Final Hardship Regulations Published

The Treasury Department and IRS have published final regulations on hardship distribution options – and there are some changes, and clarifications, from the proposed version.

You’ll recall that the Bipartisan Budget Act of 2018 (BBA 2018) directed the Secretary of the Treasury to “modify §1.401(k)-1(d)(3)(iv)(E) to (1) delete the 6-month prohibition on contributions following a hardship distribution and (2) make any other modifications necessary to carry out the purposes of section 401(k)(2)(B)(i)(IV).”

On Nov. 14, 2018, the Treasury Department and the IRS published proposed regulations regarding hardship distributions. In publishing the final regulations, the agencies note that no public hearing was requested or held, and that seven (yes, only seven – and the American Retirement Association was one of those!) comments on the proposed regulations were received during the comment period. After consideration of the comments, the proposed regulations were adopted with some minimal changes.

These final regulations update the section 401(k) and 401 (m) regulations to reflect: (1) the enactment of (a) sections 41113 and 41114 of BBA 2018, (b) sections 826 and 827 of the Pension Protection Act of 2006 and (c) section 105(b)(1)(A) of the HEART Act; and (2) the application of the hardship distribution rules in light of the modification to the casualty loss deduction rules made by section 11044 of the Tax Cut and Jobs Protection Act of 2017.

The agencies characterize the final regulations “substantially similar to the proposed regulations,” and perhaps more importantly announce that, “plans that complied with the proposed regulations will satisfy the final regulations.” This is consistent with informal comments made by officials at the IRS that taxpayers could rely on the proposed regulations.

Eligible Expenses

The final regulations, like the proposed regulations, modify the safe harbor list of expenses, expanding the notion of what constitutes a “primary beneficiary under the plan,” clarifying that the home casualty reason for hardship does not have to be in a federally-declared disaster area, and adding to that list of qualifying expenses those incurred as a result of federally-declared disasters (such as flooding, hurricanes and wildfires).

That said, some commenters expressed concerns that the latter new safe harbor expense was “narrower in certain respects” than past IRS relief. Others expressed concern that this new definition would lead the IRS to discontinue its practice of issuing announcements providing such relief. In response, the final regulations note that the new safe harbor expense differs from those announcements in three main respects.

First, only disaster-related expenses and losses of an employee who lived or worked in the disaster area will qualify for the new safe harbor expense – whereas under the disaster-relief announcements, expenses and losses of the employee’s relatives and dependents are also included. The Treasury Department and IRS have concluded that limiting distributions only to those employees directly affected by a disaster is consistent with the purposes underlying the Code’s hardship distribution provisions and “better aligns with the relief given to affected individuals under section 7508A” for similar disasters.

Second, the final regulation explains that, unlike under the disaster-relief announcements, there is no specific deadline by which a request for a disaster-related hardship distribution must be made and no specific authority to relax certain procedural requirements established by the plan administrator or plan terms (although they note that it is expected that plan administrators will be flexible in interpreting plan terms requiring documentation relating to the hardship when processing hardship distribution requests during the difficult circumstances following a disaster).

Finally, and unlike under the disaster-relief announcements, under the new safe harbor expense definition there is no extended deadline for plan sponsors to add disaster-related distribution or loan provisions to the plan. “In the absence of such an extended deadline, a plan sponsor that does not choose to add disaster-related hardship distribution provisions as part of an amendment reflecting the final regulations but instead chooses to wait until a disaster occurs to add those provisions (or to add a loan provision) would need to adopt a plan amendment by the end of the plan year the amendment is first effective.”

Ultimately, the final regulations explain that making expenses related to certain disasters a safe harbor expense is intended to eliminate any delay or uncertainty concerning access to plan funds that might otherwise occur following a major disaster – and “accordingly, the Treasury Department and IRS expect that no more disaster-relief announcements will be needed,” though they are “considering separate guidance to address delayed amendment deadlines when the new safe harbor expense or loan provisions are added to a plan at a later date in response to a particular disaster.”

Verbal Representations OK

Commenters on the proposed regulation also raised questions regarding the standard to be applied when, as the proposed (and final) regulations state that a hardship distribution may not be made if the plan administrator has actual knowledge that is contrary to the representation. Under the proposed regulations. the employee representation may be made “in writing, by an electronic medium, or in such other form as may be prescribed by the Commissioner,” and – in response to a comment regarding whether a verbal representation via telephone could be used if it is recorded – the final regulations clarify that this method is acceptable (“by referencing the definition of ‘electronic medium’ at §1.401(a)-21(e)(3)”).

