IRS describes allowable deferred comp distributions for emergencies

The IRS has provided guidance for taxpayers on when a Code Sec. 457 deferred compensation plan may make a distribution to the participant because of an unforeseeable emergency. The rules also apply to Code Sec. 409A deferred compensation plans.

Unforeseeable emergency

The plan may make a distribution if a participant has a severe financial hardship resulting from extraordinary and unforeseeable circumstances beyond the participant's control, such as:

- Illness or accident of the participant, spouse or a dependent;

- Loss of property due to casualty, such as damage to a home from a natural disaster;

- Funeral expenses of a dependent; and

- Other similar extraordinary and unforeseeable circumstances beyond the participant's control.

A hardship includes imminent foreclosure or eviction from the principal residence. Medical expenses, including nonrefundable deductibles and prescription drug costs, may also qualify. However, the purchase of a home or payment of college tuition is not generally an unforeseeable emergency.

Distribution disallowed

In three different situations described in the IRS rules, the agency discussed when hardship distributions would and would not be permitted. The IRS said that a participant's request for a distribution to pay accumulated credit card debt, which was not due to any extraordinary and unforeseeable circumstances from events beyond the taxpayer's control, was not a distribution for an unforeseeable emergency.

Distributions allowed

The IRS allowed an unforeseeable emergency distribution for amounts paid to the participant to pay for repairs to her principal residence after significant water damage from a leak in her basement was discovered. The participant provided an estimate of the costs, which were not covered by insurance. The participant experienced an extraordinary and unforeseeable circumstance from events beyond the participant's control, the IRS said. The circumstances are similar to the need to pay for damage to a home because of a natural disaster, as provided in the rules.

In the third situation that the IRS evaluated for “unforeseeable emergency status,” the participant had to pay for funeral expenses for his adult son, who is not a dependent. The participant provided a bill from the funeral home. Existing IRS rules already provide for the payment of funeral expenses for a spouse or dependent. The participant's circumstances are similar, the IRS explains, because they are also extraordinary, unforeseeable, and beyond the participant's control.