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IRS Issues Proposed Regulations Regarding Hardship Distributions IRS Issues Proposed Regulations Regarding Hardship Distributions

IRS Issues Proposed Regulations Regarding Hardship Distributions

The Internal Revenue Service ("IRS") has issued proposed regulations regarding hardship distributions from 401(k) and 403(b) plans. Hardship distributions, if allowed by the plan, permit plan participants access to funds when they are dealing with "an immediate and heavy financial need" while employed. The proposed regulations address changes implemented by the Tax Cuts and Jobs Act ("TCJA"), the Bipartisan Budget Act of 2018 ("Budget Act"), and prior IRS guidance. 

The Treasury Regulations under Internal Revenue Code ("Code") §§ 401(k) and 403(b) provide rules for determining when a financial hardship distribution is permitted. The distribution must be made on account of an "immediate and heavy financial need" and the distribution must be necessary to satisfy the financial need. The Regulations provide safe harbor rules so a plan may determine whether the hardship distribution regulations have been satisfied. Without the safe harbor rules, the plan must determine, on the basis of individual facts and circumstances, (1) whether the need is immediate and heavy and (2) whether it is necessary for the participant to have the funds withdrawn to satisfy the need. 

As set forth below, the proposed regulations do not require any changes for 2018-2019, but there may be changes that plan sponsors will want to implement to relax the hardship distribution requirements. In addition, all plan sponsors who allow hardship distributions will be required to implement certain changes by 2020.  
 
Clarification of Code Section 165 Casualty Loss Deduction
 
Prior to the TCJA, a participant could take a hardship distribution if the participant qualified for a casualty loss deduction under Internal Revenue Code ("Code") Section 165. However, the TCJA significantly limited the situations under which a taxpayer could take a casualty loss deduction to losses resulting from a federally-declared disaster which, in turn, limited hardship distributions for casualty losses to those resulting from federally-declared disasters. The Proposed Regulations would reverse this result and provide that a hardship distribution may again be made for casualty losses that would have been allowed prior to the TCJA. As a practical matter, this once again allows for a hardship distribution for damages to an individual's principal residence, even if the damage is not related to a federally-declared disaster.
 
Comment: This change is optional. The effective date is January 1, 2018. Thus, to the extent a plan provided hardship distributions for non-federally-declared disasters in 2018, the plan should be retroactively amended to conform the plan terms with plan operation. Any retroactive amendment to conform to the 2018 operations should be adopted by December 31, 2018 (for calendar year plans).

Additional Safe Harbor for Certain Disasters
 
Expenses (including loss of income) incurred as a result of certain natural disasters are added to the safe harbor rule and now qualify for hardship distributions. The preamble provides that the intent is "to eliminate any delay or uncertainty concerning access to plan funds following a disaster that occurs in an area designated by the Federal Emergency Management Agency (FEMA) for individual assistance." Plans may allow for the new safe harbor effective any time after January 1, 2018, if the plan is properly amended.
Comment: This change is optional. Any plan that wishes to allow for the new natural disaster safe harbor, effective January 1, 2018, must properly amend the plan. Further, any retroactive amendment should be adopted by December 31, 2018 (for calendar year plans).

Extension of Relief for Victims of Hurricanes Florence and Michael
 
In the preamble, the IRS extended relief relating to Hurricane Maria and California wildfires provided in Announcement 2017-15 to similarly situated victims of Hurricanes Florence and Michael, except that the "Incident Dates" (as defined in that announcement) are as specified by FEMA for these 2018 hurricanes. Relief is provided through March 15, 2019.
 
Elimination of Six-Month Suspension Period
 
The Budget Act directed the Treasury Secretary to amend regulations interpreting Code § 401(k) to eliminate the six-month suspension period for making new contributions following a safe harbor hardship distribution. 
 
After the Budget Act, questions were raised regarding whether this provision was mandatory or whether plans could continue to suspend contributions. The proposed regulations clarify that this provision is mandatory and prohibit plans from suspending participants from making contributions. This prohibition is mandatory for distributions made on or after January 1, 2020.
 
