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GT Alert

New Hurricane Relief for Eligible Retirement Plan Distributions and Loans

January 2006

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The Katrina Emergency Tax Relief Act of 2005 (“KETRA”), which was enacted in September of 2005, contained provisions that ease existing rules with regard to distributions and loans to “qualified individuals” under “eligible retirement plans”. An individual is considered a “qualified individual” under these new rules if his or her principal place of abode on August 28, 2005 was located in the Hurricane Katrina disaster area and the individual sustained economic loss from Hurricane Katrina. The Hurricane Katrina disaster area includes the entire states of Florida, Louisiana, Mississippi and Alabama. An “eligible retirement plan” includes an IRA, a qualified plan under Section 401(a) of the Internal Revenue Code of 1986, as amended (the “Code”) (which would include 401(k) plans), annuity plans under Section 403(a) or 403(b), and governmental plans under Section 457(b) of the Code.

In December of 2005, the Gulf Opportunity Zone Act of 2005 (the “GO Zone Act”) was enacted, pursuant to which the new rules applicable to distributions and loans under KETRA were extended to apply to victims of Hurricanes Rita and Wilma as well. The new expanded provisions are contained in a new Section 1400Q of the Code. This new Section affords special tax treatment to “qualified hurricane distributions,” which are defined to include distributions from an eligible retirement plan made during a specified time period (the “qualified distribution period”) established for each hurricane to an individual whose principal place of abode was located in the disaster area for that hurricane, and who sustained an economic loss by reason of that hurricane (a “qualified individual”). The relevant dates and qualified distribution periods applicable to “qualified hurricane distributions” under Section 1400Q are as follows:

The aggregate amount of distributions that can be treated as qualified hurricane distributions for all 3 hurricanes cannot exceed $100,000.

Qualified hurricane distributions receive the following favorable tax treatment:

  • They are not subject to the 10 percent penalty generally applicable to distributions made prior to age 59 1/2.
  • They are exempt from the 20 percent withholding requirements generally applicable to plan distributions (although participants may elect voluntary withholding). The plan also need not offer the qualified individual a direct rollover, and need not provide a Section 402(f) notice (which describes the tax consequences relating to the distribution).
  • They are taxable ratably over the three year period that begins in the year of the distribution (although a participant may elect to include the entire taxable amount in income in the year the distribution is made).
  • If they otherwise are eligible for tax-free roll over treatment, all or any portion of the distribution may be recontributed on a tax-free basis into an eligible retirement plan at any time during the three year period beginning the day after the date of the qualified hurricane distribution. Such recontributions are to be treated as direct trustee to trustee transfers that are deemed to have been made within 60 days of the distributions. Although a distribution on account of a hardship would not normally be eligible for a tax-free rollover, IRS Notice 2005-92 (discussed further below) indicates that a qualified hurricane distribution on account of Hurricane Katrina will not (and thus presumably any qualified hurricane distributions on account of Hurricanes Rita and Wilma should not) be treated as a hardship distribution for this purpose.
  • Elective deferrals, qualified matching contributions, and qualified non-elective employer contributions under 401(k) Plans may be distributed as qualified hurricane distributions even though the distribution of those amounts is being made before an otherwise permitted distributable event for those types of contributions (such as severance from employment, disability or attainment of age 59 1/2).

Section 1400Q also permits certain hardship distributions made from 401(k) and 403(b) plans, (and qualified first-time homebuyer distributions from IRA’s), intended to be used to purchase or construct a principal residence in one of the three disaster areas, but that were not so used due to the hurricane, to be recontributed on a tax-free basis into an eligible retirement plan (and not be subject to the 10 percent early withdrawal tax).

