Step-by-Step Instructions for IRS Form 4972

IRS Form 4972, Tax on Lump-Sum Distributions, is a tax form for individuals who receive a large payment from a qualified retirement plan. It is used to calculate the tax on this distribution using special methods that can result in a lower tax liability compared to treating the amount as ordinary income. These methods are the 10-year tax option and the 20% capital gain election.

This form is not for everyone who receives a retirement distribution; it is for those who meet strict criteria for a qualified lump-sum distribution. Filing this form is optional, but it provides a potential avenue for tax savings. The tax calculated on Form 4972 is a separate tax added to the regular income tax on your other income.

Determining Eligibility to File Form 4972

To use the special tax calculations on Form 4972, the plan participant must have been born before January 2, 1936. If you are a beneficiary, spouse, or former spouse receiving a distribution, you can use the form as long as the plan participant met this birthdate requirement.

The payment must qualify as a lump-sum distribution. This means you received the entire balance from all of your employer’s qualified plans of the same type, such as all pension plans, within a single tax year. The distribution must have been paid because of the employee’s death, after the employee reached age 59½, or due to the employee’s separation from service. For self-employed individuals, the distribution must be due to death or after reaching age 59½.

Another condition is the five-year participation rule. The plan participant must have been an active participant in the plan for at least five full tax years before the tax year of the distribution.

Information Needed to Complete Form 4972

Before starting Form 4972, you must have Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., which contains the figures needed for the calculations.

Several boxes on Form 1099-R are used for Form 4972. Box 1 shows the gross distribution, and Box 2a indicates the taxable amount. You will also need the figure from Box 3, “Capital gain,” for the amount eligible for capital gain treatment.

Other figures include Box 5, which shows your after-tax contributions, and Box 6 for any net unrealized appreciation (NUA) in employer’s securities. NUA is the increase in value of company stock within the plan and has tax rules that interact with Form 4972 calculations.

Step-by-Step Guide to Completing Form 4972

Completing Form 4972 involves progressing through its three parts using data from your Form 1099-R.

Part I

Part I is a short series of questions to confirm you meet the basic requirements, such as the birth date rule, before proceeding with the calculations.

Part II

Part II is used to make the 20% capital gain election. This election applies only if there is an amount in Box 3 of your Form 1099-R, which represents the pre-1974 portion of the distribution. You enter this amount on line 6 and multiply it by 20% (0.20) on line 7 to calculate the tax.

Part III

Part III is where the 10-year tax option is calculated on the ordinary income portion of the distribution. You begin by entering the taxable amount and subtracting any capital gain from Part II and any net unrealized appreciation. This process isolates the ordinary income portion.

The 10-year averaging calculation is then applied. First, you divide the ordinary income portion by 10. Next, you calculate the tax on that smaller amount using the tax rate schedule from the form’s instructions. Finally, you multiply this tax amount by 10. The total tax is the sum of the capital gain tax from Part II and this ordinary income tax.

Filing Form 4972 and Reporting the Tax

The total tax from Form 4972 is reported on your main income tax return on line 16 of Form 1040, 1040-SR, or 1040-NR. You must also check box 2 on line 16 to indicate the tax is from this form.

You must physically attach the completed Form 4972 to your tax return when you file. Failure to do so can lead to processing delays and a recalculation of your tax without the benefit of the special methods.

File the form with your annual tax return by the April 15 deadline, or October 15 if you have an extension. For an estate or trust, the tax is reported on Schedule G of Form 1041, U.S. Income Tax Return for Estates and Trusts.