72t election stopped in error

[Guest nlmc18]

Client made a 72t election and was paid for 3 years. He then changed IRA custodians who didn't set up his annual 72t distribution. 2 years have gone by without a distribution. He is not 59 1/2 until 3/2008. Anyone have experience with IRS on this type situation? Should he just go ahead and pay the 10% tax (and interest) on the 3 years of distributions, or is there another way to handle w/ IRS?

[Guest ERISA_kid]

If your client was taking a series of substantially equal periodic payments that were interrupted before the end of the required payment period (greater of five years or until attainment of age 59 1/2), the client has a modification under Section 72(t)(4). If that's the case, the taxpayer is required to retroactively treat all previous payments under the series as not exempt from the 10% penalty. However, given the time that has elapsed since the interruption, you should advise your client to speak with a tax attorney since there may be statute of limitation issues, which play in his/her favor.

[Mary Kay Foss]

They should go back and pay the tax. The penalty is assessed on Form 5329. The form can be attached to Form 1040-x or filed separately. Interest will be owed from the April 15 that the tax return was due until the IRS receives the payment.

The Internal Revenue Code allows for waivers of the 50% penalty but not this one. The statute of limitations is not going to save you. It is interesting that the 10% penalty tax is not treated as a tax that is dischargeable in bankruptcy; it seriously has to be paid.

Check out your state law as well. Some states impose their own penalty when the 10% penalty is owed on the federal return.