Treasury Issues Proposed Hardship Withdrawal Regulations
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Posted on March 1, 2019 by Legacy Retirement Solutions
In 2018, we wrote about the Bipartisan Budget Act of 2018 (“Budget Act”) and the unanticipated inclusion of certain provisions of the Budget Act that generally expanded the availability of hardship withdrawals from retirement plans. Since the publication of that article, the U.S. Treasury Department has released proposed regulations that begin to provide the guidance that practitioners and plan sponsors require in order to implement the changes to the hardship withdrawal rules (“Proposed Regulations”). Final regulations on this matter are anticipated sometime later in 2019. However, since several provisions of the Budget Act were slated to be effective as early as January 1, 2019, it is important to understand the content of the Proposed Regulations now in order to be poised to take advantage of them once they are finalized. Therefore, the following generally discusses the content and impact of the Proposed Regulations.
Before discussing the Proposed Regulations, it is worth mentioning that it is not possible to be entirely definitive on the impact and requirements of the new rules until they are issued in final form at some point in the future. Thus, even though there may be plan sponsors who would like to take immediate advantage of the content of the Proposed Regulations, it would be prudent to wait until the Proposed Regulations are issued in final form before attempting to effectuate the guidance provided therein in order to avoid inadvertently violating any yet to be released requirements. In this regard, it also is noteworthy that most retirement plans will need to be amended in order to take advantage of these changes. However, as a result of the yet to be final status of the Proposed Regulations, many plan document providers have not yet released the plan language and documentation necessary to formally memorialize these changes. Consequently, even though it is expected that plan sponsors will have a “grace period” during which they will be able to retroactively amend their plans to incorporate the necessary plan provisions, it remains prudent for all parties to understand the full scope of the new rules before attempting to comply with their requirements. Thus, again, it likely is in the best interests of most plan sponsors to delay implementing these new rules until final regulations are released by the U.S. Treasury Department.
Prior to the release of the Proposed Regulations, Treasury regulations existed that generally described how a hardship withdrawal would only be permissible to the extent that the amount distributed was necessary to satisfy a financial need. In this regard, the existing regulations established both a facts and circumstances method and a safe harbor method of satisfying this requirement. However, the Proposed Regulations propose to eliminate both the facts and circumstances and safe harbor methods of establishing the amount of the financial need in favor of a new three prong test that mirrors the old safe harbor method with certain exceptions. The three prongs of the newly proposed rule are as follows: 1) the distribution does not exceed the amount of the participant’s need; 2) the participant has obtained all other currently available distributions under the plan and all other plans of deferred compensation maintained by the employer; and 3) on or after January 1, 2020, the participant must represent in writing that he or she has insufficient cash or other liquid assets to satisfy the need. To further explain, this new test would only apply to determining the amount of the purported need and essentially would serve to eliminate the currently applicable regulatory requirements that a participant: 1) first obtain any nontaxable plan loans to attempt to satisfy the need; and 2) have his or her ability to make elective deferral contributions suspended for at least six months after the receipt of the hardship withdrawal.
The Proposed Regulations would also affirmatively establish that, effective as of January 1, 2020, plan sponsors shall be prohibited from suspending a participant’s ability to make elective deferral contributions following his or her receipt of a hardship withdrawal. In addition, the Proposed Regulations indicate that plan sponsors have the discretion to eliminate the elective deferral suspension rule as early as the first day of the first plan year beginning on or after December 31, 2018 and that such discretion extends to the elimination of the rule in connection with hardship withdrawals that may have been granted prior to the effective date of such change.
Finally, the Proposed Regulations formally expand the money sources from which a hardship withdrawal may be obtained to also include qualified nonelective contributions (“QNECs”), qualified matching contributions (“QMACs”) and the earnings associated with those amounts as well as earnings on elective deferral contributions. However, it is noteworthy that plan sponsors are not required to expand the sources from which hardship withdrawals may be made in this manner.
We hope that this article helped you to better understand this topic. However, please be advised that it is not intended to serve as financial, tax or legal advice so it should not be construed as such. If you have questions about this topic or are considering implementing these rule changes, we strongly urge you to further discuss it with a qualified retirement plan professional. For more information about this topic, please contact our marketing department at 484-483-1044 or your administrator at Legacy.
Over the course of the last two years, we at Legacy Retirement Solutions, LLC (“Legacy”) have diligently worked to help our clients satisfy the most recent Internal Revenue Service (“IRS”) mandated restatement of pre-approved defined contribution retirement plans. This requirement was commonly referred to as the “Pension Protection Act” (“PPA”) restatement requirement in honor of the piece of retirement plan related legislation that most significantly influenced the content of the restated plan documents.
