Taxing Lessons From Court Decisions

Penalty on Early Withdrawal of Savings

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T.C. Summary Opinion 2010-72 (Blade) clarifies the difference between a penalty on early withdrawal of savings, which is a deduction from gross income on Form 1040, US Individual Income Tax Return, and the 10% additional tax assessed when early withdrawals are taken from retirement plans.

In this ruling, the taxpayer took an early distribution from a retirement plan. She deducted the 10% assessment on line 30, page 1 of her personal tax return, because that line is labeled “Penalty on early withdrawal of savings.”

The IRS said the 10% assessment authorized under section 72(t) of the Internal Revenue Code is not the same as the line 30 deduction, which is authorized under section 62(a)(9).

The court agreed with the IRS, stating section 62(a)(9) provides for a deduction from gross income for amounts forfeited to a bank, savings and loan association, or similar institution as a penalty for premature withdrawal of funds from a time savings account, certificate of deposit, or similar deposit.

In the case of an early withdrawal from a qualified retirement plan, section 72(t) provides for an increase in the taxpayer’s income tax by 10% of the portion of the distribution that is includable in the taxpayer’s income. The section 72(t) amount is payable to the US government and is not “forfeited” to a bank, savings and loan association, or similar institution as a penalty for premature withdrawal of funds from a time savings account, certificate of deposit, or similar deposit.

Taxing Lesson: Tax forms, tax form instructions and IRS publications are not authoritative sources of tax law.

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