Owe the IRS? Use Your Traditional IRA to Pay them Penalty Free!
Do you owe the IRS back taxes or a large tax bill for the current year? Many people with no other alternatives may think it is a good idea to take money out of their Traditional IRA to pay the taxes.
If you are not yet 59-1/2 years old or older, you would be subject to a 10% early withdrawal penalty in addition to your total withdrawal amount being added to your income since Traditional IRA contributions have never been taxed. Depending on how much you take out this can put your taxable income in a higher tax bracket.
Paying your tax bill with a retirement plan wouldn’t be my first choice of advice, there are many options out there for you and some good strategies to spread out the impact. However, if this is your ONLY alternative there are several exceptions to the age 59½ rule and you may not have to pay the 10% additional tax if you are in one of the following situations
- You have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income.
- The distributions are not more than the cost of your medical insurance.
- You are disabled.
- You are the beneficiary of a deceased IRA owner.
- You are receiving distributions in the form of an annuity.
- The distributions are not more than your qualified higher education expenses.
- You use the distributions to buy, build, or rebuild a first home. (The first $10,000 only)
- The distribution is a qualified reservist distribution.
- The distribution is due to an IRS levy of the qualified plan.
- (2011 rules see Publication 590 for details on how to qualify for each of the following categories).
For this blog I wanted to let you know that if the IRS levy’s your IRA to pay your tax bill, this is one of the exceptions to the 10% penalty. This exception is only for a Traditional IRA so if your money is in a 401K, you can roll it over into a Traditional IRA and then let the IRS levy the money from your Traditional IRA. Contact the IRS regarding your specific situation to see if this is an option for you. It would also be a good idea to speak with your tax advisor to be clear on the impact this decision can have on your tax return.
I am posting general information in this blog but if you have a specific questions please post below.