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TAX TRENDS
Author:
James A. Beavers, CPA, CGMA,
J.D., LL.M.
Sec. 401(k) plan
distribution not
excludable from
income or exempt
from the Sec. 72(t)
addition to tax due to
taxpayer’s diabetes;
nonresident alien’s
Sec. 751 gain on
sale of partnership
interest sourced to
United States.
50 April 2023
Analysis of and reflections on
recent cases and rulings
because he believed that the distribu-
Gross Income tion did not constitute income due to
his medical condition.
Distribution from 401(k) The IRS thought differently and
plan taxable to taxpayer issued Lucas a notice of deficiency
with diabetes for the 2017 tax year. The deficiency
A taxpayer who had diabetes but was of $4,899 was based on the inclusion
able to control it with insulin and of the 401(k) distribution in his 2017
other medication could not exclude a gross income and the 10% additional
distribution from a Sec. 401(k) plan tax imposed by Sec. 72(t) for premature
from income and was subject to the distributions from qualified retirement
Sec. 72(t) addition to tax for premature plans. Lucas challenged the IRS’s de-
distributions on it.
termination in the Tax Court.
Background The Tax Court’s decision
The Tax Court held that Lucas was re-
In 2017, Robert Lucas, a software de-
veloper, lost his job, causing him to ex- quired to include the distribution from
perience financial difficulties. To make his 401(k) in income in 2017 and was
ends meet, he obtained a distribution subject to the Sec. 72(t) addition to tax.
Income exclusion: As the Tax
of $19,365 during that year from a Sec.
401(k) plan account he owned that was Court explained, gross income, under
administered by Matrix Trust Co. He Sec. 61(a), includes all income from
whatever source derived, except as
had not reached age 59½ at the time,
and Matrix accordingly reported this otherwise provided. Under Secs. 61(b),
amount as an early distribution with 72(a)(1), 402(a), and 401(b)(2) and
Tax Court precedent, this definition
no known exception on Form 1099-R,
Distributions From Pensions, Annuities, includes distributions from employees’
Retirement or Profit-Sharing Plans, trusts. One type of employees’ trust is a
IRAs, Insurance Contracts, etc. 401(k) plan.
For 2017, Lucas reported the distri- Although it was undisputed that
bution on his federal income tax return Lucas received a distribution from his
but did not include it in his taxable 401(k) plan in 2017, he asserted in Tax
income. Lucas had been diagnosed with Court that this distribution should be
diabetes in 2015, but he had been ef- excluded from his gross income because
fectively treated with insulin shots and of his diabetes, relying on information
other medications. He did not include from a website that (in his view) spoke
the 401(k) distribution on his return to these matters.
The Tax Adviser