In addition, Section 1400Q increased the allowable plan loan amounts to qualified individuals during an “applicable period” from employer sponsored eligible retirement plans, and provides for a one year suspension of payments by qualified individuals of plan loans outstanding on or after a “qualified beginning date” applicable to each hurricane. The “applicable period” and “qualified beginning date” for each hurricane are as follows:

Under Section 1400Q, the limitation on the aggregate amount of loans that may be made by employer sponsored plans to qualified individuals during the applicable periods is increased to the lesser of $100,000 or 100 percent of the participant’s vested accrued benefit under the plan (as opposed to the normal limit of the lesser of $50,000 or 50 percent of the participant’s vested accrued benefit).

In addition, if a qualified individual has an outstanding loan from a qualified plan on or after the applicable qualified beginning date and the due date for any payment under that loan is before December 31, 2006, that due date will be delayed for one year. Any subsequent repayments of the loan must be adjusted to reflect the delay and any interest accruing for such delay, and the period of the delay can be disregarded in determining the five year maximum repayment period and the term of the loan.

On November 30, 2005, before enactment of the GO Zone Act, the Internal Revenue Service issued Notice 2005-92 (the “Notice”), which provides interpretive guidance regarding the provisions of KETRA relating to distributions and loans to Katrina victims. The Notice indicates that an individual whose principal place of abode on August 28, 2005 was in the Hurricane Katrina disaster area and who suffered an economic loss as a result of Hurricane Katrina generally may treat any distribution received during the period from August 28, 2005 and ends on January 1, 2007 as a qualified hurricane distribution attributable to Hurricane Katrina (a “Katrina distribution”), whether or not the distribution was on account of Hurricane Katrina. Thus, for example, a qualified individual may elect to treat post-age 70 1/2 required minimum distributions made during the qualified distribution period as Katrina distributions so that the tax on those distributions can be spread over three years. Corrective distributions of excess contributions under Section 415, and excess 401(k) and matching contributions that are distributed to satisfy non-discrimination tests, cannot, however, be treated as qualified hurricane distributions.

The Notice also points out that the definition of a Katrina distribution is not limited to amounts withdrawn solely to meet a need arising from Hurricane Katrina. As a result, although a qualified individual must have sustained an economic loss as a result of Hurricane Katrina in order to be eligible to receive a Katrina distribution, the Katrina distributions are permitted without regard to the qualified individual’s need and the amount of the distribution need not correspond to the amount of economic loss suffered by the qualified individual. An employer may adopt any reasonable procedures for identifying which distributions are treated as Katrina distributions, and may rely on reasonable representations from a distributee with regard to the distributee’s principal place of abode on August 28, 2005, and whether the distributee suffered an economic loss by reason of Hurricane Katrina, unless it has actual knowledge to the contrary.

The Notice also indicates that interest accruing during the period that loan repayments are suspended under the foregoing rules must be added to the principal amount of the loan, and the loan must thereafter be repaid by amortization in substantially level installments over the remaining period of the loan (plus the suspension period).

Although the Notice literally only applies with respect to distributions and loans under KETRA, the principles contained therein presumably will be extended to apply to Section 1400Q as well.

An employer is permitted to choose whether or not to provide the foregoing relief under Section 1400Q with respect to distributions and/or loans to qualified individuals under its plans. Employers wishing to enable participants to take advantage of these rules must retroactively amend their plans on or before the last day of the first plan year beginning on or after January 1, 2007 (January 1, 2009 for governmental plans) to provide for the relief provisions, and the plan must be operated in accordance with the new rules in the interim.

 

This Alert was written by the firm’s Executive Compensation and Employee Benefits Group. Please contact any of the below group members or your Greenberg Traurig liaison if you have any questions regarding this Alert.

© 2006 Greenberg Traurig


Additional Information:

For more information, please review our Executive Compensation and Employee Benefits Group description, or feel free to contact one of our attorneys.


This GT ALERT is issued for informational purposes only and is not intended to be construed or used as general legal advice. Greenberg Traurig attorneys provide practical, result-oriented strategies and solutions tailored to meet our clients’ individual legal needs.