Monday, February 14, 2011

Roth IRA Early Withdrawal and Penalty

TaxSmarty has been flooded with similar questions asking the following: “I have a Roth IRA account and need to withdrawal money early. What is that going to cost me?”

Any distributions of investment gains taken from your Roth IRA prior to age 59 1/2 are considered early withdrawals.

Look at the term “investment gains”. What does this mean? Investment gains are the monies earned (interest, dividends or capital gains) from your original contribution. The next question is – Why is this important?

It is because if you withdraw any money YOU contributed (original contribution) it is tax free. The reason is that you contributed to you Roth IRA with after-tax funds. No need to pay tax twice on your money!

Be careful that you don’t withdraw the “investment gains”. This is where it gets a bit tricky. If you withdraw any investment gains prior to age 59 1/2, then you'll owe income taxes and a 10% early withdrawal penalty on those funds, the “investment gains”

Here is an example:

At age 21, you open a Roth IRA and contribute $5,000. You never make any additional contributions.
Fifteen years later, you decide to close the account. It's now worth $15,000.
How much of that $15,000 do you get to keep?

By closing the account early, you don't owe any taxes or penalties on $5,000 of the $15,000.

Why is this?

Because you can withdraw your original contribution any time both tax-free and penalty-free.

But the remaining $10,000 is considered an investment gain. As a result, it's subject to income taxes and a 10% Roth IRA early withdrawal penalty.

To recap:

An early withdrawal of your original contribution is always tax-free and penalty-free.

An early withdrawal of your investment gains prior to age 59 1/2 is subject to a 10% Roth IRA early withdrawal penalty as well as applicable income taxes.

The 5 Year Rule:

Even if you reach age 59 1/2, you still need to meet one more requirement before you can withdraw investment gains tax-free and penalty free.

What is this requirement?

It is the federal tax code's “5 year rule”.

This means your Roth IRA needs to be funded for at least 5 tax years before you can make tax-free and penalty-free withdrawals.

Here is an Example:

You are 59 yrs old and you decided to convert your Traditional IRA to a Roth. You do that in the year 2007, paying the applicable income taxes required by such a conversion. The funds continue to grow and in 2010, at age 62, you decide to withdraw those funds.

Will you be able to withdraw tax free since you pass the age of 59 ½?


You still haven't met the 5 year rule for that portion of your money which you the converted. You converted in 2007 and 2010 is only 3 yrs. You need to wait two more years before you can withdraw all the money tax and penalty free. The original contributions can still be withdrawn tax-free and penalty-free but not the investment gains.

Early Withdrawal Exceptions:

There other cases when you can withdraw investment gains from your Roth IRA without having to pay taxes and penalties that are specifically listed in the tax code. They are as follows:

1. IRA owner's disability. (This can be a very narrow definition, so don't consider a Roth IRA distribution for a disability until you review IRS Code Section 72(m)(7) and IRS Publication 590.)
2. IRA owner's death.
3. Withdrawals are a series of "substantially equal periodic payments" made over the life expectancy of the IRA owner.
4. Paying for unreimbursed medical expenses that exceed 7 1/2% of your adjusted gross income (AGI).
5. Paying medical insurance premiums after the IRA owner has received unemployment compensation for more than 12 weeks.
6. Paying the costs of a first-time home purchase (subject to a lifetime limit of $10,000).
7. Paying for the qualified expenses of higher education for the IRA owner and/or eligible family members.
8. Paying back taxes because of an Internal Revenue Service levy placed against the IRA.

TaxSmarty online software can guide you through these tax speed bumps. It is easy and will ensure your Roth IRA distributions are handled properly. Check us out for free at

Thursday, February 10, 2011

Tax Write-Off Ideas

Our tax customers often ask us: “What can I deduct to lower my tax bill”? Below we have listed 46 ideas that may work for you. To take full advantage of the ideas that could benefit you, use online tax software powered by CompleteTax. It will be your guide to ensure you receive the best benefits from the IRS !!

1. Fees paid to a tax preparation service like your accountant or TaxSmarty online software fee

2. Fees paid for an IRS Audit

3. Rehab treatment services like Alcohol and Drug

4. Fees paid to have items that you donate to charity appraised (valued)

5. Fees paid to have items valued that were lost in a casualty such as a fire or flood

6. Theft or Casualty losses

7. Phones (this is related to using your phone for work as required by your employer that is not your only (read: personal) phone line into your home)

8. Do you travel for business? – cleaning or laundering service while traveling

9. Certain closing costs for buying or selling a rental property or refinancing that property

10. Home computer depreciation if the computer is used for business or taxable investing

11. Contact lenses, hearing devices and prescription eyeglasses

12. Prescription expenses for contraception

13. Expenses associated with searching for a new job in your present occupation, including money spent for resume prep and employment outplacement agencies.

14. Labor Union Dues

15. Employer required expenses for education, maintaining your licenses, improving skills etc.

16. Your contributions to a state run disability fund.

17. Moving expenses (related to moving for work)

18. Money paid for self employment tax

19. Paid Foreign taxes

20. Fees paid for a safe deposit box that holds investments (i.e. stock certificates)

21. Childbirth preparation class expenses if the instruction is related to obstetrical care

22. Expenses paid for foster care

23. Gambling “losses” (deductible as an itemized deduction up to the amount of gambling winnings claimed)

24. Expenses paid to a hospital for services like: lab work, therapy, nursing services, and surgery

25. Home energy improvements such as a qualified HVAC system, insultation, windows and doors, etc. (this is a good one because it's a credit directly deducted from taxes paid as opposed to a deduction from taxable income)

26. Impairment-related work expenses for a disabled individual

27. Investment advisory fees

28. Separately billed IRA trustee admin fees

29. Expenses due to having lead paint removed from your home

30. Fees incurred in connection with collecting or obtaining alimony

31. Long-term care insurance premiums

32. Travel expenses incurred from having to travel and perhaps be lodged away from home due to medical reasons

33. Prepayment penalties and late fees for your mortgage

34. Expenses related to charitable activities such as travel or supplies purchased by you used in your charitable activities

35. Health insurance premiums

36. Monies paid for penalties associated with early savings withdrawals

37. Personal liability insurance for wrongful acts as an employer

38. Points (and other applicable closing costs) for home mortgage or investment property refinancing

39. Expenses for work-required clothing

40. Taxes associated with the sale or purchase of Real Estate

41. Certain seller-paid closing costs paid on your behalf

42. Special equipment if you are disabled

43. Special schools and separately stated fees for medical care included in tuition

44. Personal property taxes charged by your state on cars and boats

45. Professional association fees and subscriptions to professional journals

46. Theft or embezzlement losses

This list is not exhaustive, nor are all of these items necessarily in the tax code. It is a collection of items for you to consider and consult with a qualified tax preparer to determine their applicability to your situation. Your friends at look for ways to save money from time to time, so for our customers and blog readers, this list is an attempt to provide some ideas for this very thing.