Everyone wants to avoid taxes and will naturally take advantage of any loophole that can be found in order to reach that goal. For many, that route is not reporting income that might be earned or come into during the course of the year. However, one popular item that is often not reported is income from distributions from a 401(k). Many people assume that there is no record of the distribution so they never claim the income on their taxes. However, cashing out requires a 1099-R to be issued to be issued to the taxpayer which contains information about the distribution that is also reported to the IRS. Failure to timely report the income from the 401(k) will result in penalties and interest but there are some legal options to avoid taxes. The easiest way is to roll over the account into another 401(k) or IRA which avoids any tax on the transfer. But if you are under age and wanting to take the money directly then prepare to pay the penalty.
See, Does the IRS Know If I Cashed Out a 401(k)?, The Motley Fool, April 24, 2016.
Special thanks to Brian Cohan (Attorney at Law, Law Offices of Brian J. Cohan, P.C.) for bringing this article to my attention.
