When a taxpayer becomes disabled before they reach age 59-1/2, the taxpayer can receive a distribution from a traditional IRA or qualified pension plan and not be subject to the 10% additional early withdrawal penalty.
In order to be considered disabled, the taxpayer has to be able to furnish proof that they cannot do any substantial gainful activity because of some physical or mental condition. This physical or mental condition must be determined by a physician to be something that the taxpayer will have for the rest of their life or for a long, continued and indefinite period. It cannot be condition that the taxpayer can reasonably be expected to recover from or a condition that is a physical handicap but does not prevent the individual from engaging in gainful activity.
A distributions from an IRA or a pension plan to a taxpayer that has been made due to their disability is fully taxable to the taxpayer unless the owner had made non-deductible contributions to the IRA or other non-deductible contributions to a pension plan. However, such a distribution is not subject to the 10% early withdrawal penalty, regardless of the age of the taxpayer.
A distribution that has been made to an individual as a result of their disability will be reported to them on Form 1099-R. To enter this distribution into TaxSlayer Pro, from the Main Menu of the tax return (Form 1040) select:
- IRA, Pension Distributions (1099R, RRB-1099-R) - Select New. If prompted, indicate whether the Payee is the taxpayer or spouse.
- Enter the Payer EIN, Name and Address.
- Enter the Gross Distribution in Box 1 as it is shown on the 1099-R.
- Enter the Taxable amount in Box 2a. (Typically it is the same as Box 1.)
- Enter the Distribution Code in Box 7 as follows:
- if the Code is 3, the 10% additional tax for early withdrawal does not apply.
- If the Code is 1 or 2, you will be prompted to select a Form 5329 Transfer Option. Because the distribution is from a pension plan or IRA, the transfer option should be "Transfer 1099-R Box 2a to Form 5329, Part I, Line 1". After this you will be queried, "Does the Amount being Carried to Form 5329 Qualify for Any Penalty Exclusion?" If the taxpayer is claiming the disability exclusion from the 10% additional tax for early withdrawal, answer this question YES. Select exclusion 3 "Due to Total and Permanent Disability", and enter the amount that was reported in Box 2a that qualifies for an exclusion due to disability.
Note: This is a guide to entering a distribution reported on Form 1099-R into TaxSlayer Pro when the taxpayer is claiming a Disability exemption. This is not intended as tax advice.
IRS: Publication 575 - Pension and Annuity Income
IRS: Publication 590-B -Distributions from Individual Retirement Plans
IRS: Instructions for Form 5329 - Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts
IRS: Instructions for Form 1099-R - Distributions From Pensions, Annuities, Retirement or Profit Sharing Plans, IRAs