As you, hopefully, already realize due to you and/or your clients’ satisfaction of this requirement; the general deadline to adopt a pre-approved defined contribution PPA restatement was April 30, 2016. An important part of our PPA restatement efforts here at Legacy included what many plan sponsors may have perceived as “annoying” and “duplicative” follow-ups. However, the follow-up was necessary in order to best ensure that the requisite plan documents were not only received by each of Legacy’s plan sponsor clients that required them but also that they were understood and, possibly most importantly, timely executed. These efforts beg the question of: what would happen if a plan sponsor didn’t timely adopt a PPA restatement? The remainder of this article is intended to discuss the implication of such failure as well as what could be done to resolve it.
If a plan sponsor did not sign a PPA restated defined contribution plan document as required on or before the April 30, 2016 deadline; the associated retirement plan is no longer entitled to tax-favored treatment. The loss of tax-favored treatment may: 1) eliminate prior years’ deductions for contributions paid to the plan; 2) make the trust of the plan subject to taxation for current and certain prior years; and 3) force taxable distributions of all of the plan’s assets to its participants. Obviously, these consequences are both significant and severe. Fortunately, there is a voluntary correction methodology established by the IRS available to rectify this situation and which allows a plan sponsor to avoid the severe tax consequences described above.
More specifically, a plan sponsor that does not timely adopt a restated PPA pre-approved defined contribution retirement plan document can restore the tax-favored status of such plan by retroactively adopting such plan under the auspices of the Voluntary Correction Program with Service Approval Program (“VCP”) as sponsored by the IRS. Successful completion of the program results in a “compliance statement” from the IRS which is a formal memorialization of the appropriate correction of the failure. In that event, the plan at issue is able to return to its tax-favored status thereby protecting the sponsor’s deductions, the trust’s tax-exempt status and the participant’s tax deferment goals.
Although there is no requirement that a plan sponsor employ a retirement plan professional (such as an attorney) to prepare and submit a matter to VCP for correction, we strongly recommend consulting with a retirement plan professional experienced in such matters before attempting to embark down this path. This is because, while the VCP process can prove to be extremely beneficial, it also can be challenging as it requires careful preparation, attention to detail and, generally, direct negotiation with the IRS regarding the content of such submission.
As much as we hope this article helped you to better understand this topic, it is not to be construed as financial, tax or legal advice. Therefore, if you believe that the issues discussed herein may apply to your (or your client’s) company, be sure to further discuss it with a qualified retirement plan professional. For more information about this topic, please contact our marketing department at 484-483-1044 or your administrator at Legacy.
Back in July of 2014, we alerted you to the establishment of a new but only temporary “pilot” program by the Internal Revenue Service (“IRS”) which provided penalty relief to plan sponsors and plan administrators of certain retirement plans. The relief applied to the late-filing of Form 5500-EZ, Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan (“Form 5500-EZ”), or, in limited circumstances, Form 5500, Annual Return / Report of Employee Benefit Plan (“Form 5500”), with regard to plans which are not subject to Title I of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”). As a result of the rules of the program, the relief offered under the program was generally limited to plans sponsored by certain small businesses (owner-only or business partnerships) or certain foreign plans.
The temporary penalty relief program expired on June 2, 2015. However, the IRS recognized the utility and benefits of this program and, as a result, decided to make the program permanent. The following discusses the new and now permanent program in greater detail.
Background
Both the Internal Revenue Code of 1986, as amended (“Code”), and ERISA impose annual federal reporting requirements with regard to certain retirement plans. The various reporting requirements are consolidated within the Form 5500 Series Annual Return / Report. Although the IRS and Department of Labor (“DOL”) have concurrent enforcement over the filing of Form 5500, the remainder of this article generally discusses only IRS / Code implications due to the fact that the penalty relief program, which is the focus of this article, relates exclusively to plans which are not subject to ERISA.
Plan sponsors and plan administrators who fail to timely submit a Form 5500 may be subject to civil penalties under the Code. In general, the late-filing penalties set forth under the Code impose a penalty of $25 for each day the failure continues, up to $15,000 per late-filed return. Notwithstanding, no penalties are imposed under these provisions of the Code if the plan sponsor or plan administrator can demonstrate that such failure is due to “reasonable cause”.
Attempting to argue reasonable cause can be an effective way of eliminating IRS assessed Form 5500 late-filing penalties. However, as any such abatement is the result of a somewhat subjective review of the individual facts and circumstances of the specific situation by the IRS, this method of attempting to eliminate late-filing penalties includes an undesirable element of uncertainty. Will the IRS accept the factual circumstances that are relayed as persuasive enough to establish reasonable cause? There is no way to be certain until the IRS reviews such arguments and decides to either accept or reject them.
