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Tax penalty question- public safety retirement
Old 03-11-2009, 08:58 PM   #1
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Tax penalty question- public safety retirement

I've searched through the forum and didn't see this exact scenario, so I am posting the question here.

I retired in 2006 after 25 years of public safety (law enforcement) service in Florida and have not been re-employed. This is the normal length of service for special risk (generally police and fire). I have limited investment control over the money (it is still in the state retirement plan) that the state paid into the retirement account vs the normal pension plan. None of it has been taxed. My rub is that I was 46 when I retired, so I've been paying the 10% penalty since my financial needs vary and I never set up a 72T type plan.

Of late, I've been reading about some IRS rules that changed in 2006 not requiring public safety workers to pay the penalty so long as they had a normal retirement, which is defined as age 50. My tax software mirrored this. My question is if my situation constitutes a normal retirement so I don't have to pay the penalty. I'm planning on contacting a tax firm such as HR Block and/or the IRS to get an answer.

I'm looking for anyone that may have experience in this area- I can't be the first one to do this.

Thanks for any help or advice.
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Old 03-11-2009, 09:17 PM   #2
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So this is a 401k or 403b? If so, I believe that the 10% penalty rule is waived only if you, as a public safety employee, left the job in the year you turned 50, or later. So, if you left the job at age 46 you are out of luck.

However, you could rollover all (or maybe even part) of the money into a rollover IRA and do a 72t plan. At least you avoid the penalty.

If you are talking about a PERS plan that is a different situation.
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Old 03-11-2009, 10:57 PM   #3
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You might want to ask the Tax Experts at the Fairmark Forum. They always seem to be correct on tax and the changes in IRS codes.

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Old 03-11-2009, 11:30 PM   #4
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Thanks for the information. From the 1099R form, I am figuring it is a 401A account.

I will search for/and or ask the same question on the Fairmark Forum.

It looks like this is the price I paid for career planning at an early age. I'm hopeful the standard is normal retirement conditions vs. a set age, if so I'm covered by the 25 years of service. According to most of what is written on the Florida retirement website, you have to be 59.5 YOA or older to be exempt from the penalty.

My plan defines normal retirement as such:
A Regular Class member must be either age 62 and have 6 years of service or have a total of 30 years of service, and a Special Risk member must be either age 55 with 6 years or have a total of 25 years of service to qualify.

Thanks again.
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Old 03-12-2009, 09:44 AM   #5
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I never heard of a 401A before this, but it does not seem to be a defined benefit plan. Correct me if I'm wrong on that.

If it is not a DB plan, then it is not covered under the public safety employee waiver. The PPA of 2006 (section 868) changed IRS Rule 72(t) by adding a new paragraph:
Quote:
‘‘(10) DISTRIBUTIONS TO QUALIFIED PUBLIC SAFETY EMPLOYEES IN GOVERNMENTAL PLANS.—
‘‘(A) IN GENERAL.—In the case of a distribution to a qualified public safety employee from a governmental plan (within the meaning of section 414(d)) which is a defined benefit plan, paragraph (2)(A)(v) shall be applied by substituting ‘age 50’ for ‘age 55’.
‘‘(B) QUALIFIED PUBLIC SAFETY EMPLOYEE.—For purposes of this paragraph, the term ‘qualified public safety employee’ means any employee of a State or political subdivision of a State who provides police protection, firefighting services, or emergency medical services for any
area within the jurisdiction of such State or political subdivision.’’.(emphasis added)
But even if a 401A is a defined benefit plan, I don't think you're included in any event because you retired well before age 50.

Something I just noticed is that this provision makes no mention of "normal retirement age". It only says "separation of service". Which disagrees with section 845 of the PPA, which allows "eligible retired public safety officers" to elect to exclude up to $3,000 annually from gross income for certain distributions made from an "eligible government plan" to pay "qualified health insurance premiums". I never paid much attention to 845 because I was able to bank a part of my accumulated leave balance in an account with my former employer, from which they make regular withdrawals to "pay" me while deducting insurance premiums on a pretax basis. 845 is different in several ways from 868, in that it expands the eligibility to judges, prison guards, etc., and that it mandates that the recipient be separated from service due to "disability or attainment of normal retirement age."

The way I read those differences, 868 doesn't care why you left, just that you separated from service.

I retired meeting every eligibility requirement (including a defined benefit plan) except that I was under age 50. I never found a way to get around that requirement.

