Plan Sponsor Update - The Impact of Tax Reform on Qualified Plans and Fringe Benefits
President Trump has signed into law H.R. 1, a congressional revenue act originally introduced in Congress as the Tax Cuts and Jobs Act (the “Act”). The Act makes changes to the rules governing qualified plans (such as 401(k) plans and pension plans) and fringe benefit plans. These changes generally apply to plan years beginning after December 31, 2017.
1. Are there changes to the plan loan rollover rules?
Prior to the Act, a participant had 60 days to roll over a plan loan offset amount from a 401(k) or 403(b) plan account to an eligible retirement plan that accepts the rollover. The Act extends this time period until the due date (with extensions) for filing the participant’s federal income tax return. This new rule applies only to plan loan offset amounts resulting solely from the participant’s termination of employment or the employer’s termination of the plan. The plan loan offset provisions of the Act apply to amounts that are treated as distributed in tax years beginning after December 31, 2017.
A plan loan offset is a foreclosure on a participant’s account that occurs when the participant defaults on a plan loan, such as following termination from employment when a plan states that the loan becomes immediately payable in full and the loan is not timely repaid. When an offset occurs, the unpaid loan balance is deducted from the participant’s plan account (the loan is “offset”) and the amount of the loan offset is reported to the participant on a Form 1099-R as an actual distribution.
This change in the law means that in many cases, the participant will have more time in which to effect a tax-free rollover of a plan loan offset amount that occurs following termination from employment.
Plan sponsors may wish to coordinate administration of their plan loan offset rollover rules with the plan’s third-party administrator (TPA) in order to avoid inadvertently “defaulting” the participant’s plan loan.
2. What favorable tax treatment is available for plan distributions to individuals living in 2016 disaster areas?
The Act provides favorable tax treatment for “qualified 2016 disaster distributions.” A “qualified 2016 disaster distribution” is a distribution that is made: (i) from an eligible retirement plan (such as a 401(k) plan, a 403(b) plan, a governmental 457(b) plan or an IRA); (ii) on or after January 1, 2016, and before January 1, 2018; and (iii) to an individual whose principal place of abode at any time during calendar year 2016 was in an area for which a major disaster was declared by the president under section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act during calendar year 2016 (the “2016 disaster area”) and who sustained an economic loss by reason of that disaster.
Qualified 2016 disaster distributions to an individual cannot be more than the excess of (i) $100,000 over (ii) the aggregate amounts treated as qualified 2016 disaster distributions received by the individual for all prior tax years. The $100,000 limit is a single limit that applies to qualified 2016 disaster distributions made from all qualified plans in the plan sponsor’s controlled group.
Qualified 2016 disaster distributions receive the following favorable tax treatment under the Act:
The amount that is includible in the taxpayer’s gross income with respect to the distribution is included in income ratably over three years beginning with the tax year of the distribution, unless the taxpayer elects not to have the three-year rule apply.
The 10 percent additional tax on early distributions imposed under Section 72(t) of the Code (which generally applies to distributions to participants under age 59½) does not apply.
The taxpayer may make one or more repayments of the qualified 2016 disaster distribution that he or she received. Any such repayments must be made to an eligible retirement plan to which a rollover contribution could be made and must be made during the three-year period beginning on the day after the date of the qualified 2016 disaster distribution. Any such repayments will be treated by the recipient plan as a direct rollover.
Under the Act, a special tax notice (as described in Section 402(f) of the Code) does not need to be provided to recipients of qualified 2016 disaster distributions and such distributions are not subject to 20 percent withholding. The qualified 2016 disaster distribution provisions of the Act apply to distributions made on or after January 1, 2016, and before January 1, 2018.
Plans adding qualified 2016 disaster distributions will need to be amended on or before the last day of the first plan year beginning on or after January 1, 2018 (for governmental plans, January 1, 2020), or any later date that the IRS may prescribe.
3. What happened to the proposed changes to the qualified plan requirements regarding hardship distributions, in-service distributions and nondiscrimination testing?
Many of the proposals relating to qualified retirement plans that were in earlier drafts of the law were not included in the Act. Notably, the Act does not include provisions that would have: (i) eased certain restrictions on hardship distributions; (ii) lowered the minimum age for in-service distributions from certain types of tax-qualified retirement plans; or (iii) provided relief from the nondiscrimination testing rules that apply to frozen defined benefit plans and certain “replacement” contributions to defined contribution plans.