The final regulations clarify that this requirement “does not impose upon plan administrators an obligation to inquire into the financial condition of employees who seek hardship distributions.” Rather, in an effort to ensure the integrity of the determination of necessity, the agencies note that the rule is “limited to situations in which the plan administrator already possesses sufficiently accurate information to determine the veracity of an employee representation.”

Contribution Suspensions

One way in which the final regulations do differ is that – unlike the proposed regulations – the final regulations clarify that a plan subject to Section 409A (nonqualfied deferred compensation) may retain its suspension provisions (or, to the extent consistent with Section 409A and the regulations thereunder, the plan may be amended to remove them).

Asked for guidance on the continuing applicability of revenue rulings that require a “substantial limitation” on the right of a participant to withdraw matched employee contributions, such as a suspension of contributions, the regulation states that, under the final regulations, if, on or after Jan. 1, 2020, matched employee contributions are distributed in conjunction with a hardship distribution of elective contributions, “a suspension of employee contributions is not permitted.”

The final regulations, like the proposed regulations, permit hardship distributions from 401(k) plans of elective contributions, QNECs, QMACs, and earnings on these amounts, regardless of when contributed or earned. In response to commenters who asked how the new distribution rules apply to safe harbor contributions, the notice explains that since safe harbor contributions made to a plan described in Section 401(k)(12) are either QNECs or QMACs, “amounts attributable to these contributions may be distributed on account of hardship.”

403(b) Plans

Simply stated, the new rules relating to a hardship distribution of elective contributions from a section 401(k) plan generally apply to section 403(b) plans. Apparently, two commenters asked whether, “in light of historical concerns about employee self-certification in section 403(b) plans, the employee-representation requirement applies to section 403(b) plans.” The short answer – since that requirement is retained in the final regulations – is yes.

That said, the preamble to the proposed regulations states that because Code Section 403(b)(11) was not amended by Section 41114 of BBA 2018, “income attributable to section 403(b) elective deferrals continues to be ineligible for distribution on account of hardship.” It also says that, as also stated in that preamble, amounts attributable to QNECs and QMACs may be distributed from a 403(b) plan on account of hardship only to the extent that, under §1.403(b)-6(b) and (c), “hardship is a permitted distributable event for amounts that are not attributable to section 403(b) elective deferrals.” As a result, QNECs and QMACs in a 403(b) custodial account continue to be ineligible for distribution on account of hardship.

It would take a statutory change to resolve this discrepancy in sources.

Effective Dates

The changes to the hardship distribution rules made by BBA 2018 are effective for plan years beginning after Dec. 31, 2018. The final regulations provide plan sponsors with a number of options for applicability dates. While “presented differently” in the proposed regulations, the final regulations provide the same options.

The Treasury Department and IRS expect that plan sponsors will need to amend their plans’ hardship distribution provisions to reflect the final regulations, and any such amendment must be effective for distributions beginning no later than Jan. 1, 2020.

Under the final rule, the deadline for amending a “disqualifying provision” for individually designed qualified plans is set forth in Rev. Proc. 2016-37, 2016-29 I.R.B. 136. This is generally 2 years after publication on the IRS Required Amendments List.

The deadline for adopting a required amendment (as well as any integrally related amendment) to a pre-approved plan is also set forth (in section 15 of) Rev. Proc. 2016-37, and varies depending on several factors, including the type of entity sponsoring the plan and the period used for the plan year. The Treasury and IRS, however, have extended the deadline for the adoption of an amendment for pre-approved plans by treating all changes in the regulations as regulations though they were required changes. Thus, for example, if the provisions are effective for distributions on and after Jan. 1, 2020, then an interim amendment would be needed by the due date of the tax return for 2020.

The regulations note that the amendment deadline for 403(b) plans is March 30, 2020, but indicate the Treasury and IRS are considering extending that deadline for the adoption of amendments to conform to the final hardship regulations.

NOTE: As you might expect, the details – and implications – of these new regulations will be discussed in detail at the ASPPA Annual Conference. Don’t miss out on the opportunity to hear from the industry’s best on what this might mean for your practice! Find out more at www.asppaannual.org.

Nevin E. Adams, JD with assistance from Robert Richter, Bob Kaplan & Allison Wielobob