Tax Planning for Retirees

Hurricane Disaster Tax Relief for IRAs and Qualified Plans

The Gulf Opportunity Zone Act of 2005 generally provides targeted tax relief for taxpayers who sustained economic loss from Hurricanes Katrina, Rita, or Wilma. To benefit, a taxpayer must have been a resident of the Hurricane Katrina disaster area on August 28, 2005, the Hurricane Rita disaster area on September 23, 2005, or the Hurricane Wilma disaster area on October 23, 2005. (This discussion uses the term “hurricane taxpayer” to refer to a taxpayer resident in the hurricane disaster area that bears the name of the hurricane causing his or her economic loss.)

Elimination of Mandatory Withholding and the Penalty for Early Withdrawals. – The tax law generally requires 20 percent mandatory income tax withholding on distributions from qualified retirement plans eligible for rollover to other plans or IRAs. The tax law also generally imposes a 10 percent penalty tax on early withdrawals from qualified plans and IRAs by taxpayers under age 59 ½ (with certain exceptions). However, a hurricane taxpayer may withdraw up to $100,000 from his or her qualified plans and IRAs on or after a specified “beginning date” but before the year 2007 without incurring the penalty tax. The hurricane taxpayer may also elect to eliminate income tax withholding on these hurricane distributions. For this purpose, the withdrawal “beginning date” for Katrina withdrawals is 8/25/05, for Rita 9/23/05, for Wilma 10/23/05. (I.R.C. § 1400Q(a).) For a discussion of withholding and the penalty tax, see Chapters 2 and 5 of the treatise.

Tax Spread over Three Years; and Tax-Free Rollover Period of Three Years. – Although ahurricane distribution is generally taxable, the hurricane taxpayer may spread the income from the distribution equally over the three tax years beginning with the year of the distribution. Alternatively, the taxpayer may roll over all or part of the hurricane distribution tax-free to another IRA or qualified plan. Plans or IRAs eligible to receive a rollover of the hurricane distribution are the same as the plans or IRAs eligible to receive a rollover of a direct distribution to the taxpayer that is not a hurricane distribution. However, instead of the usual 60-day period to complete the rollover, the taxpayer has three years to complete a hurricane rollover. (I.R.C. § 1400Q(a).) For a discussion of the tax treatment of distributions and rollovers, see Chapters 2 and 5 of the treatise.

Loan Limits Increased and Repayment Period Lengthened. – The tax law generally allows a qualified plan to make a “qualified residential loan” or a “qualified 5-year loan” to a participant, provided the aggregate of such loans does not exceed a specified limit. For loans made to a hurricane taxpayer on or after a specified “beginning date” but before the year 2007 (hurricane loans), the amount of the limit is generally increased to double the previous amount (i.e., to the lesser of $100,000 or the plan account balance). For this purpose, the loan “beginning date” for Katrina is 9/24/05, for Rita and Wilma 12/21/05.

In addition, the tax law delays for one year all remaining payments otherwise due on qualified residential loans or qualified 5-year loans to hurricane taxpayers – provided at least one loan payment was due on or after the “qualified beginning date” but before the year 2007. However, the plan must increase the amount of interest on the loan to reflect the delay in payment. For this purpose, the “qualified beginning date” for Katrina is 8/25/05, for Rita 9/23/05, for Wilma 10/23/05. (I.R.C. § 1400Q(c).) For a discussion of the tax treatment of plan loans, see Chapter 2 of the treatise.

Rollover of Distributions Made to Acquire Residence. – Under certain circumstances, a taxpayer may withdraw amounts from an IRA or qualified plan to acquire a residence. The tax law provides special relief for hurricane taxpayers (i) who received such distributions after February 28, 2005 but before a specified “ending date” but (ii) who were unable to use the distributed funds to purchase or construct a residence because of the hurricane. Such a taxpayer may roll over the distributed funds to any IRA or qualified plan otherwise eligible to receive a rollover of a direct distribution to the taxpayer – without regard to the usual 60-day period to complete the
rollover. However, the taxpayer must roll the funds over to the IRA or plan on or after a specified “beginning date” but before March 1, 2006.

The distribution “ending date” referred to above for Katrina distributions is 8/29/05, for Rita 9/24/05, for Wilma 10/24/05. (I.R.C. § 1400Q(b).) The rollover “beginning date” for Katrina is 8/25/05, for Rita 9/23/05, for Wilma 10/23/05. (I.R.C. § 1400Q(b).) For a discussion of the tax treatment of distributions and rollovers, see Chapters 2 and 5 of the treatise.

The 2008 Midwestern Disaster Area Storms – Congress granted tax relief to victims of the 2008 storms in the “Midwestern disaster area” similar to the tax relief granted to victims of the 2005 Hurricanes Katrina, Rita, and Wilma (explained above). Heartland Disaster Tax Relief Act of 2008, Pub. L. No. 110-343, § 702.) See Chapters 3 and 6 of the treatise.