Updated 401K Hardship Guidelines
The IRS Tax Exempt and Government Entities Division has updated their guidelines to determine whether a 401K plan hardship meets the safe-harbor standards set forth in applicable regulations. Specifically, they have set out the substantiation guidelines that IRS auditors are to use in conducting related examinations.
Under Code Sec. 401(k), plans may provide that an employee can receive a distribution of elective contributions from the plan on account of hardship. Generally, a hardship distribution form a retirement account can only be made for immediate and heavy financial need of the employee and is in an amount necessary to satisfy the financial need of the applicable.
The safe harbor provision states that a distribution is deemed to be as a result of immediate and heavy financial need if made for any of the following reasons:
– Expenses for medical care deductible under Code Sec. 213(d).
– Costs directly related to the purchase of a principle residence.
– Payment of tuition, related educational fees, and room and board expenses for up to the next 12 months of post-secondary education for the employee or employee’s spouse, children or dependents.
– Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure of the mortgage on that residence.
– Payments for burial or funeral expenses for the employee’s deceased parent, spouse, children or other dependent.
– Expenses for the repair of damage to the employee’s principal residence that would qualify for the Code Sec. 165 casualty deduction.
The IRS Tax Exempt and Government Entities Division guidance details the steps that an examiner is to take in substantiation that a distribution is made for one of the enumerated reasons. First, the examiner is to determine whether the employer or a third-party administrator had the requisite source documents or summary of source documents prior to making a distribution to an affected employee. In addition, the examiner may need to ensure that the employee was given the relevant notifications prior to a hardship distribution, to include being told that the hardship is taxable, and that the amount of the distribution may not exceed the immediate and heavy financial need.
Next, the IRS examiner is to review the provided documentation to determine if they substantiate the requested hardship distribution. If they do not, the examiner is to ask the employer or the third-party administrator to substantiate that a hardship distribution is deemed to be on account of an immediate and heavy financial need. If an examiner determines that the requirements of the first and second steps are met, then the plan is to be treated as satisfying the substantiation requirement for making hardship distributions deemed to be for an immediate and heavy financial need.
If you have any questions about which 401K hardship guidelines meet the safe harbor criteria, please contact your CPA accounting expert in our office.
