Taxpayers who were born before 1986 may
be eligible for a little known tax break when receiving a lump sum distribution from an
employer pension or profit sharing plan. The pension recipient has three basic
choices with respect to the distribution.
1. Treat the entire distribution
as ordinary income in the year it is received.
2. Elect and use the ten year
averaging method. Up to 50% of the total distribution may be tax free and the
balance will be subject to very low tax rates.
3. Elect to pay a flat 20% tax on
any part of the distribution that was accumulated before 1974 and then choose
options 1. or 2. above for the balance of the distribution.
For many taxpayers, the best choice is to elect the
ten year averaging tax using IRS Form 4972. Here is how it is done,
although it may be best to have a tax professional work out the numbers using
a professional quality tax preparation program.
-
fifty percent of distributions under $20,000 may
be exempt from tax
-
the exempt portion is phased out on distributions
from $20,000 to $70,000
-
compute tax on 1/10th of taxable pension
distribution at 1986 single taxpayer rates (See Form 4972, Page 4)
-
only the cost of employer securities is
part of the lump sum amount
-
unrealized gain on employer securities is deferred
until the securities are sold
Qualifications for the ten year averaging tax
1. received your distribution after you were age
59.5
2. have not made a rollover to an IRA of any part of the plan distribution
from the same employer
3. have been a participant in the plan for at least five years
4. received the distribution in one tax year.
5. were born before 1936
For lump sum distributions of less than $70,000, this
election may result in substantial tax savings. However, this is only a very
brief and non-technical description of this election and a careful study of
the instructions to Form 4972 is required to determine whether a specific
taxpayer is eligible to use this election.
Note: In some cases, a beneficiary of a taxpayer who
is eligible for this election may also be eligible to use the election.
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