On November 2, 2017, the House Ways and Means Committee’s GOP leadership introduced the Tax Cuts and Jobs Act. The proposed legislation is generally intended to reduce individual and corporate tax rates and simplify income tax filings. It also makes changes that would affect the forms, documents, and operations of employer-sponsored retirement plans, IRAs, HSAs, education savings accounts, and other savings arrangements.
The Ways and Means Committee continues to make changes to the bill before the House of Representatives votes on it. The vote was expected to occur during the week of November 13, 2017, but may occur earlier. Meanwhile, the Senate is working on a tax reform bill of its own.
Although the legislative process is still ongoing, the following is a summary of the more significant provisions from the initial proposal that could become law and affect tax-favored savings arrangements. More subtle provisions (e.g., potential changes to the definition of compensation for certain plan purposes) continue to be analyzed.
Distribution and Loan Provisions in Employer-Sponsored Retirement Plans
Retirement plans generally have a minimum age requirement that participants must meet in order to withdraw plan assets while still employed. The minimum age requirement for these types of distributions (known as in-service distributions) varies between retirement plans, but age 59½ tends to be the most common. Pension plans and governmental 457(b) plans, however, are required to use higher age requirements (e.g., age 62). To encourage employees participating in those plans to continue working rather than retiring to access their retirement savings, the Ways and Means bill would reduce the minimum age requirement for those plans to age 59½.
This change would apply for plan years beginning after 2017.
The current rules applicable to hardship distributions are complex and may complicate matters for participants experiencing financial difficulty. The Ways and Means bill would relax these rules for qualified retirement plans and 403(b) plans by
- expanding hardship distributions to include qualified nonelective contributions (QNECs) and qualified matching contributions (QMACs)—and earnings on all contribution types removed,
- not requiring participants to take plan loans before granting certain hardship distributions, and
- not requiring elective deferral contributions to be suspended for six months after receiving certain hardship distributions.
These changes would apply for plan years beginning after 2017.
In addition to the changes noted above, the Ways and Means bill may affect a participant’s ability to qualify for a hardship distribution through a casualty loss. To determine whether a casualty loss and, therefore, a hardship exists, current regulations rely on a section of law that would be eliminated by the Ways and Means bill. It is unclear whether, in the absence of revised regulations, a participant would meet the conditions necessary to qualify for a hardship distribution based on a casualty loss.
This change would apply for tax years after 2017.
Rollover Period for Offset Plan Loans
Currently, if a loan from a qualified plan, 403(b) or governmental plan has not been fully repaid when a participant leaves employment, or a plan is terminated, the outstanding balance is “offset” against the participant’s account balance, and becomes taxable if not rolled over within 60 days. The Ways and Means bill would extend the 60-day period to a participant’s tax filing deadline (including extensions) for the tax year in which the offset occurs.
The change would apply for tax years after 2017.
Miscellaneous Provisions in Employer-Sponsored Retirement Plans
Nondiscrimination Testing for Closed Defined Benefit Plans
Defined benefit (DB) plans that are closed to new participants may, eventually, chiefly benefit highly paid employees and lead to compliance testing failures. The Ways and Means bill would extend relief to certain plans by expanding the cross-testing of contributions to a defined contribution plan maintained in addition to a defined benefit plan. The objective of this provision is to allow closed DB plans to avoid having to be frozen or terminated.
This change would apply on the date of enactment.
Unrelated Business Taxable Income
In general, if an IRA or employer-sponsored retirement plan holds assets that generate income unrelated to the plan, those revenues (known as unrelated business taxable income (UBTI)) will be subject to current-year taxation. Historically, it has been clear that IRAs and retirement plans of nongovernmental entities are subject to such annual taxation. The Ways and Means bill clarifies that retirement plans of governmental entities will also be subject to the UBTI rules.
This change would apply for tax years after 2017.
