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March 25, 2009

T.C. Summary Opinion 2009-37: Bailey v. Commissioner: Early Distribution Penalty Applies, because the account is an IRA

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This case confirms that the early distribution penalty exception for first time home buyers does not apply to retirement accounts unless they are IRAs, i.e. traditional IRAs, Roth IRAs, SEP IRAs and SIMPLE IRAs.

Highlights of the Case

The taxpayer made a withdrawal of $7,527 from her 401(k) plan, in order to use the funds to purchase a house. She included the amount on her tax return, but did not indicate that the amount was subject to the early distribution penalty.
The IRS issued a notice of deficiency to the taxpayer, indicating that the 10% early distribution penalty was owed on the amount.
The taxpayer disagreed, and indicated that she felt that the penalty should not apply, as the amount was used towards the purchase of a first home.
In response to the matter, the tax court cited IRC § 72(t)(2)(F), under which the exception applies for first time homebuyer distributions. This section explains that the provision applies only to IRAs.
The tax court concluded that the taxpayer was required to pay the 10% early distribution penalty, because the distribution occurred from a 401(k) plan, and not from an IRA. T.C. Summary Opinion 2009-37

Comments from RetirementDictionary

If the amount was rollover-eligible 

This issue could have been avoided if the taxpayer had rolled over the amount to an IRA, and then made the withdrawal from the IRA. This would have allowed the taxpayer to avoid the 10% early distribution penalty, and the time spent dealing with the IRS and the tax court.

If the amount was not rollover-eligible

If the amount was not rollover eligible, then the 10% penalty could not have been avoided, unless the individual qualified for an exception.

Additional Comments

Taxpayers, who are unsure of how the rules work and when they apply to retirement accounts, may want to consider consulting with a professional who is an expert on the technical rules which govern IRAs and employer sponsored plans. It is possible that the penalty was unavoidable, if – as noted above- the amount was not rollover eligible. However, someone familiar with the rules would have been able to help the taxpayer understand that the first-time home buyer exception does not apply to qualified plans.

Taxpayers who prefer to do their own research can start with the IRS Publications. However, any information obtained from the IRS publications should be verified against the Tax Code or other authoritative source.

For a list of the exceptions and the type of retirement account to which they apply, see Early distribution penalty exception

Written By

Denise Appleby

Denise is CEO of Appleby Retirement Consulting Inc., a firm that provides IRA resources for financial/ tax/legal professionals. She has over 20 years of experience in the retirement plans field, which includes training and technical consultation.

Denise writes and publishes educational /marketing tools for advisors; available at http://irapublications.com. Denise co-authored several books on IRAs

Denise is a graduate of The John Marshall Law School, where she obtained a Masters of Jurisprudence in Employee Benefits, and has earned 5 professional retirement designations.
She has appeared on numerous media programs, sharing her insights on retirement tax laws.

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