J. William Seabrooke CPA P.C.

As is the case with many areas of the income tax laws, retirement plans can be a relatively complex subject.  This situation is further compounded by the fact that there are literally hundreds of different retirement plans throughout the United States. This post is strictly limted to the additional income taxes that are associated with (related to) the early withdrawal (distributions) from a “traditional IRA” retirement plan.

If you are eligible to participate and have made contributions to your Individual Retirement Arrangement (IRA) plan those contributions are considered to be “tax deferred” , specifically the income is not reported on your W-2 in the year that you earn it.  The income will not be taxed until you begin receiving distributions from your IRA plan.  One of the fundamental tenets for establishing an IRA is to postpone the related income taxes from the present time (based on your current income tax bracket rate) until you have retired and will probably be earning less or may/will be in a lower income tax bracket rate.   The earliest point in your life in which IRA plan distributions can be received by you, without a 10% tax penalty (essentially a surtax), is age 59 1/2.  You must begin receiving distributions prior to April 1st in the year after you have reached the age of  70 1/2.  At that age you must receive at least the  “Required Minimum Distribution” (RMD) each year.  From the IRS website:  “You cannot keep funds in a traditional IRA indefinitely. Eventually they must be distributed. If there are no distributions, or if the distributions are not large enough, you may have to pay a 50% excise tax on the amount not distributed as required.  The requirements for distributing IRA funds differ, depending on whether you are the IRA owner or the beneficiary of a decedent’s IRA.”

You will receive a 1099 R from your retirement plan administrator if you have received an “early distribution” from your IRA plan.  Look in Block #7  (Distribution Code) of that form and there will be a code “1”.  Your tax software will correctly report all of the income (i.e. either on line #15 or #16 of your Federal form 1040) and the early distribution 10% tax penalty will appear on line #58. 

There are fifteen “exceptions” to the 10% early distribution tax penalty which are provided in the tax laws.  These exceptions can be found using this link to the IRS website.   The best source for information related to Individual Retirement Arrangements (IRAs) is IRS Publication 590. 

If you have any questions or are not absolutely sure of the facts and income tax reporting requirements, you should contact the IRS (1-800-829-1040), your IRA retirement plan administrator, your tax preparer, or your CPA.  In complex situations “all of the above” may be the best answer! 

Did You Take an Early Distribution from Your Retirement Plan? 

Some taxpayers may have needed to take an early distribution from their retirement plan last year. The IRS wants individuals who took an early distribution to know that there can be a tax impact to tapping your retirement fund.  Here are ten facts about early distributions.

1. Payments you receive from your Individual Retirement Arrangement before you reach age 59 ½ are generally considered early or premature distributions.
2. Early distributions are usually subject to an additional 10 percent tax.
3. Early distributions must also be reported to the IRS.
4. Distributions you rollover to another IRA or qualified retirement plan are not subject to the additional 10 percent tax. You must complete the rollover within 60 days after the day you received the distribution.
5. The amount you roll over is generally taxed when the new plan makes a distribution to you or your beneficiary.
6. If you made nondeductible contributions to an IRA and later take early distributions from your IRA, the portion of the distribution attributable to those nondeductible contributions is not taxed.
7. If you received an early distribution from a Roth IRA, the distribution attributable to your prior contributions is not taxed.
8. If you received a distribution from any other qualified retirement plan, generally the entire distribution is taxable unless you made after-tax employee contributions to the plan.
9. There are several exceptions to the additional 10 percent early distribution tax, such as when the distributions are used for the purchase of a first home, for certain medical or educational expenses, or if you are disabled.
10. For more information about early distributions from retirement plans, the additional 10 percent tax and all the exceptions see IRS Publication 575, Pension and Annuity Income and Publication 590, Individual Retirement Arrangements (IRAs). Both publications are available at IRS.gov or by calling 800-TAX-FORM (800-829-3676).

Links:

• Publication 575, Pensions and Annuities (PDF 227K)
• Publication 590, Individual Retirement Arrangements (IRAs) (PDF 449K)  
• Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax Favored Accounts   (PDF 72K)
• Form 5329 Instructions (PDF 40K)