An appeals court has decided in Kim v. Commissioner of the Internal Revenue Service that the Tax Court properly upheld the 10% early distribution penalty against a partner in a law firm who rolled over funds from his employer’s retirement plan into an IRA after leaving his position in the firm at age 56, but then withdrew funds from the IRA to pay for his and his daughter’s education and other expenses.
The exception for distributions from pension plans made to employees after separation from service for those 55 or older didn’t apply, the Seventh Circuit Court of Appeals court ruled in May, because the taxpayer withdrew money from his IRA, not his firm’s pension plan. The court further ruled that the taxpayer’s argument that his account was a SEP IRA and not a traditional IRA wasn’t dispositive, because the Internal Revenue Code (IRC) doesn’t distinguish between types of individual retirement plans.
Fifty-six year-old Young Kim was an attorney who left his position as a partner in a law firm and enrolled in the London School of Economics. Employees who depart employment at age fifty-five and older may withdraw money from their employer’s retirement plan; they must pay income tax on the withdrawal, of course, but they do not owe the 10% additional tax that the IRC imposes on most withdrawals before age 59 1/2. Kim had moved the funds from the law firm’s retirement plan to an individual retirement account, but a rollover is not a taxable event. Kim then withdrew about $240,000 from the IRA and paid the income tax but not the 10% additional tax. The IRS concluded that he owed the 10% tax.
Kim sought review by the Tax Court. The court held that Kim owed the 10% tax on the withdrawn money.
On appeal, Kim argued that the 10% additional tax did not apply to a distribution from a pension plan “made to an employee after separation from service after attainment of age fifty-five.” However, the court ruled that the distribution from the IRA was not “made to an employee,” i.e., he was not an employee of the IRA’s custodian. He had been an employee of the law firm, and therefore could have taken a distribution from its pension plan, but that’s not what happened.
Kim withdrew money from an IRA, which is an individual plan, not an employer plan. Kim characterized his account a as a “SEP IRA” (“simplified employee pension”) as opposed to a “traditional IRA,” but the IRC does not distinguish among flavors of individual retirement plans. Before reaching age 59 1/2, Kim withdrew money from an individual retirement plan, rather than from his former employer’s plan, and therefore must pay the 10% additional tax.