If you withdraw funds from an IRA before age 59½, you’re generally assessed a 10% penalty tax on the taxable portion of the early withdrawal, in addition to the regular income tax liability, unless a special exception applies. The list of exceptions in the tax code includes the following:
- Distributions made to a beneficiary or estate on account of the IRA owner’s death
- Distributions made due to disability
- Distributions made as part of a series of substantially equal periodic payments
- Distributions made due to an IRS levy against the account
- Distributions that are qualified reservist distributions
- Distributions for first-time homebuyer expenses (subject to a lifetime $10,000 limit)
- Distributions for higher education expenses
- Distributions for medical expenses to the extent they exceed the AGI threshold for deductible medical expenses.
Currently, the threshold for deducting qualified medical expenses is 10% of adjusted gross income (AGI) or 7.5% of AGI if you’re age 65 or older. The IRS interprets these rules narrowly, and it often prevails in the courts.
New case: A 47-year-old taxpayer, a resident of Maine, was employed at a hospital. In 2011, she earned $33,866 and took a distribution from her IRA of $5,294. Then she used the distribution to pay for her son’s medical expenses.
On her 2011 return, the taxpayer elected head-of-household filing status and claimed a personal exemption for herself and a dependency exemption deduction for her daughter, but not her son. She did not report the IRA distribution as income or pay the 10% penalty, allegedly based on the advice of her accountant.
There’s no reason why the taxpayer should not be taxed on the IRA distribution. As for the 10% penalty tax, the special tax-law exception applies only if the medical expenses are paid on behalf of the taxpayer, a spouse or a dependent. But the taxpayer’s son wasn’t her dependent. Accordingly, the taxpayer in this case had to pay the 10% penalty on top of the regular income tax. (Ireland, TC Summary Opinion 2015-60)
Tip: It didn’t matter that the taxpayer may have relied on erroneous advice from a tax pro.
- Small Business Tax Deduction Strategies No matches