As Humphrey Bogart said in The African Queen, “Things are never so bad they can’t be made worse.” That’s true when you take an early distribution from your retirement account, even if you need the money to avoid eviction.
Generally, early withdrawals—those you take from your IRA or other retirement plan before reaching age 59-1/2—are subject not only to income tax at your regular rate but also an additional 10% tax (internal revenue code section 72(t)).
As always, there are exceptions, though hardship is not one of them, as the taxpayer in T.C. Summary Opinion 2015-13 (Morles) discovered. He withdrew money from his IRA to avoid being evicted from his apartment and argued that his economic hardship should make the withdrawal excludable from income.
The court agreed the taxpayer took the distributions because of a pending financial crisis. However, the court said, “Nothing in section 72 suggests that such an exclusion exists, and we are aware of no other provision of the Internal Revenue Code that would allow for one.”
The court did note the taxpayer had basis in his IRA due to previously nondeductible contributions. Interestingly, the taxpayer failed to file the Form 8606 to report the nontaxable portion as required. Nonetheless, the court said, “Nothing in the statutory scheme suggests that a taxpayer who fails to satisfy these reporting requirements cannot include nondeductible individual retirement account contributions in the taxpayer’s investment in the contract.”
Finally, the taxpayer tried to avoid the additional 10% tax due to hardship. Unfortunately, the court pointed out there is no hardship exception to the additional 10% tax.
Do you know which of the following are exceptions to the additional 10% tax on early distributions from an IRA?
Reaching age 59-1/2
Total and permanent disability of the account owner
Qualified higher education expenses
A series of substantially equal periodic payments
Qualified first-time homebuyer
IRS levy on the plan
Unreimbursed medical expenses greater than 10% of AGI
Health insurance premiums paid while unemployed
Certain distributions to qualified military reservists called to active duty
Returned IRA contributions if withdrawn by the extended due date of the tax return
Earnings on returned IRA contributions
In-plan Roth rollovers or eligible distributions contributed to another retirement plan or IRA within 60 days
When an employee separates from service during or after the year the employee reaches age 55
And a bonus question:
Is the 10% additional early withdrawal tax deductible as “a penalty on early withdrawal of savings”?