Surprising Tax Court 72t Ruling

I don’t think this one should be banked upon just yet, as the IRS could well appeal the ruling. But the ruling does have potential to broaden the exceptions to breaking a 72t plan well beyond just the higher education exception. Up to now, death and total disability were the only exceptions that were allowed to terminate a plan, and while this one does not terminate the plan, neither does it result in a plan modification and retroactive penalties:
http://tax.cchgroup.com/news/headlines/2009/nws51209.htm#1



Denise,
Thanks for posting your excellent summary of this case. You may have noted that Bill Stecker posted an article on the 72t site that interpreted the ruling in terms of what he described as “stand alone” verbiage in various penalty exception conditions. I could not fully relate that explanation to the decision. Perhaps the tax court decision is more taxpayer friendly based on the overall trend of empathy for retirement savers whose assets have been decimated partially by lack of effective government regulation. This has led to more job losses and job losses lead to more 72t plans. Exacting more 10% penalties is contrary to the effort of rebuilding and preserving retirement assets. A busted SEPP in many cases is the final event in a string of setbacks, so this thinking is very understandable.

If the decision holds, then it will probably be expanded. Most SEPPs are done with IRA accounts, and several of those Sec 72 exceptions do not apply to IRAs including QDRO distributions. A divorce partitioned IRA account has led to various prior decisions in letter rulings, and they are all over the place. It’s so bad that no one knows for sure what the IRS will do if an IRA under a SEPP is split in a divorce action. The obvious solution would be to extend the QDRO exception to IRA accounts “transferred incident to divorce” , but to make relief in this area meaningful, a SEPP plan should just terminate as it would with death or disability.



Hi Alan,
Thanks for the feedback.
I think by ‘stand alone’ he is saying that (according to the court), one exception does not affect the other, i.e. there are not mutually exclusive.
I agree with your opinion of the Tax Court’s emphatic attitude. The question then becomes, when the economy turns around, do they reverse their position? Flip-flopping would not look good for them, but of course they could claim that they made a mistake.
I agree with you on the QDRO. For a participant who has separate from service, but kept the assets (for a qualified plan, 403(b)) with the former employer and takes SEPPs from the account, a QDRO payment should not result in a modification- and would not if we follow the court’s opinion. The IRS really needs to issue an official document on this- including a transfer due to divorce for IRAs- for the reasons you state.
Fun stuff…



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