On November 15, 2017, the Puerto Rico Department of the Treasury (the "PR Treasury") issued Administrative Determination Number 17-29 ("AD 17-29") to provide special rules and procedures applicable to distributions from qualified retirement plans and individual retirement accounts ("IRAs") following Hurricane María.
As previously discussed, on November 13, 2017, the Governor of Puerto Rico issued Executive Order 2017-067 ("EO 2017-067") authorizing the Secretary of the PR Treasury to establish tax rules to temporarily allow Puerto Rico residents to make distributions from qualified retirement plans and IRAs at a preferential tax rate.
The PR Treasury, in accordance with EO 2017-067, issued AD 17-29 establishing such rules and procedures. The following summarizes the most important aspects of the administrative determination.
Eligible Distributions – These are payments or distributions from a qualified retirement plan or an IRA made from September 20, 2017 to June 30, 2018, the Eligible Period that an Eligible Individual has requested to cover Eligible Expenses.
Eligible Distributions from a qualified plan can be made through total distributions (i.e., lump sum distributions) or partial distribution(s) on account of - hardship. Annuities and installment payments will not be considered Eligible Distributions.
The penalty for early withdrawal imposed by the PR Code will not apply to Eligible Distributions from IRAs. However, the individual may be subject to a penalty for early withdrawal imposed by the financial institution or insurance company under the IRA's terms.
AD 17-29 also establishes what supporting documentation must be included with the request for an Eligible Distribution.
Eligible Individual – An Eligible Individual is a Puerto Rico resident during taxable years 2017 and 2018. Only Eligible Individuals may make Eligible Distributions.
Eligible Expenses – These are expenses an eligible individual incurs to compensate for losses or damages suffered as a result of the passage of Hurricane María and any unforeseen and extraordinary expenses needed to cover basic needs. Eligible Expenses include, but are not limited, to: repair of losses of a residence or motor vehicle, payment of medical expenses, replacement or repair of furniture, purchase of food and gas, payments for purchase or repair of power generators, and lodging and meal expenses due to total or partial destruction of principal residence incurred in the wake of Hurricane María. The Eligible Individual will not be required to include, as part of the request for distribution, a detailed accounting of the Eligible Expenses. Pursuant to AD 17-29, Eligible Expenses may be incurred by an Eligible Individual, his/her spouse, descendants or ascendants. As an example, an Eligible Individual may request a distribution to cover part of the cost to repair his/her parent's or children's residence. Pursuant to AD 17-21, for a distribution to be considered an Eligible Distribution, it must be made during the Eligible Period. However, the expenses related to such distributions may not need to be incurred within the Eligible Period. Thus, an Eligible Employee may receive an Eligible Distribution to defray eligible expenses incurred after the termination of the Eligible Period.
Puerto Rico Income Tax Treatment – For purposes of Puerto Rico income tax, Eligible Distributions received by an Eligible Individual during the Eligible Period will be treated as a distribution on account of financial hardship and will be subject to the following tax treatment:
- The first $10,000 distributed during the Eligible Period will be exempt from income tax and the alternative basic tax and will not be subject to any tax withholding.
- Any distribution between $10,000 and $100,000 will be subject to a 10% withholding and income tax rate, in lieu of the regular withholding and income tax rate imposed by the PR Code. It is important to keep in mind that to be able to benefit from this special tax treatment, the income tax withholding must be made at the time of the distribution.
- The Eligible Individual may request various Eligible Distributions during the Eligible Period, from either qualified retirement plans or IRAs or both, but the total Eligible Distributions may not exceed $100,000 and the total exempt amount may not exceed $10,000.
- Eligible Distributions will be taken out first from the contributions and earnings portion of the account not previously taxed by the Eligible Individual (i.e., pre-tax contributions, employer contributions). If such funds are not enough to cover the Eligible Distributions, funds will be taken from the non-taxable portion of the account (i.e., after-tax contributions and Puerto Rico income taxes the Eligible Employee prepaid).
Responsibilities of the Withholding Agent – The employer, administrator or service provider of the trust or annuity contract that makes the Eligible Distributions will be considered a withholding agent and thus will be responsible for complying with the withholding rules provided in AD 17-29. Furthermore, the withholding agent will be responsible for remitting such withholding to the PR Treasury no later than the 15th day of the month following the date of the distribution. Failure to comply with the withholding and depositing rules established in AD 17-29 will result in penalties as well as the imposition of the tax not withheld and deposited.
Terms of the Qualified Retirement Plan - The provisions applicable to qualified retirement plans are optional. Therefore, employers maintaining qualified plans may, but are not required to, adopt part or all provisions of AD 17-29. For example, an employer can amend its qualified retirement plan to facilitate Eligible Distributions in accordance with AD 17-29, but limit such distributions to a maximum amount less than $100,000, or require that they be related to certain events in particular. Furthermore, the administrator of a dual-qualified retirement plan (both in the U.S. and Puerto Rico), may limit the changes to the distribution rules to Puerto Rico participants, to be consistent with those provisions under the U.S. tax code or with the changes authorized by the IRS for participants in retirement plans affected by Hurricane Maria.
Those qualified retirement plans that adopt the provisions of AD 17-29 must amend their plans accordingly no later than December 31, 2018. However, the approval and final distribution in accordance with AD 17-29 is allowed prior to the adoption of the amendment, provided the amendment is adopted on or before December 31, 2018. Therefore, distributions can be completed on or before June 30, 2018, even if the amendment has not been adopted by this date. Note that these amendments are not considered "qualification amendments"; therefore, they are not required to be submitted to the PR Treasury.
Plan Loans – Plans loans are allowed during the Eligible Period, even if at the time the loan is completed, the plan provisions do not allow for loans. However, such loans will be allowed only to the extent the plan is amended no later than December 31, 2019. Furthermore, AD 17-29 provides an extension on the repayment of any outstanding loans to Puerto Rico participants, pending as of September 20, 2017, and for new loans to Puerto Rico participants completed during the Eligible Period. The Eligible Individual may (i) extend the repayment period for up to one year from the original due date; or (ii) extend for one year the repayment of the loan, without discontinuing the repayment of the loan. For example, if a loan was initially set to be repaid over a five-year period, it can be modified to be repaid over a six-year period.
It is important to note that Eligible Employees who receive Eligible Distributions will not be subject to the contribution limitation provided under the PR Code Regulations. For instance, an Eligible Individual may receive Eligible Distributions from a qualified retirement plan without having to reduce or stop his/her contributions to the plan during such taxable year.
As a result of AD 17-29, employers must decide whether to amend their plans to incorporate these special rules. Notably, in the event that the employer decides to amend the plan accordingly, AD 17-29 is silent as to which procedure a participant must followed to receive a favorable tax treatment, in the event he/she has already received Eligible Distributions within the Eligible Period prior to the effective date of AD 17-29.