What’s in a Number? The Age of Separation

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In tax law, as you might expect, numbers matter. Age is one of those numbers. For example, once you reach age 70-1/2, you’re required to take minimum distributions from your traditional Individual Retirement Account.

Here’s another age milestone in tax law–55. That’s the age when you can qualify for the separation-of-service exception to the 10% penalty on early distributions from retirement accounts.

In Watson (T.C. Summary Opinion 2011-113), the taxpayer was 53 when she retired from her job. Two years later, at age 55, she took two distributions from her qualified retirement plan. She reported the distributions as income, but did not include an additional $3,000 penalty.

The IRS said she was under age 55 when she retired, so the distributions, though taken after she reached age 55, did not qualify for the separation-of-service exception to the penalty.

The taxpayer countered that the wording in the IRS notice was unclear. It read “… payment made from the Plan after you separate from service if you will be at least 55 during the year of the payment.”

The court agreed the wording of the IRS notice was unclear. However, the court said, the wording in the law is plain–you must be age 55 when you separate from service (see code section 72(t)(2)(a)(v))–and the penalty is due.

Taxing Lesson: When conflicting interpretations are possible, look to the source.

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