From: Lawrenceburg, Tn
Dear TaxMama,
After filing last year, the IRS wants me to pay back taxes against the previous
year. The problem occurred because my wife is disabled and collects Social
Security disablity checks.
She took her pension and 401(k) in a lump sum. They took out the taxes due,
but my tax preparer, checked the box that indicated we had to pay a penalty
for this, even though they saw that she was on disablity.
Now IRS also want me to pay taxes on her disability from the previous year.
This was through an insurance policy with Prudential insurance.
I need to know what to do to correct this.
Thanks
Tony
Dear Tony,
If your wife is on permanent disability (which she must be if Social Security/SSA
is coughing up early checks), you'll need to explain that to IRS.
There is a code on the 1099-Rs that reports the penalty status of the draw
from the 401(k). The code should have said disability, not early withdrawal.
Your tax preparer should have attached an explanation with the tax return.
There should be no penalties - but you do have to pay the tax. And generally,
the companies that administer the 401(k)s and handle the distributions don't
take enough withholding - unless you tell them to increase it. People rarely
do. So, you undoubtedly do owe taxes since, with a lump sum, and Social Security,
(80% of which is taxable at that income level) and your regular income, you're
tax bracket just zoomed up to the highest level.
You certainly could have avoided that, with just a little planning. That
401(k) money should have been rolled over to an IRA, which would have cost
you NO tax. And your wife could have drawn only as much money as she needed
each year, to keep your taxes lowest.
But...you've done what you've done. So, you have the IRS notice. Just call
the phone number on the notice. Explain your situation and that there should
be no early withdrawal penalties.
Be prepared to fax them some written proof of your wife's disability. If
you have the letter from the Social Securtiy Administration accepting your
wife's application for disability payments, that will probably work. Otherwise,
get a doctor's letter.
As to the Prudential policy, you'll need to check with her employer, if the
policy is from her job. Or check with your insurance agent if it's a private
policy.
Here's an overview of how and when disability payments are taxable.
Of course, things like VA and firefighters' disability generally isn't taxable.
Best wishes,
Eva Rosenberg, MBA, EA
