Close Isn’t Good Enough Under the Tax Code
By Jeremy T. Rodriguez, JD
Follow Us on Twitter: @theslottreport
There’s an old saying that being close only counts in horseshoes and hand grenades. Such is the case with the U.S. Tax Code. In this arena, deadlines and timing really matter. Trying to do a 60-day rollover 61 days after the actual receipt of withdrawn funds doesn’t work. Taking your annual required minimum distribution on January 2nd, instead of December 31st, isn’t good enough.
Similarly, all of the exceptions to the 10% early distribution penalty contain specific requirements which must be met. Some exceptions apply to both IRAs and qualified plans whereas others are only available to one of the two. One of the most important requirements each exception shares is timing. For example, in the case of Duronio v. Commissioner, a married couple took an IRA distribution to help finance their son’s college education. Clearly, they intended to qualify for the exception for college education expenses. Instead, they were hit with penalties to the tune of $9,483.
The Duronio’s were a married couple living in northern New Jersey. Their son had decided to attend New York University (“NYU”) beginning with the spring and fall semesters of 2002. As a result, the couple made an $18,000 tuition payment to NYU in December of 2001. This payment came from family savings and other resources. The son then obtained a $19,263 student loan in the fall of 2002. During the 2002 taxable year, no repayments were made on the student loan nor did the family make any tuition payments to NYU. To be clear, this makes sense since the loan would be used to finance the education and wouldn’t become due until after graduation.
Nevertheless, Mrs. Duronio took a $19,900 distribution from her Traditional IRA near the beginning of 2002. At the time of the distribution, she was under age 59 ½. When the couple filed their 2002 tax return, they reported the IRA distribution as taxable income. However, they did not calculate the 10% early distribution penalty, instead claiming that they qualified for the exception for college education expenses. The IRS disagreed and the matter wound up in Tax Court.
The Duronio’s made two arguments to the Court. First, they argued that the initial $18,000 tuition payment made in December 2001 strained their finances. As a result, they had to take the 2002 IRA distribution to make ends meet. In other words, they wouldn’t have taken the IRA distribution if they didn’t have a tuition bill. Therefore, they argued, they should qualify for the exception. Secondly, the Duronio’s claimed that they had personally guaranteed their son’s 2002 student loan. Thus, even if the Court rejects their first argument, the 2002 distribution should be applied to the loan guarantee, which should also qualify for the education expense exception.
Not surprisingly, the Court rejected both arguments. While the $18,000 tuition payment may have caused financial difficulty, the Court ruled that qualified higher educational expenses paid in a year other than the year of an early IRA distribution will not qualify for exemption of the early distribution penalty. It didn’t matter that the tuition payment caused the IRA distribution or that the distribution was made only a few months after the initial tuition payment. Because the IRA distribution did not occur during the 2001 taxable year, the couple could not use 2001 education expenses to offset the early distribution penalty.
As for their second argument, the Court sidestepped the issue since the couple couldn’t provide credible evidence that they guaranteed the loan. Even if they had, it is unlikely the Court would have ruled in their favor. Generally, eligible education expenses include tuition, fees, books, supplies, equipment, and in some cases, room and board. Paying off student loans after graduation is not a qualifying expense.
So in the end, not only did the Duronio’s have to deplete their IRA to make up for the 2001 tuition payment, but they got hit with an additional, and completely unnecessary, $9,000 plus tax bill. Just a little bit of planning would have avoided all of this trouble. The takeaway here is that, under the Tax Code, timing matters. Deadlines are generally firm. Being close won’t get you a cigar, but it could give you an unwelcome tax bill.
Content Citation Guidelines
Below is the required verbiage that must be added to any re-branded piece from Ed Slott and Company, LLC or IRA Help, LLC. The verbiage must be used any time you take text from a piece and put it onto your own letterhead, within your newsletter, on your website, etc. Verbiage varies based on where you’re taking the content from.
Please be advised that prior to distributing re-branded content, you must send a proof to email@example.com for approval.
For white papers/other outflow pieces:
Copyright © [year of publication], [Ed Slott and Company, LLC or IRA Help, LLC - depending on what it says on the original piece] Reprinted with permission [Ed Slott and Company, LLC or IRA Help, LLC - depending on what it says on the original piece] takes no responsibility for the current accuracy of this information.
Copyright © [year of publication], Ed Slott and Company, LLC Reprinted with permission Ed Slott and Company, LLC takes no responsibility for the current accuracy of this information.
For Slott Report articles:
Copyright © [year of article], Ed Slott and Company, LLC Reprinted from The Slott Report, [insert date of article], with permission. [Insert article URL] Ed Slott and Company, LLC takes no responsibility for the current accuracy of this article.
Please contact Matt Smith at firstname.lastname@example.org or (516) 536-8282 with any questions.