The summary Tax Court opinion in the Merrell, TC Summary Opinion 2020-5 (https://www.ustaxcourt.gov/UstcInOp2/OpinionViewer.aspx?ID=12156) ruled that the ten percent penalty on early withdrawal from an IRA applies when the withdrawal was on account of the disability of the spouse rather than the account holder himself.)
The court point out that the disability exception to the 10% additional tax on certain IRA distributions only applies to the owner and no one else. This a tax trap for the unwary.
The Case Law…. In general, Code Sec. 72(t)(1) imposes an additional tax of 10% on IRA distributions.
Code Sec. 72(t)(2)(A)(iii) provides that the additional 10% tax does not apply to a distribution that is attributable to the employee’s being disabled. In the case of an IRA, the term “employee” is defined in Code Sec. 72(t)(5) as “the individual for whose benefit such plan was established.”
The Case Facts. In this case the taxpayer was Mr. Merrell, who was under the age of 59½ and was not disabled. He took a distribution from his IRA. He did not pay the 10% additional tax on the distribution because his felt that his wife who was disabled and filing joint with him would be shielded from the 10% additional tax penalty. The IRS sent the couple a notice of deficiency, saying the IRA distribution should be subject to the 10% additional tax.
All parties agreed that Mr. Merrell was the individual for whose benefit the IRA was established, Mr. Merrell was not disabled, and no other exception to the 10% additional tax applied.
The Final Court Decision. The Tax Court held that, because Code Sec. 72(t)(2)(A)(iii) specifically requires that a distribution be attributable to the employee’s disability for the exception to the 10% additional tax to apply, the exception did not apply here because it was not the IRA owner that was disabled, but his wife.
A small point of misunderstanding cost the Merrell’s a needless penalty.
This points out the need for effective pre-planning when clients set up their individual IRA’s.