Tax Reform - Retirement Plans Left Largely Unscathed

Gavel, scales of justice and law books

President Trump signed the tax bill into law on December 22nd of last year, just under the wire of his self-imposed deadline of Christmas. The bill was originally known simply as the “Tax Cuts and Jobs Act,” but under an arcane Senate rule, this name was too short so it is formally titled “To Provide Reconciliation Pursuant to Titles II and V of the Current Resolution on the Budget for Fiscal Year 2018.”

There are no significant changes directly affecting retirement plans. This is good news because when Congress makes changes to tax laws that reduce revenues, it often looks to retirement plans to make up the loss. This happened during the last major overhaul of the Internal Revenue Code in 1986. The Tax Reform Act of 1986 included many provisions that together greatly restricted the use of retirement plans, including significant reductions in contribution limits and creating many discrimination tests.

The provision of the new tax law that may have the greatest impact on retirement plans is the 20 percent deduction for income from pass-through entities – sole proprietorships, partnerships and subchapter S corporations. This deduction effectively lowers the tax rate for income received from these entities. Put another way, the top rate of 37 percent on taxable income becomes 29.6 percent (37 percent reduced by 20 percent). This creates a discrepency since distributions from retirement plans do not qualify for this deduction. As a result, owners of small businesses may be less inclined to make contributions to retirement plans or even set up a plan in the first place.

There are a few relatively minor provisions directly affecting retirement plans. Many favorable provisions did not make it into the bill, but are still floating around Congress and may be enacted later this year.

Extended Rollover Period for Loan Offsets

When a participant separates from service with an outstanding loan, the participant is usually held in default and receives a Form 1099 for the remaining balance. Under the rollover rules, the participant had 60 days to accomplish a rollover by depositing an amount equal to the loan default into an IRA, thereby avoiding a taxable distribution. Under the new law, the period to accomplish this is extended.  A participant now has until the due date (including extensions) for filing his/her tax return for the year in which the default occurs.

Restriction on Casualty Loss Deduction

The safe harbor hardship rules allow a distribution to pay for the cost of repairing damage to a participant’s principal residence, sustained as the result of a natural disaster, if these costs would qualify for a tax deduction. The new law narrows the deduction for casualty losses. The cost of repairs is now only deductible if the damage is attributable to an event formally declared by the president to be a federal disaster.

Roth Conversions may no Longer be Reversed

Individuals may elect to recharacterize a traditional IRA as a Roth IRA. In the year of the conversion, the individual must pay income taxes on the pre-tax contributions. The individual could elect to reverse this decision any time before the due date (including extensions) for filing his/her tax return for the year of the conversion. Reversing a conversion is no longer permitted.

Adjustments to IRA Contribution Limits

The index used to adjust IRA contribution limits to reflect inflation has now been changed to an index that tends to reflect lower increases in inflation. This will result in somewhat smaller adjustments to the contribution limit in future years.

2016 Disaster Relief

The new law provides relief for distributions from retirement plans taken by disaster victims with regard to a weather event declared by the president to be a federal disaster.

  • In-service distributions permitted;
  • Taxed over three years;
  • Participant may repay within three years; and
  • No 10 percent penalty for early distribution.

ACR#275311 02/18