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Tax consequences of liquidating a 401k

IRS Tax Tip 2012-34, February 21, 2012 Taxpayers may sometimes find themselves in situations when they need to withdraw money from their retirement plan early.

And since you don’t pay taxes on the money you contribute to your 401(k) at the time you make the contribution, you must pay taxes on the funds when you withdraw them, whether it’s an early withdrawal or not.

All of this happens automatically by operation of law according to each state's entity conversion statute. Of course, nothing is quite so simple when law and taxes are involved, and both come into play when a business is converted to a new legal form.

Let's look at a common type of conversion: the conversion of a co-owned LLC to a corporation.

This ruling puts partnership-to-corporation conversions into one of three slots, and applies to LLC-to-corporation conversions since co-owned LLCs are treated like partnerships.

Here are the three conversion categories: Each of these conversion methods can have a different effect on the corporation's tax basis and holding period in the assets it receives.

Here are 10 facts from the IRS about the tax implications of an early distribution from your retirement plan.

Note: This article originally appeared in the October 2012 Footnote.

Normally, an LLC-to-corporation conversion is tax-free if the prior business owners are in control of 80% or more of the stock of the new corporation ).