In addition to the establishment of reasonable cause, the DOL established a program in 1995 known as the Delinquent Filer Voluntary Compliance Program (“DFVC”) which is available to reliably and conclusively preclude penalty assessments associated with the late-filing of Form 5500. In exchange for the payment of a nominal fee, voluntary submissions to DFVC generally absolve its users of any late-filed Form 5500 penalties assessable by either the IRS or the DOL. The certainty associated with the elimination of late-filed Form 5500 penalties under DFVC generally makes it a preferable method of addressing these issues as compared to attempting to establish reasonable cause. However, DFVC only accepts submissions in relation to ERISA plans.
As a result of DFVC only being available to plans covered by ERISA, non-ERISA plans (such as the owner-only and foreign plans mentioned above) are not eligible to employ DFVC. As non-ERISA plans are not subject to ERISA penalty assessments, this limitation is irrelevant for purposes of such plans’ need to avoid ERISA late-filed Form 5500 penalty assessments. However, the lack of availability of DFVC to non-ERISA plans also prevents plan sponsors of such plans from conclusively eliminating IRS Form 5500 late-filing penalties. Therefore, non-ERISA plans only path to attempt to abate late-fling penalties assessable by the IRS is through the establishment of reasonable cause.
As explained above, although reasonable cause arguments can be effective at eliminating IRS late-filed Form 5500 penalties, it is a less desirable method of addressing these concerns due to the subjectivity associated with the establishment of reasonable cause. Therefore, a reliable and conclusive method of eliminating such penalties with respect to non-ERISA plans remained unavailable before the establishment of the pilot program. However, with the June 2, 2015 expiration of the penalty relief program, it was thought that non-ERISA plans might be forced to return to the days where the establishment of reasonable cause was the only way to abate late-filing penalties. Fortunately, with the decision of the IRS to make the pilot program permanent, plan sponsors of non-ERISA plans now have an on-going, reliable and objective method for eliminating IRS late-filed Form 5500 penalties.
New Guidance
Under IRS Revenue Procedure 2015-32 (“Rev. Proc. 15-32”), effective June 3, 2015, the IRS made permanent the former pilot program and, in this manner, provided plan sponsors and plan administrators of certain non-ERISA plans with a permanent way to obtain relief from the IRS Form 5500 late-filing penalties discussed above. Many of the rules established under the initial pilot program remain the same under the permanent penalty relief program. However, several new rules also were implemented under the new program; most notably the assessment of a fee to employ the program.
As under the old pilot program, relief under the new program is granted on a “per plan” basis and is conditioned upon the preparation and submission of the outstanding Form(s) 5500-EZ (or in limited circumstances for plan years prior to 2009, Form 5500 in connection with non-ERISA plans that were required to file a Form 5500 as opposed to a Form 5500-EZ) including all required schedules before the assessment of any penalties by the IRS in connection with the delinquent return. In addition, similar to the pilot program, each delinquent form must be marked in red letters at the top of its first page with the words “Delinquent Return Submitted under Rev. Proc. 2015-32, Eligible for Penalty Relief.” Failure to properly mark the submitted delinquent return may cause the IRS to treat the return as ineligible for the relief provided under the new guidance and could result in the assessment of all potentially applicable penalties.
New to the permanent program is the creation of an IRS form to replace the informal “transmittal schedule” that was previously required to accompany any submission made under the terms of the program. In this regard, IRS Form 14704, Transmittal Schedule – Form 5500-EZ Delinquent Filer Penalty Relief Program (Revenue Procedure 2015-32) (“Form 14704”), was created and must be included with each submission to the penalty relief program. The rather simple, one-page Form 14704 must be completed and, in the event of multiple late forms being included with a single submission, attached to the oldest delinquent return included with such submission.
As mentioned above, also new to the program is the assessment of a fee in order to obtain the relief available under Rev. Proc. 15-32. The amount of the fee is $500 per delinquent return up to a maximum of $1,500 per submission (that is, the payment is equal to $500 for a single return, $1,000 for two returns for the same plan, and $1,500 for three or more returns for the same plan). Any submission to the program is made on a “per plan” basis. Therefore, if a sponsor had more than one plan with delinquent filing issues, each plan would need to be submitted to the program separately and each plan could separately be subject to the maximum fee per submission.
As much as we hope this article helped you to better understand this topic, it is not to be construed as financial, tax or legal advice. Therefore, if you believe that it may apply to your (or your client’s) company, be sure to further discuss it with a qualified accountant or tax professional. For more information about this topic, please contact our marketing department at 484-483-1044 or your administrator at Legacy.