On March 29, 2020, the Puerto Rico Department of the Treasury (commonly known by its Spanish name, Departamento de Hacienda de Puerto Rico, or Hacienda) issued Circular Letter of Internal Revenue No. 20-23 (CL 20-23), which extends to coronavirus-related distributions under qualified retirement plans (CRDs) essentially the same eligibility requirements, due dates, and local tax treatment that Hacienda established in Circular Letter 20-09 (CL 20-09) for distributions under qualified retirement plans related to the earthquakes that hit Puerto Rico during the beginning of the year (ERDs).
CL 20-23 is the second item of retirement plan guidance from Hacienda in less than two weeks in response to the COVID-19 pandemic. On March 24, 2020, Hacienda released Administrative Determination No. 20-09, which extended due dates for filing the local informative return on qualified retirement plan distributions and depositing with Hacienda the Puerto Rico income taxes withheld at source on certain benefit payments.
By reference to CL 20-09, the just-released CL 20-23 includes the following provisions:
- Employers have full discretion to decide whether to offer CRDs under their retirement plans in operation in Puerto Rico and to impose reasonable restrictions on, among other things, the amount, eligibility requirements, and application process for CRDs.
- Lump-sum distributions following termination of employment and in-service hardship withdrawals may qualify as CRDs, but not monthly pensions, multiyear installments, or periodic payments following termination of employment.
- For CRDs to be eligible for favorable Puerto Rico tax treatment, the participant must be a resident of Puerto Rico during 2020. No COVID-19 diagnosis or loss of employment due to the coronavirus pandemic is statutorily necessary for eligibility.
- Participants may request CRDs to help cover financial losses, unforeseen expenses, and necessities related to or resulting from the COVID-19 pandemic, related medical treatment, and compliance with governmental curfews and stay-at-home orders. For example, this includes access to funds needed to replace loss or reduction of income due to a participant’s furlough, layoff, or involuntary termination of employment.
- Together, CRDs and ERDs, whether from qualified retirement plans or individual retirement accounts (IRAs), cannot exceed $100,000. The first $10,000 of such distributions is tax-free and exempt from the withholding of Puerto Rico taxes at source, and the next $90,000 is subject to both a flat 10 percent Puerto Rico income tax rate and a 10 percent Puerto Rico tax withholding at source (i.e., the amount withheld at payment covers the corresponding tax liability). Since CRDs and ERDs are subject to the same set of statutory limits, previous ERDs, if any, reduce dollar-for-dollar the amount available for distribution as CRDs, and vice-versa.
- CRDs must be (or have been) distributed between February 20, 2020, and June 30, 2020. To ensure compliance with the June 30, 2020, distribution due date, a plan may require that participants complete the request process several weeks in advance (e.g., set a request due date of June 1, 2020).
- The Puerto Rico tax withheld on CRDs must be deposited with Hacienda by June 15, 2020, for distributions completed in February 2020 and March 2020, and by July 15, 2020, for distributions completed in April, May, and June 2020.
- To request a CRD, a participant must provide the plan administrator or its designee (e.g., the plan’s trustee, recordkeeper, or paying agent) with a sworn statement, whereby the participant certifies: (1) that he or she is a resident of Puerto Rico; (2) that the CRD is needed to help cover financial losses, unforeseen expenses, and necessities related to or resulting from the COVID-19 pandemic; (3) whether he or she has previously received CRDs or ERDs from another qualified retirement plan or IRA; and (4) that he or she will be ultimately responsible for any Puerto Rico taxes due if for any reason the distribution does not meet the statutory requirements for classification as a CRD (e.g., the participant received more than $100,000 from various plans or IRAs). The sworn statement needs to be notarized by a notary public or witnessed by the plan administrator or its designee (e.g., a member of the employer’s HR team).
In practice, this is perhaps the most troublesome aspect of the Hacienda requirements for the completion of CRDs. Before deciding whether to allow for CRDs under their Puerto Rico retirement plans, employers may want to evaluate, determine, and document which of the various parties involved with the administration of the plan will be responsible for preparing, distributing, receiving, reviewing, approving, and/or keeping custody of the sworn statements that participants need to provide as part of the CRD request process. This is the sort of matter that may be best handled through a conference call with the various service providers for the plan.
- Plans that implement CRDs must be amended accordingly by December 31, 2020. CRDs may be safely completed before the plan is amended to such effects.
Puerto Rico CRD Rules vs. CARES Act Rules
Puerto Rico’s rules on CRDs are noticeably different from the United States’ rules on CRDs provided in Section 2202 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act.
Therefore, employers may want to be careful not to incorporate within their retirement plans qualified only in Puerto Rico (commonly known as “P.R.-only plans”) features of the United States rules on CRDs that do not apply in Puerto Rico.
The analysis and decision-making process is substantially more complicated in the case of retirement plans qualified in both the United States and Puerto Rico (commonly known as “dual-qualified plans”), since, technically, those plans are subject to the United States’ and Puerto Rico’s retirement plan qualification rules. Thus, implementing CRDs with regard to Puerto Rico participants in a dual-qualified plan requires a middle-ground approach that fits both sets of qualification rules.
Among other distinctions, the differences between the United States’ and Puerto Rico’ rules on CRDs include:
- United States: CRDs must be distributed by December 31, 2020.
- Puerto Rico: CRDs must be distributed by June 30, 2020.
- United States: Any plan participant, regardless of place or residence, who has been diagnosed, or whose spouse or dependent(s) have been diagnosed with COVID-19, or who has experienced adverse financial consequences due to being furloughed, quarantined, laid off, or having his or her work hours reduced due to the COVID-19 pandemic is eligible.
- Puerto Rico: Any plan participant who is a resident of Puerto Rico during 2020 and needs a CRD to help cover financial losses, unforeseen expenses, and necessities related to or resulting from the COVID-19 pandemic is eligible.
- United States: Participants can self-certify compliance with the eligibility requirements.
- Puerto Rico: Participants must provide the plan administrator or its designee with a sworn statement certifying compliance with the eligibility requirements.
Tax Withholding at Source
- United States: CRDs are exempt from federal income tax withholding at source.
- Puerto Rico: There is a mandatory 10 percent Puerto Rico tax withholding at source on CRDs between $10,000 and $100,000.
Favorable Tax Treatment
- United States: CRDs can be repaid to the plan within three years of the date of distribution, repayments are treated as tax-free rollovers into the plan, and federal taxes owed on CRDs not repaid to the plan may be spread over three years.
- Puerto Rico: The first $10,000 is tax-free and the next $90,000 is subject to a flat 10 percent income tax rate.
- United States: The maximum limit on plan loans has increased from $50,000 or 50 percent of the vested account balance to $100,000 or 100 percent of the vested balance, and the loan repayment period may be extended for up to one year.
- Puerto Rico: No rules on plan loans.
Plan Amendment Due Dates
- United States: The plan must be amended to provide for CRDs by the last day of the 2022 plan year (i.e., December 31, 2022, for calendar year plans).
- Puerto Rico: The plan must be amended to provide for CRDs by December 31, 2020.
Ogletree Deakins will continue to monitor and report on developments with respect to the COVID-19 pandemic and will post updates in the firm’s Coronavirus (COVID-19) Resource Center as additional information becomes available. Critical information for employers is also available via the firm’s webinar programs.