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Tax Court Rejects Constitutional Challenge to Early IRA Withdrawal Penalties

(Parker Tax Publishing March 2020)

The Tax Court held that the exceptions to the 10 percent penalty under Code Sec. 72(t) on withdrawals from a qualified retirement fund for taxpayers who are under age 59 1/2, who are disabled, or who are eligible for any of the other exceptions under Code Sec. 72(t)(2) do not violate the equal protection component of the Due Process Clause under the Fifth Amendment. The court held that the age and disability classifications involve neither a substantive constitutional right or freedom nor a suspect classification and that under a rational basis standard of review, the statute easily passed muster because it reflected Congress's stated goal of encouraging retirement savings. Conard v. Comm'r, 154 T.C. No. 6 (2020).

In 2008, Sandra Conard received distributions from a qualified retirement plan. Under Code Sec. 72(t)(1), a 10 percent additional tax applies to distributions from a qualified retirement plan unless one of the exceptions in Code Sec. 72(t)(2) applies. Among others, Code Sec. 72(t) provides exceptions for taxpayers who are age 59 1/2 or older and taxpayers who are disabled when the distribution is made. Conard did not qualify for these or any other exceptions to the additional tax.

Conard reported the distributions on her tax return but did not report or pay the 10 percent additional tax. Instead, she included with her return a statement that the additional tax was arbitrary and capricious and claimed a refund of the additional tax that she had paid for earlier years. The IRS sent a notice of deficiency, and Conard filed a petition with the Tax Court. She contended that the age and disability exceptions in Code Sec. 72(t)(2) violate the U.S. Constitution's guarantee of equal treatment under the law.

The Tax Court rejected Conard's argument and upheld the deficiency. The court held that the taxation of funds distributed from a qualified retirement plan under Code Sec. 72(t) does not implicate a substantive constitutional right or freedom. The court also determined that neither age nor disability is a suspect classification for purposes of the equal protection analysis. Accordingly, the court applied a rational-basis test to Code Sec. 72(t). Under that test, a statute is presumed to be constitutional and must be upheld so long as Congress could have reasonably concluded that the challenged classification would promote a legitimate government purpose.

The court observed that this was not a case where the court had to come up with a reasonable justification for the statutory distinctions at issue without any help from those involved in drafting the law. Rather, the court cited language from the Senate Finance Committee report stating that without withdrawal restrictions, taxpayers might treat qualified retirement accounts as general savings accounts with favorable tax features rather than as retirement savings arrangements. With respect to the age and disability exceptions, the Committee explained that tax incentives for retirement savings should be provided only if the savings are not diverted to nonretirement uses, and one way to prevent such a diversion is to impose an additional tax on early withdrawals.

In the court's view, these explanations were entirely rational. The court reasoned that if taxpayers faced no disincentive for making withdrawals before their retirement years and without suffering any disability, it would be easy to imagine that such funds might be diverted to nonretirement uses, thereby frustrating Congress's objective of encouraging taxpayers to save for periods of their lives when they might not be able, or wish, to work. The court went on to say that allowing a disabled person to receive distributions from a qualified retirement plan without paying the additional tax would be fully consistent with wanting to encourage taxpayers to provide for times when they might not be able to work. The court also noted that although Code Sec. 72(t) has different rules for differently situated taxpayers, no scheme of taxation is free of all discriminatory impact. Thus, the court concluded that applying Code Sec. 72(t) to the distributions Conard received when she was not yet 59 1/2, not disabled, and not otherwise eligible for any of the other exceptions in Code Sec. 72(t)(2), did not violate the equal protection component of the Due Process Clause of the Fifth Amendment.

For a discussion of the additional tax on early distributions from qualified retirement plans, see Parker Tax ¶134,555.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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