A taxpayer was subject to income tax on a distribution he received from his Sec. 401(k) plan and was not entitled to an exception from the 10% additional tax imposed by Sec. 72(t)(1) for early distributions because his medical condition did not cause him to be disabled as defined in Sec. 72(m)(7), the Tax Court held.
The taxpayer’s diabetes did not prevent him from engaging in substantial gainful activity, the court holds.
Facts: Robert Lucas worked as a software developer at a company called Life Cycle Engineering until 2017, when he lost that job and experienced financial difficulties. To supplement his income, Lucas obtained a $19,365 distribution from his 401(k) plan. When he received the distribution, Lucas had not yet attained the age of 59½. The plan administrator reported the distribution as an early distribution “with no known exceptions” (box 7, Code 1) on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
Lucas reported the distribution on his 2017 Form 1040, U.S. Individual Income Tax Return, but did not include the distribution in taxable income, claiming that it was excludable from gross income because he had diabetes, which was first diagnosed in 2015 while he was working at Life Cycle.
The IRS issued a deficiency notice determining that Lucas’s 2017 tax return should have included the distribution from his 401(k) plan in gross income. In addition, since Lucas took the distribution before he attained age 59½, the Service also assessed the 10% additional tax imposed by Sec. 72(t)(1) for early distributions because his medical condition, in the IRS’s opinion, did not cause him to qualify for the exception to the addition to tax in Sec. 72(t)(2)(A)(iii) for disabled taxpayers.
Issues: Gross income, by definition, includes distributions from employees’ trusts for “any amount received as an annuity (whether for a period certain or during one or more lives) under an annuity, endowment, or life insurance contract” (Secs. 61(a) and 72(a)(1)). One type of trust is a 401(k) plan, which is a qualified cash or deferred arrangement “of an employer for the exclusive benefit of his employees or their beneficiaries” (Sec. 401(a)).
Lucas claimed that the distribution should not have been included as gross income because he had diabetes. In coming to this conclusion, Lucas relied on a website that, in his view, addressed the issue.
Distributions from a qualified retirement plan are subject to an additional 10% tax if the taxpayer is under 59½ years of age and cannot claim an applicable exception. One such exception is if the distribution is attributable to an employee’s being disabled within the meaning of Sec. 72(m)(7) (Sec. 72(t)(2)(A)(iii)).