Question on 401k plan and IRS?

Question

I got laid off, took my 401K monies, Fidelity took the penalties and tax out. I took most of that money and put as a downpayment on a house. I put the rest of the money in my taxes as income (did through Turbo Tax which did not flag me), now IRS wants to tax me again on the money I put as a downpayment on my first house, so that would be almost 40% tax? Is this correct? I thought you had up to 10,000 to put as a downpayment on your 1st home not to get taxed again? Help.

I got laid off and then moved and got another job and put it in an IRA savings account, does that make a difference?

Answer 1

you got laid off and then bought your first house?? hummm

a 401K doesn't qualify for the 1st time home buyer exclusion. You would have paid tax anyway,, but not the 10% penalty

if it had been an IRA account you could have used the money for down payment on first house without paying the 10% additional penalty, but not a 401K. You could have rolled the 401K into an IRA, then taken the money from the IRA without paying the 10% penalty.

Jo's guess about Turbo Tax is that you didn't enter the code from box 7 of your 1099R correctly. If you give the software the correct info it will give you the correct answer.

Answer 2

Sorry, you are mixing up several laws, and unfortunately for you, your understanding was completely off-base.

The $10,000 exemption is only from penalties, not taxes. Additionally, it is only for money from an IRA, not from a 401(k). In order to have taken the money out penalty-free for the downpayment on your house, you should have rolled it over into an IRA first.

So, you owe both penalty and income tax on the entire amount you got from the 401(k). It's probably a minimum of 35% (25% income tax plus a 10% penalty), although if you are in a higher tax bracket than 25%, it will be higher. Also, if your state has an income tax, you probably owe them taxes and penalties, too.

When Fidelity withheld money, they only withheld 20% unless you instructed them to withhold more, so you need to come up with the extra 15%, plus any penalties and interest the IRS assesses for improper filing and late payment.

As far as TurboTax not flagging you - you should have gotten a 1099R from Fidelity with information about the distribution. Did you put it into TurboTax exactly as the 1099R was printed? Or did you change the numbers? I suspect that you changed the numbers and said that $10,000 was not taxable, because otherwise TurboTax would have calculated the correct tax due. If you changed the numbers, it was your mistake, it wasn't TurboTax's mistake - garbage in results in garbage out.

"I got laid off and then moved and got another job and put it in an IRA savings account, does that make a difference?"

Based on your additional information - if you properly rolled the money over into an IRA, you could have avoided the penalty, but not the tax, on $10,000 of the withdrawal, if the rollover was made within 60 days of when you received the check. However, since Fidelity withheld taxes from the original distribution, it doesn't sound like you properly rolled the money over. If you put the money into an IRA improperly - like after the 60 days was up and you put more in than you are allowed to contribute in a single year, you have even bigger problems, and you need to see a tax professional now, before things get any worse.

Answer 3

You cannot use the proceeds from a 401(k) to purchase a first home and avoid the 10% penalty tax. That option is only available with an IRA.

The entire distribution from your retirement account is fully taxable as ordinary income plus a 10% penalty tax. The amount distributed is subject to withholding at 20% which is usually not enough to cover the total tax liability for most taxpayers.

If Turbo Tax didn't handle this properly it's because you didn't input the information into the program correctly. Turbo Tax will handle early distributions from qualified retirement plans correctly IF you put the information into the program correctly. My guess is that you "fudged" the amount by the downpayment on the house in the incorrect assumption that that money wasn't included in your taxable income.

Answer 4

You may not have properly filed your return. There should have seen some means to claim an exception to the penalty on the IRA. You will still owe the tax on the amount withdrawn.

Answer 5

You need to take this to a professional and have your return fixed now!!

Do not try to handle this on your own.

"Turbo Tax should come with training wheels" - Anonymous