In an article published by PLANADVISER, Dan Kravitz, head of Kravitz, discussed his most recent webinar, which explained the impact of the Tax Cuts and Jobs Act on employer-sponsored retirement plans. The tax bill will allow many clients to have a lower tax rate, directly impacting small business owners’ decisions about running retirement plans. “Many but not all of these owners can now deduct up to 20% of qualified business income,” Kravitz noted. “There are many limitations and phase-outs that have to be considered, but pass-through entities are taxed at the individual level, as we know, so it is important to understand the new individual rates, because it will directly impact plan design decisions that do fall within our purview.”
On December 20, 2017, the House and Senate passed H.R. 1, the final tax reform bill (the Bill). The Bill will soon be signed into law by President Trump, resulting in fulfillment of one of the GOP’s major 2016 campaign promises. The Bill will affect retirement and other tax-advantaged savings arrangements and, in some cases, will become effective as soon as it is signed. Highlights of the changes made to savings arrangements and their effective dates are described below. In addition, Ascensus has prepared a comparison chart showing the differences between the current rules, the original House and Senate proposals, and the new rules provided in the Bill.
Changes to IRAs, Education Savings, and ABLE Arrangements
Recharacterizing Roth IRA Conversions Eliminated
The Bill eliminates a taxpayer’s ability to recharacterize a conversion to a Roth IRA. As a result, converting non-Roth IRA assets or rolling over employer plan assets to a Roth IRA will be a one-way process. Annual contributions to a Roth IRA can still be recharacterized as Traditional IRA contributions for the same tax year and vice versa. (Effective for tax years beginning after December 31, 2017.)
Slower Cost-of-Living Adjustments for IRAs, HSAs, Archer MSAs, and the Saver’s Credit
The Bill will change the method for calculating adjustments for inflation so that they will occur less frequently than under the current formula. This will apply to IRA, HSA, Archer MSA, and saver’s credit-related adjustments. Annual limitations associated with employer-sponsored retirement plans will generally not be affected. (Effective for tax years beginning after December 31, 2017.)
529 Plans and ABLE Accounts
The Bill makes the following changes to 529 plans and Achieving Better Life Experience (ABLE) accounts.
- 529 plan assets (up to $10,000 annually) can be used for elementary and secondary school tuition expenses, in addition to those qualified post-secondary education expenses allowed under current law. (Effective for 529 plan distributions made after December 31, 2017.)
- 529 plan assets can be rolled over to 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 plan distributions made after the date of enactment, and rollovers before January 1, 2026.)
- An ABLE account beneficiary (the special-needs individual) can contribute his earned income even if his contribution, when added to contributions made by others, results in overall contributions above the annual ABLE contribution limit. The ABLE account beneficiary’s contribution amount will 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, will be responsible for ensuring compliance with the additional contribution limit. The additional contribution will be unavailable if the ABLE account beneficiary made deferral contributions to a 401(k), 403(b), or governmental 457(b) plan. (Effective for tax years beginning after the date of enactment, and contributions before January 1, 2026.)
- ABLE account contributions made by the ABLE account beneficiary will be eligible for the saver’s credit. (Effective for taxable years beginning after the date of enactment, and contributions before January 1, 2026.)
Provisions Applying to Employer-Sponsored Retirement Plans
Rollover of Offset Retirement Plan Loans
The Bill extends the 60-day period for rolling over the amount of an “offset” to a plan loan to the tax filing deadline, including extensions, for the tax year in which the offset/distribution occurs. The extension applies to offsets as a result of plan termination or severance from employment. (Effective for loan offsets treated as distributed in tax years beginning after 2017.)
Casualty Loss Provision Could Affect Plan Hardship Distributions
The Bill no longer allows a deduction for casualty losses unless a taxpayer suffering the casualty loss is located in a presidentially-declared disaster area. Deductible casualty losses are also among the “safe harbor” conditions for hardship distributions from employer-sponsored retirement plans under existing Treasury regulations. Unless those regulations are rewritten, casualty losses experienced by certain plan participants may no longer meet the safe harbor condition commonly used in the granting of certain hardship distributions. (Effective for losses incurred in taxable years beginning after December 31, 2017, and before January 1, 2026.)
Taxation of Pass-Through Income
The Bill generally provides owners of businesses that result in pass-through income (e.g., partnerships, s-corporations) with a deduction up to 20 percent of business income. Generous pass-through income tax rules could potentially create a disincentive for employers to establish or maintain retirement plans. But analysis of the new rule suggests that concerns about a disincentive have been minimized or eliminated compared to more generous formulas. (Effective for tax years beginning after December 31, 2017.)
Tax-Advantaged Savings Arrangements in General
Special Relief for 2016 Disaster Areas
The Bill grants retirement plan-related relief to eligible victims of any 2016 presidentially-declared disaster. This relief is basically retroactive and includes the following.
- Qualifying distributions of up to $100,000 from employer-sponsored retirement plans and IRAs before age 59½ will not be subject to the 10 percent early distribution penalty tax.
