On Friday February 9, 2018, President Trump signed into law the Bipartisan Budget Act of 2018 (the “Act”). While the Act is best known for ending the nine-hour government shut down that took place on February 9, 2018, it also contained some tax-related provisions.
One of the provisions broadly directed the IRS to make any changes necessary to ease the hardship distribution rules. This could be the first step towards correcting the problem with casualty loss hardship distributions that arose when Congress changed the deduction rules for casualty losses in the Tax Cuts and Jobs Act. This change has no effect on the qualifications to deduct casualty losses (which only applies to federal disaster areas). It only applies to accessing funds as hardship distributions due to a casualty loss.
However, until IRS issues further guidance, plans that have adopted the safe harbor hardship distribution rules will have to limit access to hardship distributions related to casualty losses. Of course, keep in mind that any guidance the IRS provides could be retroactive.
Hardship Distribution Rule Changes
In addition to the broad directive mentioned above, the Act also made some direct changes to the hardship distribution rules. Each of these changes is effective for plan years beginning after December 31, 2018. As a result, most plans that allow hardship distributions will have to be amended. The new changes are as follows:
- The six-month prohibition on elective deferrals: Under current law, once a participant receives a hardship distribution, he or she is prohibited from making contributions to the plan for six months. The Act directs the IRS to remove this six-month prohibition. This provision was actually included in the original tax reform bill drafted by the House and sent to the Senate for consideration. The Senate declined to adopt the provision, so it was not included in the Tax Cuts and Jobs Act. However, under this Act, it becomes law for plan years beginning after December 31, 2018.
- Expansion of eligible hardship distribution funds: The Act also expanded the types of retirement funds that are eligible for a hardship distribution. Currently, the employee can only receive a hardship distribution of his or her salary contributions, or elective deferrals. This does not include earnings on those contributions or any other employer contributions. Under the Act, hardship distributions will now include any qualified non-elective contributions (“QNECs”), qualified matching contributions (“QMACs”), and the earnings on salary contributions, QNECs, and QMACs. Again, this doesn’t apply until plan years that begin after December 31, 2018.
- No longer the last resort: The Act also eliminated the rule that required participants to take plan loans before accessing hardship distributions. Since there was never a reporting mechanism to enforce this rule, compliance has always been spotty. Moreover, a participant that experienced a qualifying hardship may not be able to repay a plan loan.
California Wildfire Disaster Relief
The Act also contained several relief provisions for those living in the areas affected by the California wildfire disaster of 2017. These provisions include additional access to retirement funds, relief from the 10% early distribution penalty and the 20% withholding rule, repayment of certain distributions, and an increase in the plan loan limit. Any qualified retirement plan wishing to take advantage of these changes will need to be amended. IRA owners can take advantage of the additional distribution rules. These additional rules are as follows:
- Qualified wildfire distributions (access): An individual who had his or her principle residence in the California wildfire disaster area and who sustained economic loss due to the wildfires is eligible to take a distribution from a qualified retirement plan or IRA. The distribution must be made from October 8, 2017 to December 31, 2018 and cannot exceed $100,000.
- Relief from the 10% early withdrawal penalty & withholding: The Act also provides that qualified wildfire distributions (described above) are not subject to the 10% early withdrawal penalty or the 20% withholding requirement. Moreover, the income can be included ratably over a three-year period and a participant has three years to recontribute those funds back to a plan or IRA.
- Repayment of home loan or construction distributions: The Act also grants relief to individuals who took hardship distributions for a home purchase (or construction) or an IRA distribution that qualified as a first-time homebuyer purchase. Under the new law, if the loan or construction was cancelled due to the California wildfire disaster, the individual can recontribute those funds back to a retirement plan or IRA. To qualify, the distribution must have been received after March 31, 2017 and before January 15, 2018. In addition, the funds must be recontributed between October 8, 2017 and June 30, 2018.
- Increase in plan loan limit: The plan loan limits were increased, and the repayment period was extended, for individuals with a principle residence in the California wildfire disaster area. Generally, plan loans are limited to the lesser of $50,000 or one-half of the vested account balance. For these individuals, the plan loan limit is increased from $50,000 to $100,000 and the “one-half rule” is removed. To qualify, the loans must be issued between February 9, 2018 and December 31, 2018. Moreover, if these individuals had outstanding plan loans at the time of the disaster, the repayment period can be extended.
Relief on Improper Tax Levies
Finally, the new law provides relief to individuals whose retirement accounts or IRAs were improperly levied by the IRS. Once those funds are returned, the individual can contribute that amount (including any interest received) to a retirement plan or IRA as a rollover contribution. The rollover must be completed by the individual’s tax filing due date for the year in which the funds are returned. This deadline does not include any extensions. Additionally, if the taxpayer was taxed when the levied funds came out of the retirement account (i.e., regular income tax), the taxes are waived, credited, or refunded to the taxpayer. The new law applies to levied funds returned to a taxpayer in tax years beginning after December 31, 2017.
In the end, the adage about nothing remaining constant except change couldn’t ring truer in the tax law arena today. Congress is still addressing tax provisions in a budget bill less than two months after it passed the largest tax bill in over thirty years! This is on top of the additional clarification expected from the IRS. If there was ever a time to stay tuned, it is now.