3620. What penalties apply to early distributions from an IRA?Nuco Employeercline202014-05-21T19:35:00Z2014-06-04T14:10:00Z2014-06-04T14:10:00Z411146354Albany Law School5214745414Site Map/Individual Retirement Plans/Roth IRA/Distributions/Early (Premature) DistributionsSite Map/Individual Retirement Plans/Traditional IRA/Distributions/Early (Premature) Distributions10% penalty early distribution2005-01-19T00:00:00ZTaxFactsDefaultArticleSite Map/Individual Retirement Plans/Quick Clicks/Early (Premature) Distributions114840231-00-tf1.xml232.00;#1796;#1815;#1824;#0x010100C568DB52D9D0A14D9B2FDCC96666E9F2007948130EC3DB064584E219954237AF3900242457EFB8B24247815D688C526CD44D009C4E67E972694125ABDA91AC61F5E51FTax Facts 1What penalties apply to early distributions from an IRA?128000.000000000TaxFactsDefaultArticleSBMEDIA\moss-admin2010-01-15T00:58:53Z3620. What penalties apply to early distributions from an IRA?Except as noted below, amounts distributed from a traditional IRA or a Roth IRA to the individual for whom the plan is maintained before such individual reaches age 59½ are early (premature) distributions. To the extent such distributions are taxable, they are subject to an additional tax equal to 10 percent of the amount of the distribution that is includable in gross income in the tax year.IRC Sec. 72(t). The tax is increased to 25 percent in the case of distributions from SIMPLE IRAs (Q 3641) during the first two years of participation.IRC Sec. 72(t)(6).The 10 percent penalty tax does not apply to the following.(1)Distributions made to a beneficiary or the individual’s estate on or after the death of the individual.IRC Sec. 72(t)(2)(A)(ii).Planning Point: If a surviving spouse is under age 59½ and elects to be treated as the owner of a decedent spouse’s IRA (generally, for required minimum distribution purposes), distributions may be subject to the early distribution penalty unless an exception applies. The early distribution penalty would not apply to distributions after the death of the original owner in the absence of the spouse making the election to be treated as owner. (2)Distributions attributable to the individual’s disability.IRC Sec. 72(t)(2)(A)(iii).(3)Distributions made for medical care, but only to the extent allowable as a medical expense deduction for amounts paid during the taxable year for medical care (determined without regard to whether the individual itemizes).IRC Secs. 72(t)(2)(B) Thus, only amounts in excess of 10 percent of the individual’s adjusted gross income (“AGI”) escape the 10 percent penalty. (The threshold amount was 7.5 percent for tax years prior to 2013). (4)Distributions made to unemployed individuals for the payment of health insurance premiums. The AGI floor, described above, does not have to be met if the individual has received unemployment compensation for at least twelve weeks and the withdrawal is made in either the year such unemployment compensation was received or the year immediately following the year in which the unemployment compensation was received. This exception also applies to self-employed individuals whose sole reason for not receiving unemployment compensation is that they were self-employed. The exception ceases to apply once the individual has been reemployed for a period of sixty days.IRC Sec. 72(t)(2)(D).Planning Point: If an IRA owner pays health insurance premiums in a year of unemployment, and the owner expects to need an IRA distribution within the next few years at a time when the owner does not anticipate that any other exception will apply, the owner should consider taking an IRA distribution in the year of unemployment to avoid a future penalty tax on that amount. Martin Silfen, J.D., Brown Brothers, Harriman Trust Co., LLC.