Recent Tax Law Changes Affect Hardship Distributions
The tax reform legislation commonly referred to as the Tax Cuts and Jobs Act (Act), signed into law on December 22, 2017, modifies the Internal Revenue Code (Code) in a way that impacts many qualified plan (and 403(b) plan) hardship withdrawal provisions. The Act adds a paragraph to Section 165 of the Code restricting the deduction for casualty losses to those losses that are attributable to a federally declared disaster. A withdrawal from a plan by a plan participant to pay certain expenses that qualify for the Section 165 casualty deduction is one of a few withdrawals that meet the “deemed immediate and heavy financial need” standard under the Section 401(k) Treasury regulations. This “safe harbor” standard allows plan sponsors to consider withdrawals necessary due to hardship without having to take on the more burdensome evaluation of a participant’s need based on relevant facts and circumstances.
Restricting the casualty loss deduction to losses attributable to a federally declared disaster means that only withdrawals to pay expenses to repair damage caused by a disaster determined by the president as warranting assistance by the federal government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act will satisfy the deemed immediate and heavy financial need standard. This change is effective for taxable years beginning after December 31, 2017, which, for most employees, means it is effective now.
Plan sponsors should determine whether they will modify administration to restrict withdrawals for casualty loss expenses in conformance with the Act, or whether they will apply a more liberal standard and evaluate the withdrawals based on relevant facts and circumstances. A plan sponsor opting for the latter will have to eventually amend its plan if the plan sets forth the safe harbor standard.
While considering this issue, plan sponsors may wish to look at other changes to hardship provisions that will soon go into effect. The Bipartisan Budget Act of 2018 (Budget Act), signed into law on February 9, modifies the Code to permit withdrawal of amounts that currently may not be withdrawn. Specifically, effective for plan years beginning after December 31, 2018, qualified nonelective contributions (QNECs), qualified matching contributions (QMACs), and earnings on those contributions as well as earnings on elective deferral contributions in a plan may be withdrawn due to hardship. In addition, a plan will no longer have to require that a participant obtain an available loan under the plan prior to taking a hardship withdrawal. Last, the Budget Act directs the secretary of the Treasury to remove the requirement in the Treasury regulations that a six-month suspension apply to employee contributions to any employer plan after a hardship withdrawal in order to meet the safe harbor standard deeming the withdrawal as necessary to satisfy an immediate and heavy financial need. Employers may retain this six-month suspension, but can choose to eliminate it beginning with the 2019 plan year.
Ryan Montgomery contributed to the article.