Further Consolidated Appropriations Act, 2020: Tax Changes and Retirement Planning Implications

In December 2019, President Trump signed into law the Further Consolidated Appropriations Act, 2020, a sweeping year-end spending bill that funds federal government agencies in a discretionary portion of the federal budget through September 2020. In addition to addressing government funding, the Act also extends many tax provisions that previously expired, alters other long-standing tax provisions – many of which affect retirement-planning efforts for both individuals and plan sponsors – and more.

Tax Extenders

The Further Consolidated Appropriations Act, 2020, extends many tax provisions that previously expired. It is worth noting that some extenders are applied retroactively for tax years beginning after Dec. 31, 2017. Because of this, it may be advantageous for certain taxpayers to file an amended 2018 tax return to claim a refund.

These provisions have been extended retroactively for tax years beginning after Dec. 31, 2017:

• Allowing the discharge of qualified principal residence indebtedness to be excluded from income
• Deduction for mortgage insurance premiums as qualified residence interest
• Above-the-line deduction for qualified tuition and related expenses
• Credit for qualified railroad track maintenance expenditures
• Seven-year recovery period for motorsports entertainment complexes
• Deduction for qualified film, television, and theatrical production expenditures
• Extension of Empowerment Zone designations
• Biodiesel and renewable diesel tax credit (IRS issuing special guidance for claiming the credit for prior years)
• Nonbusiness energy property credit for qualified energy improvements to the building envelope of principal residences (lifetime cap of $500)
• Alternative fuel refueling property credit
• Credit for electricity produced from certain renewable resources
• Extension and clarification of excise tax credits relating to alternative fuels (IRS issuing special guidance for claiming the credit for prior years)

The following provisions were set to expire after the 2018 tax year but have been extended by the Further Consolidated Appropriations Act, 2020.

• Reduction of adjusted gross income floor from 10% to 7.5% for medical and dental expense deductions
• Mine rescue team training credit
• Classification of certain race horses as three-year property
• Second generation biofuel credit
• Qualified fuel cell motor vehicles credit
• Two-wheel plug-in electric vehicle credit
• Energy-efficient homes credit
• Special allowance for second generation biofuel plant property
• Energy efficient commercial buildings deduction
• New Markets Tax Credit
• Employer tax credit for paid family and medical leave
• Work Opportunity Tax Credit
• Reduction of certain excise taxes related to beer, wine, and distilled spirits
• Look-through rule for related controlled foreign corporations
• Credit for health insurance costs of eligible individuals

Key Provisions Impacting Individuals

Partial elimination of stretch IRAs

One of the most important changes under the Further Consolidated Appropriations Act, 2020, relates to inherited retirement accounts. Under the prior tax law, certain beneficiaries (both spousal and non-spousal) were allowed to stretch out the tax-deferral advantages of the plan or IRA by taking distributions over the beneficiary’s life expectancy. This is sometimes referred to as a “stretch IRA.”

Under the Further Consolidated Appropriations Act, 2020, for deaths of plan participants or IRA owners beginning in 2020, non-spouse beneficiaries are generally required to draw down the account by taking distributions within 10 years following the plan participant or IRA owner’s death. So, for those beneficiaries, the “stretching” strategy is no longer allowed. Thus, in many cases, the beneficiaries will receive income much earlier than they would have under the old law.

Exceptions to the 10-year rule are allowed for distributions to the following:

1. The surviving spouse of the plan participant or IRA owner
2. A child of the plan participant or IRA owner who has not reached majority (but only until such age is attained, at which point the remainder must be withdrawn within 10 years)
3. A chronically ill individual
4. Any other individual who is not more than 10 years younger than the plan participant or IRA owner

Those beneficiaries who qualify under an exception may generally still take their distributions over their life expectancy (as allowed under the prior rules).

Repeal of maximum age for traditional IRA contributions

Under the prior rules, traditional IRA contributions were not allowed once an individual attained age 70½. Starting in 2020, the new rules allow an individual of any age to make contributions to a traditional IRA, if the individual has compensation, which generally means earned income from wages or self-employment.

Required minimum distribution age raised from 70½ to 72

Before 2020, retirement plan participants and IRA owners were generally required to begin taking required minimum distributions from their plan by April 1 of the year following the year they reached age 70½. For distributions required to be made after Dec. 31, 2019, with respect to individuals who attain age 70½ after that date, the age at which individuals must begin taking distributions from their retirement plan or IRA is increased from 70½ to 72. Therefore, if an individual attained age 70½ before Jan. 1, 2020, the delayed withdrawal does not apply.

