Today TaxMama hears from Terry in Georgia with this problem . “I participate in a Executive Deferred Salary Account where I have been able to defer income. Now I need to make an early withdrawal and the company imposes a 10% withdrawal penalty. Is this charge deductible?”
Dear Terry,
I wonder….Is that a penalty from the company? Or is the 10% penalty the one IRS charges for early withdrawals?
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Interesting question. Suppose the penalty is on the account itself, and they issue you a 1099-R for the full amount of the draw. Then, if you’re taxed on the full amount, including the penalty, you should be able to deduct the early withdrawal penalty on line 30 of your Form 1040.
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If they issue the 1099-R for the net amount, after the penalty, you won’t have a deduction.
Regardless of which way this goes, I have some really bad news for you.
You never paid taxes on any of that money. So… when you draw that money, you will face a 10% penalty from IRS, and perhaps even another penalty from your state. In addition, all the money you withdraw will be subject to federal and state income tax.
So, if you’re going to take this money out, expect to lose about 50% of it to taxes and penalties.
Instead, see if you can borrow from the deferred compensation account. The loan will be tax-free. There won’t be any penalties. And you’ll be paying yourself back over the next 2 – 5 years or so.
One warning, though. If you leave the company before the loan is paid back, you will have to pay taxes and early withdrawal penalties on that money. For the moment, you’re better off borrowing and gamble that your finances will turn around before you have to leave your job.
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Better yet, borrow from a credit card. That’s still cheaper than these taxes and penalties – and maybe you can get a 0% credit card loan. There are 7 such offers at TaxMama’s Credit Card center right now. The 0% cash advances are good for 12 – 15 months.
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And remember, you can find answers to all kinds of questions about emergency money and other tax issues, free. Where? Where else? At TaxMama.com
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