My DB pension payments are taxed as normal income, and that has been sufficient, so far, and supplemented by withdrawals from a taxable account unrelated to my former employment, to let me do what I need/want. My plan did include a partial lump-sum payment that I rolled over into a regular IRA without penalty. The only way I see of tapping that is either through a SEPP allowed under 72(t), or reconfiguring some things and using money from the IRA to pay for the kids' college educations.

In any event, the way I read the law and understand what you have written about your situation, you are not eligible for the waiver of early distributions for two reasons: (a) you retired before age 50, (b) and, the plan you're making withdrawals from is not a defined benefit governmental plan.

If you find away around the age 50 requirement, I would be very interested to know the details.
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Old 03-12-2009, 09:57 AM   #6
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A 401a plan is a specific type of defined contribution plan. If the plan meets certain requirements you may have the ability to take money out without the penalty but only if you retired from the employer which provided the plan in the year you turned age 50 as a public safety employee. You do not meet that requirement. http://www.irs.gov/publications/p575...ublink10004541

See also: http://fuguerre.googlepages.com/PPA.htm#ppa828

However, I do believe that you can rollover your plan into an IRA and do SEPP withdrawals. I also have some vague recollection that maybe you can do a sepp directly from the 401a, but I am not sure.



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Old 03-12-2009, 09:57 AM   #7
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I never heard of a 401A before this, but it does not seem to be a defined benefit plan. Correct me if I'm wrong on that.

If it is not a DB plan, then it is not covered under the public safety employee waiver. The PPA of 2006 (section 868) changed IRS Rule 72(t) by adding a new paragraph:
Quote:
‘‘(10) DISTRIBUTIONS TO QUALIFIED PUBLIC SAFETY EMPLOYEES IN GOVERNMENTAL PLANS.—
‘‘(A) IN GENERAL.—In the case of a distribution to a qualified public safety employee from a governmental plan (within the meaning of section 414(d)) which is a defined benefit plan, paragraph (2)(A)(v) shall be applied by substituting ‘age 50’ for ‘age 55’.
‘‘(B) QUALIFIED PUBLIC SAFETY EMPLOYEE.—For purposes of this paragraph, the term ‘qualified public safety employee’ means any employee of a State or political subdivision of a State who provides police protection, firefighting services, or emergency medical services for any area within the jurisdiction of such State or political subdivision.’’.(emphasis added)
But even if a 401A is a defined benefit plan, or part of a DB plan, I don't think you're included in any event because you retired well before age 50.

Something I just noticed is that this provision makes no mention of "normal retirement age". It only says "separation of service". Which disagrees with section 845 of the PPA, which allows "eligible retired public safety officers" to elect to exclude up to $3,000 annually from gross income for certain distributions made from an "eligible government plan" to pay "qualified health insurance premiums. 845 is different in several ways from 868, in that it expands the eligibility to judges, prison guards, etc., and that it mandates that the recipient be separated from service due to "disability or attainment of normal retirement age." In other words, for a waiver under 72(t)(10) it doesn't matter why or how you left service, just that you have separated.

I retired meeting every eligibility requirement (including a defined benefit plan) except that I was under age 50. I see no way to get around that requirement. Even if your 401A plan is part of a defined benefit plan, I think you're in the same boat.

My DB pension payments are taxed as normal income, and that has been sufficient, so far, when supplemented by withdrawals from a taxable account unrelated to my former employment, to let me do what I need/want. My plan did include a partial lump-sum payment that I rolled over into a regular IRA without penalty. The only way I see of tapping that is either through a SEPP allowed under 72(t), or reconfiguring some things and using money from the IRA to pay for the kids' college educations. Even though the source of the money was a governmental plan as defined under 414(d) of the IR Code, it no longer qualifies for the waiver since I've moved it into a IRA.

In any event, the way I read the law and understand what you have written about your situation, you are not eligible for the waiver of early distributions for two reasons: (a) you retired before age 50, (b) and, the plan you're making withdrawals from is not a defined benefit governmental plan. Even if the 401A is part of a DB plan, you're still stuck with (a) being what appears to me as an insurmountable obstacle.

If you find away around the age 50 requirement, I would be very interested to know the details.
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Old 03-12-2009, 10:06 AM   #8
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When I started employment, the DB was the only option offered. In 2002, the State of Florida began offering the DC plan, so I switched in 2004.

As I read it, if I set up a SEPP, I'm stuck with that until age 59.5 (10 years), or I can pay one more year of penalty since I hit 5-0 next year.

