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

Capital gain or loss

The difference between amount realized and adjusted basis on the sale or exchange of capital assets. Long-term capital gains are taxed favorably. Capital losses are deducted first against capital gains, and then again up to $3,000 of other income.

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