Long-awaited guidance on Section 162(m) of the Internal Revenue Code (the “Code”), has finally arrived. On August 21, 2018, the IRS issued Notice 2018-68, which provides guidance on certain changes made to Section 162(m) by the Tax Cuts and Jobs Act (the “Act”). The guidance is limited to (a) the identification of covered employees and (b) the so-called “Grandfather Rule.” The Notice does not address all of the issues raised by the Act’s changes to Section 162(m) and it makes clear that the Grandfather Rule will be narrowly interpreted. The guidance is effective for tax years ending on or after September 10, 2018 and will be incorporated into future regulations. The material provisions of the guidance are summarized below.
In welcome news, the IRS reversed its course on the maximum annual health savings account contribution for a family with high deductible health coverage. As you may recall, the IRS initially set the maximum 2018 HSA contribution for family coverage at $6,900. In March 2018, the IRS lowered that maximum to $6,850. Via Rev. Proc. 2018-27, the IRS announced its decision that—notwithstanding its March guidance—it would allow taxpayers to treat $6,900 (not $6,850) as the maximum family HSA contribution for 2018.
The IRS also provided relief for those taxpayers who had already contributed between $6,850 and $6,900 to an HSA for 2018, and then received a distribution of that excess amount plus earnings based on the IRS’s March guidance. Forms of relief include timely repaying the distribution to the HSA, retaining the distribution as an excess contribution, or, if attributable to employer contributions, using it to pay qualified medical expenses.
We have updated our previous limitations post to reflect these changes, and will continue to do so should further changes arise for 2018.
On March 5, 2018, the IRS announced adjustments – effective immediately – to various annual limitations already in place for 2018. One such adjustment is to the maximum annual health savings account contribution for a family with high deductible health coverage. Previously set at $6,900 for 2018, the IRS has lowered the limit to $6,850, based on a change to the calculation of cost-of-living adjustments under the Tax Cuts and Jobs Act. (The maximum annual health savings account contribution limit for single coverage was not affected.) Employers sponsoring high deductible health plans will want to consider how to communicate this late-breaking change, and its impact, to their health plan participants. For example, individuals making contributions to their health savings accounts each payroll period may want to adjust their elections so as not to exceed the limit for 2018. Those who have already contributed the full $6,900 should consider seeking a distribution of the excess $50 contribution prior to the end of 2018 in order to avoid adverse tax consequences.
In the same guidance, the IRS also lowered the maximum per child adoption assistance credit for 2018 from $13,840 to $13,810. We have updated our previous limitations post to reflect these changes, and will continue to do so should further changes arise for 2018.
The Tax Cuts and Jobs Act (Tax Act) did not directly modify the rules governing hardship withdrawals from 401(k) plans. However, one change enacted by the Tax Act does necessitate a careful review of 401(k) plan hardship withdrawal language and could impact the administration of hardship withdrawal requests. Further, the Bipartisan Budget Act of 2018, enacted on February 9, 2018 (Spending Act), makes certain changes to the statutory rules governing hardship withdrawals and requires that the IRS make certain additional changes to applicable regulations. It will be important for 401(k) plan sponsors to understand these recent changes, monitor related IRS guidance, and assess whether changes in administration of hardship withdrawal requests and/or plan amendments are required.
Among the many changes made by the Tax Act is a narrowing of the circumstances under which taxpayers may be eligible for a deduction under Section 165 of the Internal Revenue Code (Code) with respect to a casualty loss. For tax years beginning before January 1, 2018, a taxpayer could potentially take a casualty loss deduction pursuant to Section 165 for uncompensated damage to the taxpayer’s home resulting from any fire, storm, flood or other isolated incidents. Under the new law, however, in order to be deductible under Section 165 for a tax year beginning on or after January 1, 2018 and before January 1, 2026, the loss must result from a Federally-declared disaster. The change to Section 165 of the Code may indirectly impact whether a hardship withdrawal is permitted under many 401(k) plans.
Often 401(k) plans that allow hardship withdrawals rely on “safe harbors” set forth in IRS regulations for determining whether a request satisfies the regulations’ requirements. One of the safe harbor reasons for determining whether the request relates to an immediate and heavy financial need (a requirement for hardship withdrawals) is to cover expenses for the repair of damage to the participant’s principal residence that would qualify for the casualty deduction under Section 165 of the Code (determined without regard to a minimum threshold that applies to the casualty loss deduction). When a plan document specifically cross references deductibility under Section 165, permitting a withdrawal for expenses that result from an isolated incident could now be contrary to the plan’s terms. For example, the Tax Act’s changes to Section 165 may prevent a hardship withdrawal by a participant who incurs expenses to repair damage to his or her principal residence resulting from an isolated incident, such as a fire or thunderstorm.
It isn’t clear whether Congress intended to narrow the circumstances in which a hardship withdrawal may be taken when enacting the change to Section 165, and it’s possible that the IRS will publish guidance obviating the need to impose the Federally-declared disaster requirement in the hardship context. In the meantime, however, it’s important for a 401(k) plan sponsor to be sure that its tax-qualified plan is administered in accordance with the plan’s terms. Therefore, the Section 165 changes should be taken into account if necessary in light of plan language, or plan administrators should forego use of the IRS safe harbor and plan documents should be amended if necessary to align with administration.
While reviewing plan documents and administration in light of the foregoing Tax Act change, plan sponsors should also consider future changes to hardship withdrawal administration to take advantage of additional flexibility enacted by the Spending Act, which apply to plan years beginning after December 31, 2018.
The Spending Act directly expands availability of hardship withdrawals to qualified nonelective contributions, qualified matching contributions, and earnings, which amounts are not eligible for distribution due to hardship under current rules. Further, the Spending Act modifies current rules that require a participant, in some circumstances, to have exhausted any available plan loans before taking a hardship withdrawal.
Finally, in addition to the safe harbor described above, under current IRS regulations, a hardship withdrawal will be deemed necessary to satisfy an immediate and heavy financial need (also a requirement for hardship withdrawals) if certain requirements are met, including that the participant is restricted from contributing to the plan and all other plans maintained by the employer for at least six months after taking the withdrawal. The Spending Act directs the IRS to modify the regulations so that the six-month suspension is not required to rely on the safe harbor.
Although not quite as entertaining as the intrigue in Game of Thrones or Hamilton, the House and Senate have continued their dueling ways with respect to tax reform. The most recent salvo came from the Senate in the form of a Joint Committee on Taxation, Description of the Chairman’s Modification to the Chairman’s mark of the “Tax Cuts and Jobs Act” (JCX-56-17), November 14, 2017.
Unlike the original Senate version of proposed changes to the House version of the Tax Cuts and Jobs Act (both of which are summarized in our Client Alert dated November 14, 2017), which provided for drastic changes to the nonqualified deferred compensation rules, the new description appears to leave the deferred compensation rules in place. It also adds a transition rule for the modifications to section 162(m) of the Code that would provide that the expansion of section 162(m) would not apply to any remuneration under a written binding contract that was in effect on November 2, 2017 and that was vested as of December 31, 2016. In addition, the proposal eliminates the limitations on 401(k) catch-up contributions for high wage earners.
We are looking forward to the next episode…..