- Repayment of qualifying distributions from employer-sponsored retirement plans and IRAs can be made within three years.
- Distributions not repaid will generally be taxed ratably over a three-year period, unless electing otherwise.
- Otherwise-mandatory withholding will be waived for qualifying distributions.
- Delayed amendment deadlines for employers that grant the relief but without enabling plan provisions; plans can be amended to add such provisions by the end of the first plan year beginning on or after January 1, 2018.
(Effective as of the date of enactment, and applicable to distributions on or after January 1, 2016, and before January 1, 2018.)
Items Eliminated From Prior Senate and House Bills
The following items were among provisions in earlier versions of the House and Senate bills, but subsequently removed either before passage, or by the conference committee that resolved differences between the House and Senate bills.
- Relaxation of hardship distributions to include qualified nonelective contributions (QNECs), qualified matching contributions (QMACs), and earnings on these and employee deferrals.
- Alignment of annual and catch-up deferral contributions among 401(k), 403(b), and governmental 457(b) plans.
- Alignment of the in-service distribution eligibility age of 59½ as an option for all plans.
- Adding the assessment of a 10 percent early distribution penalty tax to distributions from governmental 457(b) plans.
- Creation of a safe harbor formula for employers to determine “independent contractor” vs. “employee” status.
- Creation of a nondiscrimination testing safe harbor for certain defined benefit pension plans closed to new participants.
- Creation of a simplified tax return form for taxpayers age 65 and older.
In the context of tax-advantaged savings arrangements, and by comparison to some of the drastic changes that were initially being considered by Congress (e.g., limiting pretax elective deferrals to employer-sponsored retirement plans), the result is a positive one. As is always the case with tax law changes, questions will arise no matter how straightforward some changes seem on the surface. Ascensus will continue to monitor any and all developments resulting from tax reform pertaining to IRAs, employer-sponsored retirement plans, and other tax-advantaged savings arrangements. Visit www.Ascensus.com for the latest developments.
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.
It is widely expected that the U.S. House of Representatives will act this week on tax reform, after the Senate passed its budget resolution late last week. That Senate action came after Senate GOP leaders reportedly conferred with House leaders to craft and pass a resolution that would not require lengthy deliberation between House and Senate in a formal conference committee process. The Senate narrowly passed its budget resolution along party lines.
Once the budget resolution process outlining broad revenue and spending provisions is complete, actual legislative text will be completed and released. This will provide the first official glimpse of potential changes to the U.S. Tax Code through dramatic tax reforms.
However, already widely expected are a reduction of the current individual income tax brackets from seven to three, reducing the maximum corporate tax rate from 35 percent to a hoped-for 20 percent (with a slightly higher rate for pass-through businesses), and replacing most tax deductions and exclusions with increased standard deductions and certain tax credits.
Uncertain at this time are impacts on tax-favored savings arrangements, including retirement plans. Reports have varied from proposals to drastically reduce deductible contributions to retirement plans, to “no change” in comments issued by President Trump.
Under the tax reconciliation process being followed, the Senate can pass a tax reform bill by simple majority, avoiding a potential Democratic filibuster that could otherwise block the legislation.
Steve Christenson recently posted an opinion piece in Financial Advisor IQ titled “How Healthy are HSAs under Trump?” Christenson notes one of the first questions he received after the 2016 election was whether or not he thought health savings accounts (HSAs) would be at risk of being negatively affected or eliminated. “My answer—absolutely not,” he adds. Of all the subjects discussed during the campaign, it was one of the few issues both sides agreed on. Looking ahead, Christenson predicts for the first time, consumers will frequently see healthcare and HSAs in the headlines for the foreseeable future.
LifeHealthPro recently quoted Executive Vice President Steve Christenson in this article titled “HSAs and FSAs Lost Election Attention War.” Christenson stated that he was hoping the presidential campaign would give health savings accounts and other personal health account concepts much-needed publicity. He pointed to the many recent cases in which Democrats in the U.S. House joined with Republicans to support health savings account program improvement measures.
In his most recent article for Credit Union Insight, Compliance Manager Dennis Zuehlke discusses what the retirement savings outlook might be in a Clinton or Trump administration. “It is clear from an analysis of the candidates’ tax proposals, however, that retirement plans will be affected, regardless of whether Clinton or Trump is the next president. Both have indicated that they would propose limiting the tax benefits for certain income tax deductions and exclusions (not including charitable contributions), such as deductible IRA contributions and 401(k) plan exclusions from income,” he concludes.
ERISA Retirement Attorney Jessica Reynolds’ recent Retirement Spotlight article on the proper classification of independent contractors was republished in the March 2016 print edition of Employee Benefit News. The article, titled “Classify workers ahead of tax season,” reviews the guidelines of the IRS’ Fair Labor Standards Act which was issued in order to offer clarfication as to which employees can truly be classified as “independent.” Read more here.