(5)Distributions made to pay “qualified higher education expenses” during the taxable year for the taxpayer, the taxpayer’s spouse, or the child or grandchild of the taxpayer or the taxpayer’s spouse.IRC Sec. 72(t)(2)(E). “Qualified higher education expenses” means tuition, fees, books, supplies, and equipment required for the enrollment or attendance of the student at any “eligible educational institution.” For tax years beginning after 2001, this includes expenses for special needs services in the case of a special needs beneficiary that are incurred in connection with such enrollment or attendance. Room and board (up to a certain amount) also is included if the student is enrolled at least half-time.IRC Secs. 72(t)(7), 529(e)(3). “Qualified higher education expenses” must be incurred for the taxable year of the distribution.Lodder-Beckert v. Comm., T.C. Memo 2005-162 (2005). These expenses must be reduced by any scholarships received by the individual, any educational assistance provided to the individual, or any payment for such expenses (other than a gift, devise, bequest, or inheritance) that is excludable from gross income.IRC Sec. 72(t)(7)(B). An “eligible educational institution” is any college, university, vocational school, or other postsecondary educational institution described in Section 481 of the Higher Education Act of 1965.See IRC Sec. 529(e)(5). Thus, virtually all accredited public, nonprofit, and proprietary postsecondary institutions are considered eligible educational institutions.Notice 97-60, 1997-2 CB 310, at 14 (Sec. 3, A16). This exception to the 10 percent penalty is not available if the withdrawal qualifies for one of the other exceptions provided under IRC Section 72(t)(2) (other than the following exception for “qualified first-time homebuyers”).IRC Sec. 72(t)(2)(E).Planning Point: If an IRA owner has higher education expenses in a year and he or she expects to need an IRA distribution within the next few years at a time when he or she does not anticipate that any other exception will apply, the IRA owner should consider taking an IRA distribution in the year of the higher education expenses to avoid a future penalty tax on that amount. Martin Silfen, J.D., Brown Brothers, Harriman Trust Co., LLC.(6)Distributions that are “qualified first-time homebuyer distributions” (Q 3617). This exception to the 10 percent penalty is not available if the withdrawal qualifies for one of the other exceptions provided under IRC Section 72(t)(2).IRC Sec. 72(t)(2)(F).(7)Distributions that are part of a series of substantially equal periodic payments made (at least annually) for the life or life expectancy of the individual or the joint lives or joint life expectancy of the individual and his or her designated beneficiary (Q 3621). IRC §72(t)(2)(A)(iv).(8)Distributions that are “qualified hurricane distributions” which distributions may not exceed $100,000.IRC Sec. 1400Q; Notice 2005-92, 2005-2 CB 1165.(9)Distributions that are “qualified reservist distributions.” Qualified reservist distributions are those made to reserve members of the U.S. military called to active duty for 180 days or more at any time after September 11, 2001. Reservists have the right to return the amount of any distributions to the retirement plan for two years following the end of active duty.IRC Sec. 72(t)(2)(G).The penalty tax has been held not to apply to compulsory distributions where the IRS levied on a taxpayer’s IRA and where the federal government seized a taxpayer’s IRA as part of a plea agreement.Larotonda v. Comm., 89 TC 287 (1987), nonacq.; Murillo v. Comm., TC Memo 1998-13, affd. 166 F.3d 1201 (2nd Cir. 1998). Where a taxpayer withdrew from his IRA to satisfy a court order to pay alimony and child support, the penalty tax did apply.Baas v. Comm., TC Memo 2002-130. See also Czepiel v. Comm., TC Memo 1999-289, affd. by order (1st Cir. 2000).No early distribution occurs where accumulation units in an individual retirement annuity are surrendered to purchase a disability waiver of premium feature.See Let. Rul. 7851087. Ineligibility to set up an individual retirement plan does not prevent imposition of this penalty.Orzechowski v. Comm., 69 TC 750 (1978), aff’d 79-1 USTC ¶7220 (2nd Cir. 1979). The fact that an IRA distribution was mandated by the insolvency of the financial institution issuing the IRA did not prevent the application of the 10 percent penalty tax when the funds were received and not rolled over.Aronson v. Comm., 98 TC 283 (1992).The amount reportable as an early distribution from a time deposit (such as a certificate of deposit) that is subject to an early withdrawal penalty of the trustee is the net amount of the distribution after deduction of any early withdrawal penalty imposed by the trustee.Let. Ruls. 8643070 and 8642061.It appears that amounts includable in income as a result of a prohibited transaction, borrowing on an annuity contract, or using an account as security for a loan would be subject to the 10 percent penalty.