True to its tradition for last-minute tax legislation, Congress approved these changes with only a few days left in the year. As advisors, business owners, individual investors, and taxpayers, our ability to digest and prepare for their effects on year-end planning was somewhat limited, yet the consequences of most changes continue past 2019. While not exhaustive, this article will provide relevant details and highlights within both areas that should provide value to financial advisors and investors alike.
The SECURE Act
The SECURE Act was the culmination of Congress’ attempt to pass major retirement plan reform legislation over the past several years. Having passed the House in early 2019, it slowed down in the Senate, but it finally succeeded being included with the 2020 spending bill. The thrust behind the Act’s provisions is to encourage greater retirement savings by Americans through two main objectives: 1) increase employer incentives to adopt new plans or enhance existing plans, and 2) provide expanded opportunities for individuals within employer-based and individual retirement saving plans.
Many aspects of the new law are geared toward increasing small business participation, using techniques such as improved plan adoption flexibility, safe harbor incentives, expanded tax credits, and access for employees to participate. The Act also encourages greater investment by individuals through relaxing age-related rules affecting contributions to traditional IRAs, required minimum distributions, and investments in annuities. As with most new tax laws, ambiguities exist throughout the SECURE Act’s provisions, so expect clarifications from the IRS and the U.S. Department of Labor (DOL) in the months to come. Highlights of the Act’s provisions for expanding and preserving retirement savings and administrative improvements are described below.
The Positives – Expanding and Preserving Retirement Savings and Administrative Improvements
Increased plan start-up tax and automatic enrollment credits starting 1/1/2020. The tax credit for small employers (less than 100 employees earning more than $5,000 per year) for the first three years of the plan is $250 per eligible, non-highly compensated employees. The minimum credit is $500, and the maximum credit is $5,000. An additional $500 tax credit is available for automatic enrollment in 401(k) and SIMPLE IRA plans for up to three years, along with an opt-out alternative.
Deadline to set up a new retirement plan starting 1/1/2020. An employer has until the due date of their company’s tax return, including extensions, to establish a new qualified retirement plan for the year. This deadline has traditionally been the last day of the employer’s tax filing year. This provides greater flexibility in decision-making for owners whose tax situation is not clarified until after the year is over. Tax-deductible contributions may still be made under a similar deadline for the adoption year.
Safe Harbor 401(k) rule simplification and savings expansion starting 1/1/2020. Employers will have more flexibility to amend their existing 401(k) plans and add a non-elective safe harbor feature any time up to 30 days before the end of the year, and afterward as long as the sponsor makes a 4% contribution in the first year. Secondly, the Act eliminates the notice requirement for safe harbor plans that make non-elective contributions to employees. Additionally, the automatic employee deferral contribution cap increases from 10% to 15% of employees’ pay under an automatic enrollment safe harbor plan. These enhancements provide greater flexibility to plan administrators and employers, potentially resulting in a higher number of safe harbor plans that are favorable to all employee groups.
Participation by part-time employees for plan years starting by 1/1/2021. Employees who have three consecutive years of at least 500 hours of service per year are now allowed to participate (group A). This group was previously excluded from participation, but as of 2021, employers must make them eligible. The existing law for the one-year, 1,000-hour service requirement for plan participation is still in effect (group B). Employees in either group must meet the plan’s minimum requirement of age 21. Furthermore, group A participants are not counted for non-discrimination testing purposes. Other qualification rules must be met by employees. Applicability to existing plans is uncertain, so grandfathering may be available once the law is clarified.
Open Multiple-Employer Plans (MEPs) starting 1/1/2021. The Act expands access to Open MEPs starting in 2021 by allowing MEPs to consist of diverse, unrelated employers. Previously, employers in an MEP needed to possess characteristics similar to other employers in the same MEP. A common example is a trade association retirement plan MEP that employers in similar industries could join, thereby benefitting from larger plan participation and centralized cost-effective administration. Under the new law, more employers with limited participation and concerns about costs and fiduciary responsibilities can benefit from joining other employers in an Open MEP.
Lifetime income disclosures starting in 2021. Participants must be provided a calculation showing the monthly payments due assuming the account balance was used to provide lifetime income in an annuity.
Annuity safe harbor and portability starting 1/1/2020. Selection of a lifetime income provider is now possible without exposing employers to liability for annuity repayment losses (the objective fiduciary safe harbor). This will encourage employers to offer more in-plan annuity options. In addition, moving annuities between plans and IRAs is allowable without causing surrender charges and fees.
Required Minimum Distributions (RMDs) starting 1/1/2020. The age at which RMDs must begin from traditional IRAs and employer plans is increased from age 70½ to 72. It is not clear how this affects a person who began RMDs in 2019 but who has not reached age 72 in 2020. Additional guidance is expected from the IRS on this interpretation.
Maximum age for traditional IRA contributions repealed starting 1/1/2020. Individuals may now contribute to traditional IRAs regardless of age, similar to existing rules for Roth IRA and 401(k) plans. The previous law did not allow contributions in the year a taxpayer reached age 70½. Earned income requirements continue to apply.
Birth and adoption withdrawals allowed starting 1/1/2020. Up to $5,000 may be withdrawn from a qualified plan before age 59½ for expenses relating to birth or adoption of a child without incurring the additional 10% tax on early distributions. The $5,000 limit applies to each parent individually, and the distribution must be made within one year after the birth or when the adoption becomes final.
Distribution expansions from 529 plans starting 1/1/2019. Distributions from 529 plans up to $10,000 per year are allowed for payments toward a registered apprenticeship program. Repayment of qualified student loans for the beneficiary or beneficiary’s sibling is also allowed up to a $10,000 plan maximum.
