Hardship Withdrawal

[Guest tlemaster]

I have a participant that received a hardship distribution for the purchase of primary residence. The financing of the home fell through. Is the participant required to return the money? If so, how is this accomplished (specifically, how are the tax withholdings handled?) If not required, is it an option for the participant to return the money if they would like? Again, if so, how is this accomplished?

Facts: Check has been cashed. 10% was withheld.

[Appleby]

Effective tax years beginning 01/01/02, distributions due to hardship are no longer rollover eligible. The participant has no choice but to retain the funds and treat it as ordinary income.- EGTRRA 2001

If the participant was under age 59 ½ when the distribution occurred., he/she will be subject to the 10 percent excise tax, unless he/she meets an exception.

[Appleby]

PS..The withholding was handled properly – assuming the participant did not provide the necessary waiver.

[Guest Harry O]

There is a general concept of "recission" in the federal tax law. There is an early 1980s revenue ruling on the subject. Generally, you need to unwind the transaction in the same tax year it occurred. The wi/h taxes should not be a problem since the employer can just adjust the next quarterly return by reducing taxes owed by the amount refunded to the employee. It should be possible to unwind the distribution.

[Appleby]

Harry ,

You peaked my interest. Generally, we allow such "recissions" when the transaction in question occurred as a result of an error made by a party other than the plan, plan participant, plan administrator etc. The intent is to make the affected participant ‘whole’. We use Wood v. Commissioner, 93 T.C. 114 (1989) and similar cases as our premise. Of course, as you may already know, there have been cases since then that provided opposite ruling- but that is another issue. I don’t recall seeing a Revenue Ruling to that effect. Do you think you can dig up the number?

[mbozek]

See Fender Sales,Inc v. Comm, 22 TCM 550 (CCH) 1963. The employee could return the funds as an erroneous payment, see rev. rul 79-311, since the funds were to be used to purchase a residence. The recission must take place in the same year the funds are paid to the employee.

[Guest Harry O]

I am at home and don't have the citation available but the "recission" idea was the subject of a number of tax articles after the tech "bubble" burst in 2000 and 2001. Many employees exercised stock options before the bubble burst, recognized lots of compensation income and then were faced with selling the same stock for pennies on the dollar later in that same calendar year (generating short-term capital losses that could not be fully utilized within any reasonable time frame). A similar problem arose with ISOs and AMT. The idea was to "rescind" the option exercise by the end of the year to cancel out the transaction -- no compensation income and no unusuable short-term capital losses. You may want to get in touch with a knowledgable tax lawyer (not a benefits lawyer since benefits lawyers are generally not necessarily that expert in tax matters in my experience).

[Guest tlemaster]

Thanks for all the information, it was very helpful. I did confirm with the IRS, the money can go back in the plan as long is it happens in the same tax year. The employer would pay back the taxes withheld to the plan, adjust their quarterly return, and cancel the 1099.

[RCK]

I'm surprised at the way this ended up.

tlemaster, are you saying that the plan has the option of taking the money back, or that it must? As a plan administrator, I've been in this position before, and have refused to accept the money back. (The participant had a valid hardship, proved it, and plan made the distribution. Plan has no right or responsibility to monitor what the money was used for).

A cynical person, would also ask how you managed to find an answer to that question at the IRS. But I'm not that cynical.

RCK

[WDIK]

Am I being cynical?

News Article?

[Appleby]

Doesn’t Fender Sales,Inc v. Comm, 22 TCM 550 (CCH) 1963 and Rev.Rul 79-311 address return of overpayment of compensation and the treatment thereof???

... not sure it they could be applied to the treatment of distributions from qualified plans

[Guest tlemaster]

RCK, the pay back of the money was not a must, but according to the IRS agent I spoke with, is permissible. Given that the agent echoed the opinions of several individuals off this site as well as a couple of professionals I am acquainted with, It would seem there is precedence enough in a gray area such as this to take the money back.

[Guest jashendo]

tlemaster -- One further thing (unless I am being too picky or am misunderstanding your point)

You said that the employer would repay the plan the withheld taxes, adjust the 1099, etc. Did you lieterally mean that?

I agree that a payor may certainly adjust its income tax withholding within the same year. However, the plan trustee's withholding, filing 945's and 1099's, etc. is not the same as the employer's withholding, 941, etc. If the employer pays the plan/trust an amount equal to the $$ withheld and remitted to the IRS, then (1) why is that not a contribution by the employer to the plan (and likely a nondeductible contribution), (2) how does that "adjust" the plan's withholding on its 945, (3) how does the employer reflect that on his 941, and (4) why is the participant not still taxable on the amount originally withheld and sent to the IRS ?

If you meant something else (like, e.g., the employer would lend the participant the $$ so that he could repay the full distribution amount, and the plan trustee would make the necessary adjustments in its returns, etc.), then never mind.