The whole penalty thing upsets me. It is like rewarding those with poor financial skills that obtained "bad" mortgages.
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Old 03-12-2009, 10:10 AM   #9
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Leo, your post came up twice. Publication 575 talks about a similar rule for certain defined benefit plans allowing retirement without the 10% penalty for qualified public service employees at age 50. Either way, it looks like he does not meet the exception as he retired before age 50.
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Old 03-12-2009, 10:13 AM   #10
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Quote:
Originally Posted by RetLeo View Post
When I started employment, the DB was the only option offered. In 2002, the State of Florida began offering the DC plan, so I switched in 2004.

As I read it, if I set up a SEPP, I'm stuck with that until age 59.5 (10 years), or I can pay one more year of penalty since I hit 5-0 next year.

The whole penalty thing upsets me. It is like rewarding those with poor financial skills that obtained "bad" mortgages.
I am sorry to say that turning age 50 will not remove the penalty because you did not retire at age 50. You are probably going to have to do some rollovers. One thing to look at with a tax accountant is the possibility of rolling over into more than one IRA and then doing 72t with only one of them.

See my signature. You need to talk to an accountant. I personally would not do H & R Block for this issue.
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Old 03-12-2009, 10:21 AM   #11
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hello and welcome to the forumn. I can't answer your question but it will be interesting to see how it plays out. I'm in year 27 as an LEO in Illinois and will go either this September or next February. In Illinois you must be at least 50y/o to start disbursement of pension benefits. Our deferred plan is a 457b and there is no early wirhdrawl tax penalty, i.e. you don't have to be 591/2. Your pension rules and deferred rules are probably not the same.
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Old 03-12-2009, 10:32 AM   #12
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Ratface, one of the nice things about a 457 plan is the lack of a penalty for early withdrawals. Unfortunately, this is not true with other defined contribution plans.
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Old 03-12-2009, 10:43 AM   #13
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Thanks again for the advice, I will try & find a tax accountant to see what our best course of action is.
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Old 03-12-2009, 11:09 AM   #14
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Quote:
Originally Posted by Martha View Post
Leo, your post came up twice.
Ooops. I had too many tabs open at once and I think I was editing in two of them at the same time. Well, at least that explains what happened to some changes I thought I had made which "disappeared".

Looking at publication 575, it appears to comply with the changes in the law, but it's hard to compare the PPA and the publication because the PPA made references to the tax code which I didn't bother to read all of the definitions. Still, we are in complete agreement that age 50 looks like a hard and fast rule.
Quote:
Originally Posted by Martha View Post
I am sorry to say that turning age 50 will not remove the penalty because you did not retire at age 50.
I agree also, I closed all of the tabs I had open, but publication 575 seems clear when it says "...after your separation from service in or after the year you reached age 55 (age 50 for qualified public safety employees)..." That matches my memory of what I read in both the PPA and the IRC. The key is your age when you separated, not your age when you take a distribution.
Quote:
Originally Posted by RetLeo View Post
When I started employment, the DB was the only option offered. In 2002, the State of Florida began offering the DC plan, so I switched in 2004.
I find that interesting. The common thinking is that a DB is the best option and beats DC almost all of the time. Was there something especially attractive about making the switch?
Quote:
Originally Posted by RetLeo View Post
As I read it, if I set up a SEPP, I'm stuck with that until age 59.5 (10 years), or I can pay one more year of penalty since I hit 5-0 next year.
See Martha's post and my comments, but I think it's a SEPP exception or nothing. Maybe some tax wizard has a different idea, but I've never found it nor heard mention of it.

The only problem I see with a SEPP for you is the mention that your needs tend to vary from one year to the next. I can't think of a way around that. The best I could come up with would be to try and guesstimate your future needs as best you can and build a SEPP on that.

Building a SEPP is not terribly difficult, but the penalties for "busting" one are extreme. The 10% penalty could be applied to the entire amount of the IRAs inside the SEPP, and not just what you withdrew in excess one year. If the payments are not enough to live on one year, you can't go back and change the SEPP without getting slaughtered with the "special tax". You can, however, have more than one IRA and any combination of them inside a SEPP, and still leave some of them outside the SEPP. So, you could leave the SEPP intact and protect yourself in that area, and leave a smaller amount in a different IRA that is outside the SEPP. It wouldn't prevent paying the special tax, but it would limit it to just the IRA you took the extra distribution from.

