Ambiguity of Exceptions to Early Distribution

[Guest Barry2005]

Taxpayer, a teacher, took a medical retirement in 2000 and at age 55 in 2005, requested lump sum distribution from 403(b).

The 1099-R received from the Payer shows Box 7 Distribution Code as "1" - "Early distribution - no known exception", even though the Payer requested, received and acknowledged certification of the separation from service and Doctor's letter confirming medical cause for retirement.

Taxpayer believed that the Payer company, based on the communication that there was a "Separation from Service" noted on their request letter, should have executed the 1099-R to show a Distribution Code "2" - "Early distribution - exception applies".

Taxpayer contacted the Payer, and were told that they agreed, but that the Taxpayer should file the 1099-R as is, with the exception noted. Which is what was done.

Now the Taxpayer's 2005 return is being examined by the IRS to pay the 10% penalty plus interest.

In 2005, and certainly in 2000, the only information we could get was the Tax Code, which lists "Separation of Service" as 1 of 4 exceptions and Pub. 575 which states: "Additional exceptions for qualified retirement plans. The tax does not apply to distributions that are from a qualified retirement plan (other than an IRA) after your separation from service in or after the year you reached age 55."

This is ambiguous, and does not expressly state that the separation AND distribution both must occur in year which you reach 55.

Having taken a medical retirement at age 50, without return to work, and delaying the distribution to age 55 seemed to fulfill the requirement. We could think of no logical reason that an earlier separation would have any impact, if the distribution did not occur until age 55. Especially considering that the original code seemed to give separation of service (no time constraint) equal footing with death, total disability, or age 59 1/2, as an exception to the 10% tax.

Are we just blowing in the wind?

[Guest mjb]

Taxpayer, a teacher, took a medical retirement in 2000 and at age 55 in 2005, requested lump sum distribution from 403(b).

Now the Taxpayer's 2005 return is being examined by the IRS to pay the 10% penalty plus interest.

In 2005, and certainly in 2000, the only information we could get was the Tax Code, which lists "Separation of Service" as 1 of 4 exceptions and Pub. 575 which states: "Additional exceptions for qualified retirement plans. The tax does not apply to distributions that are from a qualified retirement plan (other than an IRA) after your separation from service in or after the year you reached age 55."

This is ambiguous, and does not expressly state that the separation AND distribution both must occur in year which you reach 55.

Having taken a medical retirement at age 50, without return to work, and delaying the distribution to age 55 seemed to fulfill the requirement. We could think of no logical reason that an earlier separation would have any impact, if the distribution did not occur until age 55. Especially considering that the original code seemed to give separation of service (no time constraint) equal footing with death, total disability, or age 59 1/2, as an exception to the 10% tax.

Are we just blowing in the wind?

Where is the ambuigity in " the tax does not apply to distributions that are from a qualified retirement plan after your sepration from service in or after the year you reached age 55?" Separation from service means the year an employee stops working for the employer, not the date retirement benefits are paid. See instructions to 5329 form P 3.

[Appleby]

So in other words, the taxpayer is not eligible for the age 55 exception because she separated from service before the year she reached age 55.

The exception applies to taxpayers who separate from service in the year they reach age 55 or later and the distribution occurs after they separate from service

[joel]

So in other words, the taxpayer is not eligible for the age 55 exception because she separated from service before the year she reached age 55.

The exception applies to taxpayers who separate from service in the year they reach age 55 or later and the distribution occurs after they separate from service

Appleby: I appreciate the eloquence as well as substance of your answer. I'll bet that you are one of those nice guys that finish first.

Joel