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Lessons from the Tax Court: penalty-free plan distributions

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in Small Business Tax

Normally, you can’t withdraw funds from a qualified plan or IRA prior to age 59 1/2 without paying a 10 percent tax penalty. But several exceptions exist, including one for disabled taxpayers.

How severe does the disability have to be? In one new case, an injured boiler mechanic took a lump-sum distribution from his retirement plan after being out of work for two years.

It couldn’t be determined when he would resume work, so the payout is exempt from the 10 percent penalty. (Rideaux, TC Summary Opinion 2006-74)

On the other hand, the Tax Court recently imposed the penalty on an employee who missed two months of work due to depression. In that case, the disability was only temporary, the Court reasoned. Therefore, it said, the 10 percent penalty applied. (Johnson, TC Summary Opinion 2006-62)

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