I have a client who was let go from his job in 2004, had a 401K with about $60K. He took a distribution of $40K (he was over 55 years old) and rolled over $20K. In 2004 we used an exception for being over 55 and not working for the company any longer, no problem that I heard about. In 2005 he cleans out the $20K from the IRA again we use an exception for being over 55, I'm thinking this is still part of his 401K. This guy gets a letter form the IRS concerning his 2005 distribution, they would like a 10% penalty. Do any of you know of a way out of this mess. Of course this is one of those pro bono returns, but I would like to something to get them off the hook. Thanks for time.
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Section 72(t)(2)(A)(v) says the 10% penalty does not apply to any distributions “which are made to an employee after separation from service after attainment of age 55.”
Section 72(t)(3)(A) says the above exception to the 10% penalty does not apply to IRAs.
The courts have ruled that the employee cannot have separated from service prior to the attainment of age 55. The employee must have reached age 55, then separate from service, and then take a distribution to qualify for the 10% penalty exception, in that order. Nothing in the code says whether or not there is a time limit on how long the employee has to take a distribution penalty free once the employee has attained age 55 and separated from service. Nor does the code say there is a limit as to how many times a distribution can be taken penalty free after attaining age 55 and separating from service.
As long as your client attained the age of 55, and then separated from service, and then took distributions from his 401(k), in that order, the distributions are not subject to the 10% penalty.
Explain it to the IRS that way in a letter, and they should not have a problem with it. -
But, it's an IRA
But, it's an IRA this time from which he took a distribution. Any exception to the over 59.5 at the time of distribution? He can no longer use the 401(k) rules since he was not taking a distribution of his no longer existing 401(k) this time. A good lesson in why people should talk to their tax advisor, paid or not, BEFORE than do something and not just when they come to you in the following year to have their taxes prepared. Free yet. He could've paid you and still had more money in his pocket if he'd talked to you!Comment
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Thanks
I should get the letter Monday, I think there is a little more to it than I first thought. I hope this is not a total blunder on my part, I tend to come down pretty hard on myself. The really bad part of this is, the guy hasn't been able to find a job for almost a year, the last thing he needs is something from 2005 kicking him in the teeth.Comment
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Sorry, I missed the part about the second distribution comming out of an IRA.
The exception does not apply when it comes out of an IRA.Comment
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