan.
A “declared disaster” is a natural or man-made disaster that entitles residents of Puerto Rico to emergency public financial assistance through the issuance of an executive order by the Governor of Puerto Rico. As with CRDs, Hacienda will in due course establish specific rules for implementing DRDs by issuing a circular. That is, even if the governor has issued a Declaration of Disaster Order, payments to participants in a Puerto Rico Eligible Plan should not be treated as DRD in Puerto Rico until Hacienda issues the appropriate circular.
For DRDs eligible expenses
To be eligible for a DRD, the participant must request payment in order to access resources necessary to cover eligible expenses incurred or incurred as a result of a reported disaster. “Eligible Costs” are all costs that a Participant incurs or will incur to cover any loss or damage suffered, as well as the cost of unforeseen costs and necessities incurred as a result of a reported disaster. Eligible expenses may be incurred by the entrant or their spouse, descendants, or ancestors (e.g., an entrant may request a DRD to access funds necessary to cover their parents' eligible expenses).
Favorable tax treatment
The first $ 10,000 in DRDs attributable to pre-tax contributions will be distributed tax-free and with source tax exempt in Puerto Rico. The next $ 90,000 in DRDs attributable to pre-tax contributions (DRDs between $ 10,001 and $ 100,000) are subject to both a 10 percent flat rate and 10 percent withholding tax in Puerto Rico at source. The source amount covers the tax liability a participant owes in the applicable local tax return. DRDs that are attributable to an employee after taxes are not taxable. DRDs must first be funded from the pre-tax portion of an employee account and then from post-tax contributions.
Participants are not limited to any DRD or DRDs from any qualifying plan or IRA in Puerto Rico. Participants can receive multiple DRDs from different plans, but the total limit on DRDs is $ 100,000 and only the first $ 10,000 of DRDs attributable to pre-tax contributions are exempt from the 10 percent flat tax and withholding tax requirements.
Even if it is a declared disaster, lump sum distributions and hardship withdrawals greater than $ 10,000 that are not subject to 10 percent withholding tax in Puerto Rico are not considered DRDs. Therefore, the participant would not be entitled to the favorable tax treatment described above. In addition, the employer, trustee, or payer responsible for processing the distribution may be held liable to Hacienda for withholding tax violations.
Puerto Rico Tax Compliance
DRDs must be reported through Hacienda's online portal called Sistema Unificado de Rentas Internas (SURI) by emailing the local Form 480.7C by February 28 of the year immediately following the year of distribution. The plan sponsor or its agent (usually the trustee of the plan's trust fund, the clerk, or an outside paying agent) must send the participant a copy of Form 480.7C by February 28. Puerto Rico 10 percent income tax withheld at source on DRDs must be electronically deposited with Hacienda by the 15th day of the month immediately following the month of distribution via SURI.
© 2020, Ogletree, Deakins, Nash, Smoak & Stewart, P. C., All rights reserved.National Law Review, Volume XI, Number 30