IRS 4972: Tax on Lump-Sum Distributions

IRS Form 4972, Tax on Lump-Sum Distributions, is a specialized form for individuals who receive a specific type of retirement payout. Its purpose is to calculate the tax on a qualified lump-sum distribution using methods that can result in a lower tax liability compared to treating the funds as ordinary income. These methods are the 10-year tax option and a capital gain election. This form separates the distribution from other income, applying a potentially more favorable tax treatment.

Determining Eligibility for Special Tax Treatment

Use of Form 4972 is restricted to a very specific group of taxpayers. The primary requirement is that the retirement plan participant must have been born before January 2, 1936. This provision grandfathers certain individuals into tax rules that were in place before major changes in the 1980s.

To qualify, the payment must be a lump-sum distribution, which means it represents the entire balance from all of the employer’s qualified plans of a similar type. For example, if an employer has multiple pension plans, the employee must receive the total balance from all of them within a single tax year for the distribution to qualify. Partial payments or rollovers of a portion of the balance would disqualify the distribution from this special treatment.

Certain life events must trigger the distribution for it to be considered a qualifying lump-sum payment. These events include the death of the plan participant, the participant reaching age 59½, or a common-law employee’s separation from service. For self-employed individuals, disability as defined by the Internal Revenue Code can also be a qualifying event.

A final condition involves the participant’s history with the retirement plan. The individual must have been an active participant in the plan for at least five full tax years before the year the distribution is made. The five-year period does not need to be continuous but must total five full years of participation.

Information Needed to Complete Form 4972

Before beginning the calculations on Form 4972, specific financial information must be gathered, almost all of which is provided on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. This document, sent by the plan administrator, is the primary source for the figures needed to accurately complete Form 4972.

Several boxes on Form 1099-R are of particular importance. Box 1 shows the gross distribution, which is the total amount paid out before any withholdings. Box 2a contains the taxable amount of the distribution, which is often the same as the gross distribution but can sometimes be less.

For taxpayers considering the capital gain election, Box 3 is essential as it reports the portion of the distribution that may be eligible for capital gains treatment. Another key figure is found in Box 6, which details the net unrealized appreciation (NUA) in employer securities. This amount represents the increase in value of company stock held within the retirement plan and receives its own special tax considerations.

Calculating the Tax Using Form 4972

Part II of the form addresses the capital gain election. If an amount is shown in Box 3 of Form 1099-R, the taxpayer can elect to have that portion of the distribution taxed at a 20% rate.

The core of the form is Part III, which details the 10-year tax option. This method is designed to tax the lump sum as if it were received over a decade, which can place the income in a much lower tax bracket. From this amount, a minimum distribution allowance is subtracted, which helps to reduce the taxable portion for smaller distributions.

The next step involves dividing the resulting amount by ten. This smaller figure is then used to calculate a preliminary tax amount based on the single taxpayer tax rates that were in effect in 1986, which are provided in the instructions for Form 4972.

After the tax is calculated on this one-tenth portion of the distribution, the result is multiplied by ten. This final figure represents the total tax on the ordinary income portion of the lump-sum distribution under the 10-year option. If the capital gain election was also made, the tax from that calculation is added to this amount to arrive at the total tax liability for the distribution.

Filing Form 4972

The total tax amount calculated on Form 4972 is not paid separately but is integrated into the taxpayer’s overall tax liability for the year. This final tax figure is carried over to the taxpayer’s Form 1040, 1040-SR, or 1040-NR and included in their total tax. The completed Form 4972 must be physically attached to the taxpayer’s income tax return when it is filed. Forgetting to attach the form can lead to processing delays, notices from the IRS, and a recalculation of the tax based on ordinary income rates.

The tax liability from Form 4972 is added to any other taxes owed, such as income tax or self-employment tax, to determine the total tax for the year. This combined amount is then paid by the regular tax filing deadline, typically April 15. If an extension to file is obtained, the return and the attached Form 4972 are due by the extension deadline, usually October 15.