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Early IRA Distribution Used to Pay Taxes Doesn’t Cover Penalties

Nice try, but no. That appears to be the message from a court that said that a couple who used funds from an early IRA distribution to pay state and federal taxes cannot claim that qualifies as an exception to the penalty for taking an early distribution.

In “Close Is Not Enough When it Comes to the 10% Penalty,” a recent entry in the Slott Report blog, Sarah Brenner discusses the recent ruling by the U.S. Tax Court in David D. Pritchard et ux v. Commissioner, T.C. Memo 2017-136 (July 10, 2017).

David and Barbara Pritchard took an IRA distribution before age 59½. They put the money from that distribution into an account and used it to pay taxes they owed the state of California and the federal government. The Pritchards argued that since they took the distribution to pay tax bills, they qualified for an exception to the 10% early distribution penalty that is granted for IRA distributions taken due to an IRS levy.

They did not take the distribution specifically due to a levy by the IRS, something even the Pritchards recognized, Brenner writes. “Basically, the Pritchards argued that close was good enough,” she says. The Tax Court that close was not good enough, and that the early distribution they took did not qualify for the exception and was subject to the 10% penalty.

The Pritchards are in good company, Brenner writes. “Many taxpayers have tried to get courts to grant relief from the 10% penalty even though no exception exists in the law as written,” she says,but notes, “This never results in a good outcome.

This result, Brenner argues, serves as a reminder of the need for caution when taking early distributions — and the importance of meeting the specific requirements of the federal tax code for the exception to the 10% early distribution penalty.