Distributions from IRA Subject to (Unnecessary) Tax
Timothy M. Nichols
Sometimes form trumps substance, especially in the qualified plan area. Such was the case in a recent Seventh Circuit of Appeals decision that illustrates the importance of understanding your distribution options and their tax consequences.
Kim v. Comm’r, 2012-1 U.S.T.C. ¶ 50,340 (7th Cir.)
As background, the tax code generally imposes an additional 10% tax on amounts distributed from a qualified retirement plan before the employee-beneficiary attains age 59½. However, there are several exceptions, including an exception for distributions made to an employee who has attained age 55 and terminated employment with the employer.
The taxpayer in Kim v. Comm’r had retired as a partner in a law firm at age 56, and would have qualified for the exception from the 10% tax. However, instead of taking a distribution directly from his former firm’s retirement plan, the taxpayer first rolled over funds from his retirement plan to an individual retirement account (“IRA”) and then took the distribution from the IRA. The tax code specifically provides that the exception from the 10% tax for employees over age 55 does not apply to distributions from an IRA.
The taxpayer argued that he could have obtained the exact same result without the 10% tax by simply receiving the distribution directly from the retirement plan, and therefore imposing the tax made no sense. The first part of this argument was almost certainly correct; except for the tax consequences, a distribution directly from the retirement plan would have been identical to a distribution from the IRA. However, by law the exception that applies to retirement plan distributions does not apply to IRAs. Thus, the court found the taxpayer liable for the 10% tax on the distribution. To add insult to injury, the court also upheld the imposition of an accuracy-related on the taxpayer for the failure to pay the 10% tax.
Although the result in Kim v. Comm’r is not surprising, it does highlight the often technical requirements for qualified plans and IRAs can trip up unsuspecting taxpayers.
TAX ADVICE LIMITATION: To ensure compliance with the requirements of Circular 230, we inform you that any tax advice contained above is not intended or written to be used and cannot be used (i) by any taxpayer for the purpose of avoiding penalties that may otherwise be imposed under the Internal Revenue Code or (ii) by anyone for the purpose of promoting, marketing or recommending to another party any entity, investment plan or arrangement addressed herein.