"The Pension Specialists" Blog

IRS Guidance on Tax Treatment of Expenses Related to a Qualified Birth or Adoption Distribution

October 2020

IRS Guidance on Tax Treatment of Expenses Related to a Qualified Birth or Adoption Distribution

The SECURE Act created another exception to the 10% additional tax of Code section 72(t). There is now an exception for expenses on account of a birth or an adoption of an individual. Code section 72(t)(2) sets forth the exceptions to the 10% tax. Sometimes an exception applies only to a distribution from an IRA or from an employer retirement plan and sometimes to both. A distribution from either an IRA or a 401(k) plan may qualify for this new exception.

A person is required to include a qualified birth or adoption distribution in their gross income, but the person does not owe the 10% additional tax. A qualified birth or adoption distribution is any distribution of up to $5,000 from an eligible IRA or other applicable retirement plan to a person as long as the distribution is made during the 1-year period beginning on the date of birth of the individual’s child or the date the legal adoption of an eligible adoptee by the individual is finalized.

This section of the article focuses on a qualified birth or adoption distribution from an IRA.

A person who has received a qualified birth or adoptiondistribution is authorized to recontribute the distribution to an eligible plan to which a rollover may be made. A recontribution is another type of rollover. The IRS will in future guidance discuss the recontribution rules, including the rules related to the timing of the recontributions. The statute failed to discuss the deadline for making a recontribution of a qualified birth or adoption distribution and so the IRS will need to furnish guidance. This should be defined in a technical correction tax bill.

The IRS has clarified the following. An individual may receive a qualified birth or adoption distribution of up to $5,000 with respect to the same child or eligible adoptee. If a person is related to multiple births or adoptions, the person may have a qualified birth or adoption distribution with respect to each child or eligible adoptee. If a person is married, each parent may receive a qualified birth or adoption distribution of up to $5,000 with respect to the same child or eligible adoptee.

An eligible adoptee is any individual who has not attained age 18 or is physically or mentally incapable of self-support. A person is considered to be physically or mentally incapable of self-support if the person is disabled as defined in Code section 72(m)(7). That is, the individual is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death or to be of long-continued and indefinite duration. However, an eligible adoptee cannot include an individual who is the child of the taxpayer’s spouse.

How does an IRA custodian report these transactions? Code “1” will be used in box 7 of the Form 1099-R. The recontribution (i.e rollover) is to be reported in boxes 14a and b as a repayment. The repayment amount is reported in box 14a and enter “BA” in box 14b for repayment of a qualified birth or adoption distribution. It is not to be reported in box 2 as a rollover or in box 13a as a late certified rollover.

The individual will need to complete their tax return to show their was a qualified birth or adoption distribution. Presumably, the individual will do this by completing the applicable section of Form 5329 and claim exception to the 10% additional tax and attach it to his or her tax return. The individual must include the name, age, and the taxpayer identification number of the child or the eligible adoptee on their tax return for the tax year in which the distribution is made.

If the individual makes a rollover or repayment contribution, then the individual will need to show such rollover contribution on their Form 1040.

This section of the article focuses on a qualified birth or adoption distribution from a 401(k) plans or other defined contribution plan.

An employer is not required to amend its plan to permit an in service distribution which qualify as a qualified birth or adoption distribution. Such an amendment is a discretionary amendment. It is not a mandatory amendment.

If a plan sponsor chooses to amend its plan to provide or a qualified birth or adoption distribution, it must do so by the last day of the first plan year beginning on or after January 1, 2022.

A plan sponsor may rely on a participant’s certification that he or she is eligible for a qualified birth or adoption distribution. If a plan permits a participant to take a qualified birth or adoption distribution, then such plan is required to permit that participant to make a recontribution if such participant is otherwise eligible to make a rollover contribution.

The 401(k) rules restrict the in-service distributions which may be made to a participant. However, there are exceptions, including an exception for certain hardship distributions. A qualified birth or adoption distribution is treated as meeting such an exception. Thus, if the applicable rules are met a participant may withdraw their elective deferrals. qualified non-elective contributions, qualified matching contributions or a safe harbor contribution.

With respect to a participant who is taking a qualified birth or adoption distribution, the plan sponsor is not required to offer a direct rollover or to provide a section 402(f) notice. Because there is no duty to offer a direct rollover the 20% mandatory withholding rule does not apply. The standard withholding rules will apply.

Even though a participant is ineligible under the plan for an in service distribution qualified birth or adoption distribution, such participant may treat on their tax return an otherwise permissible in-service distribution as a qualified birth or adoption distribution.

The IRS will need to issue guidance on the subject, if a participant takes a qualified birth or adoption distribution from their 401(k) account, then is the participant able to make a rollover contribution into the plan or may the person make a rollover into their IRA. At this time we believe the participant may rollover their qualified birth or adoption distribution from their 401(k) plan into their IRA and not into the distributing 401(k) plan.

In summary, there is a new exception to the 10% additional tax which generally applies when a person under age 591/2 takes a distribution from an IRA or pension plan. The new exception is for a qualified birth or adoption distribution.