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401(k) Tax Notices must be updated for Tax Reform

The Internal Revenue Code (the "Code") requires that each qualified retirement plan sponsor provide a special tax notice to each plan participant.

This notice must describe how the participant's retirement account will be taxed at the time of a distribution from the plan ("tax notice"). All plan sponsors must update their tax notices to incorporate provisions of the Tax Cuts and Jobs Act (the "2017 Tax Reform").

Some 401(k) plans allow participants to borrow against their 401(k) accounts (a "plan loan"). Generally, such plan loans must be repaid in full if the participant leaves employment with the plan sponsor before the loan is repaid according to its terms. If the participant does not repay the unpaid loan balance (the "loan balance"), there is a default and the plan can offset the participant's account balance by the loan balance. The offset is treated as a distribution of the loan balance (the plan is distributing the unpaid loan balance as an asset held in the participant's account) and the participant must pay tax on the loan balance for the year during which the participant receives the distribution (the "distribution").

The participant may be required to pay a tax penalty equal to 10 percent of the loan balance if the participant is under age 59 & ½ at the time of the distribution. A participant can avoid being taxed on the loan balance if the loan balance is treated as an "eligible rollover distribution" under the Code.

The 2017 Tax Reform increased the amount of time during which a terminating participant may complete an eligible rollover distribution of a loan balance. The pre-2017 Tax Reform 60 day requirement no longer applies to loan balances. A terminating participant now has until the due date of the participant's personal federal income tax return for the year of the distribution to complete the rollover. This new period can be extended by filing for an extension of time to file a participant's personal federal income tax return.

All tax notices must be updated to incorporate this 2017 Tax Reform change. The IRS has not yet updated its model notices to incorporate the change, so the IRS model notice cannot be relied upon. Tax notices are often handled by a plan's third party administrator, but it is the plan sponsor who has the ultimate responsibility to provide accurate tax notices to plan participants. A plan sponsor could be held liable for a breach of fiduciary duty if participant losses result from inaccurate information contained in a tax notice.

Plan sponsors should talk to their third party administrators and review current tax notices to confirm that recent changes in the law have been incorporated.

This article is for general information purposes only and should not be considered legal advice. Please contact Liam K. Healy by email at lhealy@fosterswift.com or at 248.785.4740 if you have concerns regarding 401 (k) tax notices.

Categories: Employee Benefits, Employment Tax & Withholding, Tax


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