By Arris R. Murphy, Contributing Editor

In Puerto Rico, September 20, 2017, will be remembered for the wrath of Hurricane Maria, one of the most destructive tropical storms in the island’s history, which followed just 13 days after Hurricane Irma passed through the northern part of the island.

On the mainland, the Internal Revenue Service (IRS) regulates qualified retirement plans. When a natural disaster (as declared by the U.S. government) strikes, the tax agency issues disaster relief. The relief is intended to relax some of the initial application requirements for loans and hardship withdrawals from retirement plans to make plan assets more accessible. The supporting documentation may be provided at a later date, when it is expected that an affected participant’s circumstances have stabilized.

However, the IRS does not regulate qualified plans in Puerto Rico. Instead, the plans are governed by the Puerto Rico Internal Revenue Code, specifically Section 1081.01, and the Puerto Rico Treasury. As a result, the IRS’s disaster relief issued in October 2017 is not applicable to Puerto Rico retirement plans.

Employer-sponsored retirement plans that seek to be qualified under the U.S. federal tax code as well as the Puerto Rico Code should note the rules of both to ensure compliance when making disaster relief distributions to participants in Puerto Rico.

On November 8, 2017, the Governor of Puerto Rico issued Executive Order No. OE-2017-67, authorizing the Puerto Rico Treasury to establish rules that allow residents of Puerto Rico to withdraw savings from their employer-sponsored retirement plans and individual retirement accounts (IRAs) at preferential tax rates.  

On November 15, the Puerto Rico Treasury issued Administrative Determination No. 17-29 to employers, fiduciaries, and administrators containing rules applicable to distributions related to Hurricane Maria by qualified retirement plans and IRAs.

Here is a summary of the applicable disaster relief rules and requirements that plan sponsors adopting them should be aware of.

Eligibility Requirements

Eligible distributions are partial or total cash withdrawals from retirement plans made to correct losses or damage suffered from Hurricane Maria. They are considered extreme economic emergency (EEE) distributions to attend to liquidity problems caused by unforeseen expenses incurred during the post-hurricane emergency period. An eligible distribution must be taken between September 20, 2017, and June 30, 2018, to benefit from preferential tax rates.

The rules provide that distributions in the form of annuities or periodic payments are not considered eligible distributions. While eligible distributions may be taken from multiple plans or IRAs, the total amount that will receive preferential tax rates is limited to $100,000 for the eligibility period noted above.

A Puerto Rico qualified plan that offers hardship withdrawals usually also imposes a suspension afterward in which the participant may not make any plan contributions for a 12-month period. But, as an accommodation for EEE distribution, this 12-month suspension period will not apply to eligible distributions.

To be eligible to take a distribution, the employee must be an individual who was a resident of Puerto Rico in Tax Year 2017 and intends to live there in 2018. An EEE distribution may be taken to correct damage suffered by the employee, his or her spouse, and lineal descendants or ascendants.

Eligible expenses include, but are not limited to, expenses for the repair of damage to a residence or motor vehicle, payment of medical expenses, replacement or repair of real estate, purchase of food and fuel, payments for purchase or repair of electricity generators, or lodging and food expenses incurred during the recovery period from total or partial destruction of the main residence.  

No details about the expenses incurred need be submitted at the time the withdrawal request is made. Nor is it required that the expense be incurred during the eligible period, which means that a participant may request funding for a future repair project.

Application Requirements

There are a few administrative requirements that a participant has to satisfy to take advantage of the preferential tax rates on EEE distributions from Puerto Rico retirement plans. Before plan assets are distributed, an eligibility application must be submitted to the employer that maintains the plan or to the plan’s service provider, if handling these requests.

The request must contain the following information:

1. Name and mailing address of the participant or eligible individual;
2. Primary residence address of the eligible individual on the date of the application for eligible distribution;
3. Certification that the individual is a resident of Puerto Rico in 2017 and will continue to be a resident in 2018; and
4. Certification or sworn statement that:
   1. The amount requested does not exceed the allowable limit;
   2. The amount will be used to cover hurricane-related expenses;
   3. The individual has not received eligible distributions from other retirement plans (or, if so, provide the distribution date and amount received from other retirement plans); and
   4. The individual has not received eligible distributions exempt from taxes (or, if so, provide the distribution date and amount received from other retirement plans).
5. Certification that the individual assumes responsibility for payment of the applicable tax if it is discovered by year-end that he or she did not comply with the requirements regarding residency, use of the distribution amount, or disclosure of amounts withdrawn.

The plan administrator or service provider must verify that the eligible individual is a Puerto Rico resident, and whether the participant has received other EEE distributions, so that any future distributions are reduced accordingly.

However, during the eligibility period, the plan administrator that receives the application and certification for an EEE distribution is not obligated to verify that the participant has a financial need, what the amount of that need is, or that the need is related to hurricane damage.

Plan Loans

The disaster relief rules also apply to Puerto Rico plan loans issued to participants during the eligible period, as well as loans outstanding on September 20, 2017.

Under the order, it is permissible to suspend repayment of the loan for up to 1 year, or to extend the repayment period for 1 year and reamortize the loan; so that a loan that was to be repaid in 5 years would have 6 years to be repaid, for example. However, if the period is extended, the relief does not permit loan repayments to be stopped at any point during the repayment period.

Taxation on Eligible Distributions

The first $10,000 distributed as an eligible distribution will be exempt from Puerto Rico income tax and alternate basic tax. Any eligible distributions in excess of $10,000 are subject to a fixed tax on income and withholding at a 10% tax rate, and all distributions are to be reported to the participant and Puerto Rico Treasury on Form 480.7C (Informative Return—Retirement Plans and Annuities).

It is the responsibility of the service provider processing the distribution to remit the 10% withholding to the Puerto Rico Treasury no later than 15 days after the date of the distribution. Failure to comply with the tax withholding will subject the service provider to paying the Puerto Rico Treasury the amount due and any applicable penalties.

Considerations

The good news is that a Puerto Rico retirement plan may implement deferential distribution procedures as soon as administratively possible. For employers that elect to implement the relief, their plans will need to be amended no later than December 31, 2018. Because the amendment is not considered a qualifying amendment, it does not have to be filed with the Puerto Rico Treasury.

EEE distributions in the Executive Order are optional, so plan sponsors may or may not adopt the provision. Plan sponsors also have flexibility to adopt the provision partially or to impose limits. For example, a plan may limit the eligible distribution amount to $25,000, instead of the $100,000 maximum, or limit the events that warrant an eligible distribution.