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INDIVIDUALS

Sec. 72(t) penalty: In Grajales,20 the
The IRS issued much-anticipated taxpayer argued that the 10% “exaction” on
her early pension withdrawal was not valid
guidance on the timing of because a penalty requires supervisory
tax-exempt income arising from approval under Sec. 6751(b)(1). The IRS
the forgiveness of Paycheck Protection contended that the amount was not a
penalty, addition to tax, or additional
Program (PPP) loans. amount but was in fact a tax. The Tax
Court agreed, and the Second Circuit
affirmed the decision.
determined that taxpayers who make the IRS reminded eligible educators In Salter,21 the taxpayer received a
one or more representations that they that, due to an inflation adjustment,18 distribution from his retirement plan
satisfy the conditions for the forgive- they could deduct as out-of-pocket before age 59½ and owed the 10% ad-
ness of a PPP loan but do not factu- eligible classroom expenses up to $300 ditional tax. He reduced the amount
ally satisfy the forgiveness conditions in tax years 2022 and following, the first subject to the 10% tax by $5,647, repre-
— and thus improperly receive loan increase since the deduction was enacted senting unreimbursed medical expenses
forgiveness from their lender — must in 2002. he incurred that year. He knew that he
include the loan amount in gross did not need to itemize deductions to
income and are not eligible to exclude Sec. 72: Annuities; certain use that exception under Sec. 72(t)(2)(B).
the amount of the forgiven loan from proceeds of endowment and However, the Tax Court held, the excep-
gross income under 15 U.S.C. Section life insurance contracts tion applies to expenses allowable as an
636m(i) or Section 276(b)(1) of the Sec. 72(t) and 72(q) exceptions itemized deduction, i.e., in excess of the
COVID-Related Tax Relief Act of expanded: Taxpayers have been al- 10%-of-AGI limitation (applicable to
2020.17 lowed an exemption since 1989 from the that tax year). The medical expenses did
In addition to the guidance men- 10% penalty for early distribution from not exceed that limitation, the Tax Court
tioned above, the IRS also outlined a retirement plan by taking substantially noted. The court also found that the tax-
in News Release 2022-162 on Sept. equal periodic payments over their life payer failed to provide documentation
21, 2022, three specific conditions expectancy. The 1989 notice allowing for the expenses.
required to exclude forgiven PPP loan this exception was modified in 2002
amounts from income: by Rev. Rul. 2002-62. Notice 2004-15 Sec. 108: Income from
1. The loan recipient was eligible to allowed the same methods for early dis- discharge of indebtedness
receive the PPP loan; tributions from nonqualified annuities Insolvency: In Kelly, married
2. The loan proceeds were used to pay with respect to the Sec. 72(q) penalty. taxpayers argued that their insolvency
eligible expenses, such as payroll The exemption was modified again allowed a Sec. 108(a)(1) exclusion of
costs, rent, interest on the recipient in 2022 by Notice 2022-6 (modifying income with respect to their limited
business’s mortgage, and/or utili- and superseding Rev. Rul. 2002-62 and liability company’s (LLC’s) canceled
ties; and Notice 2004-15). Three methods are debt.22 However, the bankruptcy court
3. The loan recipient applied for allowed to calculate the payments that disagreed due to the taxpayers’ lack of
loan forgiveness. avoid these penalties. Two rely on a supporting documentation. While the
reasonable interest rate limited by 120% taxpayers testified to their financial situ-
Sec. 62: Adjusted gross of the federal midterm rate under Sec. ation and provided statements for some
income defined 1274 at the start of payments.19 The Sec. checking and retirement accounts, the
Certain trade or business 1274 rates have been very low in recent court explained that without supporting
deductions of employees — years; the current notice allows a maxi- documentation of all assets and liabili-
eligible educators: In News Re- mum interest rate of 5% if that exceeds ties, insolvency could not be determined
lease 2022-70 issued March 29, 2022, the value calculated by the 120% rule. for the period in question. Additionally,

17. Subtitle B, Title II, of Division N of the Consolidated Appropriations Act, 20. Grajales, 47 F.4th 58 (2d Cir. 2022), aff’g 156 T.C. 55 (2021).
2021, P.L. 116-260. 21. Salter, T.C. Memo. 2022-29.
18. Sec. 62(d)(3). 22. In re Kelly, No. 18-60514 (Bankr. N.D.N.Y. 12/14/21).
19. The fixed amortization and fixed annuitization methods.

34 March 2023 The Tax Adviser