1099R Incorrect Distribution Code

[Crank]

36 y.o. client received a $45,000 total distribution from a 401K in 2009. Box 7 of the 1099R has a "distribution code" of 1 (early distribution. no known exception) and ATX is correctly calculating a 10% penalty.

However, client is a paraplegic who is classified as "totally and permanently disabled", receiving Social Security benefits and enrolled in Medicare. Under a Social Security Program he works on a part-time basis with limited earnings (less than $1,000 per month) but is still considered disabled. I believe that the 1099R should have had a code 3 (disability) in Box 7 and he should not be subject to the 10% penalty. Client contacted the payer and requested a corrected 1099R to reflect the disability code but the payer refused stating that the code 1 is correct.

If we file the return with the current 1099R but omit the 10% penalty I'm sure,upon review, the IRS will add it back in. So I believe the only option is to file a paper 1040 explaining the situation as to why the 10% penalty was omitted from the return.

I just wanted to post this here and hopefully get some responses on handling this situation.

Thanks!

[Lion EA]

Form 5329 can be e-filed. Exception 03 if I remember correctly.

[TAXBILLY]

Agree with Lion. Form 5329 with exception 03.

taxbilly

[jainen]

>>the payer refused stating that the code 1 is correct<<

I agree with the payer. You have not described what if any proof of disability was actually given to the payer, but in any case they have no obligation to evaluate the medical condition. Nor are they required to understand that his substantial earnings do not constitute an ability to do gainful work. In fact, I very greatly doubt that your client even wants his former employer to know his medical details.

In my opinion, you have no basis and no reason to question the 1099. Use the 5329 instead.

[Jake]

I agree with the other posters use the F 5329 and have your client document his disability so that you can respond to the correspondence that will almost certainly be coming from the IRS.

[Crank]

Thanks to all for the help. I will use 5329 as its the easiest route. But in my opinion its a workaround and not the prefered method.

Jainen,

I see your point, however under your reasoning code "3" would almost never be utilized by a payer. It's there for a reason. I'm sure the IRS intended for it to be used in the appropriate circumstances. The client is still employed by the same employer who is fully aware of his medical situation and his disabled status. Both the client and I believe I have the "basis and the reason to question" the code the payer used since as Jake pointed out this method will almost certainly result in additional correspondence and documention with the IRS.

[Lion EA]

From the payer's viewpoint, it is an early distribution. The payer did not certify your client as disabled, sounds like his doctor did and the SSA, too. Form 8329 is not a workaround; yours is one of the reasons for the Form. From your client's viewpoint, 03 is the explanation and Form 8329 is how you explain the situation to the IRS. I have used it. And, I haven't had any clients get IRS letters from it. I wouldn't be surprised if your client hears back, especially if this is his first year. But, you said you have documentation.

[Crank]

Point well taken. Yes he has documentation. Thank you Lion.

[BulldogTom]

Thanks to all for the help. I will use 5329 as its the easiest route. But in my opinion its a workaround and not the prefered method.

Jainen,

I see your point, however under your reasoning code "3" would almost never be utilized by a payer. It's there for a reason. I'm sure the IRS intended for it to be used in the appropriate circumstances. The client is still employed by the same employer who is fully aware of his medical situation and his disabled status. Both the client and I believe I have the "basis and the reason to question" the code the payer used since as Jake pointed out this method will almost certainly result in additional correspondence and documention with the IRS.

Crank, the code three would be used if the company that the employee worked for put him on Disability. I have seen this before. When an employee is hurt on the job and becomes totally disabled and the company grants them a disability pension. In that case, the company would be telling the IRS that they know that this employee is totally disabled under their plan and the penalty does not apply.

Your situation is a standard tax transaction and appears to be reported properly, and the form is there to eliminate the penalty. I would have the documentation to support the disability claim if the IRS inquires, but it should be a pretty standard inquiry.

Tom

Lodi, CA