In Fields v. Commissioner, T.C. Memo. 2014-48 (March 19, 2014), the Tax Court determined that a petitioner was liable for a 10 percent additional tax pursuant to Internal Revenue Code Section 72(t)(1), due to an early distribution from her qualified retirement plan. Here’s why.
Prior to 2010, Jennifer Lynn Fields worked for Wal-Mart and participated in its IRC Section 401(k) retirement plan. In 2010, she received a $7,383 distribution (which represented the full amount of her account balance under the plan) and liquidated the account. She asked that all required taxes be withheld from the distribution. As a result, 20 percent of the distribution ($1,477) was withheld, and she received a net distribution of $5,906. At the time of the distribution, Jennifer wasn’t 59½. She didn’t use the distribution to pay medical expenses, health insurance premiums, or expenses attributable to a disability, or to make a first home purchase.
In 2010, Jennifer worked for Redland Christian M. Associates (Redland) and Storybook Cottage, Inc. (Storybook). Redland and Storybook paid wages to Jennifer of $13,136 and $7,405, respectively. In 2010, she also received $2,332 in unemployment compensation from the State of Florida and $47 in interest income.
The Tax Returns
Jennifer prepared her own 2010 individual income tax returns (Form 1040) on which she reported income of $27,971, comprised of the wages she received from Redland and Storybook, interest income and the distribution from her retirement plan. She didn’t report any amount on line 58 (which refers to additional tax on individual retirement accounts or other qualified retirement plans). She reported a total tax of $2,728. Jennifer also claimed a $400 work pay credit under IRC Section 36A(a) and reported $2,967 in federal income tax withholding on line 61 (federal income tax withheld from Forms W-2 and 1099). The $2,967 federal income tax withholding represented the amounts withheld by Redland, Storybook, and the State of Florida, as well as the $1,477 withheld from the distribution. She also claimed a refund of $639.
The 10 Percent Additional Tax
IRC Section 72(t)(1) imposes a 10 percent additional tax on the taxable amount of an early distribution from a qualified retirement plan, which includes a Section 401(k) plan. Under Section 72(t)(2)(A)(i), a distribution is “early” if it’s made before a recipient reaches age of 59½. The 10 percent additional tax doesn’t apply to certain early distributions, however, such as a distribution attributable to a taxpayer’s disability, used to pay certain medical expenses or health insurance premiums or used for a first home purchase (Section 72(t)(2)(A), (B), (D), (F)).
The taxpayer typically has the burden of proving that she’s entitled to any of these exceptions. In this instance, because Jennifer wasn’t 59½ years old in 2010, the distribution from her retirement plan was an early distribution under Section 72(t). But, she didn’t withdraw the $7,383 from her retirement plan to pay medical expenses, health insurance premiums, or to make a first home purchase. Jennifer also wasn’t disabled in 2010.
The Tax Court didn’t find any evidence that Jennifer used the $7,383 for the payment of any other expense that would allow her to fit within any of the statutory exceptions and avoid the 10 percent additional tax. The court also rejected Jennifer’s argument that she shouldn’t be required to pay the additional tax because she asked that all taxes be withheld at the time of the distribution. It found that “[d]espite her good intentions,” she should have reported the 10 percent additional tax, and this failure caused her to improperly claim a $639 refund. As such, Jennifer is liable for the 10 percent additional tax on the distribution.