How to Calculate Taxes Owed on Early Withdrawal From an IRA

Though an IRA, or individual retirement account, is typically money set aside for retirement, there are often unavoidable situations in life that make it necessary to withdraw funds early. Unfortunately, an early withdrawal from your IRA can make you subject to some significant penalties and taxes that you must calculate on your next tax return.

Difficulty:

Moderately Easy

Instructions

Things You'll Need

• Form 5329
• Form 1040

Confirm Taxes Owed on an Early Withdrawal From an IRA

1. Confirm that you actually will owe taxes on your early withdrawal. There are situations in which you can withdraw money from your IRA without penalty. For example, withdrawals made before the year of required minimum distribution but after you turn 59 1/2 are not subject to tax penalties.

2. Know the cases in which you will not need to calculate the penalty taxes on an early withdrawal from your IRA. You will not be assessed the 10 percent tax if you were disabled, rolled the funds over to a new account (either directly or via lump sum), used the funds to pay for health insurance while you were unemployed, paid your college tuition (or that of a dependent) or paid for medical expenses in excess of 7.5 percent of your taxable income. Additionally, no tax penalties are owed if the IRS uses your IRA funds to pay off a tax debt.

3. Include the tax penalty in the tax return of the year of early withdrawal. You can calculate it either directly on your tax return (Form 1040) or on Form 5329, which is attached to your return. In either case, you must have the 1099-R from your IRA.

Calculate Owed Taxes

1. Calculate the taxes owed on Form 1040 using a standard formula. Multiply the Taxable Amount on your 1099-R (box 2a) by 0.10 and write the sum on line 60 of your 1040.

2. Indicate that you do not need to attach Form 5329 by writing "no" on line 59.

3. Complete Form 5239 by reporting the Taxable Amount from your 1099-R (box 2a) and indicating any amount that doesn't need to be taxed because of an exception. You will also need to enter the correct exception code. The codes are on the instructions for Form 5329, which can be found at the IRS website (see Resources below).

4. Subtract the second line from the first to get the amount subject to additional taxes. Multiply the difference by 0.10 to figure the penalty. This number also needs to be entered on line 60 of your 1040.

Tips & Warnings

• Count on paying taxes twice on your early distribution. Not only will you pay a 10 percent tax penalty on the amount withdrawn, but any early distributions from a retirement fund are also included as taxable income subject to income taxes on the next return you file.

• Keep in mind that for a Roth IRA, there are no taxes owed on an early withdrawal, as long as the account has been established for at least 5 years.

Resources

• Instructions for Form 5329 at the IRS