401(k): Unintended Impact of Tax Reform on 401(K) Hardship Withdrawals

Tax reform may have had unintended effect on hardship withdrawals under 401(K) plans

Last year’s tax reform act, officially called the Tax Cuts and Jobs Act of 2017 (“TCJA”), may have had an unintended adverse effect on hardship withdrawals under 401(k) retirement plans, asserts the American Institute of CPAs (“AICPA”).  As a result, the professional accountant’s advocacy group has formally requested the IRS to issue immediate guidance to clarify the intent of the new law as applied to 401(k) plan hardship withdrawals.

TCJA, which both eliminated and tightened up many previously available tax deductions, amended Internal Revenue Code (“Code”) Section 165 to narrow the definition of “casualty” for purposes of the tax deductibility for certain losses. Under the new definition, in order to be tax deductible, losses resulting from casualties from years 2018 through 2025 are limited to those occurring in “federally declared disaster areas.”

The problem arises because one of the criteria that permits a 401(k) plan participant to take a hardship withdrawal under a 401(k) plan (assuming the plan permits hardship withdrawals) is “casualty losses,” as defined under Code Section 165.  Thus, under TCJA, as written, the hardship withdrawal criteria is now also limited to casualty losses that occur in federally declared disaster areas.

It is unlikely that this result was taken into account when TCJA was enacted, notes the AICPA, pointing out that there is no specific requirement that the hardship withdrawal criteria be linked to that particular Code section.  Accordingly, the AICPA, in its letter, is asking that the IRS and the U.S. Department of Treasury (“Treasury”) use a different standard for defining “casualty loss” for purposes of hardship withdrawals from 401(k) plans.

Technically, it is unclear whether the IRS and Treasury have the authority to make this change to the statute. This is exactly the type of “fix-it” that Congress usually addresses through “technical corrections” that are passed following tax legislation. However, there has been very little – if any – talk of any technical correction legislation taking place this year with respect to TCJA, so the chances of Congress taking action to make repairs or clarifying changes to TCJA do not seem encouraging — to say the least.

Leave a Reply

Your email address will not be published. Required fields are marked *