10% Penalty IRA Early Distribution

[Lion]

New client took money from her IRA. She'd worked in NY but was laid off. Her husband fell ill, so she stayed home until he died. When she dealt with NY, they told her it was too late to apply for unemployment benefits. Does that mean she can't use Exception 07 to lower her 10% penalty. TTB says "if the individual has received unemployment compensation for 12 consecutive weeks."

If we use Exception 05 instead, do we included COBRA payments?

By the way, can we use more than one exception to apply to different amounts?

[Lion]

Exceptions

Bumping this up!

[Bees Knees]

The code for exception 07 says:

(D) Distributions to unemployed individuals for health insurance premiums

(i) In general Distributions from an individual retirement plan to an individual after separation from employment—

(I) if such individual has received unemployment compensation for 12 consecutive weeks under any Federal or State unemployment compensation law by reason of such separation,

(II) if such distributions are made during any taxable year during which such unemployment compensation is paid or the succeeding taxable year, and

(III) to the extent such distributions do not exceed the amount paid during the taxable year for insurance described in section 213 (d)(1)(D) with respect to the individual and the individual’s spouse and dependents (as defined in section 152, determined without regard to subsections (b)(1), (b)(2), and (d)(1)(B) thereof).

(ii) Distributions after reemployment Clause (i) shall not apply to any distribution made after the individual has been employed for at least 60 days after the separation from employment to which clause (i) applies.

(iii) Self-employed individuals To the extent provided in regulations, a self-employed individual shall be treated as meeting the requirements of clause (i)(I) if, under Federal or State law, the individual would have received unemployment compensation but for the fact the individual was self-employed.

The code for exception 05 says:

(B) Medical expenses
Distributions made to the employee (other than distributions described in subparagraph (A), (C), or (D)) to the extent such distributions do not exceed the amount allowable as a deduction under section 213 to the employee for amounts paid during the taxable year for medical care (determined without regard to whether the employee itemizes deductions for such taxable year).

Basically, that means any medical expenses in excess of 7.5% of AGI that would be deductible on Schedule A as a medical expense qualifies for the 10% penalty exception. If the COBRA payments are deductible as medical expenses, it qualifies for the 10% penalty exception.

[Lion]

07

Thanks, Bees. I read Exception 05 the same way you do. Do you also think that we can't use Exception 07 for this client since she was denied unemployment benefits for waiting too long and it ONLY applies after receiving benefits? (Premiums would be in excess of $6,000 under 07 but under 05 only about $3,000 exceeds 7.5%, so was looking for a loophole to use 07.)

[Bees Knees]

Do you also think that we can't use Exception 07 for this client since she was denied unemployment benefits for waiting too long and it ONLY applies after receiving benefits?

Unless self-employed, a strict reading of the code says you can't use Exception 07. Unless someone else can come up with another citation (court case, Rev. Rul., etc) that carves out some exception to the rule. I know of none.

[New York Enrolled Agent]

I think Bees is correct - there is no exception unless you are self-employed.

Chief Counsel gives the following in CCA200920052

[start]There have not been any regulations issued regarding section 72(t)(2)(D).

A distribution qualifies under section 72(t)(2)(D) if it was made from an individual retirement plan to an individual after separation from employment:

(1) If such individual has received unemployment compensation for 12 consecutive weeks under any Federal or State unemployment compensation law by reason of such separation, sec. 72(t)(2)(D)(i)(I);
(2) if such distribution was made during any taxable year during which such unemployment compensation is paid or the succeeding taxable year, sec. 72(t)(2)(D)(i)(II); and
(3) to the extent such distribution does not exceed the amount paid during the taxable year for insurance, sec. 72(t)(2)(D)(i)(III).
A self-employed individual shall be treated as having satisfied the requirement of section 72(t)(2)(D)(i)(I) (number (1) above) if, under Federal or State law, the individual would have received unemployment compensation but for the fact that the individual was self-employed. Sec. 72(t)(2)(D)(iii). Thus, if the taxpayer is self-employed, the taxpayer has to present evidence that he would have been eligible to receive any Federal or State unemployment compensation, but for the fact that the taxpayer was self employed. Although not able to cite as precedence, see the attached Tax Court Summary Opinion 2005 -78 and how the Tax Court handled a S case dealing with section 72(t)(2)(D)(iii). [end]

The TCS case is one where the taxpayer did not receive any benefits even though out of work.

[Lion]

Thank you, all

Thank you Bees and NY. I also think we can use only medical > 7.5%. That lowers her penalty from $2,000 to about $1,500. She wasn't my client when she took the early distributions! In fact, her broker referred he to me.