The Internal Revenue Service has published new examination guidelines for documenting a hardship distribution.
Specifically, the memorandum sets forth substantiation guidelines for EP Examinations employees examining whether a section 401(k) plan hardship distribution is “deemed to be on account of an immediate and heavy financial need” for safe harbor distributions, and will now allow the use of a summary compiled from source documents, electronic documents or even call center records if certain requirements are met.
The memorandum instructs personnel looking to determine if those distributions are, in fact, made on account of “a deemed immediate and heavy financial need” to follow a two-step process.
Step 1: Determine whether the employer or third-party administrator, prior to making a distribution, obtains: (a) source documents (such as estimates, contracts, bills and statements from third parties); or (b) a summary (in paper, electronic format, or telephone records) of the information contained in source documents, and if so, determine whether the employer or third-party administrator provides the employee notifications required prior to making a hardship distribution, specifically:
- 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.
Step 2: If the employer or third-party administrator obtains source documents as note above, review the documents to determine if they substantiate the hardship distribution, check to make sure the summary contains the relevant items listed in the Attachment I.
The memorandum states that if the notification to employees or the substantiation information is incomplete or inconsistent on its face, the examiner may ask for source documents that substantiate the need, and that if it is complete and consistent but there are employees who have received more than two hardship distributions in a plan year, then, “in the absence of an adequate explanation for the multiple distributions and with managerial approval, you may ask for source documents from the employer or third-party administrator to substantiate the distributions.”
If a third-party administrator obtains a summary of information contained in source documents, the examiner is told to determine whether the third-party administrator provides a report or other access to data to the employer, at least annually, describing the hardship distributions made during the plan year. If the applicable requirements in Step 1 and Step 2 above are satisfied, the plan should be treated as satisfying the substantiation requirement for making hardship distributions deemed to be on account of an immediate and heavy financial need.