Modification of section 72(t) SEPP

[Guest CJA]

If an individual starts to receive SEPP in annual distributions, can frequency of payments be changed (i.e., can individual take annual distribution one year, switch to quarterly in year two and then to monthly in year three)? I don't want to allow changes in frequency if it would result in application of 10% penalty. Besides a PLR issued in 1989, I can't find much guidance.

[Belgarath]

As far as I know, there isn't any other guidance on this. For anyone who is interested, the PLR follows.

LTR-RUL, PEN-RUL 17,378 P, IRS Letter Ruling 8919052, February 15, 1989.

IRS Letter Ruling 8919052, February 15, 1989.

Individual Retirement Accounts: Additional tax on early distributions: Substantially equal periodic payments

Distributions from an IRA that were part of a group of substantially equal periodic payments made over the joint lives of the taxpayer and designated beneficiary were not subject to the 10% additional tax on early withdrawals. Back reference: See "Finding Lists".

[Reproduced below is the text of Letter Ruling 8919052, relating to the taxation of substantially equal periodic payments from an IRA. The ruling carries the stamped legend: "This document may not be used or cited as precedent. Sec. 6110(j) of the Internal Revenue Code."]

This letter is in response to your request for a ruling on behalf of Taxpayer P and Taxpayer J as to whether certain proposed distributions from an Individual Retirement Account (IRA) owned by Taxpayer P are part of a series of substantially equal periodic payments and are therefore not subject to the 10% additional tax imposed under section 72(t) of the Internal Revenue Code on early distributions. The original ruling request, dated November 17, 1988, was subsequently modified in phone conversations with our office and by a letter dated January 12, 1989.

According to the facts, Taxpayer P, following termination of his employment on June 21, 1988, at the age of 55, received a distribution from his retirement plan. The distribution was paid in two installments both received on July 28, 1988. The entire distribution was rolled over into a self-directed Individual Retirement Account (IRA) on August 3, 1988. Taxpayer J is Taxpayer P's spousal beneficiary on the IRA account. Taxpayer P decided to start receiving distributions from his IRA in 1988, with the annual distribution amount to be determined by amortizing the IRA account balance over the joint life and last survivor expectancy of Taxpayer P and Taxpayer J (obtained from Table VI in section 1.72-9 of the Income Tax Regulations), using an assumed interest rate of earnings of 9%. Beginning within 60 days from the date of this letter and continuing thereafter, the annual distribution amount will be paid in the form of equal monthly payments.

Section 408(d) of the Internal Revenue Code provides that amounts paid or distributed out of an individual retirement plan must be included in gross income by the payee or distributee in the manner provided under section 72 of the Code.

Section 72 of the Internal Revenue Code provides rules for determining how amounts received as annuities, endowments, or life insurance contracts and distributions from qualified plans are to be taxed.

Section 72(t)(1) of the Internal Revenue Code provides for the imposition of an additional 10% tax on early distributions from qualified plans, including IRAs. The additional tax is imposed on that portion of the distribution which is includible in gross income. Section 72(t)(2)(A)(iv) of the Code provides that section 72(t)(1) shall not apply to distributions which are part of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the employee or the joint lives (or joint life expectancies) of such employee and his beneficiary.

Section 72(t)(4) of the Code imposes the additional limitation on distributions expected from the 10% tax by section 72(t)(2)(A)(iv) that if the series of payments is subsequently modified (other than by reason of death or disability) before the later of (1) the close of the 5-year period beginning with the date of the first payment, and (2) the employee's attainment of age 591/2 , then the taxpayer's tax for the first taxable year in which such modification occurs shall be increased by an amount determined under regulations, equal to the tax which would have been imposed except for the section 72(t)(2)(A)(iv) exception, plus interest for the deferral period.

Section 1.72-9 of the regulations provides tables that are to be used in connection with computations under section 72 and the regulations thereunder. Included in this section are tables giving life expectancies for one life (Table V) and joint life and last survivor expectancies for two lives (Table VI).

The proposed method for determining periodic annual payments described in the ruling request is to first obtain a monthly payment and then multiply this monthly payment by 12 to obtain an annual payment. The monthly payment is an end of month payment derived by amortizing the account balance (as of one month before the first payment) over a number of months equal to the joint life and last survivor expectancy of the account owner and his spousal beneficiary (obtained from Table VI of section 1.72-9 of the regulations) in years multiplied by 12, and assuming a nominal annual interest rate of return equal to 9%, compounded monthly. Under the proposed method the annual periodic payment, once determined, will not change except in the case of the death of Taxpayer P or Taxpayer J. Should either Taxpayer die, the survivor may elect to have the annual distribution amount for the year following the year in which such death occurs, and continuing thereafter, recalculated using the survivor's life expectancy only (obtained from Table V of section 1.72-9 of the regulations). The original request provided that the annual payment would be distributed in one or more installments which, when aggregated for the distribution year, would equal the annual distribution amount. Pursuant to discussions with our office, this payment schedule has been modified such that beginning within 60 days from the date of this letter and continuing thereafter, such annual payment will be distributed on a monthly basis. Furthermore, such annual payments were determined as a level amount payable over the joint life and last survivor expectancy of Taxpayer P and Taxpayer J. The joint life and last survivor expectancy and the interest rate used to determine the periodic payments are such that they do not result in the circumvention of the requirements of sections 72(t)(2)(A)(iv) and 72(t)(4) of the Code (through the use of an unreasonably high interest rate or an unreasonable life expectancy).

Accordingly, we conclude that the proposed method (as modified) of determining periodic payments results in substantially equal periodic payments within the meaning of section 72(t)(2)(A)(iv) of the Code. Accordingly, such payments will not be subject to the additional tax of section 72(t) unless the requirements of section 72(t)(4) are not met.

[masteff]

Revenue Ruling 2002-62 ( http://www.irs.gov/pub/irs-irbs/irb02-42.pdf ) refers repeatedly to the "annual" amount. Based on this and on the PLR, I would presume that as long as you consistently calculate the amount received in total annually, then you're fine. So figure your annual amount and divide it by the number of payments during the year (1, 2, 4, 12, etc).

[JanetM]

I agree with you masteff. The IRS only sees the 1099R from IRA company. It doesn't designate the number or timing of payments. What would cause them to look in to the timing if the required annual amount is taxed?

[jevd]

I agree with you masteff. The IRS only sees the 1099R from IRA company. It doesn't designate the number or timing of payments. What would cause them to look in to the timing if the required annual amount is taxed?

I Agree with Janet & Masteff also and the following site is dedicated to this topic.

72(t).Net

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