But don't mistake me for a tax guy. Go find a CPA who is also an EA would be my advice. If there is someone who does tax work for other cops from your state/agency, I might start there. This is kind of like brain surgery, one "ooops" and you're screwed forever.
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Old 03-12-2009, 11:41 AM   #15
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I'm going to do this in another post rather than an edit because it's a different take on the question at hand.

Distributions from a 401a do have some exceptions to the special tax, depending on how you spend the money. And there are some different exceptions to the special tax for withdrawals from IRAs. If the money coming from your 401a is covering all of your expenses, I'm reading between the lines and thinking that is the case, you may want to look at the exceptions for both 401a's and IRAs.

Withdrawals from 401a can be done without paying the extra 10% if it is for, among other reasons:
  • Made because the employee has a qualifying disability.
  • Made as part of a series of substantially equal periodic payments.
  • Made to an alternate payee under a qualified domestic relations order (QDRO).
  • Made to an employee for medical care.
  • Made because of an IRS levy on the plan.
IRA's also have penalty exempt withdrawals:
  • Permanent disability of the IRA owner.
  • Non-reimbursed medical expenses.
  • Withdrawals used to help pay for first-time home purchase.
  • Higher education costs.
  • Withdrawals used to pay medical insurance premiums.
If the variable part of your cost of living, or a lot of it anyway, is in some of these areas, you might want to create a SEPP to cover as much of your expenses that are predictable, and then pay for the above listed expenses from the 401a or an IRA that is not part of the SEPP. What you can do is limited to actually having some expenses that qualify above. In the years when the costs go up, you can always pay for something under the exceptions and pay for everything else from the SEPP funding. In the years when your expenses are lower, you don't make any other withdrawals and live off whatever the SEPP pays. Being able to budget and being smart about making the withdrawals would be vital to the sucess of this, and, in case I didn't mention it earlier, the extra withdrawals have to come from outside the SEPP.

We're getting kind of creative here, but it may be something to consider depending on the particulars of your situation. Again, go find a real tax expert before doing any of this. In my case, once I figured that I was making it without tapping my IRA early, I never got much farther in the planning than knowing I could either do a SEPP, or pay for some of the listed expenses with a penalty free withdrawal.
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Old 03-12-2009, 06:10 PM   #16
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Thanks for the input. I pretty much figured I'm screwed here, but am looking for a CPA that does other LEO work in the area.

What sucks to me is that I played by the rules. I was hired on knowing I could retire in 25 years and that is what I did. I know I'm preaching to the choir for some, but that is a lot of overnight work, inclement weather work, and stuff that is rather distasteful to many.

It's not fair I'm being penalized to this degree, and that it will continue until age 59.5. For that, I could in theory go back to work for my employer and work until age 50, since they considered my departure a "resignation" vs. a "retirement" (the state system considers me retired but allows re-employment after 30 days). From what I've read on the IRS rules, this would cover me for the public safety exemption, since they are hung up on age vs. years of service. Only issue is that I'd have to take an entry level job that would not cover our needs, so the penalty is the lesser of two evils.

I think after the CPA I will get with my Congressman & Senator. The tax law should mirror what the state laws/rules are for retirement so people don't have this happen to them.

EDIT
I can see why some here retire overseas. Our tax code is way too complicated for any 100 people to understand.
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Old 03-12-2009, 09:36 PM   #17
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Your situation was really perplexing to me.

The thing that stunned me the most was why this plan was even available to you in the first place. If you knew, when you made the choice to switch plans, that you were leaving before 55 (the early out age for PSO's back then), somebody should have stopped you. If the plan did a good job of explaining the tax implications, that somebody was ultimately you.

But I spent some time looking at the FERS website, and it dawned on me that there are a lot of different types of employees in that system - not just public safety folks. They're covering people who aren't eligible for the waiver of the special tax at the age of 50. The tax implications are explained, but its written toward the situation of people who aren't eligible for the PSO waiver.

There are people out there for whom the plan you chose makes sense, but I don't think you're one of them.
Quote:
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I think after the CPA I will get with my Congressman & Senator. The tax law should mirror what the state laws/rules are for retirement so people don't have this happen to them.
I think your time would be better spent talking with your state elected officials, your union, and any other employee representative organization. I don't see the feds changing the law to try and comply with thousands of different plans. No, I think the pension systems all need make sure that they educate their members about the implications of pension decisions.

