IRS Definition of Financial Hardship

by Jeannine Mancini
Medical expenses can qualify as financial hardship under IRS rules.

The Internal Revenue Service's definition of a financial hardship varies depending on the context. The Internal Revenue Code mentions financial hardships in two specific and very different circumstances. If you have a retirement account, you may borrow funds if you endure a hardship. For taxpayers can't pay their tax bill because of financial hardship, the IRS can set up an installment program. The IRS defines a hardship as a heavy and immediate financial need.

Hardships for Retirement Accounts

If you have an employer-sponsored retirement plan, such as 401(k) or 403(b), you cannot touch the funds until you reach 59 1/2. Unlike an individual retirement account, which allows you to tap into the account for any reason, the employer is responsible for approving 401(k) early distributions, even for hardships. According to the Internal Revenue Service, retirement plans are not required to allow hardship distributions. If you have an employer-sponsored retirement plan, it is up to your employer to determine whether your circumstance qualifies as a hardship.

Safe Harbor Hardships

Under IRS "safe harbor" regulations, certain circumstances are automatically deemed to be an immediate and heavy financial need. Qualifying expenses include medical, education, mortgage and funeral. The amount of the distribution must be great enough to end the immediate need. Your distribution must also be no more than the amount of the qualifying need. For example, if you owe $3,000 in medical debt, but you are attempting to take $5,000 from your 401(k), the employer will deny your request. Early distributions are subject to taxes and a 10 percent penalty on the amount. Once you take a hardship distribution, you cannot repay it back to the plan.

Tax Hardships

If you cannot pay taxes you owe by the deadline of April 15, you could face late fees and interest. After your taxes become delinquent, the IRS can use enforcement methods that include garnishing your wages, intercepting future tax refunds and even levying your assets. If you are facing a financial hardship, the IRS offers installment options. For delinquent taxes, an offer in compromise allows you to settle tax debt for less than you owe. If the IRS has already levied your bank account or your wages, it may agree to alternate arrangements if the levy is creating an economic hardship.

Immediate Economic Hardship

The IRS considers an economic hardship the inability to pay reasonable and necessary living expenses. The IRS determines what expenses qualify as basic expenses, which will vary depending on the taxpayer's circumstances. Generally, basic expenses include your rent or mortgage, utilities, food, transportation and health care. The IRS states that qualifying circumstances do not include a luxurious standard of living.

About the Author

Jeannine Mancini, a Florida native, has been writing business and personal finance articles since 2003. Her articles have been published in the Florida Today and Orlando Sentinel. She earned a Bachelor of Science in Interdisciplinary Studies from the University of Central Florida.

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