Repeal of “kiddie” tax changes originally enacted by the TCJA

In 2017, Congress passed the Tax Cuts and Jobs Act of 2017 (TCJA), which made changes to the so-called “kiddie tax,” a tax on the unearned income of certain children. Before enactment of the TCJA, the net unearned income of a child was taxed at the parents’ tax rates if the parents’ tax rates were higher than the tax rates of the child.

Under the TCJA, for tax years beginning after Dec. 31, 2017, the taxable income of a child attributable to net unearned income is taxed according to the brackets applicable to trusts and estates. Children to whom the kiddie tax rules apply and who have net unearned income also have a reduced exemption amount under the alternative minimum tax (AMT) rules.

The new rules repeal the kiddie tax measures that were added by the TCJA. This means that starting in 2020 (with the option to apply retroactively in 2018 and/or 2019), the unearned income of children is taxed under the pre-TCJA rules, at the higher of the child’s tax rate or their parents’ tax rate, as opposed to using the trust/estate tax rates. And starting retroactively in 2018, the new rules also eliminate the reduced AMT exemption amount for children to whom the kiddie tax rules apply and who have net unearned income.

Expansion of qualified expenses for 529 plan distributions

A Section 529 education savings plan is a tax-exempt program established and maintained by a state, or one or more eligible educational institutions (public or private). Any person can make nondeductible cash contributions to a 529 plan on behalf of a designated beneficiary. (Note: States may offer an incentive for contributing to a 529 plan.) The earnings on the contributions accumulate tax-free. Distributions from a 529 plan are excludable up to the amount of the designated beneficiary’s qualified higher education expenses.

The Further Consolidated Appropriations Act, 2020, expanded tax-free distributions from 529 plans to include payment for fees, books, supplies, and equipment required for the designated beneficiary’s participation in a registered apprenticeship program. This expansion applies to distributions made after Dec. 31, 2018. (Note: This provision is retroactive.) Additionally, tax-free distributions – up to a $10,000 lifetime limit – can be used to pay the principal or interest on a qualified education loan of the designated beneficiary, or a sibling of the designated beneficiary.

Plan withdrawals for expenses related to birth or adoption of a child

Generally, a distribution from a retirement plan must be included in income. Additionally, unless an exception applies (for example, distributions in case of financial hardship), a distribution before the age of 59½ is subject to a 10% early withdrawal penalty on the amount includible in income.

Starting in 2020, plan distributions of up to $5,000 that are used to pay for expenses related to the birth or adoption of a child are penalty-free. That $5,000 amount applies on an individual basis, so, for a married couple, each spouse may receive a penalty-free distribution up to $5,000 for a qualified birth or adoption.

Use of retirement funds related to disaster relief

The Further Consolidated Appropriations Act, 2020, provides an exception to the 10% early withdrawal penalty by allowing qualified disaster relief distributions from retirement plans (subject to certain limitations). It also allows for the recontribution of retirement plan withdrawals for home purchases that were canceled due to eligible disasters, and it provides increased flexibility for loans from retirement plans for qualified hurricane relief.

Other miscellaneous provisions affecting individuals

• Certain taxable non-tuition and stipend payments are treated as compensation for purposes of IRA contributions.
• Excluded difficulty-of-care payments can increase the nondeductible contribution limit to IRAs and defined contribution plans.
• The exclusions of state or local benefits and qualified payments for volunteer emergency responders are reinstated for tax year 2020.
• The limitation on charitable contributions associated with qualified disaster relief within one or more qualified disaster areas is temporarily suspended. This applies to such contributions made between Jan. 1, 2018, and Feb. 20, 2020.
• The deduction for casualty losses arising in a disaster area does not need to exceed 10% of adjusted gross income. It also eliminates the need to itemize deductions to claim the casualty loss.
• There is now a special rule for determining the earned income of taxpayers in disaster areas for those who claimed the earned income tax credit or child tax credit on their 2018 tax return.
• There is an automatic 60-day extension for any tax filing if the taxpayer’s principal place of abode or principal place of business is in a disaster area. This applies to federally declared disasters that are declared after Dec. 20, 2019.

