On February 23, 2017, the Internal Revenue Service issued a “Memorandum for Employee Plans (EP) Examinations Employees,” outlining Substantiation Guidelines for safe harbor hardship distributions from 401(k) plans (“Memorandum”). The purpose of the Memorandum is to provide IRS field examiners with guidance when examining 401(k) plans, for compliance with the 401(k) hardship regulations. The IRS is clear that the Memorandum is for internal use and is not to be viewed as a law or regulation and hence is not in violation of recent Presidential Executive Orders regarding issuance of new regulations. The Guidelines suggest that the examiners, when reviewing hardship distributions take the following steps:
Step 1: (a) Determine whether the Plan administrator (employer or third party), prior to making the distribution obtains, (1) source documents (estimates, contracts, bills or statements from third parties) or (2) a summary in paper, electronic or telephone records of the information contained in such source documents.(b) if the summary of source documents is used, the administrator must provide the employee with certain notification items prior to making the distribution.
Step 2: The second step instructs the examiners to review any source documents maintained by the Plan administrator and determine if they substantiate a hardship distribution. If the administrator instead receives a summary of information on source documents, the examiner is to review the summary and the Notice to determine whether it contains the items listed on Attachment I to the Memorandum. If the information is incomplete or inconsistent, then the examiner should ask for source documents to substantiate the immediate and heavy financial need. Examiners are instructed to apply special scrutiny where employees have received more than 2 hardship distributions in a single plan year.
Plan administrators accepting summaries of source documents, must provide a Notice to the employee including the following information:
1. The hardship distribution is taxable and additional taxes could apply;
2. The amount of the distribution cannot exceed the immediate and heavy financial need;
3. Hardship distributions cannot be made from earnings on elective contributions or from QNEC or QMAC accounts, if applicable; and
4. The employee agrees to preserve source documents and to make them available at any time upon request to the employer or Plan administrator.
Attachment I also provides that all hardship requests must include the participant’s name, the total cost of the event causing the hardship, the amount of the distribution requested and a certification by the participant that the information provided is true and accurate. The Memorandum Attachment I also provides a list of specific information that should be requested for the specific safe harbor hardships – medical care, purchase of principal residence, educational payments, foreclosures/eviction, funeral and burial expenses and casualty loss repairs. https://www.irs.gov/pub/foia/ig/spder/tege-04-0217-0008.pdf
Those plan sponsors relying on employee self-certification (no source documents) should start providing the Notice to shorten plan reviews by the IRS.