Changes To The 402(f) Special Tax Notice

On December 22, 2017, President Trump signed into law tax reform legislation known as the “Tax Cuts and Jobs Act” (the “Act”). The Special Tax Notice was revised as a result of this Act.

The Act reduces the potential tax burden on some participants who default on plan loans as a result of termination of employment or plan termination. Participants who terminate employment with an outstanding loan from their 401(k) plan or other qualified plans often are immediately deemed to be in default of their loans. Therefore, the participant’s account balance is permanently reduced by the amount of the outstanding loan. This is commonly referred to as a plan loan offset.

The intent of the Act is to give participants more time to roll over the loan offset. A participant who incurs a “qualified” loan offset (meaning such offset was caused by termination of employment or termination of the plan) after December 31, 2017, will have until the participant’s tax return due date (for the year in which the loan offset occurred) to roll over up to 100% of the plan loan offset amount into an IRA or another employer plan, and avoid paying federal income tax (and the early withdrawal penalty, if applicable) on the amount rolled over. The Act basically provides more time for participants to come up with money to repay the outstanding loan that would otherwise be treated as a taxable distribution due to the termination of employment.

As a Plan Sponsor, you should review your loan policies or loan program and your Special Tax Notices to make sure that those documents accurately describe the tax consequences of terminating employment with an outstanding loan, and, the new (longer) time frame for avoiding the unpaid loan being treated as a taxable distribution.

sample Special Tax Notice for plans that contain Roth monies and a sample Special Tax Notice for non-Roth monies are available on our website. Both reflect the new required language. If you currently utilize your fund company’s Notice, no further action will be required. The fund companies will be updating their Notices accordingly. If you utilize our volume submitter adoption agreement, we will be providing you with updated Special Tax Notices.

Please contact Watkins Ross if you have any questions regarding your loan policies/loan program or Special Tax Notices (402(f) Notices).

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