If you are going through a challenging time financially, you may consider withdrawing funds from a retirement account. The IRS allows you to withdraw from certain accounts if you are experiencing financial hardship. Theoretically, you would need to have documentation proving that you meet its criteria in the case of an IRS audit.
How often does the IRS audit hardship withdrawals? Not often, but preparing for one is still a wise idea.
When you apply for a hardship withdrawal from a 401(k) or other eligible retirement account, you will not need to submit documentation proving that you meet the qualifications. The only time you would need to offer proof is on the off chance the IRS audited you.
To be eligible for a hardship withdrawal, you would need to have an “immediate and heavy” financial need that you cannot fulfill with other reasonably available assets, requiring you to withdraw from your retirement account to fulfill them. You would first need to exhaust savings, liquid investments, and eligible distributions from retirement accounts.
If you are still in financial hardship after using these funds, you could apply for a 401(k) withdrawal if you meet one of these circumstances:
If the IRS were to audit your hardship withdrawal, you would need to provide evidence that you meet these criteria.
Your 401(k) sponsor may have additional rules for early withdrawals. You would still owe taxes on the distribution amount, but would be able to waive the early distribution penalty.
Why would the IRS decide to audit you? Often, IRS audits are random, which means anyone is at risk of being audited. The organization uses statistical formulas to determine “norms” for tax returns. If yours strays from the norm, it may lead to an audit.
The IRS may also audit you if it believes you:
If it finds any errors, you may owe additional taxes or fees to meet tax compliance guidelines.
If the IRS audits you and finds you did not meet the requirements for a hardship withdrawal, you would face the typical penalties for early distributions. This often involves paying a 10% penalty on the amount you withdrew if you are under the age of 59 1/2.
If your tax return significantly strays from your actual financial situation, you may face additional penalties of up to 20% on the amount you owe.
How often does the IRS audit hardship withdrawals? Not too often, but you should prepare for one if you plan to take early distributions from your retirement funds. If you do not meet IRS qualifications for financial hardships, you may want to seek funds in a different way to avoid penalties.
Levy & Associates can answer all your tax questions and support your compliance. Call 877-620-6490 or fill out our online form for a consultation.
Levy & Associates is available for free initial consultations. We’re happy to answer any questions you have about the audit process or address any concerns about your specific situation.
There’s never a good time to be audited, and the time-consuming process will take away from your business or family if you try to face it alone. Let us handle and coordinate communication, so you can return to your daily life.