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IRS Guidance from Eileen Shaw

IRS Guidance on Hardship Withdrawal Substantiation 

By: Eileen Shaw

On February 23, 2017, the Department of Treasury issued Memorandum of Employee Plans Examinations Employees (“Memorandum”) regarding substantiation guidelines for safe harbor hardship withdrawals.  The Memorandum adds to the Internal Revenue Manual Administrative Guidelines for examiners reviewing hardship documentation.

Historically IRS procedures have required the plan obtain from a participant documentation substantiating an event that qualifies as a hardship as defined under the plan.  IRS auditors have requested to see paperwork such as medical or repair bills, tuition invoices, and home purchase contracts to demonstrate the event and the substantiate the amount of money needed to pay off the hardship.  However, plan sponsors have been cited upon audit for not having the necessary documentation in their files.

The Memorandum provides a means for plan sponsors to rely on certification and document retention by the participants.  If the plan sponsor does not retain the substantiation documentation, then they must demonstrate that they are following the procedures identified in the Memorandum.  Those procedures are:

  1. Disclosure – The employer must provide a participant requesting a hardship distribution with a notice informing the participant of the taxability of the hardship, the limitations on a hardship distribution, and the requirement that the participant must maintain the source documents to prove the hardship and the expenses associated with it.
  2. The participant must provide a summary of the hardship event and the total cost of the hardship, the amount requested and certification by the participant that the information provided is true and accurate.  Additional information is required based on the type of hardship incurred.  A list of documentation is attached.
  3. The plan must have a procedure in place that limits hardship distributions to no more than 2 per year.

Under the Memorandum, the IRS examiners will audit the summary of information rather than the source documents and request the source documents only if the summary is insufficient or inconsistent.

The Memorandum makes it clear that the new procedure applies to all current and future audits.  However, because the certification process was not known previously, plan sponsors should maintain source documentation for hardships for years that are open for examination (the statute of limitations for examinations expires 3 years after the filing of the Form 5500 for that year.)

HARDSHIP SUBSTANTIATION INFORMATION AND NOTIFICATIONS FOR SUMMARY OF SOURCE DOCUMENTS

  1. Notifications that the Employer/Administrator Must Provide to the Employee
  • The hardship distribution is taxable and additional taxes could apply.
  • The amount of the distribution cannot exceed the immediate and heavy financial need.
  • Hardship distributions cannot be made from earnings on elective contributions or from QNEC or QMAC accounts, if applicable.
  • The recipient agrees to preserve source documents and to make them available at any time, upon request, to the employer or administrator.
  1. General Information for All Hardship Requests
  • Participant’s name
  • Total cost of the event causing hardship (for example, total cost of medical care, total cost of funeral/burial expenses, payment needed to avoid foreclosure or eviction)
  • Amount of distribution requested
  • Certification by the participant that the information provided is true and accurate

III. Specific Information on Deemed Hardships

  1. Medical Care
  • Who incurred the medical expenses (name)?
  • What is the relationship to the participant (self, spouse, dependent, or primary beneficiary under the plan)?
  • What was the purpose of the medical care (not the actual condition but the general category of expense, for example, diagnosis, treatment, prevention, associated transportation, long-term care)?
  • Name and address of the service provider (hospital, doctor/dentist/chiropractor/other, pharmacy)
  • Amount of medical expenses not covered by insurance
  1. Purchase of Principal Residence
  • Will this be the participant’s principal residence?
  • Address of the residence
  • Purchase price of the principal residence
  • Types of costs and expenses covered (down-payment, closing costs and/or title fees)
  • Name and address of the lender
  • Date of the purchase/sale agreement
  • Expected date of closing
  1. Educational Payments
  • Who are the educational payments for (name)?
  • What is the relationship to the participant (self, spouse, child, dependent, or primary beneficiary under the plan)?
  • Name and address of the educational institution
  • Categories of educational payments involved (post-high school tuition, related fees, room and board)
  • Period covered by the educational payments (beginning/end dates of up to 12 months)
  1. Foreclosure/Eviction from Your Principal Residence
  • Is this the participant’s principal residence?
  • Address of the residence
  • Type of event (foreclosure or eviction)
  • Name and address of the party that issued the foreclosure or eviction notice
  • Date of the notice of foreclosure or eviction
  • Due date of the payment to avoid foreclosure or eviction
  1. Funeral and Burial Expenses
  • Name of the deceased
  • Relationship to the participant (parent, spouse, child, dependent, or primary beneficiary under the plan)
  • Date of death
  • Name and address of the service provider (cemetery, funeral home, etc.)
  1. Repairs for Damage to Principal Residence
  • Is this the participant’s principal residence?
  • Address of the residence that sustained damage
  • Briefly describe the cause of the casualty loss (fire, flooding, type of weather-related damage, etc.), including the date of the casualty loss
  • Briefly describe the repairs, including the date(s) of repair (in process or completed)