The Treasury Department and the Internal Revenue Service (collectively referred to hereafter as “IRS”) on September 23, 2019 published the final regulations on hardship distributions, finalizing the regulations proposed in November 2018. The plans primarily affected are 401(k) and 403(b) plans. The final regulations reflect changes in the Internal Revenue Code dating back to the Pension Protection Act of 2006 through the Bipartisan Budget Act of 2018. The preamble states that the regulations are substantially similar to the proposed regulations and, notably, compliance with the proposed regulations will satisfy the final regulations. Although this treatment was expected, confirmation is great news for employers.
Key hardship distribution rules provisions affected by the final regulations are summarized below.
- The suspension of elective deferrals after taking a hardship distribution is prohibited as of January 1, 2020, and may have been eliminated as early as January 1, 2019. The IRS clarified that this prohibition applies to qualified plans (401(k)), 403(b) plans, and 457(b) plans, but not to nonqualified deferred compensation plans.
- The new three-part financial need test to establish that the participant has no alternative means reasonably available to satisfy the financial need must be applied as of January 1, 2020, and may have been applied as early as January 1, 2019. The three parts of the test are (i) the participant must obtain all other currently available distributions from the plan and all other plans of the employer that provide deferred compensation, (ii) the participant must make a written representation (the representation may be made via electronic medium, which includes a recorded telephone call) that the participant has insufficient cash or other liquid assets reasonably available to meet the need (this representation can be made if cash/assets on hand at the time are earmarked for other obligations in the near term, such as rent), and (iii) the plan administrator must not have actual knowledge contrary to the participant’s representation (based on information already known – this does not require the administrator to make inquiries about the participant’s finances).
- The safe harbor casualty loss event expansion is optional, and may have been implemented in 2018. As expanded, the loss need not qualify for a federal tax deduction.
- The new federally declared disaster area loss safe harbor event is optional, and may have been implemented in 2018. For this event, the participant’s principal residence or principal place of employment must be within the disaster area.
- Eliminating a requirement to take all available plan loans before a hardship is available is optional, and may have been eliminated as early as January 1, 2019.
- Expanding the sources from which a hardship distribution may be taken (to include QMACs, QNECs and earnings on deferrals, QMACs and QNECs) is optional, and may have been made as early as January 1, 2019.
Operational compliance with the final regulations is required for hardship distributions made on/after January 1, 2020. If the proposed regulations were implemented earlier, then operational compliance with the proposed regulations is required as of the implementation date.
The deadline for nongovernmental individually designed plans to adopt amendments for the final regulations is December 31 of the second calendar year following the calendar year in which the regulations appear in the IRS Required Amendments List. If the regulations are in the 2019 Required Amendments List, as is expected, conforming amendments must be adopted by December 31, 2021. For plans using a preapproved plan document (i.e., a prototype plan or a volume submitter plan), the amendment deadline is the federal tax filing deadline, including extensions, for the employer’s 2020 tax year. The preambles to the final regulations provide amendment relief for optional amendments as well as required amendments. Instead of the normal deadline for discretionary amendments, the amendment deadlines for adopting the final regulations also apply to other amendments to a plan’s hardship distribution provisions with an effective date by the amendment’s adoption date.
Although the final regulations generally apply to 403(b) plans, there are a few important 403(b) distinctions: earnings on elective deferrals are ineligible for distribution, QNECs and QMACs in a custodial account are ineligible for distribution, and the amendment deadline is March 31, 2020 (although the preamble indicates an extension may be announced).
Now is the time for employers to catalog operational changes made based on the proposed regulations (and whether modifications to those changes are needed beginning January 1, 2020) and identify operational changes to be implemented January 1, 2020 (whether required or optional) in preparation for the looming amendment deadlines.
More Recent Posts
Tax Law Insights
- Alabama Tax (1)
- Federal Tax (185)
- Sales and Use Tax (0)
- South Carolina Tax (115)