IRA - Early Distributions

Exceptions to the 10% IRA Early Distribution Tax

     

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The IRS chares a penalty for any money taken from an IRA account before the age of 59.5.  This penalty usually will have a devastating impact on the tax bill.   However, there are provisions for relief for taxpayers in certain financial conditions.

1. Exception for medical expenses
2. Exception for unemployment & health insurance
3. Exception for equal periodic payments
4. Do I Qualify for any of the medical or insurance exceptions?
5. Exception for disability
6. Exception for beneficiaries
7. Exception for withdrawals from an IRA on account of an IRS levy
8. Distributions from Individual Retirement Plans for higher education expenses
9. Certain distributions for first-time home purchases

If your unreimbursed (out of pocket) medical expenses paid exceed 7.5% of your adjusted gross income.

If you collect at least 12 weeks of unemployment compensation and you use the IRA distribution to pay for health insurance. If you are self-employed and by state law do no collect the unemployment solely for being self-employed then you have the same rule apply to you. Note: once the individual has been re-employed for at least 60 days, this exception is not available. {For taxable years beginning after Dec. 31, 1996}

A distribution which is part of a series of substantially equal periodic payments made not less frequently than annually over the life (or life expectancy) of the IRA owner or the life (or life expectancies) of the IRA owner and his beneficiary.

Do I Qualify for any of the medical or insurance exceptions?

A distribution attributable to the IRA owner's being disabled. An individual is considered disabled if he cannot perform any substantial gainful activity in which he customarily engaged before he was disabled or before retirement (if retired when the disability arose) because of a medically determinable physical or mental impairment expected to result in death or to continue for a long and indefinite period.

A distribution to a beneficiary from the IRA on or after the death of the IRA owner can be released from the 10% penalty. This exception is necessary as a technical matter because the recipient of an IRA distribution is taxable whether it is the IRA owner or his beneficiaries; the IRA owner may have died before attaining age 59 1/2.

For distributions made after December 31, 1999, under §6631.

The Taxpayer Relief Act of 1997 exempted the 10% early withdrawal tax distributions from an individual retirement plan to pay qualified higher education expenses of the taxpayer, the taxpayer's spouse, or any child or grandchild of the taxpayer or the taxpayer's spouse at an eligible educational institution for the taxable year. Such distributions, however, may not exceed the qualified higher education expenses of the taxpayer. Amounts in excess of the qualified higher education expenses of the taxpayer are subject to the 10% early withdrawal tax of §72(t). The Act defines "qualified higher education expenses," under §529(e)(3), to mean tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a designated beneficiary at an eligible institution. Such expenses also include room and board for students enrolled at an eligible educational institution on at least a half-time basis. The 1997 Act provides for the reduction of the amount of qualified higher education expenses for any taxable year for a qualified scholarship excludible under §117; an educational assistance allowance; 593 a payment (other than a gift, bequest, devise, or inheritance 594 for such individual's educational expenses, or attributable to such individual's enrollment at an eligible educational institution, which is excludible from gross income under any other law of the United States. An eligible educational institution is an institution described in §481 of the Higher Education Act of 1965 which is eligible to participant in Department of Education student aid programs. Generally, such institutions are accredited post-secondary educational institutions offering credit toward a bachelor's degree, an associate's degree, a graduate-level or professional degree, or another recognized post-secondary credential. Certain proprietary institutions and post-secondary vocational institutions are also eligible educational institutions. The exception does not apply to elementary or secondary education expenses such as tuition at a private grade school.

The Taxpayer Relief Act of 1997 597 also permitted distributions from an individual retirement plan to be used pay certain qualified first-time homebuyer expenses without incurring the 10% penalty tax. A "qualified first-time homebuyer distribution" is any payment or distribution received by an individual to the extent that the individual uses it before the close of the 120th day after the day on which it is received to pay "qualified acquisition costs" with respect to a principal residence of a first-time homebuyer who is the individual, the individual's spouse, or any child, grandchild, or ancestor of the individual or the individual's spouse. An individual only may make $10,000 of such distributions per lifetime without under this exception. "Qualified acquisition costs" are the costs of acquiring, constructing, or reconstructing a residence, including any usual or reasonable settlement, financing, or other closing costs. An individual is considered a "first-time homebuyer" if: (1) the individual (and if married, the individual's spouse) had no present ownership interest in a principal residence during the two-year period ending on the date of acquisition of the principal residence for which the distribution is being made; and (2) former §1034(h) or (k) did not suspend the running of any period of time specified in former §1034 with respect to the individual on the day before the date the distribution is applied to pay qualified costs. The "date of acquisition" of a principal residence means the date: (1) on which a binding contract to acquire the residence is entered into; or (2) on which construction or reconstruction of the residence begins. If a distribution fails to qualify solely by reason of a delay or cancellation of the purchase or construction of the residence, the amount of the distribution generally may be rolled over tax-free into an individual retirement plan, provided this occurs within 120 days of the date on which the distribution was made. This exception applies to payments and distributions in taxable years beginning after Dec. 31, 1997.

If any of the answers were no, you will not qualify for the exception. Please call if you believe you have an exception and it is not included in the above.

Bob Parrish CPA PC

For the firm,

 

Bob Parrish CPA

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