09/15/05 - IRS Issues Katrina Guidance Updating This Article

New Hardship Safe Harbors
Rev. 09/15/05, E-mail Alert 2005-18

The final 401(k) regulations created two new safe harbor reasons for hardship withdrawals; one for funeral expenses and the other for casualty damages. There are many inquiries about how to use these new safe harbors following Hurricane Katrina.

Using the safe harbors right now might require the incorporation of all the 401(k) final regulations into the plan. But the lack of IRS model language for incorporating the regulations poses a challenge. There may be other alternatives.

1. Injuries or sickness resulting from Hurricane Katrina will definitely qualify for the existing safe harbor provisions of medical care under tax code section 213. There is also the potential to obtain a hardship withdrawal if a new principal residence must be obtained or a mortgage foreclosure be forestalled. (Physical damage to personal property and real estate that resulted from this storm will also qualify as casualty damage under the final regulations.)
2. One potential option would be to operate a plan already permitting hardship withdrawals under the "old" hardship rules as if the final regulations had been implemented and the new hardship reasons been adopted, and then retroactively self-correct the plan under the Employee Plans Compliance Resolutions Systems (EPCRS) to incorporate those provisions into the plan retroactively. A similar strategy could be utilized by a plan that had not previously permitted hardship withdrawals (see, Rev. Proc. 2003-44, App. B, Section 1.07, Example 21). However, based on the guidance that the IRS is expected to issue any day now, employers will have expanded rights to make loans and hardships that are Hurricane related. If retroactive amendments are required, then the employer will have an extended time to make the amendment, without going to the IRS.
3. Treasury and the Congress are both working on Hurricane Katrina relief. We will post a news flash on our Website as soon as any guidance is released. Things under discussion, but not yet announced, include:
   
   
   1. Permitting hardship and participant loans even for plans without those provisions.
      
   2. Waiving the 10% penalty on the hardship distribution.
      
   3. Permitting distributions from Katrina affected plans to automatically satisfy the hardship rules.
      
   4. Permitting hardships to be taxed over three years
      
   5. Filing extensions.
      
   6. Doubling of loan amounts.