# The Purpose of Form 4972 and Instructions to Fill It

Form 4972 is an IRS form with stipulated terms and conditions that is filled out to reduce the taxes that may be incurred on huge distribution amounts. The Buzzle article below explains the purpose of Form 4972, and the instructions to fill it.

Buzzle Staff

**Please Remember:**

- Form 4972 must be filed along with form 1040/1040NR/1041.
- If you receive a lump-sum distribution from any employee annuity and the other participant was born before January 2, 1936, you may have a couple of tax options to find out the tax on the distribution.

The Purpose

- Tax Form 4972 is used for reducing taxes.
- Do not misread the statement, it means that the form is filled and submitted to reduce the tax for enormous distributions of different accounts.
- This happens with two kinds of plans, either an inherited account or an employer account.
- If it is an employer account, in order to qualify for a tax reduction, the beneficiary should have been born before January 2, 1936.
- Besides, the whole account must be given to the beneficiary within one tax year.
- In case of an inherited account, the only condition is that the participant should be born before January 2, 1936.
- In this case, two tax options are available: a 10-year tax option or a 20% capital gain election.
- The debt needs to be paid immediately in case of either options, and not over the next decade.
- That means, you do not pay the tax over the next 10 years, you pay only once, for whichever year you receive the distribution.
- Your separate tax is calculated using special formulas, which may be a smaller amount than your regular tax.
- The regular tax in this case is the one that is calculated if you report your taxable distribution amount as regular income.

Important Terms

Qualified Lump-sum Distribution

- Consider an employer's qualified plans, in which the participant has a shareâ€•pension, profit-sharing, bonus, etc.
- Qualified lump-sum distribution is the payment in one tax year of the participant's entire balance from all the above qualified plans.
- The participant's balance does not include any forfeited amounts or deductible contributions.
- If the participant dies, and you receive the distribution; in order for you to receive it, the participant must have been born before January 2, 1936.
- If you are the spouse of the participant and are receiving the distribution, you will receive this qualified lump-sum distribution payment as an alternate payee.

Capital Gain Election

- A capital gain is the amount that is obtained after the disposition of stocks and bonds (or any capital asset).
- The amount so obtained exceeds the purchase price.
- If a capital gain amount is included in the distribution of the participant, he can qualify for one of the two tax options, i.e., to pay a 20% tax on this amount.
- Remember though, that this option works only on the taxable amount of distributions.

Net Unrealized Appreciation (NUA)

- In financial terminology, NUA is the difference between the average value of shares and their current market price.
- This value comes into picture if your employer is distributing company stock from your self-sponsored retirement plan (tax-deferred, of course).
- That said, after distribution, the NUA value is not subject to regular income tax.
- Experts recommend that it is better to get the company stock transferred to a regular account instead of the individual retirement account (IRA); otherwise, the NUA of the company stock will be taxed at a regular tax rate while distribution.
- You can choose to add the NUA in Form 4972 as a part of the taxable income.
- You can use the 20% option for this value, and opt for a smaller tax.

Death Benefit Exclusion

- If the participant has died before August 21, 1996, the beneficiary may qualify for a death benefit exclusion of USD 5,000.
- If you qualify for the same and include it in Form 4972, the taxable amount on the form is reduced by any federal tax on the distribution.
- If the first beneficiary dies, the second beneficiary does not qualify for death benefit exclusion.

Instructions to Fill Form 4972

Step I

- If you go through the form carefully, you will find that you have to fill only the first page, the other three pages mainly contain related information and instructions.
- The third page, however, contains the NUA and the death exclusion worksheet.
- The first page is divided into three parts. Part I contains just a few questions, for which you have to answer in a 'Yes' or 'No' format.
- This part is designed to find out if you qualify for filling form 4972.
- For example, one of the questions will be, "Was this distribution paid to you as a beneficiary of a plan participant who was born before January 2, 1936?". If it is true, you need to check the 'Yes' box. And only then will you be eligible to even qualify for filling out this form.

Step II

- Next, proceed towards Part II of the form. You have to fill this form only if you choose the 20% capital gain election option. If not, ignore this part.
- If yes, you have to refer to Form 1099-R. Box 3 of this form shows the capital gain amount.
- Check box 6 of the same form; if it contains an NUA amount, a part of it is also included as a capital gain amount.
- After filling out this amount, which will be on line 6 of the form, multiply it by 20%, and fill the value on line 7.