4. Are there any changes to the plan hardship distribution rules?
Although there are no direct changes in the Act to the retirement plan hardship distribution rules, changes to the rules for deducting a personal casualty loss under Section 165 of the Code will impact 401(k) plans and 403(b) plans that follow the “safe harbor” standards for allowing participants to receive hardship distributions.
The Act amends Section 165 of the Code to provide that personal casualty losses are deductible only to the extent such losses are attributable to a federally declared disaster (i.e., a disaster that is determined by the president to warrant federal assistance under the Robert T. Stafford Disaster Relief and Emergency Assistance Act). This change applies to losses incurred in tax years beginning after December 31, 2017, and before January 1, 2026.
The revisions to Section 165 of the Code have the effect of limiting the circumstances under which a plan participant may receive a hardship distribution to pay expenses to repair damage caused by a casualty loss, where the plan relies on the retirement plan “safe harbor” standards for approving hardship distributions. For example, under the Act, expenses to repair damage caused by a house fire would not justify a hardship distribution unless the fire is the result of a federally declared disaster.
It is possible that the narrowing of the “casualty loss” hardship distribution rules is an unintended consequence of the changes to Section 165 of the Code. If so, this unintended consequence may be addressed in subsequent guidance. In the meantime, plans that follow the “safe harbor” standards for approving hardship distributions should make sure that any necessary administrative changes are made to conform to Section 165 of the Code – this may require coordination with the plan’s TPA, if the TPA has been delegated responsibility for approving and administering hardship distributions.
5. What happened to Rothification?
As a major source of tax revenue to offset tax cuts, the House Committee on Ways and Means had considered changes to the treatment of employee deferrals to 401(k) plans, such as permitting employee deferrals to be made only as Roth contributions (so-called “Rothification”) or lowering the annual pre-tax contribution limit. These changes were not included in the Act.
6. Fringe benefits are generally excluded from an employee’s income. Are there any changes to these rules?
Yes, the Act changes the income inclusion and deduction rules for certain fringe benefits.
Employer Deduction for Qualified Transportation Fringe Benefits. Prior to the Act, an employer could deduct the value of qualified transportation fringe benefits provided to employees. Effective for tax years beginning after December 31, 2017, and before January 1, 2026, the Act denies the employer a deduction for all qualified transportation fringe benefits.
Although the Act denies the employer a deduction for all qualified transportation fringe benefits, qualified transportation fringe benefits other than qualified bicycle commuting reimbursements (e.g., transit passes, parking expenses) remain excludable from an employee’s income under Section 132 of the Code up to certain dollar limits.
Qualified Bicycle Commuting Reimbursements. Prior to the Act, an employee could exclude up to $20 per month in qualified bicycle commuting reimbursements received from his or her employer. This exclusion is eliminated by the Act for tax years beginning after December 31, 2017, and before January 1, 2026.
Moving Expenses. Prior to the Act, an employee could (i) claim a deduction for qualified moving expenses (in general, these are expenses incurred in connection with starting a new job provided the new job is at least 50 miles farther from the taxpayer’s former residence than his or her former place of work); and (ii) exclude from gross income reimbursements received from his or her employer for qualified moving expenses.
The Act suspends the deduction and the exclusion for qualified moving expense reimbursements, except in the case of a member of the U.S. Armed Forces on active duty who moves pursuant to a military order and incident to a permanent change of station. This change applies to tax years beginning after December 31, 2017, and before January 1, 2026.
Employers may wish to review the definition of “compensation” in their qualified retirement plans. A plan’s definition of compensation frequently includes fringe benefits based on whether those benefits are taxable to the employee (e.g., the long-form definition of compensation in Section 415(c) of the Code).
7. Does the Act change the tax treatment or deduction of meals provided to employees for the convenience of the employer?
Prior to the Act, meals provided to employees for the convenience of the employer were excluded from employees’ gross income and were fully deductible by the employer. The Act changes these rules by imposing a 50 percent limit on the employer’s deduction for food or beverages provided to employees for the employer’s convenience. This change applies to tax years beginning after December 31, 2017, and before January 1, 2026. Effective January 1, 2026, these expenses are non-deductible.
These changes do not impact the employee tax treatment of meals provided by the employer to the employee for the employer’s convenience; the value of such meals is still excludible from the employee’s gross income. However, human resources personnel may wish to coordinate with their finance/tax departments on the continued provision of such meals to employees.