Thursday, October 29, 2020


Tax Court Summary Opinion 2019-19 deals with a mistake I have seen taxpayers, including a couple of clients, make over the years.  And it emphasizes the importance of three points –

* A little knowledge is dangerous

* Always check with your tax professional before making a move that could affect your taxes.  And

* What I have continually said is the best advice I can give any taxpayer - do not accept tax advice from anyone other than a professional tax preparer.

Here are the facts of the case.

If you take a withdrawal from an IRA account or a qualified retirement plan, such as a 401(k), prior to turning age 59½, and the withdrawal is not rolled over to another retirement account within 60 days, you are subject to a 10% premature withdrawal penalty.

The taxpayer in the case, under age 55, closed out her 401(k) plan account to make the down payment for her and her husband’s first home.  She was told by her plan representative that she would not pay a premature withdrawal penalty on the full amount because they were first-time home buyers.  But she did not verify this with a tax professional.

The IRS correctly assessed a 10% penalty on the entire amount of the withdrawal, which was upheld in TC Summary Opinion 2019-19

The taxpayer and her 401(k) representative were correct that there is an exception to the 10% penalty – Exception 09 – for a distribution of up to $10,000 for first-time home purchases (the little knowledge).  However, this exception is ONLY for distributions from an IRA account and does NOT apply to withdrawals from a qualified employer retirement plan like a 401(k).

Of the various available exceptions to the premature withdrawal penalty some are for withdrawals from ANY qualified retirement account, some are only for withdrawals from an IRA account or IRA annuity, and one is only for withdrawals only from a qualified employer retirement plan like a 401(k).  The first-time home purchase exception is one of those that applies only to IRA withdrawals.

If the taxpayer had checked what she was told by her plan representative with her, or a, tax professional before closing out the account she would have been told that none of the withdrawal would qualify for the penalty exception.

The tax professional would probably have told her to rollover her 401(k) account directly into an IRA account and then withdraw the money from that IRA account to cover the down payment.  Then $10,000 would be exempt from the penalty and the taxpayers would have saved $1,000 plus the resulting penalty and interest assessment as well as the applicable court costs.

Don’t make the same mistake, or a similar one.  Always check with a qualified tax professional before taking any action, regardless of what anyone else has told you or what you have read somewhere.


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