How does the IRS know I”m using 72t?

L1: How does the IRS know I”m using 72t?I recently was contacted by the IRS concerning my 72t distributions. They want me to pay the 10% penalty on my 2006 distributions.
It”s not clear to me how they WOULD know that I”m using 72t. There”s nothing on the Form 5329 to indicate that I”m taking substantially equal periodic payments.
I”m optimistic that I canget the current issue resolved but how do I preventthe same thingin my 2007 return?
Thanks,
Denny2008-01-28 12:34, By: Denny, IP: [12.4.141.8]

L2: How does the IRS know I”m using 72t?Hello Denny:
The IRS generally does not know you are taking SEPP distributions; but for two forms: one, your 2006 1099R from your trustee/custodian may have a “2” in box 7 which indicates SEPP distributions; or you completed Form 5329 with your 2006 tax return and put a “2” on line 2 of that form.
Now, sometimes either of the two codings above are sufficient; sometimes they are not; the result of which is that you receive a deficiency notice in the mail requesting the 10% surtax plus some amount of interest.
At this point the burden of proof is on the taxpayer. You should write (never call) back to the IRS & explain (again) that you are taking SEPP distirbutions along with all of the particulars of your computations. Then your job is done and the burden reverts back to the IRS. Most people never hear another word.
I do not know how to prevent this situation from recurring other than they must keep track somehow becuase I do not recall having a client who got the same letter two tears in a row.
TheBadger
wjstecker@wispertel.net
2008-01-28 14:00, By: TheBadger, IP: [72.42.66.180]

L2: How does the IRS know I”m using 72t?Denny,
I am working on my 2007 taxes, with two SEPP plans, using Tax Cut on my PC as usual. This is the first year that a 1099-R for an IRA withdrawal (my new plan with Vanguard) is not coded with the “2”, so one of my 2 IRA SEPP plans caused it to produce form 5329. In box 1a, (in Tax Cut worksheet) the SEPP with code 2 has the dollars listed, and in box 1b (“other excepted amounts”) I put the Vanguard SEPP $$.In box 2, there is a place for the code you use to describe why your withdrawal does not require a 10% penalty. I entered code “2”. Below it, (in Tax Cut worksheet area that does not print on final form to IRS) there is a place where I choose from 12 reasons why there is no penalty due.I checked off the 2nd choice of the 12 whichstates ” Distrib as part of series of substantially equal lifetime pmnts”. Afterselectingthat in their program, all of the SEPP monies from the 1099-Rs for IRA SEPP payments generate no additional tax, and the dollar totalof both SEPP withdrawals for 2007 ends up on the printed form 5329 in box 1 and also in box 2 (“early distribs that are not subject to addit tax”) with the code 2 also in the middle of box 2. I can see what you mean about not much information ending up on the final printed 5329 to validate your SEPP. It may be that your 1099-R had a code “1”, like mine does from Vanguard, and as The Badger said, they want your proof that this is for a valid SEPP, since the computer may have kicked it out as not having the code “2” like the one that I have on my Schwab SEPP 1099-R. KEN2008-01-28 15:24, By: Ken, IP: [75.67.65.254]

L2: How does the IRS know I”m using 72t?Ken,
While this is no big deal, it appears that you are also addressing the Schwab 1099R which is correctly coded with the “2” exception code in the worksheets. That causes the Schwab distribution to also appear on the 5329 when it technically should not because it is correct as issued. It does not show as “early” on their 1099R.
The split between lines 1 and 2 of the 5329 apply when you wish to correct only part of a single 1099R entry. Let”s say you ask for a 15,000 distribution from your IRA and only use 10,000 for higher education expenses. In that case 15,000 would go on line 1 because the entire amount is coded early (code 1), but 10,000 of that amount should not be penalized because of the higher education exception. 10,000 goes on line 2 which is subtracted from line 1 to leave 5,000 subject to penalty instead of 15,000.
Accordingly, the Vanguard 1099R amount incorrectly coded early should be the only entry on line 1 and also on line 2. When you subtract line 2, you are then left with none of the Vanguard 1099R subject to penalty.
Like I indicated, this is no big deal because the result is the same. You just ended up also correcting the Schwab 1099R to a “2” when it showed that exception all along and did not need to be part of the 5329.
2008-01-28 19:10, By: Alan S., IP: [24.116.165.60]

L2: How does the IRS know I”m using 72t?Thanks, Guys. This is good info.
I, too, am getting my distributions from Vanguard and asked them about the “1” code on the 1099R. They said that they always put the “1” on the forms and it”s up to me, the taxpayer, to correct it with the IRS. I guess this covers their butts.
Thanks for all your help.
Denny2008-01-29 06:02, By: Denny, IP: [12.4.141.8]

L2: How does the IRS know I”m using 72t?Hi Alan,
Thanks for the feedback on my 5329 posting. In the past, I did not have a 5329 (using tax cut) cuz only IRA 1099-R was for Schwab with code 2, but after I entered the two IRA 1099-R”s (both SEPP”s), Tax Cut put the $$ from the Schwab (code 2)1009 on line 1a (in their worksheet) and it put the balance with the code 1 (Vanguard SEPP ) in line 1b. Then it asked me about line 1b as I described above. When done, it all came out as no penalty, (and these 1a and 1b lines did not print on final 5329 as I recall.. because I had printed it to see what “shows” on 5329) but I see your point. I have just gone to my other house, so When I get back to my Cape home, I will take a harder look at Tax Cut in light of your comments. I appreciate your expertise, and always enjoy reading your responses whether here, or onEd Schlott”s IRAsite (and maybe Fairmark as well!). It is great to have such an expert to help us all, and to educate us. Your knowledge and time helping us is greatly appreciated. KEN2008-01-29 14:28, By: Ken, IP: [151.203.42.107]

L2: How does the IRS know I”m using 72t?More info for Alan on Tax Cut-
I am back at computer where I am working on the Tax Return and reviewing form 5329. The Tax Cut worksheet parts of form 5329 come into play–(in section at top titled “Early distributions other than Roth” it lists the sum of both SEPP 1099s with description of”1099”s with code 1-2-3 or 5 in box 7″, and that combined total also ends up on line 1 titled “early distributions included in income”. Under line 1 combined total, it then lists(in worksheet part) line 1a whereit lists the Schwab IRA $$ (code 2 one) in box titled “Taxable amounts in with codes 2 or 3 in box 7”. Then in worksheet1b line it lists the Vanguard (code 1) IRA $$ as “other excepted amounts”. In worksheet box 1d it lists “sum of 1a and 1b”, and I am back to combined total of my SEPPS. That combined total is then listed in box 2 as “Early distribs not subject to addit tax” and the box below it is coded “2” for reason.Only box 1 and 2 and the code “2” below box 2 print out on the form 5329. I guess that is how taxcut documents it in detail, even though those worksheet figures do not endup on the form submitted to IRS. I can see why IRS might audit a return with a code 1 1099, if the filer claims it as not requiring additionaltax for early withdrawal.At least it all works out in Tax Cut. KEN
2008-01-30 15:48, By: Ken, IP: [75.67.65.254]