February 2, 2023 1:57 am

Diabetes Isn’t Disability for Purposes of the Early Withdrawal Penalty Exception

Distributions from a qualified retirement plan and IRA before age 59½ are subject to a 10% penalty (in addition to the regular tax), unless a penalty exception applies. One exception is a distribution received on account of disability, but it’s not easy to prove that the exception applies. In one case, a taxpayer with diabetes was laid off and took a distribution. He reported the distribution in the amount stated on Form 1099-R, but didn’t include it in taxable income on the grounds that he qualified for the 10% penalty exception for disability. He argued that a website noted diabetes was a disability. The Tax Court disagreed (Lucas, TC Memo 2023-9).

Disability for purposes of the penalty exception means being unable to engage in customary or comparable substantial gainful activity at the time of the distribution. That wasn’t the situation here. The taxpayer was able manage his disability with insulin shots and medication and the condition didn’t prevent him from working. The website, which mentioned diabetes, isn’t legal authority (and besides, it wasn’t on point).

Tax Glossary

Installment sale

A sale of property that allows for tax deferment if at least one payment is received after the end of the tax year in which the sale occurs. The installment method does not apply to year-end sales of publicly traded securities. Dealers may not use the installment method. Investors with very large installment balances could face a special tax.

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