Tax Penalty for Early Withdrawal on Profit-Sharing Accounts

The Internal Revenue Service tacks on a 10 percent penalty to distributions from your profit-sharing plan before you're 59 1/2 years old. For example, if you take out $8,000, you owe an extra $800 on top of the income taxes on the distribution. Plus, general financial hardships won't cut it -- you need a specific exception to avoid it. For example, no one will argue that paying your mortgage to avoid foreclosure isn't a financial emergency, but it won't get you out of the 10 percent penalty.

Some penalty exceptions get you out of the penalty on your entire distribution, no matter how much you're withdrawing. For example, if you're receiving the distributions from a profit-sharing plan you inherited, you can take out all you want without penalty. The same is true if you suffer a permanent disability or take distributions after you leave your job at age 55 or older. Finally, qualified reservist distributions -- generally withdrawals made to reservists serving in active duty for at least half a year -- also come out tax-free.

Other exceptions get you out of only a specific dollar amount of early withdrawals. For example, if you take a distribution under a qualified domestic relations order or the IRS levies your profit-sharing plan, only the amounts required to be withdrawn come out penalty-free. In addition, if you have medical expenses that exceed 10 percent of your adjusted gross income, you can take a withdrawal to cover the amount of the excess without penalty.

Filing your taxes takes a bit longer with an early withdrawal from your profit-sharing plan. Besides reporting the distribution as income, you also must complete Form 5329 to calculate your penalty or report your exception. If you qualify for an exception, look up the code to write next to line 2 on the form in the IRS Instructions. For example, if you left your job after turning 55, use code "01." If you owe a penalty, it gets copied to line 58 of Form 1040.