Taxing Lessons From Court Decisions

Decisions — The Value of Time

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Image source: LetsgomusicStyle (Own work) [CC BY-SA 3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia Commons
Image source: LetsgomusicStyle (Own work) [CC BY-SA 3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia Commons
Generally, when you withdraw funds from your retirement account before you reach age 59-1/2, you’ll owe a 10% additional tax on the withdrawal (internal revenue code section 72(t)).

There are, of course, exceptions—16 or more of them, depending on how you count. One exception is distributions attributable to being disabled at the time the distribution is made. You’re disabled if you’re unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration (Treasury Regulation 1.72-17A(f)(1)).

That regulation goes on to define “substantial gainful activity” as the activity, or a comparable activity, you customarily engaged in before the onset of the disability. In addition, the regulation supplies examples, including progressive physical diseases, such as diabetes, that have resulted in the physical loss or atrophy of a limb. However, the impairment does not, by itself, mean you qualify as disabled. The impairment must be assessed with reference to whether it prevents you from engaging in substantial gainful activity.

In T.C. Summary Opinion 2015-37 (Trainito), the taxpayer was diagnosed with diabetes in 2005. Due to the diabetes, he experienced symptoms such as blurry vision and neuropathy. He resigned from the Boston Department of Environmental Health in October 2010 after more than ten years on the job due to problems stemming from diabetes, including being unable to perform the required task of lifting heavy manhole covers.

Following his diagnosis with diabetes in 2005, the taxpayer saw a primary care doctor twice per month until his resignation from his job with DEH in October 2010. He did not produce any medical records relating to these visits, nor did his primary care doctor testify on his behalf.

On April 22, 2011, when he was 45, the taxpayer received a distribution of his retirement savings account from the city of Boston. During June and July of that year, he was in the hospital as the result of a diabetic coma. The coma resulted in muscle atrophy and the reduced use of an arm and a leg. The taxpayer provided medical records to substantiate his hospital stay. In March of 2012, the taxpayer applied for disability benefits from the state of Massachusetts.

The taxpayer filed his federal income tax return for 2011 in November of 2012. He claimed the April 2011 distribution from his retirement account was exempt from the 10% early withdrawal penalty due to his permanent disability.

The IRS said the distribution did not qualify for an exception to the penalty. The IRS said the taxpayer was not disabled (per the definition in the treasury regulation) when he received the retirement plan distribution on April 22, 2011.

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Note: Taxing Lessons provides a summarized version of sometimes lengthy court decisions. The full case may include facts and issues not presented here. Please use the link provided to read the entire case.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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The taxpayer provided records that relate to the diabetic coma he suffered in June 2011. He did not provide any medical records for periods before this date, including medical records for periods before April 22, 2011, the date of the distribution of his retirement funds.

The taxpayer testified at trial that, following his diagnosis with diabetes in 2005, he saw a primary care doctor twice per month until his resignation from his job with the Boston Department of Environmental Health in October 2010. However, despite receiving frequent treatment, the taxpayer did not produce any medical records relating to these visits, nor did his primary care doctor testify on his behalf.

The taxpayer argues that he was disabled within the meaning of section 72(m)(7) because he suffered from diabetes. However, notwithstanding the severe medical event experienced in June 2011, the relevant date we must consider is April 22, 2011, because section 72(t)(2)(A)(iii) requires that the distribution be attributable to the taxpayer’s being disabled.

A taxpayer may not escape the 10% early withdrawal penalty by suffering a disability at just any point during the tax year; rather the disability must be present at the time the distribution is made. (See Kopty v. Commissioner, T.C. Memo. 2007-343 (finding that distributions were not attributable to disability where diagnosis of heart condition was not made until after taxpayer received distributions from his retirement fund)).

Thus the fact that the taxpayer suffered a diabetic coma in June 2011 does not indicate whether he was disabled in April 2011. The taxpayer undoubtedly suffered from diabetes in April 2011, but he has not provided sufficient evidence to show that his diabetes caused him to be disabled within the meaning of section 72(m)(7).

Accordingly, the distribution from the retirement plan in April 2011 was not attributable to his being disabled within the meaning of section 72(m)(7). The taxpayer has not shown that any other exception to the section 72(t) early withdrawal penalty applies.

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