IRS loosens rules for retirement plans to lend money to Hurricane Harvey victims

The Internal Revenue Service granted additional relief to victims of Hurricane Harvey on Wednesday by making it easier for 401(k)s and other employer-sponsored retirement plans to give loans and hardship distributions to aid victims.

The IRS pointed out the relief is similar to what was provided to victims of previous disasters, including Louisiana floods and Hurricane Matthew.

The IRS said 401(k) plan participants, along with employees of public schools and tax-exempt organizations with 403(b) tax-sheltered annuities, as well as state and local government employees with 457(b) deferred-compensation plans, can be eligible for the streamlined loan procedures and liberalized hardship distribution rules. While IRA participants are barred from taking out loans, they're also eligible to receive distributions under the looser procedures.

Luke Sharrett/Bloomberg

Retirement plans can provide relief to employees and some members of their families who live or work in disaster area localities affected by Hurricane Harvey and designated for individual assistance by the Federal Emergency Management Agency. Currently, parts of Texas qualify for individual assistance, but the storm is spreading Wednesday to parts of Louisiana as well, and those areas may also eventually qualify. For a complete list of eligible counties, visit https://www.fema.gov/disasters. To qualify for this relief, hardship withdrawals must be made by Jan. 31, 2018.

The IRS said it is also relaxing procedural and administrative rules that normally apply to retirement plan loans and hardship distributions. That will allow eligible retirement plan participants to access their money more quickly and encounter less red tape. On top of that, the usual six-month ban on 401(k) and 403(b) contributions that typically affects employees who take hardship distributions will not apply.

Under the IRS relief, a retirement plan can allow a victim of Hurricane Harvey to take a hardship distribution or borrow up to the specified statutory limits from a storm victim’s retirement plan. Someone who lives outside the disaster area can also take out a retirement plan loan or hardship distribution if they want to use the money to help a son, daughter, parent, grandparent or other dependent who lived or worked in the disaster area.

Retirement plans will be permitted to make loans or hardship distributions before they are formally amended to allow for such features. The plan can ignore the reasons that usually apply to hardship distributions, enabling the funds to be used, for instance, for food and shelter. If a plan requires certain documentation to be provided before a distribution can be made, the plan can waive this requirement as described in a new IRS announcement, Announcement 2017-11, which the IRS released Wednesday.

The IRS stressed that the tax treatment of loans and distributions stays unchanged. Typically, retirement plan loan proceeds are tax-free if they are repaid over a period of five years or less. Under current law, hardship distributions are usually taxable and subject to a 10-percent early-withdrawal tax.

More details are available in Announcement 2017-11 on the relief to victims of Hurricane Harvey, which caused damage to parts of Texas. It permits easier access to victims’ funds held in workplace retirement plans and in IRAs, for the period beginning Aug. 23, 2017, and ending Jan. 31, 2018. Additional information about other tax relief related to Hurricane Harvey can be found on the IRS disaster relief page. For information on government-wide relief efforts, visit www.USA.gov/hurricane-harvey.

The IRS typically charges a 10 percent tax on early distributions from retirement accounts such as 401(k)s unless the taxpayer qualifies for an exception to the tax. However, many of the Texas residents hit by Hurricane Harvey may need to withdraw money or borrow from their retirement plan to pay for urgent expenses. According to the IRS, a loan from a retirement plan won't be taxed if the loan meets the rules and the money is paid back according to the repayment schedule.

In order to make a loan or distribution (including a hardship distribution), the IRS noted that a plan needs to contain language authorizing the loan or distribution. Unless a distribution consists of already-taxed amounts, the distribution will be included in gross income and it's generally subject to the 10-percent additional tax. Similar rules relating to income inclusion and taxation apply to a distribution from an IRA.

It is estimated that 80 percent of homeowners in Texas in the areas hit by Hurricane Harvey lack flood insurance, according to the Washington Post. Many of the homeowner policies don't include flood insurance, and residents have needed to buy policies from the National Flood Insurance Program, which can cost up to $2,000 per year. The government-run program is due to end in late September, pending action by Congress to reauthorize the program. On top of that, a new law takes effect in Texas on Friday that could reduce insurance payments and penalties on insurers who don't pay for claims in the event of disasters, and attorneys are urging hurricane victims to file insurance claims before the end of this week.

Diesel Fuel Penalty Waived

Separately, the IRS also announced Wednesday that it is waiving the diesel fuel penalty, in response to shortages of undyed diesel fuel caused by Hurricane Harvey. The IRS said it would not impose a penalty when dyed diesel fuel is sold for use or used on the highway.

This relief applies starting Aug. 25, 2017, in the areas and counties for which the Environmental Protection Agency issued waivers for Texas Low Emission Diesel Fuel.

Those areas and counties include: the Houston-Galveston-Brazoria area (the counties of Brazoria, Chambers, Fort Bend, Galveston, Harris, Liberty, Montgomery, and Waller); the Beaumont-Port Arthur area (the counties of Hardin, Jefferson, and Orange); the Dallas-Fort Worth area (the counties of Collin, Dallas, Denton, Tarrant, Ellis, Johnson, Kaufman, Parker, and Rockwall); and the counties of Anderson, Angelina, Aransas, Atascosa, Austin, Bastrop, Bee, Bell, Bexar, Bosque, Bowie, Brazos, Burleson, Caldwell, Calhoun, Camp, Cass, Cherokee, Colorado, Comal, Cooke, Coryell, De Witt, Delta, Falls, Fannin, Fayette, Franklin, Freestone, Goliad, Gonzales, Grayson, Gregg, Grimes, Guadalupe, Harrison, Hays, Henderson, Hill, Hood, Hopkins, Houston, Hunt, Jackson, Jasper, Karnes, Lamar, Lavaca, Lee, Leon, Limestone, Live Oak, Madison, Marion, M atagorda, McLennan, Milam, Morris, Nacogdoches, Navarro, Newton, Nueces, Panola, Polk, Rains, Red River, Refugio, Robertson, Rusk, Sabine, San Jacinto, San Patricio, San Augustine, Shelby, Smith, Somervell, Titus, Travis, Trinity, Tyler, Upshur, Van Zandt, Victoria, Walker, Washington, Wharton, Williamson, Wilson, Wise, and Wood.

The penalty relief is available to anyone who sells or uses dyed fuel for highway use. In the case of a vehicle operator who uses dyed fuel, the relief is available only if the operator or the person selling the fuel pays the 24.4 cents per gallon tax that’s usually applied to diesel fuel for highway use. The IRS said it won’t impose penalties for failure to make semimonthly deposits of this tax. IRS Publication 510, Excise Taxes, has information on the proper method for reporting and paying the tax.

Dyed diesel fuel is usually not taxed because it’s sold for uses exempt from excise tax, for example, to farmers for farming purposes, for home heating and to local governments for buses.

Consistent with the EPA waivers, the IRS’s penalty waiver for dyed diesel is effective through Sept. 15, 2017. Also, consistent with the EPA waiver, the waiver doesn’t apply to the tax code penalty for using adulterated fuels that don’t comply with applicable EPA regulations. Therefore, diesel fuel with sulfur content over 15 parts-per-million can’t be used in highway vehicles.

The IRS added that it is closely monitoring the situation and will provide more relief as needed.