A retirement distribution is considered early when it is distributed before the taxpayer turns 59 ½. In this case there is no 10% tax penalty attached to this distribution.
If a distribution is taken before turning 59 ½, not only is the amount taxable but there is an additional 10% tax penalty. The 10 percent penalty is calculated as 10 percent of the distribution. So, if you take out $5,000 from your 401K before turning 59 ½, you will have to include that amount to your other taxable income, as well as pay an additional $500 as penalty.
There is a list of exemptions that release taxpayers from that 10% penalty. One of those exemptions is the medical exemption, which is the subject of this post.
The 10% penalty is not imposed on taxpayers if early retirement distributions were used to pay for qualified medical expenses of the taxpayer, spouse, or dependent. Such medical expenses must not have been reimbursed at any point.
According to the Internal Revenue Code (72(t)2(B)), distributions must “not exceed the amount allowable as a deduction under section 213 to the employee for amounts paid during the taxable year for medical care (determined without regard to whether the employee itemizes deductions for such taxable year).”
Section 213 is the section that tells us that we can only itemize the medical expenses that exceed 7.5% of our adjusted gross income. For example, a taxpayer with an AGI of $45,000 can only itemize medical expenses in excess of $3,375.
As 72(t)2(B) states though, a taxpayer doesn’t have to itemize to qualify for the medical exemption to the early distribution penalty.
Using our previous example, let’s assume the taxpayer with an AGI of $45,000 had medical expenses of $7,000 (and did not itemize). According to section 213, she can only claim $3,625 in medical expenses ($7,000-$3,375).
In order to qualify for the medical exemption, her distribution must not have been more than $3,625.
As with any other claim on the 1040, burden of proof lies with the taxpayer. Records must be kept for every medical expense that qualifies you for the exemption.
the Confident Taxpayer 