Supervisory Approval Not Required for Tax on Early Distribution

Supervisory Approval Not Required for Tax on Early Distribution

U.S. Tax Court

The Tax Court found that an individual is liable for the additional tax on early retirement distributions, holding that the section 72(t) exaction on an early distribution from a qualified retirement plan is a tax and is not subject to the section 6751(b)(1) written supervisory approval requirement that applies to penalties. In 2015 Kirgizia I. Grajales was 42 years old and received distributions from her New York State pension plan. She did not report the distributions on her 2015 tax return as income. The IRS issued a notice of deficiency including the distributions in her income and imposing the section 72(t) 10 percent additional tax on early retirement distributions. In the Tax Court, Grajales claimed that she was not liable for the additional tax because it is a penalty or additional amount and written supervisory approval was not obtained as required under section 6751(b)(1). The IRS agreed that supervisory approval was not obtained but asserted that it was not required because the section 72(t) exaction is not a penalty, addition to tax, or additional amount within the meaning of section 6751(b) and (c). Judge Michael B. Thornton, writing for the Tax Court, agreed with the IRS that the section 72(t) exaction is not a penalty, addition to tax, or additional amount, but rather is itself a tax. Thornton explained that the court has repeatedly held outside of the supervisory written approval context that the section 72(t) exaction is a tax. Thornton also pointed out that section 72(t) expressly labels the exaction a tax and the larger statutory structure supports that conclusion. The Tax Court rejected Grajales’s argument that the section 72(t) exaction is an additional amount, explaining that “additional amount” is a term of art used to refer to civil penalties in chapter 68, subchapter A. The court also disagreed with her claim that the exaction should be treated as a penalty based on the Supreme Court’s decision in National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012), regarding the individual mandate of the Affordable Care Act. According to Thornton, the Supreme Court explained that an exaction might be considered either a “penalty” or a “tax” depending on the context. Thornton concluded that there was no reason to stray from the court’s well-established jurisprudence that the section 72(t) exaction is a tax and that it should be treated as such for purposes of the written supervisory approval requirement in section 6751(b). Therefore, the court held that Grajales is liable for the additional tax on the early distributions she received.

Affirmed by <a href="/lr/resolve//7dz5g">Grajales v. Commissioner</a>, No. 21-1420 (2nd Cir. 2022).

The Tax Court found that an individual is liable for the additional tax on early retirement distributions, holding that the section 72(t) exaction on an early distribution from a qualified retirement plan is a tax and is not subject to the section 6751(b)(1) written supervisory approval requirement that applies to penalties.

The Tax Court found that an individual is liable for the additional tax on early retirement distributions, holding that the section 72(t) exaction on an early distribution from a qualified retirement plan is a tax and is not subject to the section 6751(b)(1) written supervisory approval requirement that applies to penalties. In 2015 Kirgizia I. Grajales was 42 years old and received distributions from her New York State pension plan. She did not report the distributions on her 2015 tax return as income. The IRS issued a notice of deficiency including the distributions in her income and imposing the section 72(t) 10 percent additional tax on early retirement distributions. In the Tax Court, Grajales claimed that she was not liable for the additional tax because it is a penalty or additional amount and written supervisory approval was not obtained as required under section 6751(b)(1). The IRS agreed that supervisory approval was not obtained but asserted that it was not required because the section 72(t) exaction is not a penalty, addition to tax, or additional amount within the meaning of section 6751(b) and (c). Judge Michael B. Thornton, writing for the Tax Court, agreed with the IRS that the section 72(t) exaction is not a penalty, addition to tax, or additional amount, but rather is itself a tax. Thornton explained that the court has repeatedly held outside of the supervisory written approval context that the section 72(t) exaction is a tax. Thornton also pointed out that section 72(t) expressly labels the exaction a tax and the larger statutory structure supports that conclusion. The Tax Court rejected Grajales’s argument that the section 72(t) exaction is an additional amount, explaining that “additional amount” is a term of art used to refer to civil penalties in chapter 68, subchapter A. The court also disagreed with her claim that the exaction should be treated as a penalty based on the Supreme Court’s decision in National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012), regarding the individual mandate of the Affordable Care Act. According to Thornton, the Supreme Court explained that an exaction might be considered either a “penalty” or a “tax” depending on the context. Thornton concluded that there was no reason to stray from the court’s well-established jurisprudence that the section 72(t) exaction is a tax and that it should be treated as such for purposes of the written supervisory approval requirement in section 6751(b). Therefore, the court held that Grajales is liable for the additional tax on the early distributions she received.

Sec. 72 Annuities; certain proceeds of endowment and life insurance contracts

Sec. 6751 Procedural requirements

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Supervisory Approval Not Required for Tax on Early Distribution