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CCH® PENSION AND BENEFITS — 05/21/09

Exception to premature distribution tax for IRA distributions used to pay health insurance premiums is limited to payments made during tax year of distribution

A taxpayer who received IRA distributions in 2004 was not entitled to claim the exception from the 10% early withdrawal tax for the amount of premiums that she paid in 2003 and 2005, even though she may have been prevented from taking a distribution from her IRA in 2003 because of state unemployment compensation laws, the U.S. Tax Court has ruled in Davis v. Commissioner of Internal Revenue.

The taxpayer was laid off in July 2003 and began receiving state unemployment compensation benefits. The taxpayer understood that she would forfeit her unemployment benefits if she received any distributions from her retirement plans during the period she received such benefits. During 2004, the taxpayer received distributions from two IRAs. Since she had not attained age 59½ at the time of the distributions, the IRS determined that the entire 2004 distribution was subject to the 10% additional tax on early withdrawals.

The taxpayer contended that a portion of the 2004 distributions should be applied to her 2003 health insurance premiums and, hence, be excepted from the 10% tax, because she was prevented from taking a distribution from her IRA during 2003 on account of state unemployment compensation laws. She also contended that the portion of the 2004 distribution to pay health insurance premiums during 2005 should also be excepted from the tax. The Tax Court disagreed. The statutory exception for health insurance premiums is limited to the amount of premiums paid during the taxable year of the distribution, the court said. Thus, the taxpayer was not entitled to claim the exception for the amounts of premiums that she paid in 2003 or 2005. This is so, the court held, even though the taxpayer may have been prevented from taking a distribution from her IRA in 2003 because of state unemployment compensation laws.

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