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Lev
Lev, Tax Advisor
Category: Tax
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Experience:  Taxes, Immigration, Labor Relations
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My sister, as a part of her divorce settlement, was to receive

Customer Question

My sister, as a part of her divorce settlement, was to receive her share of the equity in her (and her ex's home) from her (ex) husband. In order for him to pay her, he took the $20k out of what was left of his half of his IRA (the other half already being paid to my sister as part of the divorce settlement). She rolled over the half of the IRA, but didnt notice that the house equity payment had been taken from pre-tax money as well, and did not roll that money over. The IRS says she owes full IRA early withdrawal tax on that $20k. Is there anything that can be done to eliminate the penalty?
Submitted: 1 year ago.
Category: Tax
Expert:  Lev replied 1 year ago.

LEV :

Hi and welcome to Just Answer!

The following exceptions apply to distributions from any qualified retirement plan - please verify if any may be used in your situation:

  1. Distributions made to your beneficiary or estate on or after your death.
  2. Distributions made because you are totally and permanently disabled.
  3. Distributions made as part of a series of substantially equal periodic payments over the life expectancy of the owner or life expectancies of the owner and the beneficiary. If these distributions are from a qualified plan other than an IRA, you must separate from service with this employer before the payments begin for this exception to apply.
  4. Distributions that are equal to or less than your deductible medical expenses, that is, the amount of your medical expenses that is more than 7.5% of your adjusted gross income. You do not have to itemize to meet this exception.
  5. Distributions that are qualified reservist distributions.
  6. Distributions made due to an IRS levy of the plan.
LEV :

After you reach age 59½, you can receive distributions without having to pay the 10% additional tax.

Even if you receive a distribution before you are age 59½, you may not have to pay the 10% additional tax if you are in one of the following situations.

You have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income.

The distributions are not more than the cost of your medical insurance due to a period of unemployment.

You are totally and permanently disabled.

You are the beneficiary of a deceased IRA owner.

You are receiving distributions in the form of an annuity.

The distributions are not more than your qualified higher education expenses.

You use the distributions to buy, build, or rebuild a first home.

The distribution is due to an IRS levy of the qualified plan.

The distribution is a qualified reservist distribution.

LEV :

Distributions that are timely and properly rolled over are not subject to either regular income tax or the 10% additional tax. Generally, a rollover is a tax-free distribution to you of cash or other assets from one retirement plan that you contribute to another retirement plan. The contribution to the second retirement plan is called a “rollover contribution.” You generally must make the rollover contribution by the 60th day after the day you receive the distribution from your traditional IRA or your employer's plan.
The IRS may waive the 60-day requirement where the failure to do so would be against equity or good conscience, such as in the event of a casualty, disaster, or other event beyond your reasonable control. In the absence of a waiver, amounts not rolled over within the 60-day period do not qualify for tax-free rollover treatment. You must treat them as a taxable distribution from either your IRA

LEV :

There are slightly different rules for distributions from 401k plans - however if her distribution is from IRA account - all above would be applied.

Customer :

It would appear then, that there is nothing to be done to save the nearly 25% in taxes (there is a $184 penalty as the early IRA distribution was made in 2011). Any other ideas?

LEV :

Generally - a waiver might be granted within a year after distribution.
Since distribution was in 2011 - I doubt that the IRS will waive 10% early distribution penalty.
Also - because distribution already took place - it will be included into taxable income - so nothing may be done here...
Because - there are additional late payment penalty - you may apply to abate such penalties.

LEV :

The best path forward might be to ask the IRS to abate penalties, however it would be very unlikely that interest charges are abated. File a form 843 -http://www.irs.gov/pub/irs-pdf/f843.pdf
to request the "accuracy related penalty" be abate based on reasonable cause. If you provide the reason like "I forgot" - I do not think it will be considered as reasonable - so be careful when prepare an abatement request.
Here are instructions - http://www.irs.gov/pub/irs-pdf/i843.pdf
If the IRS accepts your reasons as reasonable - and agrees to abate penalties - at least part of the issue would be resolved.

LEV :

Unfortunately - that seems the only possible option.

Customer :

Yes, thats what we thought. There is a waiver of the 10% early penalty for qdro related distributions on 403's . Are you aware of that?

Customer :

I found that in Pub 575 under the Taxes heading.

Customer :

nothing on 401's though.

LEV :

Yes - distributions from qualified retirement plans under QDRO are exempted from 10% penalty - no need to apply for a waiver. But that exemption doesn't apply to IRAs.
That exemption does apply to 401k distributions.

Customer :

ok, thanks. you appear quite knowledgable.

LEV :

Thanks - that is my profession for many years.

LEV :

Sorry if you expected a different answer.

Customer :

Hey, its not your fault...its the friggen law. Ill help my sister pay her debt, and get on with living.

LEV :

Appreciate your understanding.
If the tax debt is too large to pay immediately - your sister may apply for installment payment plan.
Separately - she may ask to abate penalty as I stated above.

Customer: replied 1 year ago.

as best ive been able to determine, your answer was incorrect. I
found two other sources that have stated that if the disbursement from
an IRA was due to a court ordered decree such as a divorce settlement,
and the IRA money was NOT rolled over, only the standard income tax is
due on that amount NOT the 10% early withdrawal penalty.

Expert:  Lev replied 1 year ago.
Will not argue with you - as long as you believe that your position is correct - you are OK.
However - I might suggest to verify with the IRS directly by calling _1_800_829_1040_ or by visiting a local IRS office.

Here is a publication 590 which covers most issues related to IRA accounts - http://www.irs.gov/pub/irs-pdf/p590.pdf
Let's take a look at page 55 where all exceptions to the age 59 1/2 rule are listed - as we could see - there is NO exceptions which you are referring.

What you might confused - there is such exemption for distributions from qualified retirements plans - for instance for distributions from 401k plans if transfers are under a Qualified Domestic Relations Order (QUADRO) - however that doesn't affect IRA accounts.
So far most likely there is a misunderstanding, but if you provide references to other sources - I will definitely verify for you.
Appreciate your understanding.

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Lev
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Taxes, Immigration, Labor Relations