Kiddie tax restored to pre-TCJA rules starting 1/1/2018. The taxes for many children subject to kiddie tax in 2018 and 2019 were higher than intended from the use of the trust tax table. The Act repealed this rule and restored the original kiddie tax rules retroactive to 1/1/2018, allowing for amending, if desired.
The Negatives – The Revenue Provisions
The revenue provisions of the SECURE Act are intended to cover the costs of tax decreases caused by the above changes. These provisions fall into three general areas:
- Modification of required distribution rules for designated beneficiaries (the “Stretch” IRA rules),
- Increases in penalties for failure to file retirement plan returns and other documents, and
- Increased information sharing to administer excise taxes.
Of the three items above, I’m going to focus on the modification of RMD rules for beneficiaries of inherited IRAs.
Stretch IRA converts to mandatory 10-year payout span starting 1/1/2020. Most non-spouse beneficiaries of inherited IRAs are now required to take taxable distributions within 10 years of the death of the retirement account owner. Through 2019, the rule was that an RMD began the year following death using the life expectancy of the beneficiary. Beginning with deaths on or after 1/1/2020, the new 10-year rule applies to most beneficiaries except for the following types:
- Surviving spouse
- Minor children of IRA owner until majority age
- Chronically ill and disabled
- Those who are younger and within 10 years of the deceased IRA owner’s age
The above excluded categories of beneficiaries are exempt from the 10-year rule and will continue with pre-SECURE Act RMD life expectancy tables.
As a caution, planned distributions to beneficiaries of future inherited IRAs and other retirement plans are at risk of being adversely affected by this change. In many cases, distributions mandated under the new law could be substantially increased in earlier years causing excessive unintended payouts and greater tax consequences to beneficiaries. The coordination of future payouts to affected beneficiaries should be reviewed as soon as possible to mitigate undesirable consequences. The current IRA/retirement plan owner may also consider converting some or all retirement plan funds to a Roth IRA over time to help reduce the future tax impact on beneficiaries caused by the new 10-year rule. To note, for Roth IRAs the stretch feature is also replaced by the 10-year rule, so RMDs will be accelerated similar to non-Roth IRAs and retirement plans, even though Roth IRA distributions are not taxable.
The Taxpayer Certainty and Disaster Tax Relief Act of 2019
In addition to the SECURE Act, Congress was able to slide in a restoration of over 30 tax incentives with a limited shelf life, which expired at the end of 2017 and 2018 or were due to expire on 12/31/2019. Congress revived these incentives on a retroactive basis and, in most cases, until the end of 2020 or later. Some taxpayers will amend 2018 returns to take advantage of the retroactive reinstatements. With less than one year left on the revived incentives, we may see more legislation later this year or afterward to extend them further into the 2020s. There were also new tax provisions targeted to victims of federally declared disasters going back to 2018.
Listed below are some of the more popular extender incentives being brought back to life, plus a summary of the disaster relief provisions.
Discharge of principal residence debt extended through 12/31/2020. Taxpayers whose principal residence debt was discharged is excludable from taxation on cancelled debt up to $2 million through 12/31/2020. This extender is applied retroactively to 1/1/2017.
Mortgage insurance premiums (MIP) extended through 12/31/2020. The deductibility of MIP as qualified home mortgage interest on a primary residence is deductible as an itemized deduction through 12/31/2020. This extender is applied retroactively to 1/1/2017.
Medical expense deduction adjusted gross income (AGI) floor extended through 12/31/2020. The itemized deduction for qualified medical expenses is now allowable for amounts in excess of 7.5% of AGI for 2019 and 2020. The AGI floor was previously set at 10% starting in 2019. Under new law, it will reset to 10% beginning in 2021.
Energy credit programs. A total of 14 tax incentive programs for alternative energy and conservation expenditures were renewed, including these more popular areas:
- Energy efficient homes credit (Section 45L) and nonbusiness energy property
- Energy efficient commercial buildings deduction (Section 179D)
- Qualified fuel cell motor vehicles
- Alternative fuel refueling property credit
Deduction for qualified tuition and related expenses extended through 12/31/2020. Up to $4,000 of qualified tuition and related expenses may be deducted for taxpayers with AGI less than $65,000 or $2,000 for AGI less than $85,000. This extender is good now through 12/31/20, applied retroactively to 1/1/2019.
Work Opportunity Tax Credit (WOTC) extended through 12/31/2020. The WOTC is an elective general business credit provided to employers hiring individuals meeting criteria of one or more of 10 targeted groups of economically challenged workers.
Disaster tax relief for disasters occurring in 2018 through January 19, 2020. Abatement of the 10% additional tax on early distributions is granted on retirement plan withdrawals up to $100,000 to cover costs from federally declared disasters. Additionally, an employee retention credit is available to employers for up to 40% of qualified wages paid during the time a business is shut down due to a natural disaster for the first 150 days. New rules for personal casualty losses were also enacted. While there were no federally declared disasters affecting our immediate area, many reader’s families, friends, or clients may benefit from knowing more about these tax benefits.
In summary, the spending legislation did much to improve expected retirement plan savings incentives for American taxpayers and simplify their access. The extenders that were revived will yield tax benefits for many individuals and business taxpayers, but keep in mind they are due to expire at the end of 2020 causing another wave of possible extender legislation at the end of the year. As we work through these law changes, we can expect clarifications from the IRS and DOL for some of the more complicated areas these changes bring.
By Robert S. Smith, CPA – Director of Tax