132 T.C. No. 15
UNITED STATES TAX COURT
GREGORY T. AND KIM D. BENZ, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 15867-07. Filed May 11, 2009.
In 2002 P-W elected to receive a series of
substantially equal periodic payments from her
individual retirement account (IRA) that qualified for
a statutory exception to the 10-percent additional tax
imposed on early distributions pursuant to sec.
72(t)(2)(A)(iv), I.R.C. Sec. 72(t)(4), I.R.C.,
provides that an employee who modifies a series of
periodic payments within the first 5 years (other than
by reason of the employee’s death or disability) is
liable for the 10-percent additional tax. In 2004 P-W
received distributions from her IRA for higher
education expenses pursuant to sec. 72(t)(2)(E),
I.R.C., in addition to the elected periodic payment
that qualified for a statutory exception to the 10-
percent additional tax. R determined that P-W no
longer qualifies for the periodic payment exception for
2004 because the distribution for higher education
expenses is an impermissible modification of her
election to receive a series of substantially equal
periodic payments.
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Held: A distribution for higher education
expenses is not a modification of P-W’s election to
receive a series of substantially equal periodic
payments.
Howard S. Levy, for petitioners.
Richard J. Hassebrock, for respondent.
OPINION
GOEKE, Judge: Respondent determined a Federal income tax
deficiency of $8,959 for 2004. The deficiency results from the
imposition of the 10-percent additional tax under section 72(t)
on early distributions from an individual retirement account
(IRA).1 The sole issue for decision is whether a distribution
for qualified higher education expenses is an impermissible
modification of a series of substantially equal periodic
payments. We hold that a distribution for qualified higher
education expenses is not a modification of a series of
substantially equal periodic payments.
Background
This case was submitted to the Court fully stipulated
pursuant to Rule 122. The stipulation of facts and the attached
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
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exhibits are incorporated herein by this reference. Petitioners
resided in Ohio at the time the petition was filed.
While employed by Proctor & Gamble, petitioner wife
maintained an IRA. In January 2002 after separating from her
employment with Proctor & Gamble, petitioner wife made an
election to receive distributions from her IRA in a series of
substantially equal periodic payments. This election included an
annual fixed distribution of $102,311.50 to be made on January 15
each year for a period based on petitioner wife’s life
expectancy. On or before January 15, 2004, petitioner wife
received a $102,311.50 distribution from her IRA in accordance
with her election to receive a series of substantially equal
periodic payments. During 2004 petitioner wife received two
additional distributions from the IRA: A $20,000 distribution in
January 2004 and a $2,500 distribution in December 2004.
Petitioner wife had not attained age 59-1/2 when she received
these additional distributions. Petitioner wife used the $20,000
and $2,500 distributions for qualified higher education expenses
as defined in section 72(t)(7) relating to her son’s college
expenses. For 2004 petitioners spent $35,221.50 in qualified
higher education expenses for their son.
Petitioners timely filed Form 1040, U.S. Individual Income
Tax Return, for 2004, reporting the $124,811.50 in distributions
from petitioner wife’s IRA during 2004. Petitioners did not
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report the 10-percent additional tax for an early withdrawal from
an IRA pursuant to section 72(t) with respect to any portion of
the distributions. Petitioners attached Form 5329, Additional
Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored
Accounts, to their return and reported that the withdrawals were
not subject to any additional tax under section 72(t)(2).
On June 22, 2007, respondent issued a notice of deficiency
to petitioners for 2004, determining a Federal income tax
deficiency of $8,959. Respondent determined that $89,590 of the
$124,811.50 distributed from petitioner wife’s IRA was subject to
the 10-percent additional tax imposed by section 72(t)(1) on
early distributions. Respondent determined that the exception
for qualified higher education expenses under section 72(t)(2)(E)
applied to the remaining $35,221.50.
Discussion
In general, amounts distributed from an IRA are includable
in gross income as provided in section 72. Sec. 408(d)(1).
