7.4 Averaging on Form 4972

If you were born before January 2, 1936, and the other averaging tests (7.2) are satisfied, you may elect on Form 4972 to compute the tax on a lump-sum distribution received using a 10-year averaging method based on 1986 tax rates for single persons.

If you were born after January 1, 1936, you may not elect averaging for a lump-sum distribution of your account balance. However, you may elect averaging as the beneficiary of a deceased plan participant who was born before January 2, 1936 (7.6).

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image Caution
Averaging Not Allowed for Those Born After January 1, 1936
If you were born after January 1, 1936, a lump-sum distribution from your plan is not eligible for averaging.
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Averaging on 2012 returns.

If you qualify for averaging (7.2), follow IRS instructions to Form 4972 for applying the 10-year averaging method. If you received more than one qualified lump sum, you may elect averaging for one of the distributions only if you elect averaging for all.

The amount eligible for averaging is the taxable portion of the distribution shown in Box 2a of Form 1099-R. You may also elect to add to the Box 2a amount any net unrealized appreciation in employer securities (shown in Box 6) included in the lump sum. If you are receiving the distribution as a beneficiary of a plan participant who died before August 21, 1996, follow the instructions to Form 4972 for claiming a death benefit exclusion that reduces the Box 2a taxable portion.

If the distribution includes capital gain (Box 3 of Form 1099-R) and you want to apply the special 20% capital gain rate (7.5), you should subtract the capital gain in Box 3 from the taxable amount in Box 2a and apply averaging to the balance of ordinary income.

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The tax computed on Form 4972 is reported on Form 1040, Line 44, as an additional tax. It is completely separate from the tax computed on your other income reported on Form 1040.

See the following Example and the Sample Form 4972 above.

EXAMPLE
Andrew Kellogg was born in 1935. In 2012, he retired from StarShine Systems, Inc., where he had worked since 1970. He received a lump-sum distribution of $182,438, before withholdings. The Form 1099-R provided by the company (see page 157) shows in Box 3 the capital gain portion of $8,620, attributable to pre-1974 participation.
On Form 4972, Andrew applies the special 20% rate to the capital gain portion for a tax of $1,724. He then figures the tax on the $173,818 ordinary income part of the distribution under the 10-year averaging method. As shown on the sample Form 4972 on page 160, Andrew’s total tax on the distribution is $31,844, the sum of the $30,120 tax under 10-year averaging and the $1,724 tax on the capital gain portion. In Andrew’s case, the special 20% capital gains rate is advantageous because it results in a lower tax than if the capital gain were treated as ordinary income subject to the averaging computation. The tax would be $32,360 if the special capital gain rate was not elected.

Community property.

Only the spouse who has earned the lump sum may use averaging. Community property laws are disregarded for this purpose. If a couple files separate returns and one spouse elects averaging, the other spouse is not taxed on the amount subject to the computation.

EXAMPLE
A husband in a community property state receives a lump-sum distribution of which the ordinary income portion is $10,000. He and his wife file separate returns. If averaging is not elected, $5,000, or one-half, is taxable on the husband’s return and the other $5,000 on his wife’s return. However, if he elects the averaging method, only he reports the $10,000 on Form 4972.
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