Re-coding 1099-R to reflect ESPP/ 72(t)

Submitted by Josh Harmon on Sun, 2018-09-23 12:55

I have a client who has been taking ESPP withdrawals from his IRA for a few years. To limit liability, our investment firm always codes the 1099-R as a premature distribution, leaving it up to the client and CPA to re-code it to reflect the 72(t) election. I make sure to communicate with every client and their CPA each time this happens, and haven’t had any issues…until now. This particular client’s CPA didn’t re-code his 2016 distribution, and said that it is up to our firm to correct it. The client has already been sent a bill from the IRS for the penalty, and paid it. What can I tell the CPA to fix this issue? Thank you!



Submitted by David Mertz on Sun, 2018-09-23 15:05

While some IRA custodians will code the distribution with code 2 if they were involved in the calculation of the 72(t) distribution amount and they have made the distributions in agreement with that calculation, the custodian has no obligation to do so.  Refer the CPA to the instructions for Form 5329 line 2.  The CPA should have prepared 2016 Form 5329 and indicated on line 2 that the amount qualifies for an exception to the early-distribution penalty for reason code 02, indicating that the distribution was made as a series of substantially equal periodic payments.  https://www.irs.gov/pub/irs-prior/i5329–2016.pdf



Submitted by Alan - IRA critic on Sun, 2018-09-23 15:32

  • I agree. The CPA is incorrect and should have filed the 5329 accordingly.  Over the last couple decades the number of IRA custodians willing to “underwrite” the accuracy of the plan has steadily declined and a considerable majority of custodians code the distribution as early (code1).  One of the reasons is that taxpayers can “aggregate” their 72t plans over multiple accounts and custodians do not have first hand knowledge about activity on accounts they do not hold. Another reason is that other than RR 2002-62, there is very little specific guidance from the IRS on a number of SEPP related issues. What we have now is a collection of PLRs, tax court rulings and years of IRS oversight trends to go on, all of which have led to a general consensus of what is acceptable to the IRS.  Actually, the flexibility shown by the IRS has increased somewhat over the years.  Nonetheless, all 72t (SEPP) plans should be thoroughly documented at the time of the first distribution and that documentation retained until at least 3 years has passed since the plan modification date.
  • If the client’s distributions comply with the 72t requirements, a 1040X should be filed with a correct 5329 per DMx’s instructions to request a refund of the penalty. And the CPA should not charge for it under the circumstances.


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