Barry C. Picker, CPA/PFS, CFP

Section 72(t) of the Internal Revenue Code imposes a 10% excise tax on withdrawals from IRAs unless an exception applies. The main exception to the additional tax is attaining the age of 59½. An exception available to individuals younger than that is to take a series of substantially equal payments, not less frequently than annually, over the individuals life expectancy or the joint life expectancy of the individual and the IRA's designated beneficiary. There are various methods that can be used to compute what is commonly known as the Section 72(t) payment.

If such a withdrawal plan is started, it must be followed until the LATER of the individual attaining age 59½, or for five years from the date of the first withdrawal. It cannot be subsequently modified, except for reason of death or disability of the individual IRA holder. If it is subsequently modified, all pre-59½ withdrawals will be subject to the 10% additional tax, plus interest computed as if the additional tax had been imposed each year of the withdrawal.

Recently, the IRS has issued two Private Letter Rulings concerning the interaction of a series of substantially equal periodic payments (a Section 72(t) plan), and divorce.

In PLR 2000-27060 the question was asked by the ex-wife concerning her share of the ex-husband's IRA. The husband was withdrawing money under a Section 72(t) plan prior to the divorce. In the divorce decree, the ex-wife was given $65,000 of the IRA, which represented approximately 13% of the IRA value. She wanted to know if she had to continue taking a proportionate share of the Section 72(t) withdrawals to avoid the imposition of the retroactive 10% additional tax. The IRS ruled that since the portion of the IRA transferred to her incident to the divorce was now HER IRA, she was not required to take a proportionate share of the withdrawals to avoid the additional tax.

What is interesting about this ruling is that although it was the ex-wife how requested the ruling, the ruling was actually to the benefit of the ex-husband. Had the IRS ruled that the ex-wife had to take the withdrawal, and she didn't, it would have been the ex-husband who got hit for the additional tax since it was HIS IRA from which the Section 72(t) withdrawals were being taken. So an adverse ruling would have permitted the ex-wife to really zing it to hubby by hitting him with a nice tax bill from the IRS.

What was left unsaid in this ruling was whether the ex-husband now had to continue taking 100% of the Section 72(t) plan payments, even though he was left with only 87% of the IRA.

That question has now been answered, in PLR 2000-50046. This case had a similar fact pattern in that the ex-husband was taking substantially equal periodic payments from his IRA prior to the divorce. In this case his annual withdrawal was $300,000, In the divorce, the ex-wife gets approximately 1/3 of the IRA. The ex-husband wants to reduce his future annual withdrawals to $200,000 to reflect the IRA split. The IRS ruled in favor of the taxpayer, stating that under the circumstances of the divorce, the reduction in the annual distribution does not constitute a "subsequent modification" of the periodic payments.

This leads to the question, what other circumstances will permit a reduction in annual withdrawals to not constitute a subsequent modification? For example, if a taxpayer taking withdrawals under a Section 72(t) plan has experienced a tremendous decrease in IRA value due to current market conditions, can he reduce his annual withdrawals? Imagine a taxpayer who, due to a sharp decline in his IRA value, exhausts his IRA completely prior to attaining age 59½. Will the IRS add insult to injury by imposing the 10% excise tax due to the fact that he cannot take his required annual withdrawal?

For people with a Section 72(t) plan and a heavy dot com portfolio, the IRS may be asked to rule on this real soon.