Step III

- Before proceeding to Part III, take a look at the third page, which contains the NUA worksheet and the death exclusion benefit worksheet.
- If you qualify for the NUA and you want to use the 20% tax option, check the value in box 6 of Form 1099-R (as mentioned in the previous step).
- In the worksheet, in line A, enter the actual capital gain amount obtained from box 3 of Form 1099-R.
- Check box 2a of the same form, enter this value in line B.
- Divide the first value by the second and enter the value in line C.
- Box 6 of 1099-R contains an NUA amount, enter the same in line D.
- Multiple the values in line C and D, and enter the answer in line E. This is the portion of NUA that is included as a capital gain.
- Subtract the value in line E from the value in line D. Enter the same in line F. This is the portion of NUA that is read as ordinary income.
- Add the values in line A and C. This is your capital gain amount, which you have to enter in line 6 of Part II of the form.
- Do not get confused due to multiple instructions; the actual capital gain amount will be the one you will obtain from box 3 in Form 1099-R.
**But**, if you**qualify**for an**NUA**, the capital gain amount will be the one calculated in the above manner.

Step IV

- If the NUA worksheet is completed, proceed towards filling the death exclusion worksheet.
- Remember, the NUA and the death exclusion details should be filled if, and only if, you qualify for the same.
- In this worksheet, in line A, include the amount from box 3 of Form 1099-R.
- If you qualify for an NUA, you can enter the value in line G of the NUA worksheet.
- Similarly, in line B, fill the value from box 2a of Form 1099-R. Again, if you plan to include NUA in your taxable income, enter the value from box 6 of Form 1099-R.
- Divide the first value by the second, and enter the value in line C.
- Enter the death benefit exclusion amount in line D.
- This value will be USD 5,000 if you are the only beneficiary.
- If other beneficiaries are included, multiply USD 5,00 by your share percentage (percentage of the entire payment of the plan).
- Multiply the values in line C and D, and enter the same in line E. This is the portion of the death benefit exclusion of the capital gain.
- Subtract the value in line E from the value in line A. If you qualify for death benefit exclusion, this is the value you will enter in line 6 of Part II of Form 4972.

Step V

- Now, you may proceed towards Part III. This part is to be filled if you choose the 10-year tax option.
- If you have not chosen the 20% option, obtain the value from box 2a of Form 1099-R, and fill it in line 8 of Part III.
- If you have chosen the 20% option, obtain values from box 2a and box 3 of Form 1099-R, subtract the latter from the former, and fill the value in line 8.
- Refer to the death benefit exclusion worksheet, and fill out the value on line 9.
- Subtract the value in line 9 from line 8, and enter the value in line 10. This is your taxable amount.
- Refer to box 8 of Form 1099-R. This is your current annuity value. If it exists, fill that value in line 11, or leave it blank.
- Add values in line 10 and 11. Enter the same in line 12. This is your adjusted taxable amount.
- Check if this value is more than or equal to USD 70,000. If not, proceed to the next step.

Step VI

- If your adjusted taxable amount is less than USD 70,000, multiply the value in line 12 by 50%, and enter the answer in line 13. This value entered, should not exceed USD 10,000.
- If the value in line 12 is less than USD 20,000, you may leave line 14 blank. If the value exceeds USD 20,000, subtract 20,000 from this value and enter the result in line 14.
- Multiply this value by 20%, and enter the answer in line 15.
- Next, subtract this value from the value in line 13. This is the minimum distribution allowance. Enter it in line 16.
- Subtract this value from the adjusted taxable amount (line 12), and enter the value in line 17.

Step VII

- Take a detour to the last point of step V. It says that step VI should be followed if and only if the adjusted taxable amount is less than USD 70,000.
- In accordance, if it is equal to or more than USD 70,000, you have to skip step VI and jump to step VII. In the form, you need to skip lines 13 to 17 and arrive at line 18 directly. Don't forget to enter this value in line 17.
- In line 18, enter the federal estate tax that is actually attributed to your lump-sum distribution. Subtract this value from the one in line 17, and enter the answer in line 19.
- Now, check if your current annuity value is 0. If not, go to step VIII. Or else, go to step IX.

Step VIII

- Divide the current annuity value by the adjusted taxable amount (line 11/line 12), and enter this value in line 20.
- Multiply this value with the minimum distribution allowance in line 16. Enter the value in line 21.
- Subtract this value from the current annuity value, and enter it in line 22.

Step IX

- You will arrive at this step, i.e., directly on line 23 if your current annuity value is 0.
- Multiply the value in line 19 by 10%. Enter the answer in line 23.
- For line 24, calculate the tax on the amount entered in line 23. You have to refer to the tax rate schedule for this purpose, which is displayed on page 4 of the form. The same applies to line 27 as well.
- After calculating the tax, multiply it by 10, and enter the answer in line 25.
- Again, refer to line 11. If the value is not zero, multiply the amount in line 22 with 10% (0.1), and enter the value in line 26.
- Use the tax rate schedule again and calculate tax on this value. Enter the same in line 27, multiply the same by 10, and enter the value in line 28.
- Subtract this value from the value in line 25, and enter this value in line 29.
- If the value in line 11 in zero, you need to omit lines 26, 27, and 28; instead, enter the value obtained in line 25 in line 29.
- Finally, add the values in line 7 and 30. This is your tax on the lump-sum distribution.