Ask Me Help Desk - Early 401k withdrawal Penalty

Hi there! I can't seem to find a good answer on this topic, so I'm asking the experts!!

Last year, I made a 401k withdrawl for higher education expenses. The withdrawl amount was 14k. I took the option of paying taxes on the amount, so I received 12k.

1) The 1099 form received states the 14k withdrawl, but I only received 12k for school. So, now I'm being taxed on the 2k difference. Does this seem right/make sense?

2) For MI taxes, (Schedule 1, Line 20) only allows for credit for higher education when the account falls under IRC Section 408. I don't believe that the 401k program meets this burden. Am I correct? Am I missing an alternate exemption or am I stuck paying the penalty on the full amount?

Thanks in advance for the help!!

You are stuck paying both income taxes and the 10% early withdrawal penalty on the full $14K amount. As for whether this is "fair" - well, it's similar to the way you report wages - using the pre-tax amount, so at least it's consistent. And since this is money that was deferred wages in the first place it makes sense. Report the $14K amount from the 1099-R on your 1040 as "pensions and annuities" income on line 16 of the 1040. Show the $1,400 10% penalty on line 60 - "Additional tax on IRAs, other qualified retirement plans, etc"). Include the $2K that was withheld as taxes already paid on line 64. Note that you must use form 1040, and not 1040-A or 1040-EZ.

As for the question regarding MI taxes - I believe that they are saying that early withdrawals from an IRA do not have a 10% penalty if used for higher education. Unfortunately withdrawals from a 401(k) do not have such an exception.

I have been using TurboTax and it placed the amount on 1040 line 15b?

Also, the amount used for higher education isn't subject to the penalty...

TurboTax calculated the penalty only on the amount that I didn't receive (the amount paid for taxes)... I guess the moral is that I shouldn't have been proactive in paying the tax on the withdrawal amount, hey?

1040 line 60 computed the penalty on the 2k at $200.

1040 line 64 only states that amounts on the w-2 and 1099 should be shown. However, the 2k isn't shown on the 1099.

Hehehe... taxes and fair don't belong in the same sentence!

Quote:

Originally Posted by TaxHelpInMI

I have been using TurboTax and it placed the amount on 1040 line 15b?

Also, the amount used for higher education isn't subject to the penalty...

TurboTax calculated the penalty only on the amount that I didn't receive (the amount paid for taxes)......I guess the moral is that I shouldn't have been proactive in paying the tax on the withdrawal amount, hey?

1040 line 60 computed the penalty on the 2k at $200.

1040 line 64 only states that amounts on the w-2 and 1099 should be shown. However, the 2k isn't shown on the 1099.

Hehehe....taxes and fair don't belong in the same sentence!

The mistake you are making is that you are trying to report this as withdrawal from an IRA, but you told us that it was from a 401(k). Which is it? If it's from a 401(k) then you should go back and check your TurboTax entry - line 15 is to report IRA withdrawals, not 401(k), and you use line 16 for 401(k). Unfortunately, an early withdrawal from a 401(k) is subject to the 10% penalty, even if used for higher education. But early withdrawals from an IRA are indeed exempt from the 10% penalty if used for higher education, so again, please clarify what kind of distribution this was.

The $2K that was withheld should be shown in box 4 of the 1099-R. It would be helpful if you could tell us exactly what amounts are in each of the boxes of your 1099-R, whether there is a code shown in box 7 (I would expect it to be a 1, but if it's a 2 that would explain some of the discrepancy), and also whether the IRA/SEP/SIMPLE box is checked?

You are right. I apologize for being confusing. I double checked my records... the plan is a Rollover IRA (was a 401(k), but rolled over after leaving employment in 2006).
1099-R Form:
Box 1: 14158.36
Box 2a: 14158.36
Box 2b: checked at "Taxable Amount Not Determined"
Box 3: N/A
Box 4: 1415.83
Box 5: N/A
Box 6: N/A
Box 7: Code 1
IRA/SEP/SIMPLE: checked
Remaining boxes (beside state code) empty.

Federal Taxes Form 1040:
15b: 14,158
60: 146 (calculated from taxes not paid on the 1415.83)

From Michigan Form 1040:
13: 12,700
This amount is taken from Schedule 1, Miscellaneous Subtractions under distributions from IRA. In the Instructions for this schedule, I found this note:

The amount of a distribution from individual retirement accounts that qualify under IRC section 408 if the distribution is used to pay qualified higher education expenses (tuition,
Books, fees, etc.) at a postsecondary educational institution.

Whew! So the original question still applies... does this qualify as an IRA under IRC section 408 for this deduction?

Thank you for all of your time and patience!

One of the mistakes you are making is in thinking the $2K was the taxes on the withdrawal. It wasn't, it was WITHHOLDING. Just like the amounts taken from from your regular paycheck. So you are taxed on the full amount of the withdrawal and the amount withheld is then applied to your total tax liability.

Quote:

Originally Posted by ScottGem

One of the mistakes you are making is in thinking the $2K was the taxes on the withdrawal. It wasn't, it was WITHHOLDING. Just like the amounts taken from from your regular paycheck. So you are taxed on the full amount of the withdrawal and the amount withheld is then applied to your total tax liability.

Oh, that makes sense! Thanks!:D

Quote:

Originally Posted by TaxHelpInMI

Whew! So the original question still applies....does this qualify as an IRA under IRC section 408 for this deduction?

Yes it does - IRC section 408 defines IRA plans, which your rollover plan is. Here's a Wikipedia article on section 408:
Individual Retirement Account - Wikipedia, the free encyclopedia
As a distribution from a roll-over used for higher education you do not have to pay the 10% penalty. So no problem there.

One other thing: since the reason code given on your 1099-R is "1," this means that your IRA administrator couldn't say whether the distribution is subject to the 10% penalty or not. To avoid some unpleasant future correspondence with the IRS I suggest you attach form 5329 to your return and put the appropriate exception code on line 2 of that form (code 08, for higher education). Does TurboTax automatically prepare this form for you?

Quote:

Originally Posted by ebaines

Does TurboTax automatically prepare this form for you?

It did fill out the form and put the reason code in...

I just finished and mailed my taxes! Thank you very much for all of your time and answers! You were an awesome help!!