When my husband and I bought our new home in 2005, we both withdrew money from our 401Ks. I took $5,693 of which they took 20% in federal income tax withheld and he took $8,000 of which they took 10% in federal income tax withheld. They are now coming back to me and saying we both owe the 10% penalty. My question is, if they only took 10% from him to begin with, why do they only want 10% more from him but they still also want an additional 10% from me when I already paid a full 20%? I also thought that using your 401K as a downpayment on a new home negated the requirement to pay the penalty. Please explain.

You can be exempt from the 10% penalty if you are using the 401K withdrawal to purchase your FIRST home, but not an upgrade.

Even if you are exempt from the penalty, you still have to pay taxes on the amount. The amount withheld from the distribution is just a withholding. You have to add the amount of the withdrawal to your taxable income for the year and then figure out your tax liability. Whatever was withheld is applied towards your tax liability.

Did you have someone prepare your 2005 taxes or did you do it yourself. A preparer could be held liable for any penalites due to this mistake.

I did my taxes through turbo tax.

Did you get 1099s for the distribution? Did you enter those in TT? I'm not sure if TT would pick up on the fact that they were 401K withdrawals. You can check with Intuit to see if their guarantees will cover you.

But that will only cover any penalities for incorrect filing. But if this wasn't your first house, then you owe the penalty on the withdrawal. If you didn't add the income from the 1099s then you owe taxes on that income.

Scott:

The exemption from the Early Withdrawal Penalty for "first time homebuyers" applies for IRA early withdrawals, NOT 401K.

Whoops. So that means it more liekly they owe the penalty.

Yes, that is MOST likely!