Key Provisions Impacting Retirement Plan Sponsors

In addition to the extender provisions and provisions affecting individuals, the Further Consolidated Appropriations Act, 2020, altered the rules for creating and maintaining employer-provided retirement plans. The changes in the law apply to both large employers and small employers, but some of the changes are especially beneficial to small employers. However, not all the changes are favorable, and there may be actions needed to minimize any negative impact. The key provisions impacting plan sponsors include:

Increased credit for small employer pension plan start-up costs

The new rules increase the credit for plan start-up costs to make it more affordable for small businesses to set up retirement plans. Starting in 2020, the credit is increased by changing the calculation of the flat dollar amount limit on the credit to the greater of $500 or the lesser of either $5,000 or $250 multiplied by the number of non-highly compensated employees of the eligible employer who are eligible to participate in the plan. The credit applies for up to three years.

New small employer automatic plan enrollment credit

The Further Consolidated Appropriations Act, 2020, created a new tax credit of up to $500 per year to employers to defray start-up costs for new 401(k) plans and SIMPLE IRA plans that include automatic enrollment. This credit is in addition to the increased plan start-up credit discussed above and is available for three years starting with tax years beginning after Dec. 31, 2019. The new credit is also available to employers who convert an existing plan to a plan with an automatic enrollment design.

Increased penalties for failure-to-file retirement plan returns

Starting in 2020, the Further Consolidated Appropriations Act, 2020, modifies the following failure-to-file penalties for retirement plan returns:

• The penalty for failing to file a Form 5500 for annual plan reporting is changed to $250 per day, not to exceed $150,000.
• A taxpayer’s failure to file a registration statement incurs a penalty of $10 per participant per day, not to exceed $50,000.
• The failure to file a required notification of change results in a penalty of $10 per day, not to exceed $10,000.
• The failure to provide a required withholding notice results in a penalty of $100 for each failure, not to exceed $50,000 for all failures during any calendar year.

Other miscellaneous provisions affecting retirement plan sponsors

• Allows unrelated employers to more easily band together to create a single retirement plan
• Expands retirement savings by increasing the auto enrollment safe harbor cap
• Allows long-term, part-time employees to participate in 401(k) plans
• Loosens notice requirements and amendment timing rules to facilitate adoption of nonelective contribution 401(k) safe harbor plans
• Expands portability of lifetime income options
• Requires new annual disclosures for estimated lifetime income streams
• Provides fiduciary safe harbor added for selection of annuity providers
• Allows plans adopted by filing due date for year may be treated as in effect as of close of year
• Bars qualified employer plans from making loans through credit cards and similar arrangements
• Modifies nondiscrimination rules to protect older, longer service participants in closed plans

Other Tax Provisions of the Further Consolidated Appropriations Act, 2020

Repeal of unrelated business taxable income for certain fringe benefit expenses

The TCJA required tax-exempt organizations to increase their unrelated business taxable income (UBTI) by including expenses related to employer-provided parking, a qualified transportation fringe benefit. The Further Consolidated Appropriations Act, 2020, repealed this requirement for amounts paid or incurred after Dec. 31, 2017. Therefore, if a tax-exempt organization paid the tax on its UBTI because of expenses related to qualified transportation fringe benefits, it could file an amended 2018 tax return to claim a refund.

Modification of excise tax on the net investment income of private foundations

The Further Consolidated Appropriations Act, 2020, replaced the two-tier 1% or 2% excise tax on net investment income with a flat 1.39% excise tax. The goal of the change is to encourage private foundations to make larger one-time donations, such as is needed in the case of disaster relief. This applies to tax years beginning after Dec. 20, 2019 (i.e., 2020 for calendar-year foundations).

Repeal of certain ACA provisions

The Further Consolidated Appropriations Act, 2020, repealed the following three provisions of the ACA:

• The 2.3% medical device tax for sales occurring after Dec. 31, 2019
• Health Insurance Providers Fee for years beginning after Dec. 31, 2020
• “Cadillac tax” (high-cost employer-sponsored health coverage tax) for tax years beginning after Dec. 31, 2019

Employee retention credit

The Further Consolidated Appropriations Act, 2020, creates a new tax credit for wages paid by a disaster-affected employer to an employee within a core disaster area, as designated by the President from Jan. 1, 2018, through Feb. 18, 2020. The credit applies to wages without regard to whether services associated with those wages were performed.