In 2002 my wife was laid off from her job. She
was 55 years old at the time and she liquidated
her 401(k) plan. The IRS later required
us to pay a 10 percent early withdrawal penalty.
It was my understanding that the early withdrawal
penalty is waived in these circumstances. Which
position is correct?
An early withdrawal penalty generally applies to distributions
from retirement plans prior to age 59½. As with all general tax rules there
The IRS relies on the payer of the
pension funds in issuing Form
1099-R to determine if an exception to the
10 percent penalty applies. If the payer knows
that an exception applies to your early distribution,
distribution code 2, 3 or 4 should be shown in
box 7 of your Form 1099-R (see Page 7 of the online
form) and you do not have to report the distribution
on Form 5329.
an exception applies but distribution code 1 (early distribution, no known exception)
is shown in box 7, you must file Form
5329. Enter the taxable amount of the distribution shown in box 2a of your
Form 1099-R on line 1 of Form 5329. On line 2, enter the amount that can be excluded
and the exception number shown in the Form 5329 instructions. Page 3 of Form 5329
lists exception code 1 as a distribution received in a year that you separated
from your employer's service (i.e. quit, dismissed or laid off) in the year that
you reached age 55.
If you're dealing with 2002, the IRS has
probably already assessed you the penalty and you may already have paid it. In
this case the statute of limitations may limit your ability to reopen the matter.
You usually have two years from the date that you paid a tax to make a claim for
refund. The claim would be done by filing Form
1040X for the year that the IRS assessed the penalty. IRS
Publication 556 provides further information on claims for refund.