To avoid extra 10% tax, who decides whether a participant is disabled?

[Peter Gulia]

A participant took a distribution that attracts the extra 10% tax on a too-early distribution, unless the participant is totally and permanently disabled.

The plan's administrator approved the participant's claim for the distribution because the participant was severed from employment. (Nothing in the plan's provisions calls for any decision about whether a participant is disabled.)

The payer asked the plan's administrator to sign a form to state the administrator's finding that the participant is disabled. The administrator declined to sign, not only because it had not made such a finding but also because such a finding is unnecessary in the plan's administration.

The participant is worried that the payer will tax-report the distribution without putting the disability code on the Form 1099-R. She worries that the IRS's computer will flag her tax return as one that ought to have included the form for declaring the extra 10% tax on a too-early distribution.

Is the participant's worry grounded in BenefitsLink mavens' experience?

If the payer wants to respond to the participant's worry, may the payer make its own decision (without involving the plan's administrator), solely for tax-reporting purposes, about whether the distributee is disabled?

[jpod]

I have no experience with this, but could the 72(t) exception even apply if the participant was entitled to a distribution whether or not disabled? My guess is that it could, but I never considered it.

[Peter Gulia]

The participant became entitled to a distribution not because she attained any 50-something age but rather because she was severed from employment.

This circumstance is why the tax-reporting question turns on a point the plan's administrator had not decided.

BenefitsLink mavens, what happens in the real world?

[jpod]

I guess mine is a chicken or egg question. If participant became entitled to a distribution because of a separation, can she avoid the 72(t) tax because she happened to be disabled?

[GMK]

(Nothing in the plan's provisions calls for any decision about whether a participant is disabled.)

This seems odd, or is it common for plans not to have distribution conditions based on disability?

In any case, if she didn't terminate due to total disability (as defined in the Plan), I agree with jpod that it doesn't seem likely she can avoid the 10% penalty in this case.

[jpod]

I actually think it IS likely, but I don't know for sure and am just raising the issue.

[Lou S.]

What are the Plan's provisions for proving disability? If she meets those and provides the evidence I would think the Plan Administrator would have to issue the 1099-R with disability code.

[Peter Gulia]

Internal Revenue Code § 72(t)(2)(A)(iii):

Except as provided in paragraphs (3) and (4), paragraph (1) [the imposition of the tax] shall not apply to any of the following distributions: Distributions which are — (iii) attributable to the employee’s being disabled within the meaning of subsection (m)(7)[.]

A fact-finder might find that a distribution grounded on severance from employment is “attributable to the employee’s being disabled” if the employment ended because the former employee is unable to work.

In the situation I described, the payer makes its tax-reporting decision separately from the administrator’s decision that a severance from employment entitled the participant to a distribution.

If the payer does not put the disability code on the Form 1099-R, will the IRS look for the extra 10% tax?

[ETA Consulting LLC]

Regardless of what is put in box 7 on the Form 1099R, the taxpayer will have a chance to apply the exemption to the early withdrawal penalty when completing their Form 1040. I think it's done on Form 5329.

Even with the "3" is box 7 on the Form 1099R, you 'may' still need to prove to the IRS if asked that you meet the conditions of Section 72(m)(7).

Good Luck!

[jpod]

My guess is that "attributable to" has not been interpreted literally, as in "but for" the disability, but again I haven't looked into it and am guessing.

[Peter Gulia]

ETA Consulting and jpod, thank you for the good help.

In my experience, many participants prefer to avoid a need to explain a tax position, and so try to persuade the payer to tax-report a payment so everything is logically consistent for the IRS's computers.

Does any BenefitLink maven have experience with how a payer reacts to a request that the payer make a finding that the plan's administrator had not made?

[Bird]

Does any BenefitLink maven have experience with how a payer reacts to a request that the payer make a finding that the plan's administrator had not made?

Working from memory, I am pretty sure there are at least some recordkeepers who will not code a distribution with the disability code under any circumstances; they leave it to the participant to report it as exempt. As noted above there is a Form 5329 for that. I imagine they will follow up and ask for proof of disability, but I doubt that they will ask for proof that the termination is "due to" the disability.

[masteff]

When I was in Benefits at a large corporation, the only time we made a disability distribution was when "total and permanent" had been found under the long term disability plan or if the participant brought proof of Social Security disability.

Otherwise as noted twice above, the participant's method of claiming the exemption is Form 5329.

[Mike Preston]

GFAK!! Not you. My best guess as to the reaction.

[Tom Poje]

just for grins (since you indicated "Nothing in the plan's provisions calls for any decision about whether a participant is disabled." I tried looking in some of the documents we have. they all seem to at least partially address the issue (which seems to correspond closely to mastiff comments)...

FT William

Definition of Disability

a. [ ] Under Code section 22(e). The Participant is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months. The permanence and degree of such impairment shall be supported by medical evidence.

b. [ ] Under the Social Security Act. The determination by the Social Security Administration that the Participant is eligible to receive disability benefits under the Social Security Act.

c. [ ] Inability to engage in comparable occupation. The Participant suffers from a physical or mental impairment that results in his inability to engage in any occupation comparable to that in which the Participant was engaged at the time of his disability. The permanence and degree of such impairment shall be supported by medical evidence.

d. [ ] Pursuant to other Company Disability Plan. The Participant is eligible to receive benefits under a Company-sponsored disability plan.

e. [ ] Under uniform rules established by the Plan Administrator. The Participant is mentally or physically disabled under a written non-discriminatory policy.

f. [ ] Other:

NOTE: If A.21f is selected, provide the definition of Disability. The definition provided must be objectively determinable and may not be specified in a manner that is subject to discretion.

Accudraft

1.1 Disability. The term Disability means a physical or mental impairment arising after an Employee has become a Participant which, in the opinion of the Social Security Administration, qualifies the Participant for disability benefits under the Social Security Act in effect on the date that the Participant suffers the mental or physical impairment.

Corbel

1.80 "Total and Permanent Disability" means the inability to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than twelve (12) months. The disability of a Participant shall be determined by a licensed physician. However, if the condition constitutes total disability under the federal Social Security Acts, the Administrator may rely upon such determination that the Participant is Totally and Permanently Disabled for the purposes of this Plan. The determination shall be applied uniformly to all Participants.

Fidelity

11.03. Disability Retirement. If so provided by the Employer in Subsection 1.14© of the Adoption Agreement, a Participant who becomes disabled while employed as an Employee shall have a 100 percent vested interest in his Account regardless of any vesting schedule elected in Section 1.16 of the Adoption Agreement. An Employee is considered disabled if he satisfies any of the requirements for disability retirement selected by the Employer in Section 1.15 of the Adoption Agreement and terminates his employment with the Employer. Such termination of employment is referred to as a disability retirement.

[Peter Gulia]

Thank you - Bird, masteff, Mike Preston, and Tom Poje - for the further help.