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Unqualified Catastrophe Expenses
Additional Tax Exceptions
Withdrawals from an account for any purpose other than qualified catastrophe expenses are subject to South Carolina income tax at your regular rate and an additional tax of 2.5% payable on your South Carolina income tax return for the year of withdrawal. This additional tax is reported on page one of the South Carolina 1040 under “taxes.” There are certain exceptions that allow withdrawals without paying any South Carolina income taxes and certain exceptions that allow withdrawals, which require the taxpayer to pay the regular state income tax rate, but not the 2.5% additional tax. These exceptions are:
Withdrawals from an account for any purpose other than qualified catastrophe expenses are subject to South Carolina income tax at your regular rate and an additional tax of 2.5% payable on your South Carolina income tax return for the year of withdrawal. This additional tax is reported on page one of the South Carolina 1040 under “taxes.” There are certain exceptions that allow withdrawals without paying any South Carolina income taxes and certain exceptions that allow withdrawals, which require the taxpayer to pay the regular state income tax rate, but not the 2.5% additional tax. These exceptions are:
- Taxpayer is 70 years or older and has a homeowners policy. A withdrawal of funds from an account set up by a taxpayer who has a homeowners insurance policy and is 70 years old or older is not subject to the 2.5% additional tax. Furthermore, the withdrawal is not incredible as ordinary income for South Carolina income tax purposes. Once a taxpayer 70 years or older makes a nontaxable withdrawal for other than qualified catastrophe expenses, the taxpayer cannot make any further contributions to a catastrophe savings account.
- Example: Beth has a $2,000 insurance deductible. She deposited $4,000 into her catastrophe savings account and over time the account has earned $500 in interest. After Beth turned 70, she withdrew $4,500 from the account to pay for a car. The withdrawal is not subject to the 2.5% additional tax because Beth withdrew the money after she turned 70 years old. Furthermore, the amount is not included as ordinary income for South Carolina income tax purposes because she had insurance and her catastrophe savings account was based on the amount of her insurance deductible.
- Taxpayer is 70 years or older and is self-insured. A withdrawal from an account set up by a self-insured taxpayer is not subject to the 2.5% additional tax once the self-insured taxpayer is 70 years old. However, the amount withdrawn is included as ordinary income for South Carolina income tax purposes.
- Example: Tim, who self-insures his legal residence, deposited $100,000 into his catastrophe savings account. When Tim was 72 years old, he withdrew $100,000 from his account to pay his grandson’s college tuition. The withdrawal is not subject to the 2.5% additional tax because he withdrew the money after he turned 70 years old. The $100,000 withdrawal is subject to state income taxation.
- Account holder no longer owns a legal residence. A non-eligible withdrawal of funds made when the taxpayer no longer owns a legal residence is not subject to the 2.5% additional tax. However, the amount withdrawn is included in South Carolina taxable income.
- Example: On Jan. 1, 2007, Donna deposited $6,000 into a catastrophe savings account. On Jan. 1, 2009, Donna sold her home and moved in with her sister. In February 2009, she withdrew $6,000 from her catastrophe savings account for a family emergency. The withdrawal is not subject to the 2.5% additional tax because she withdrew the amount when she no longer owned a home. The $6,000 withdrawal is subject to South Carolina income taxation.
- Death of the account holder. A withdrawal upon the death of an account holder is not subject to the 2.5% additional tax. The account, however, is included in the South Carolina taxable income of the person who receives the account, unless that person is the surviving spouse of the taxpayer.