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Tax Court Rejects Diabetic Taxpayer's Attempt to Avoid Penalty on Early Retirement Distribution.

(Parker Tax Publishing July 12, 2015)

The Tax Court held that a diabetic taxpayer could not claim a disability exemption to avoid the 10 percent early distribution penalty on amounts distributed from his retirement account. Despite suffering a debilitating coma just weeks after the distribution, the court found the taxpayer could not prove he was disabled within the meaning of the exemption at the time of the distribution. Trainito v. Comm'r, T.C. Summary 2015-37.

Background

Beginning in 1997, Charles Trainito was employed by the City of Boston Department of Environmental Health (DEH). His duties with DEH involved lifting heavy manhole covers and placing rat bait as a means of decreasing the city's rat population. In addition to his work with DEH, Trainito worked part time as a chef at an Italian restaurant in Boston.

Trainito was diagnosed with type 2 diabetes in 2005. As a result of his diabetes, he sometimes experienced symptoms such as blurry vision and neuropathy. Trainito resigned from DEH on October 23, 2010, attributing his resignation to problems stemming from diabetes. He continued to work as a part-time chef after his resignation.

On April 22, 2011, Trainito received an early distribution from his qualified retirement savings account with the City of Boston Retirement Board.

A few weeks later, he began experiencing nausea, vomiting, and diarrhea. Family members, alarmed at being unable to reach Trainito on June 12, contacted Emergency Medical Services, who discovered him unconscious at his home and determined that he had lapsed into a diabetic coma. He was hospitalized until the end of July, and the coma resulted in muscle atrophy and the reduced use of an arm and a leg.

On his tax return for 2011, Trainito attached a Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, claiming the distribution was exempt from the 10 percent penalty tax on early distributions. The IRS rejected taxpayer's claimed exemption and imposed the penalty.

Analysis

Code Sec. 72(t)(1) imposes a 10 percent additional tax on a taxpayer who receives an early distribution from a qualified retirement plan, unless such taxpayer qualifies for an exemption. Code Sec. 72(t)(2)(A)(iii) provides an exemption for distributions which are attributable to the taxpayer's being disabled within the meaning of Code Sec. 72(m)(7).

Code Sec. 72(m)(7) provides that a taxpayer is considered disabled if he or she is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration. The "substantial gainful activity" referred to is the activity customarily engaged in by the taxpayer before the onset of the disability.

The Tax Court noted that because Code Sec. 72(t)(2)(A)(iii) requires that the distribution be attributable to the taxpayer's disability, the relevant date to consider was April 22, 2011.

The court stated that the disability must be present at the time the distribution is made to avoid the 10 percent early withdrawal penalty, noting a taxpayer cannot avoid the penalty just by suffering a disability at any point during the tax year. The court concluded the fact that Trainito suffered a diabetic coma in June did not indicate whether he was disabled on the date of the distribution and was not relevant to that determination.

With regard to whether he was disabled on the distribution date, Trainito testified that, following his diagnosis with diabetes in 2005, he saw a primary care doctor twice a month until his resignation from his job with DEH in 2010. However, despite receiving frequent treatment for diabetes, he did not produce any medical records relating to his condition on April 22, and his primary care doctor did not testify on his behalf. Trainito also claimed that he suffered from clinical depression at the time of the distribution, but failed to produce medical records to support the claim.

The court determined that while Trainito undoubtedly suffered from diabetes when he received the retirement distribution, he had not provided sufficient evidence to show that either his diabetes or alleged depression caused him to be disabled within the meaning of Code Sec. 72(m)(7) at the time of the early distribution from his retirement plan.

For a discussion on early distributions from retirement accounts, see Parker Tax ¶134,555. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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