Special Additional Taxes(p78)

To discourage the use of pension funds for purposes other than normal retirement, the law imposes additional taxes on early distributions of those funds and on failures to withdraw the funds timely. Ordinarily, you will not be subject to these taxes if you roll over all early distributions you receive, as explained earlier, and begin drawing out the funds at a normal retirement age, in reasonable amounts over your life expectancy. These special additional taxes are the taxes on:

• Early distributions, and
• Excess accumulation (not receiving minimum distributions).

These taxes are discussed in the following sections.

If you must pay either of these taxes, report them on Form 5329. However, you do not have to file Form 5329 if you owe only the tax on early distributions and your Form 1099-R correctly shows a "1" in box 7. Instead, enter 10% of the taxable part of the distribution on Form 1040, line 59 and write "No" under the heading "Other Taxes" to the left of line 59.

Even if you do not owe any of these taxes, you may have to complete Form 5329 and attach it to your Form 1040. This applies if you meet an exception to the tax on early distributions but box 7 of your Form 1099-R does not indicate an exception.

Most distributions (both periodic and nonperiodic) from qualified retirement plans and nonqualified annuity contracts made to you before you reach age 591/2 are subject to an additional tax of 10%. This tax applies to the part of the distribution that you must include in gross income.

For this purpose, a qualified retirement plan is:

• A qualified employee plan,
• A qualified employee annuity plan,
• A tax-sheltered annuity plan, or
• An eligible state or local government section 457 deferred compensation plan (to the extent that any distribution is attributable to amounts the plan received in a direct transfer or rollover from one of the other plans listed here or an IRA).

If an early withdrawal from a deferred annuity is otherwise subject to the 10% additional tax, a 5% rate may apply instead. A 5% rate applies to distributions under a written election providing a specific schedule for the distribution of your interest in the contract if, as of March 1, 1986, you had begun receiving payments under the election. On line 4 of Form 5329, multiply the line 3 amount by 5% instead of 10%. Attach an explanation to your return.

Certain early distributions are excepted from the early distribution tax. 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 and you do not have to report the distribution on Form 5329. If 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.

The tax does not apply to distributions that are:

• Made as part of a series of substantially equal periodic payments (made at least annually) for your life (or life expectancy) or the joint lives (or joint life expectancies) of you and your designated beneficiary (if from a qualified retirement plan, the payments must begin after your separation from service),
• Made because you are totally and permanently disabled, or
• Made on or after the death of the plan participant or contract holder.

The tax does not apply to distributions that are:

• From a qualified retirement plan (other than an IRA) after your separation from service in or after the year you reached age 55 (age 50 for qualified public safety employees),
• From a qualified retirement plan (other than an IRA) to an alternate payee under a qualified domestic relations order,
• From a qualified retirement plan to the extent you have deductible medical expenses (medical expenses that exceed 7.5% of your adjusted gross income), whether or not you itemize your deductions for the year,
• From an employer plan under a written election that provides a specific schedule for distribution of your entire interest if, as of March 1, 1986, you had separated from service and had begun receiving payments under the election,
• From an employee stock ownership plan for dividends on employer securities held by the plan,
• From a qualified retirement plan due to an IRS levy of the plan, or
• From elective deferral accounts under 401(k) or 403(b) plans or similar arrangements that are qualified reservist distributions.

If you are a qualified public safety employee, distributions made from a governmental defined benefit pension plan are not subject to the additional tax on early distributions. You are a qualified public safety employee if you provide police protection, firefighting services, or emergency medical services for a state or municipality, and you separated from service in or after the year you attained age 50.

A qualified reservist distribution is not subject to the additional tax on early distributions. A qualified reservist distribution is a distribution (a) from elective deferrals under a section 401(k) or 403(b) plan, (b) to an individual ordered or called to active duty (because he or she is a member of a reserve component) for a period of more than 179 days or for an indefinite period, and (c) made during the period beginning on the date of the order or call and ending at the close of the active duty period. You must have been ordered or called to active duty after September 11, 2001. For more information, see Publication 575.

The tax does not apply to distributions that are:

• From a deferred annuity contract to the extent allocable to investment in the contract before August 14, 1982,
• From a deferred annuity contract under a qualified personal injury settlement,
• From a deferred annuity contract purchased by your employer upon termination of a qualified employee plan or qualified employee annuity plan and held by your employer until your separation from service, or
• From an immediate annuity contract (a single premium contract providing substantially equal annuity payments that start within one year from the date of purchase and are paid at least annually).

To make sure that most of your retirement benefits are paid to you during your lifetime, rather than to your beneficiaries after your death, the payments that you receive from qualified retirement plans must begin no later than on your required beginning date (defined later). The payments each year cannot be less than the required minimum distribution.

If the actual distributions to you in any year are less than the minimum required distribution for that year, you are subject to an additional tax. The tax equals 50% of the part of the required minimum distribution that was not distributed.

The tax may be waived if you establish that the shortfall in distributions was due to reasonable error and that reasonable steps are being taken to remedy the shortfall. See the instructions for Form 5329 for the procedure to follow if you believe you qualify for a waiver of this tax.

For this purpose, a qualified retirement plan includes:

1. A qualified employee plan,
2. A qualified employee annuity plan,
3. An eligible section 457 deferred compensation plan, or
4. A tax-sheltered annuity plan (for benefits accruing after 1986).

Unless the rule for 5% owners applies, you generally must begin to receive distributions from your qualified retirement plan by April 1 of the year that follows the later of:

• The calendar year in which you reach age 701/2, or
• The calendar year in which you retire from employment with the employer maintaining the plan.

However, your plan may require you to begin to receive distributions by April 1 of the year that follows the year in which you reach age 701/2, even if you have not retired.

You might not receive the minimum distribution because assets are invested in a contract issued by an insurance company in state insurer delinquency proceedings. If your payments are reduced below the minimum due to these proceedings, you should contact your plan administrator. Under certain conditions, you will not have to pay the 50% excise tax.

If you are a 5% owner, you must begin to receive distributions by April 1 of the year that follows the calendar year in which you reach age 701/2.

You reach age 701/2 on the date that is 6 calendar months after the date of your 70th birthday.

For example, if you are retired and your 70th birthday was on June 30, 2008, you were age 701/2 on December 30, 2008. If your 70th birthday was on July 1, 2008, you reached age 701/2 on January 1, 2009.

By the required beginning date, as explained earlier, you must either:

• Receive your entire interest in the plan (for a tax-sheltered annuity, your entire benefit accruing after 1986), or
• Begin receiving periodic distributions in annual amounts calculated to distribute your entire interest (for a tax-sheltered annuity, your entire benefit accruing after 1986) over your life or life expectancy or over the joint lives or joint life expectancies of you and a designated beneficiary (or over a shorter period).

For more information on this rule, see Tax on Excess Accumulation in Publication 575.

You must file a Form 5329 if you owe a tax because you did not receive a minimum required distribution from your qualified retirement plan.