Is the penalty paid on early withdrawal of a 401k tax deductible | 401k Questions

Question

Asked 2/10/2009

Is the penalty paid on early withdrawal of a 401k tax deductible

We had to withdraw our 401k due to financial problems,we did not claim hardship because it is so hard to do and now I have received a tax form showing the total amount of the 401k but not the actual amount we received. Do I have to claim the total amount even though we only received a little over half after penalties?

Share | Abuse

Post Response

Answers

Answer 1/1 - Submitted 2/15/2009

According to the IRS, 401K plans are required to withhold 20% of your 401K withdrawal if taken before the age of 59 1/2. This 20% withholding will be treated just like taxes that are withheld from wages. This is not a penalty, it is an income tax withholding.

What I don't understand is how you received "a little over half" of your funds. What you should legally have received was the 'market value' of the funds on the day your 401K was liquidated, minus 20% tax withholding. For example: $100,000 - $20,000 = $80,000.

What I suspect happened here is that the 'market value' of your funds had dropped significantly due to the stock market declines versus your last recollection of what you thought you had in your account. Maybe I'm wrong and hope I am.

What I would do is verify the GROSS 'market value' of your account on the day is was liquidated. Once you have that number (let's say it was $100,000), if the NET amount that you received is anything less than 80% of that number ($80,000 for our example), then there was an error made and you need to get it corrected.

The Form 1099R (the tax statement that your received) should show the GROSS amount of the early distribution (which should be the GROSS 'market value' of your account on the day it was liquidated). It will also show the amount withheld which should be 20% of the GROSS amount. If it's more than 20%, there was a mistake made.

The amount of the early distribution listed on the 1099R (GROSS amount) will be combined with all of your other income for the year and taxed at whatever tax bracket your total income puts you in.

The amount of tax that was withheld (again, should be 20% of the GROSS amount) will be combined with your other tax withholdings from wages, etc. (So, you are getting a credit for the 20% withheld on your form 1040.)

In addition to your income tax, you will also have to pay a 10% penalty for taking the early distribution.

This has been a painful answer to write, but it's my best understanding of the situation. I think it is worth your while to enlist the services of a good accountant to help you track this down and see if errors were made.

ProAdviser

Share | Abuse

Answer This Question Now

Type your Answer in the box below and post your answer.

Learn more about how this works

401k Plans Related Topics

Related Questions (Ask a New Question)

Can i avoid 10% penalty on 401k loan considered an early withdrawal when company shut down?

I had taken out a 401k loan a couple years ago and was repaying systematically. in january 2009, my company was sold and went out of business and the 401k program was terminated and accounts rolled over into personal ira rollovers. the remaining balance of the 401k loan has been treated as an early...

See Answers

I paid almost $3k in penalties for early withdrawal on my 401k in 2010 for my 2009 taxes. can that amount of penalties be ded...

On my 2009 tax return i incurred a $2943.00 penalty for early withdrawal of my 401k ( i was and still am unemployed) can i deduct that amount as an expense on my 2010 return?

See Answers

401k early withdrawal

I withdrew my 401k earlier this year and took the early penalty and had income taxes withheld. how do i file this on my income tax for this year?

See Answers