The race to enact comprehensive tax reform in 2017 is closer to the finish line with the December 1, 2017, Senate passage of the Tax Cuts and Jobs Act. It remains to be seen whether there is enough momentum for tax reform to be finished this year. The changes to savings arrangements that are included in the bill would affect forms, documents, and operations if the provisions become law. The major savings related changes included in the bill are described below.
Changes to IRAs, Education Savings, and ABLE Arrangements
IRA Recharacterizations Eliminated
Under current law, a Roth IRA contribution can generally be recharacterized as a Traditional IRA contribution for the same tax year if done by the following October 15 (six months following the April 15 tax filing deadline). The reverse—recharacterizing a Traditional IRA contribution to a Roth IRA—can also be done. Furthermore, those who convert Traditional or SIMPLE IRA assets or roll over pretax employer plan assets to a Roth IRA can recharacterize their conversions or rollovers.
A recharacterization is commonly done to align IRA contributions with taxpayer eligibility, as well as personal tax objectives. Under the Senate bill, the ability to change the nature of a Traditional or Roth IRA contribution, or to undo a Roth IRA conversion or employer plan rollover, would be eliminated.
The stated purpose of this provision is to prevent “gaming the system” by timing a conversion to coincide with a drop in account value, thereby reducing the tax obligation for such conversion. This provision is also contained in the House version of the tax reform bill. (Effective beginning with 2018 tax years.)
Slower Cost-of-Living Adjustments for IRAs, HSAs, Archer MSAs, and the Saver Credit
Many of the annual dollar limitations that apply to IRAs—such as the maximum contribution amount—are adjusted periodically for inflation. The same is true for a taxpayer’s income-based eligibility to receive the “saver credit” for contributions to IRAs or deferrals to employer retirement plans.
The Senate bill would change the method for calculating annual adjustments so that they would occur less frequently than under the current formula. Annual limitations associated with employer retirement plans would generally not be affected, but IRA, HSA, Archer MSA, and saver credit-related adjustments would be. (Effective beginning with 2018 tax years.)
529 Plans and ABLE Accounts
- 529 plan assets could be rolled over to Achieving Better Life Experience (ABLE) accounts for special-needs individuals, in amounts up to the annual ABLE contribution limit (e.g., $14,000 for 2017); such rollovers would offset other contributions to that ABLE account for the year. (Effective for 529 distributions after the date of enactment, and before 2026 tax years.)
- 529 plan assets could be used for elementary and secondary school tuition expenses and expenses for homeschooling, in addition to those qualified post-secondary education expenses allowed under current law.
- An ABLE account beneficiary (the special-needs individual) could contribute his earned income even if his contribution, when added to contributions made by others, resulted in overall contributions above the annual ABLE contribution limit. The ABLE account beneficiary’s contribution amount would be limited to the lesser of his income or the federal single-person poverty limit. The ABLE account beneficiary, or a person acting on his behalf, would be responsible for ensuring compliance with the additional contribution limit.
The additional contribution would be unavailable if the ABLE account beneficiary made deferral contributions to a 401(k), 403(b), or governmental 457(b) plan. (Effective for taxable years after the date of enactment, and before 2026 tax years.)
- ABLE account contributions made by the ABLE account beneficiary would be eligible for the saver credit. (Effective for contributions after the date of enactment, and before 2026 tax years.)
Provisions Applying to Employer-Sponsored Retirement Plans
The following provisions in the Senate bill apply to employer-sponsored retirement plans.
Rollover of Offset Retirement Plan Loans
If a retirement plan loan has not been fully repaid when a participant leaves employment, or a plan is terminated, the outstanding balance is typically “offset” against the participant’s account balance, and becomes taxable. The outstanding loan can be rolled over within 60 days.
The Senate bill would extend that 60-day period to the tax filing deadline, including extensions, for the tax year in which the offset/distribution takes place. This provision is also contained in the House version of the bill. (Applies to loan offsets in 2018 and later tax years.)
Hardship Distributions Expanded
The following changes to the hardship distribution rules are contained in the Senate bill. (Effective beginning with 2018 plan years.)
- Hardship distributions could include not only employee deferral contributions (current law), but also an employer’s qualified nonelective contributions (QNECs) and qualified matching contributions (QMACs)—and earnings on all three contribution types.
- Available plan loans would not have to be taken before a hardship distribution is granted.
Taxation of Pass-Through Income
The Senate bill addresses the taxation of businesses structured in a manner that generates pass-through income, such as S-corporations, by proposing an income tax deduction of an amount that may be as high as 23 percent of taxable income reduced by capital gain. Generous pass-through income taxation could potentially create a disincentive for some employers to establish or maintain retirement plans, though it is not clear that the Senate bill would lead to that result.
Tax-Advantaged Savings Arrangements in General
Special Relief for 2016 Disaster Areas
This provision would grant retirement plan related relief to eligible victims for any 2016 presidentially-declared disaster event. This relief is of a magnitude normally associated with special federal legislation, such as that recently enacted in 2017 for victims of Hurricanes Harvey, Irma, and Maria. The relief would extend well beyond the frequently-granted ability to complete certain time-sensitive tax-related acts on a delayed basis in disaster circumstances. The relief granted to2016 federally-declared disaster area victims would include the following.
- Qualifying distributions of up to $100,000 from employer plans and IRAs before age 59½ would not be subject to the 10 percent additional penalty tax.
- Qualifying distributions from employer plans without enabling plan provisions if plans are amended to add such provisions by the end of the first plan year beginning on or after January 1, 2018.
- Repayment of qualifying distributions from employer-sponsored retirement plans and IRAs within three years.
- Ratable taxation over a three-year period for distributions not repaid.
- Waiver of mandatory withholding from qualifying distributions.
(Effective on date of enactment and applicable to distributions on or after January 1, 2016, and before January 1, 2018.)
Items Removed From Original Senate Bill
The following items were included in the proposed Senate bill but subsequently removed and excluded from the Senate-passed tax reform bill.
- Alignment of annual and catch-up deferral contributions to 401(k), 403(b), and governmental 457(b) plans.
- Alignment of the age 59½ eligibility requirement for employer plan in-service distributions.
- Assessment of a 10 percent penalty tax for early distributions from 457(b) plans.
- Safe harbor formula for employers to determine “independent contractor” vs. “employee” status.
- Simplified tax return form for taxpayers age 65 and older.
The next step in the tax reform process will be a conference committee process by which alignment of Senate and House bills must take place. Before a bill can be signed into law by President Trump, the House and Senate must agree on identical bill text. While much progress has been made, there is clearly a lot more work to do before tax reform becomes a reality. Ascensus will continue to closely monitor the process and provide additional details as they become available. Visit www.Ascensus.com for the latest developments.