Pass-Through Income Rate
Under the Ways and Means bill, businesses structured in a manner that generates pass-through income (e.g., S-corporations) would be taxed at a 25 percent rate for “business income,” rather than the proposed maximum 20 percent corporate tax rate. Owner-employees would be taxed at individual income tax rates for “compensation.” In general, no more than 30 percent of revenues could be treated as business income and taxed at the favorable 25 percent rate, and at least 70 percent would be treated as compensation and taxed at the individual income tax rates.
Unduly generous pass-through taxation could potentially create a disincentive for employers to establish or maintain retirement plans for themselves and their employees. But the requirement to treat much of a business’ revenue as compensation—taxed at individual income tax rates—seems to limit this concern.
This provision would apply for tax years after 2017.
Taxation of Nonqualified Deferred Compensation
Under current rules, nonqualified deferred compensation generally remains subject to creditor claims and business risk, and, when paid, is treated as compensation. The Ways and Means bill would tax such amounts when they are no longer subject to a substantial risk of forfeiture rather than when actually paid.
This provision generally would apply to tax years beginning after 2017, but is subject to certain transition rules.
Changes to IRAs, Health Savings Arrangements, and Education Savings Arrangements
Under current law, a Traditional IRA contribution can be recharacterized as a Roth IRA contribution for the same tax year if done by the following October 15 (six-months following the IRA owner’s April 15 tax filing deadline). The reverse—recharacterizing a Roth IRA contribution to Traditional IRA—can also be done. In addition, IRA owners can recharacterize the conversion of Traditional IRA assets to a Roth IRA. Under the Ways and Means bill, the ability to change the nature of a Traditional or Roth IRA contribution, or to undo a Roth IRA conversion, would be eliminated. The elimination of recharacterizations is intended to prevent “gaming the system” to reduce a tax obligation.
This provision applies for tax years after 2017.
Coverdell Education Savings Account, 529 Plan Changes
Under current law, a distribution from a Coverdell education savings account (ESA) that is “contributed” to a 529 plan is considered a tax-free event for the ESA, but subject to the 529 plan’s maximum accumulation amount. Under the Ways and Means bill, contributions could no longer be made to ESAs. ESAs could remain open, however, with rollovers permitted between ESAs or from an ESA to a 529 plan. The bill would treat the ESA-to-529 plan asset movement as a rollover, not a 529 plan contribution.
In addition, up to $10,000 of 529 plan assets—currently usable only for post-secondary academic or vocational education—could be used annually for elementary or secondary (high school) tuition, or for costs associated with participation in a qualified apprenticeship program. A 529 plan could also be set up during pregnancy on behalf of an unborn child.
These provisions would apply to distributions and contributions after 2017.
HSA, MSA Changes
Under current law, individuals may deduct Archer medical savings account (MSA) contributions. Under the Ways and Means bill, taxpayers would no longer be eligible to deduct MSA contributions, nor would an employer contribution to an employee’s MSA be excluded from the employee’s taxable compensation. The bill merely simplifies the rules by consolidating two similar tax-favored accounts into a single account with more taxpayer-friendly rules.
In addition, the bill would clarify certain HSA comparable contribution and reporting requirements and would replace certain laws for health flexible spending accounts (FSAs), health reimbursement account (HRAs), and MSAs that had been relied upon to govern HSAs.
These provisions apply to tax years beginning after 2017.
The details in this Washington Pulse are based on the initial proposal from the Chairman of the House Ways and Means Committee. That proposal is already being debated by the Ways and Means Committee and may change. In addition, the Senate is soon expected to introduce its tax reform proposal, leading to a conference committee process if the House and Senate bills differ. All of this, before the possibility of being signed into law. If Congress can get this done, it is expected that savings arrangements will be affected one way or another. Clearly, there is much more to come. Ascensus will continue to closely monitor this fast paced legislative process and provide additional details as they become available. Visit www.Ascensus.com for the latest developments.