A well-known quote attributed to baseball great, Frank Robinson, says “Close doesn’t count in baseball. Close only counts in horseshoes and hand grenades.” In a recent Tax Court Case, David D. Pritchard et ux. v. Commissioner; T.C. Memo. 2017-136 (July 10, 2017),the Court found the exceptions to the 10% penalty for early distributions from retirement accounts to be more like baseball than horseshoes or hand grenades. Close is not good enough!
An IRA Distribution to Pay Taxes
Here is the story behind the court case. David and Barbara Pritchard had ongoing tax troubles with both the IRS and the state of California. In 2008, either David or Barbara (the record is unclear as to who) took a distribution from an IRA. Both David and Barbara were under age 59 ½ at the time. The Pritchards deposited the funds into a bank account and used the funds to pay taxes due to both the state of California and the IRS. The issue of whether the Pritchards owed the 10% early distribution penalty on the money they took out of their IRA ended up in the Tax Court.
Close is Not Good Enough
The Court held that the IRA distribution was subject to the 10% early distribution penalty, despite some creative arguments put forward by the Pritchards that an exception should apply.
There is an exception to the 10% early distribution penalty for IRA distributions due to an IRS levy. The Pritchards said that even though the IRA distribution was not actually due to a levy by the IRS, it was pretty close because the funds were used to pay taxes and, therefore, this exception to the 10% penalty should apply. Basically, the Pritchards argued that close was good enough.
The Court disagreed and said close is not good enough. As many courts have said before, the court does not have the power to expand the exceptions to the 10% penalty beyond what was specifically included by Congress when it was written into law.
Many taxpayers have tried to get courts to grant relief from the 10% penalty even though no exception exists in the law as written. This never results in a good outcome. While many other taxpayers have tried to argue financial hardships as a way to get out of the penalty, these taxpayers tried a more creative argument. They argued that close was good enough. This argument met with the same bad results. No relief can be granted when the requirements for an exception as written in law are not met.
If you are thinking about taking an early distribution from your retirement account, be careful. Close is not good enough. You must meet the specific requirements of one of the exceptions listed in the tax code to avoid the 10% early distribution penalty. Just being in the ballpark, as these taxpayers found out, will not work to escape the penalty. Because the rules for the exceptions to the 10% penalty can be confusing, your safest bet may be to discuss your situation with a knowledgeable tax or financial advisor.