72t
We have a client that has been making 72t distributions since October of 2006.
From October 2006 – December 2006 he withdrew $25,666 including his withholding for taxes
From October 2006 – September 2007 he withdrew $69,316 including his withholding for taxes
From October 2007 – September 2008 he withdrew $77,000 including his withholding for taxes
From January of 2007 – December 2007 he withdrew $77,000 including his withholding for taxes.
The intention was to spend $4850 a month and do 25% withholding each year. All withholding has been done in December, which i thinik might have created the problem.
The 25% withholding done in December 2006 was based on the distributions that occurred from October – December ($4850 distributed twice in October, once in November and once in December. The taxes were $6266 held in December).
The 25% withholding done in December 2007 was based on the entire calendar year distribution of $58,200 and $18,800 was withheld for a total of $77,000.
A fixed amortization method was used to calculate the 72t distributions.
Calendar Year Fiscal Year (October – September)
2006 $25,666 $69,316
2007 $77,000 $77,000
2008 $77,000 TBD
It appears that the SEPP has not been met because of when the tax withholding was done. If a fiscal year distribution method is to be used then the withholding should have been done either on a monthly basis or before the end of the fiscal year (September of each year).
Is there a Silver Lining here? Could there be a pro – rata formula that I’m missing that would keep this from “Busting”?
Permalink Submitted by Alan Spross on Tue, 2008-12-09 03:07
Although you can “back into” a valid 72t with some luck if you catch an error soon enough no matter what your intent was, I cannot find a way for this one.
First of all, a 72t is inherently a calendar year plan and the IRS will be looking a 1099R forms which are on a calendar year, attained age as of a calendar year etc. I do not know, nor did I consider what would transpire if he were on a tax fiscal year starting 10/1, but assume that this is not the case and that he is a calendar year filer.
While the first 3 month “stub year” can produce either a 3 month or a full 12 month distribution, this does not fit the 77,000 annual amount. The plan was busted at some point in 2007.
Now, if the wittholding error had not been made, and a uniform amount was taken each month, he could still back into a calendar year plan, but the withholding plan messed up that possibility.
Client is probably best served to file a 5329 for 2007 reporting the retroactive penalty for the 2006 and 2007 distributions. For 2008, a new plan can be started since the payment of the penalty for 2007 effectively ends the first plan.
To avoid a penalty for 2008, there is a chance of backing into a valid plan. The start date would be January, 2008. I figure that 43,650 has been withdrawn through end of Sept, 2008. You would need to find an account balance sometime late in 2007 on which to base a new plan and the proper interest rate at the time would be the Nov or Dec, 07 rate of either 5.28 or 4.97. Use his age attained in 2008, and see what the annual figure is. Then determine how much more needs to be taken before year end to reach that figure. You can lower the interest rate below those numbers to reduce the annual distribution or use a joint life expectancy with a beneficiary to also reduce it. That provides some flexibility and a very interesting math challenge. If it can be done, carefully document that calculations used, and 2008 can perhaps be salvaged.
The IRS will probably bill back interest on the retroactive penalty, so that should be paid ASAP. That’s probably the least of the problems. And of course get the withholding on a controlled basis, quarterly estimates provides more taxpayer control than withholding.
Permalink Submitted by Scott Grenier on Wed, 2008-12-10 14:34
Thank you for your response to the 72t question. Since the client distributed 1/3 of the total amount in 2006 for a 72t that started in October 2006, is it possible that he can finish the remaining distribution in the final stub year.
Here is what the income would look like for a calendar year vs. 12 month distribution period:
Calendar Year
2006 $25,666
2007 $77,000
2008 $77,000
2009 $77,000
2010 $77,000
2011 $51,334
The stub ends of the calendar year distributions would create a full year distribution that would have the following attributes:
October – December 2006
$25,666 which is 1/3 of $77,000
January – September 2011
$51,334 which is 2/3 of $77,000
My interpretation of the reply to this question is that the first stub year did not have the correct prorated distribution for that calendar year. There were three months of potential distributions, but the client exceeded the prorata distribution amount by taking $25,666 instead of the $77,000 / 4 (3 months out of a 12 month time frame) = $19,250.
Out of curiosity would have the following worked out:
October – December 2006 (3 months)
$19,250 which is 1/4 of $77,000
January – December 2007, 2008, 2009, and 2010
$77,000
January – September 2011 (9 months)
$57,750 which is 3/4 of $77,000
Permalink Submitted by Alan Spross on Wed, 2008-12-10 19:13
There is no precedent for offsetting a first stub year error by an offsetting adjustment in the final stub year. Each of those years is limited to certain options, but this is not one of them.
To limit damage, I think the client could file a stand alone Form 5329 for year end 2006 reporting the plan busted in that year by the withholding error. That would reduce the penalty to only 2,566 plus interest from 4/15/07 to date of payment. The new plan would start in 2007 rather than 2008 and eliminate the penalty on 2007 distributions.
Under the new plan he would take out exactly 77,000 for 5 calendar years, or longer if age 59.5 were reached after 2011. That is, if the 77,000 number can be justified for a Jan, 07 start date. That is the key.
The following letter ruling is seen to provide clearance to report a prior busted plan in the year of the first error, providing what was done thereafter met the requirements of a new plan. If the 77,000 annual payment could be justified using a 12/31/06 balance and interest rate of Nov or Dec 06, a valid new plan would have started in 2007.
This appears to offer the least financial damage considering the situation.
PLR 1999 09059:
http://www.legalbitstream.com/scripts/isyswebext.dll?op=get&uri=/isysque…