Advanced Underwriting Consultants

Ask the Experts – April 1

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: I have a client who’s receiving series of substantially equal periodic distributions for life (SEPL) under Section 72(t) from her IRA to avoid the 10% early distribution penalty. After starting the SEPL plan, she made a direct trustee-to-trustee transfer of the entire IRA balance to a new carrier, but the new carrier is reporting that no exception applies when it sends my client a 1099-R. What should she do?

Answer: Fortunately, Congress and the IRS make the rules—not your client’s new carrier—so as long as she follows the SEPL rules under Section 72(t), and if the direct trustee-to-trustee transfer doesn’t disqualify the SEPL, she will not owe a penalty on the distributions.

Ordinarily, the carrier files Form 1099-R when it makes a SEPL distribution and shows in Box 7 that an exception to the 10% early distribution penalty applies. If this is the case, the taxpayer is not required to file Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.

However, the carrier isn’t required to verify that an exception applies when it makes a distribution and sends out the 1099-R. In such cases, the carrier will generally claim in Box 7 that “no known exception” applies to the 10% penalty.

If this happens, the taxpayer will have to file Form 5329, assuming an exception actually applies. She will only be required to fill out Part I of Form 5329 with respect to this distribution, and it should show that no additional tax is required.

On a side-note, if the carrier reports on the 1099-R that no known exception to the penalty applies, and if the taxpayer agrees that the 10% penalty should apply, she can skip Form 5329 and directly report the penalty on her Form 1040, line 58.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.