Hardship withdrawal - grossed up for taxes
Posted 04 August 2004 - 02:12 PM
I have a hardship withdrawal on my desk with a Good Faith Estimate indicating that the ee needs to bring $5,480 to home purchase closing. The participant is requesting $8,000 with no withholding. The client is looking to me to bless the amount needed to satisfy the "immediate financial burden". Since no one really knows the tax liability, i.e. tax rate, until the end of the year (except the rich folks, of course) is there any guidance from IRS on the appropriate tax rate to assume when grossing up the hardship distribution for taxes and penalties? I am inclined to recommend 15% plus 10% which would put the actual hardship distribution amount at $7306.67, but I really have no basis for that thinking.
Also, not that I want to make up rules, but it doesn't seem logical that an employee can elect to have the distribution grossed up for taxes and penalties, then turn around and also elect no withholding. Of course, logic is not law or guidance for that matter!
Sal's book says "reasonable".
What would you do?
Posted 04 August 2004 - 03:46 PM
Also, I see nothing wrong with grossing up for taxes and then taking the whole thing. The money will ahve to be paid sometime.
Posted 04 August 2004 - 03:56 PM
He makes around $50K. But I have no clue about other income or deductions.
Are you saying that you would gross up the amount....25% for taxes plus 10% for the penalty to arrive at $8430 and therefore process the hardship at the original $8,000 he requested?
I normally wouldn't belabor such a silly thing as this, but I've been dealing with IRS and DOL auditors lately and it seems my clients are having to justify at great length every tiny thing they do upon audit.
Posted 04 August 2004 - 04:05 PM
That's where I got the 25%. So the calculation $5480 / .65 = $8430.
It all depends on the tax bracket. If the participant and the plan administrator believes this is a "reasonable" approximation of the taxes, you're okay.
Posted 04 August 2004 - 04:12 PM
Instead of guessing, could the participant have insight on what their marginal rate will be (as long as it sounds reasonable, I'd use it)?
Arizona state taxes run from about 3% to 5% marginal rates. (Also note that some states follow the feds with their 10% early distribution tax; for example Wis uses, or once used, an extra 3%. I don't know what Arizona does.)
In response to your question about the oddity of no withholding, I see absolutely nothing problematic about that. You don't know what the person's existing withholding looks like -- it could be based on not having home deductions and they may not want to be overwithheld once they have the larger deductions in place. Withholding and tax liability are two very separate issues. As long as the person has the right to not withhold, their invoking that right shouldn't have any bearing on what you do.
Edited by MGB, 04 August 2004 - 04:14 PM.
Posted 05 August 2004 - 07:43 AM
Edited by Archimage, 05 August 2004 - 09:59 AM.
Posted 05 August 2004 - 09:55 AM
I always thought this rule dealt more with the fact that you used to have to withhold 20% from hardships and you still do if you are taking a hardship from a source other than deferrals
You do not have to withhold 20% from any source of money being taken for hardship withdrawal since none of it is eligible for rollover.
Posted 05 August 2004 - 10:30 AM
My point is how do you know whether other requests have included a gross up or not? Do you require substantiation of the amount if there's no mention of a gross up? Or did you just stumble across the fact the amount was grossed up?
Finally, what's the harm in asking the participant to simply provide a written statement that the difference represents his calculation of his estimated federal, state and local taxes plus the federal 10% early withdrawal penalty and any other state penalty?
Posted 06 August 2004 - 09:22 AM
Posted 06 August 2004 - 09:26 AM
Joel--in 401(k) plans: for 401k deferrals, only contributions may be taken. If the plan allows for other sources (such as match or profit sharing) contributions and earnings may be taken. It's all up to the plan document.