Section 72(t) provides for a 10-percent additional tax on early
distributions from qualified retirement plans, unless the
distribution falls within a statutory exception. Sec. 72(t)(1)
and (2). Section 72(t)(2)(A)(iv) provides an exception from the
10-percent additional tax for distributions that are “part of a
series of substantially equal periodic payments (not less
frequently than annually) made for the life (or life expectancy)
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of the employee or the joint lives (or joint life expectancies)
of such employee and his designated beneficiary”.2 If the series
of substantially equal periodic payments is modified within 5
years of the date of the first distribution (other than by reason
of death or disability), then the 10-percent additional tax will
be imposed retroactively on prior distributions made before the
taxpayer attains age 59-1/2 (referred to as the recapture tax),
plus interest. Sec. 72(t)(4)(A)(ii)(I). The recapture tax also
applies when a modification occurs after the initial 5-year
period but before the employee has attained age 59-1/2. Sec.
72(t)(4)(A)(ii)(II).
Independent from the equal periodic payment exception,
section 72(t)(2)(E) provides an exception from the 10-percent
additional tax for distributions for qualified higher education
expenses. Section 72(t)(2)(E) provides:
Distributions from individual retirement plans for
higher education expenses.--Distributions to an
individual from an individual retirement plan to the
extent such distributions do not exceed the qualified
higher education expenses (as defined in paragraph (7))
of the taxpayer for the taxable year. Distributions
shall not be taken into account under the preceding
sentence if such distributions are described in
2
The Internal Revenue Service has provided three examples of
methods to determine a series of substantially equal periodic
payments for purposes of sec. 72(t)(2)(A)(iv). See Notice 89-25,
Q&A-12, 1989-1 C.B. 662, 666, modified by Rev. Rul. 2002-62, sec.
2.01, 2002-2 C.B. 710. Rev. Rul. 2002-62, sec. 2.02(e), 2002-2
C.B. at 711, provides specific instances that would cause a
modification to occur. They focus on tax-free additions to or
distributions from the account and are not applicable here.
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subparagraph (A), (C), or (D) or to the extent
paragraph (1) does not apply to such distributions by
reason of subparagraph (B).
By specifically creating an exception for distributions used for
higher education expenses, Congress recognized “it is appropriate
and important to allow individuals to withdraw amounts from their
IRAs for purposes of paying higher education expenses without
incurring an additional 10-percent early withdrawal tax.” H.
Rept. 105-148, at 330 (1997), 1997-4 (Vol. 1) C.B. 319, 652.
Distributions for qualified higher education expenses serve one
of numerous purposes Congress identified as deserving special
treatment. Those purposes include paying a tax levy, paying for
medical care, paying for health insurance during periods of
unemployment, and purchasing a first home. Sec.
72(t)(2)(A)(vii), (B), (C), (D), and (F).
Petitioner wife’s two additional distributions for qualified
higher education expenses were made within 5 years of the first
annual periodic payment and before petitioner wife had attained
age 59-1/2. Respondent maintains that the two additional
distributions constitute an impermissible modification to the
periodic payment election under section 72(t)(4). According to
respondent, the substantially equal periodic payment exception is
no longer effective for the 2004 distribution. Respondent
concedes that $35,221.50 of the total 2004 distributions
satisfied the exception for qualified higher education expenses
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under section 72(t)(2)(E) and is not subject to the 10-percent
additional tax.
The sole issue for decision is whether a distribution that
qualifies for a statutory exception to the 10-percent additional
tax under section 72(t)(1) constitutes a modification of a series
of substantially equal periodic payments triggering the recapture
tax under section 72(t)(4). Respondent argues that an employee
who elects a series of substantially equal periodic payments is
not allowed any further distributions within the first 5 years of
the election irrespective of whether the distribution would
qualify for another statutory exception to the section 72(t) tax
unless the employee dies or becomes disabled. Petitioners argue
that a distribution used for a purpose that qualifies for a
statutory exception is not a modification of a series of
substantially equal periodic payments that triggers the recapture
tax under section 72(t)(4). In Arnold v. Commissioner, 111 T.C.
