On February 20, 2020, the Puerto Rico Treasury Department (PR Treasury) issued Internal Revenue Circular Letter Number 20-09 (CC RI 20-09) to provide special rules and procedures applicable to distributions from qualified retirement plans and individual retirement accounts (IRAs) following the recent earthquakes. The following is a summary of the most significant provisions of CC RI 20-09.
Eligible Distributions – These are payments or distributions from a qualified retirement plan under Section 1081.01 of the Puerto Rico Internal Revenue Code (PR Code) or an IRA that an Eligible Individual has requested to cover Eligible Expenses. Payments must be made between February 20, 2020 and June 30, 2020 (the Eligible Period).
Eligible Distributions from a qualified plan are hardship distributions, which may be made through total distributions (i.e., lump sum distributions) or partial distributions. Annuities and installment payments will not be considered Eligible Distributions. Eligible Individuals may choose to receive these special distributions regardless of other forms of payment that they may have available under the retirement plan or IRA. In other words, the Eligible Individual need not exhaust other plan options, such as loans, prior to requesting this type of hardship distribution.
The penalty for early withdrawal imposed by the PR Code will not apply to Eligible Distributions from IRAs. However, the individual may be subject to a penalty for early withdrawal imposed by the financial institution or insurance company under the IRA's terms.
CC RI-20-09 also establishes the supporting documentation that must be submitted by the participant with the request for an Eligible Distribution.
Eligible Individual – An Eligible Individual is a bona fide Puerto Rico resident during the entirety of taxable year 2020 who is a participant in the plan. Only Eligible Individuals may request Eligible Distributions.
Eligible Expenses – CC RI 20-09 defines "eligible expenses" as those that an Eligible Individual incurs to compensate for losses or damage suffered as a result of the earthquakes and any related unforeseen and extraordinary expenses needed to cover basic needs. These include, but are not limited to: expenses to repair a residence, business establishment, or motor vehicle; expenses to verify that the property meets the established construction codes; expenses to repair the property to bring it into compliance with construction codes; expenses to acquire a new principal residence or business establishment due to the earthquakes; payment of medical expenses; replacement or repair of furniture; purchase of food and gas; payments for purchase or repair of power generators; and lodging and meal expenses incurred during the recovery period due to total or partial destruction of principal residence incurred as a result of the earthquakes.
While the Eligible Individual must provide supporting documentation with the request, the documentation need not include a detailed accounting of the Eligible Expenses.
Pursuant to CC RI 20-09, Eligible Expenses may be incurred by an Eligible Individual, their spouse, descendants or ascendants. As an example, Eligible Individuals may request a distribution to cover part of the cost to repair a parent's or child's residence.
Finally, while an Eligible Distribution must be made during the Eligible Period, the expenses related to such distributions need not be incurred within the Eligible Period. Thus, an Eligible Employee may receive an Eligible Distribution to defray Eligible Expenses incurred after the termination of the Eligible Period.
Puerto Rico Income Tax Treatment – For purposes of Puerto Rico income tax, Eligible Distributions received by an Eligible Individual during the Eligible Period will be treated as a distribution because of financial hardship and will be subject to the following tax treatment:
- The first $10,000 distributed during the Eligible Period will be exempt from income tax and the alternative basic tax and will not be subject to any tax withholding.
- Any distribution over $10,000 and up to $100,000 will be subject to a 10% withholding and income tax rate, in lieu of the regular withholding and income tax rate imposed by the PR Code. In order to benefit from this special tax treatment, the income tax withholding must be made at the time of the distribution, or the distribution will be considered taxable income subject to the regular tax treatment for such distributions under the PR Code.
- The Eligible Individual may request more than one Eligible Distribution during the Eligible Period, from either qualified retirement plans or IRAs or both, but the total Eligible Distributions cannot exceed $100,000 and the total exempt amount cannot exceed $10,000.
- Eligible Distributions will be taken first from the pre-tax contributions and earnings portion of the account. If such funds are not enough to cover the Eligible Distributions, funds will be taken from after-tax contributions or contributions for which the Eligible Employee prepaid taxes.
Responsibilities of the Withholding Agent – The employer, administrator or service provider of the trust or annuity contract that makes the Eligible Distributions will be considered a withholding agent and thus will be responsible for complying with the withholding rules provided in CC RI 20-09, and for remitting them to the PR Treasury no later than the 15th day of the month following the date of the distribution. Failure to comply with the withholding and remittance rules established in CC RI 20-09 will result in penalties as well as the imposition of the tax not withheld and remitted.
Restrictions on Post-Distribution Contributions to the Plan – Eligible Individuals who receive Eligible Distributions will not be subject to the 12-month contributions limitation provided under the PR Code Regulations. In other words, Eligible Individuals may request and receive Eligible Distributions, and may continue making contributions to the retirement plan.
Terms of the Qualified Retirement Plan – The provisions applicable to qualified retirement plans are optional. Therefore, employers maintaining qualified plans may choose to, but are not required to, adopt part or all provisions of CC RI 20-09. Plan sponsors may, for example, choose to amend their retirement plan to allow Eligible Distributions in accordance with CC RI 20-09, but can establish limits to such distributions to a maximum amount less than $100,000, or can require that distributions be related to certain events in particular. Furthermore, the administrator of a dual-qualified retirement plan (both in the U.S. and Puerto Rico), may limit the changes to the distribution rules to Puerto Rico participants, to be consistent with those provisions under the U.S. tax code or with the changes authorized by the Internal Revenue Service for participants in retirement plans affected by the earthquakes.
Qualified retirement plans that adopt the provisions of CC RI 20-09 must amend their plans accordingly no later than December 31, 2020. However, the approval and payment of Eligible Distributions may be made prior to the adoption of the amendment. Therefore, distributions can be completed on or before June 30, 2020, regardless of the adoption date of the amendment, provided that the adoption occurs by December 31, 2020.
Finally, these amendments are not considered "qualification amendments;" therefore, they are not required to be submitted to the PR Treasury.
As a result of CC RI 20-09, employers in Puerto Rico should consider whether to amend their plans to incorporate these special rules in order to provide assistance to their employees. Employers that choose to incorporate these changes, however, should consult with counsel to ensure compliance.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.