Comment: The prohibition is mandatory for distributions made on or after January 1, 2020. However, those plans that have enforced a six-month suspension period in 2018 may either: (1) continue to enforce a six-month suspension into 2019 or (2) could end the suspension January 1, 2019. Plans must be amended to conform to the Proposed Regulations.

Elimination of Requirement That Participant Take All Available Plan Loans
 
The Budget Act provides that a participant shall not be treated as failing to meet the requirements of a hardship "solely because the employee does not take any available loan under the plan." The Proposed Regulations provide that, on or after January 1, 2019, plan sponsors can opt to either continue to require that an employee take all available loans under the plan or eliminate this requirement.
 
Comment: This change is optional. However, any plan sponsors wishing to eliminate the requirement that a participant take all available loans under the plan must properly amend the plan.

Expansion of Available Sources
 
Prior to the enactment of the Budget Act, hardship distributions could only be taken from a participant's elective deferrals. The Budget Act expands the sources from which hardship distributions may be taken to include not only participant elective deferrals, but also qualified non-elective contributions, qualified matching contributions, and the earnings on all of these contributions. The Proposed Regulations implement this provision of the Budget Act. However, plans may continue to limit the contribution sources available for hardship distribution. 
 
Comment: This change is optional, and plans may continue to limit the availability of these sources for hardship distributions. Importantly, the Budget Act did not amend Code Section 403(b)(11). Thus, earnings on elective deferrals in 403(b) plans are ineligible for hardship distributions. In addition, qualified non-elective contributions and qualified matching contributions held in a 403(b)(7) custodial account continue to be ineligible for hardship distributions. Qualified non-elective contributions and qualified matching contributions in a non-custodial 403(b) annuity plan may be an available source for a hardship distribution.

Hardships of Primary Beneficiary

Although not new, the proposed regulations would add that a participant's primary beneficiary under the plan may qualify as an individual for whom qualifying medical, educational, and funeral expenses may be incurred.
 
Comment: This change is optional.  This provision has been permitted since the Pension Protection Act. See Notice 2007-07.

Elimination of "Facts and Circumstances" Test
 
As mentioned above, if a plan does not rely on the safe harbor hardship rules, the plan administrator must determine, on the basis of individual facts and circumstances, whether the need is immediate and heavy and whether it is necessary for the participant to have the funds withdrawn to satisfy the need. The proposed regulations eliminate the facts and circumstances test and replace it with a three-part general standard. The standard would require that:
 
  • the hardship distribution not exceed the amount of a participant's need (including any amounts necessary to pay any taxes or penalties reasonably anticipated to result from the distribution),
  • the participant must have obtained other available distributions under the employer’s plans before taking the hardship distribution, and
  • the participant must represent that he or she has insufficient cash or other liquid assets to satisfy the financial need. As with the current standard, a plan administrator may rely on a participant’s representation of the need unless the plan administrator has actual knowledge to the contrary.
Comment: This change is mandatory for those plans utilizing a facts and circumstances determination. Plan administrators may begin applying this standard on January 1, 2019, but the requirement to obtain a participant’s representation becomes mandatory for hardship distributions made on or after January 1, 2020.

Plan Amendment Deadlines
 
As the preamble points out, Rev. Proc. 2016-37 provides that, for an individually designed non-governmental plan, the deadline for amending the plan to reflect a change in qualification requirements (the "mandatory" changes identified above) is the end of the second calendar year that begins after the issuance of the Required Amendments List that includes the change. However, any plan that implements an optional provision in 2019 should be amended by December 31, 2019 (for calendar year plans). Furthermore, for those plan sponsors who wish to retroactively apply applicable provisions in 2018 (such as the re-expansion of the casualty loss hardship or the new natural disaster hardship), amendments are required by December 31, 2018. See Rev. Proc. 2016-37 (providing that the plan amendment deadline for discretionary amendments to individually designed, non-governmental plans is "the end of the plan year in which the plan amendment is operationally put into effect.")
 
Comment Period
 
The IRS is accepting comments until January 14, 2019.
 
Should you have questions about hardship distribution requirements or would like to discuss possible plan amendments, please contact the attorney with whom you work in the Ice Miller Employee Benefits Group.
 
This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.
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