250, 255-256 (1998), the Court held that an additional
distribution that did not qualify for a statutory exception was
an impermissible modification to a series of substantially equal
periodic payments. In Arnold, we stated: “In order to avoid the
section 72(t) tax, petitioners must show that the November 1993
distribution falls within one of the exceptions provided under
section 72(t)(2)(A). They have not done so.” Id. at 255. Today
we also recognize that distributions under section 72(t)(2)(E),
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enacted in 1997 and after the year in issue in Arnold, do not
trigger the section 72(t) additional tax where the taxpayer
receives the distribution within 5 years after the taxpayer
begins receiving distributions under a series of substantially
equal periodic payments.
The last sentence of section 72(t)(2)(E) recognizes that an
employee may qualify for more than one statutory exception to the
10-percent additional tax. It provides that the amount of
distributions attributable to higher education expenses does not
take into account distributions described in subparagraph (A),
(B), (C), or (D). Sec. 72(t)(2)(E). If a distribution qualifies
for more than one statutory exception, the employee is exempt
from the 10-percent additional tax on the basis of the applicable
exception under subparagraph (A), (B), (C), or (D) and need only
rely on the higher education expense exception for the additional
amount of the distribution. Subparagraph (A) includes the
periodic payments exception. Similar language is included in
subparagraphs (B) (relating to distributions for medical
expenses) and (F) (relating to distributions for first home
purchases). Sec. 72(t)(2)(B) and (F). A modification occurs for
purposes of section 72(t)(4) when the method of determining the
periodic payments changes to a method that no longer qualifies
for the exception. The legislative history explains the 5-year
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prohibition of modifications to a series of substantially equal
periodic payments as follows:
if distributions to an individual are not subject to
the tax because of application of the substantially
equal payment exception, the tax will nevertheless be
imposed if the individual changes the distribution
method prior to age 59 1/2 to a method which does not
qualify for the exception. * * * For example, if, at
age 50, a participant begins receiving payments under a
distribution method which provides for substantially
equal payments over the individual's life expectancy,
and, at age 58, the individual elects to receive the
remaining benefits in a lump sum, the additional tax
will apply to the lump sum and to amounts previously
distributed.
In addition, the recapture tax will apply if an
individual does not receive payments under a method
that qualifies for the exception for at least 5 years,
even if the method of distribution is modified after
the individual attains age 59 1/2. Thus, for example,
if an individual begins receiving payments in
substantially equal installments at age 56, and alters
the distribution method to a form that does not qualify
for the exception prior to attainment of age 61, the
additional tax will be imposed on amounts distributed
prior to age 59 1/2 as if the exception had not
applied.
H. Conf. Rept. 99-841 (Vol. II), at II-457 (1986), 1986-3 C.B.
(Vol. 4) 1, 457 (emphasis added). The method of calculating
petitioner wife’s annual periodic payments will not change as a
result of the additional distributions for higher education
expenses. Congress enacted the recapture tax under section
72(t)(4) to apply to prior distributions received under a series
of periodic payments where the employee fails to adhere to the
payment schedule elected for at least 5 years. There is no
indication that Congress intended to disallow all additional
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distributions within the first 5 years of the election to receive
periodic payments.
The legislative purpose of the 10-percent additional tax
under section 72(t) is that “Premature distributions from IRAs
frustrate the intention of saving for retirement, and section
72(t) discourages this from happening.” Dwyer v. Commissioner,
106 T.C. 337, 340 (1996) (citing S. Rept. 93-383, at 134 (1973),
1974-3 C.B. (Supp.) 80, 213) . This legislative purpose is not
frustrated where an employee receives distributions for more than
one of the purposes that Congress has recognized as deserving
special treatment.
We hold that a distribution that satisfies the statutory
exception for higher education expenses is not a modification of
a series of substantially equal periodic payments. Because we
find that a distribution for higher education expenses is not a
modification, the 5-year rule prohibiting modifications except in
the case of death or disability is not violated.
To reflect the foregoing,
Decision will be
entered for petitioners.