My pension system only covers cops in our city and nobody else. All the information provided only concerns us and our plan. FERS has a few paragraphs on taxation issues affecting people who retire early, while my plan had a whole chapter on it. When the time came for me to sign the papers, there wasn't a decision open to me that had not already been completely explained in depth. It was already clear to me then how I could stay clear of the special tax on withdrawals, but I know if I had tried it they would have explained to me, again, in depth, just how stupid that was.

I think you were neglected or underserved by the folks at your pension who were advising you.

Not that informed people don't make mistakes. A friend's wife, both of them were cops, retired at the same time he did. She let some insurance guy scam her into buying an annuity, and she paid for it by making a withdrawal from her lump-sum payment, payable to her directly. There was no reason for her to buy an annuity in the first place (the pension is much better), and it costs her $20,000 in taxes. Hubby said "What can I say, everybody told her not to do it, but she's stubborn and wouldn't pay attention." (they handle their finances separately)
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...but that is a lot of overnight work, inclement weather work, and stuff that is rather distasteful to many.
I'm definitely the choir on that topic. There were a lot of nights when the thought of that pension was the only thing that kept me there. A former coworker, 56-years-old, who can't afford to retire yet because he has kids in college, got shot in the face last week while executing a search warrant. The last time somebody shot at me I was in my early 40's, I can't imagine being out there in my late 50's and still doing that crazy stuff.
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Old 03-12-2009, 11:04 PM   #18
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Thanks Leonidas. I was venting, last year was financially good for us & we drew more than usual to pay off some items, so we pay more in taxes. I don't thank God enough for 25 safe years with the worst thing happening being a piece of steel laying in the road being thrown into my leg after a van ran over it.

I do stand by the statements that the tax code is really too difficult and the penalty is unfair, but such is life here. I'm hopeful things won't be as bad taxwise this year & the following ones.
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Letter to my congressman
Old 03-14-2009, 12:48 AM   #19
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Letter to my congressman

I've accepted having to pay the 10 years of penalty, but wrote to my Congressman anyway since the situation just is not fair:

Congressman Boyd,
I am a retired law enforcement officer and am interested in effecting a change in the tax code as relates to like public safety retirees.

I worked for 25 years and anticipated a normal retirement based on the information I received when I was hired in 1981. The rules in Florida were/are that you can retire after 25 years of special risk or public safety employment. After I retired at age 46, I learned that IRS rules (specifically rule 72t) require employment until age 50. This was enacted in 2006 by the Pension Protection Act (PPA), which specifies a person must be age 50 or older at the time of retirement versus a set number of years of service. From my reading of the PPA, it appears the goal was to define a normal retirement situation for public safety, with the end result being an arbitrary age of 50 regardless of years of service. I've since learned there is nothing I can do- I cannot be re-employed until age 50 to remove the penalty, and it cannot be waived when I reach age 50. I must pay the 10% tax penalty until age 59.5. I am unable to use any of the exceptions mentioned in rule 72t.

Since I followed the rules of my employer for years of service, I feel I am being unfairly penalized by the IRS rules based solely on age and my diligence in career planning at a young age. I would like to see what can be done insofar as legislation to amend rule 72t to allow for a normal retirement versus a set age as it now exists. I realize a majority of public safety retirees do not fit into this category, however, as such, the impact on government revenue would be minimal.

I do not mind paying my fair share of income tax, but the penalty places a heavy burden on my family since our retirement savings have lost much of their value.

I look forward to speaking with you or your designate about this issue.

Thank you for any consideration.
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Update
Old 04-23-2009, 01:04 AM   #20
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Update

As an update, I've had NO RESPONSE from my elected officials. In addition to the email from his website, I also faxed my letter and called his local office. The clerk there acknowledged receiving the letter. I was referred to the DC office and left a voice mail for the person that handles tax issues. This was April 6, and as of today no response, not even a phone call.

I've also written to the members of the joint committee on taxation, all but Mr. Hatch, since he clearly states on his website he won't return correspondence unless you are a Utah resident. Perhaps it is the joint committee for Utah taxation in his case?

What is wrong with our country to where the elected officials can't even acknowledge correspondence? I've never encountered this at the state and local level. This brings to mind the phrase taxation w/o representation.

I have started a website and message board for public safety retirees at Retired Public Safety.com.

I'm requesting the taxpayers that have had enough with our unfair system of taxation contact their representative and senator to loudly but professionally complain about our tax code that punishes achievement. The congress can "do something" about the AIG bonuses in under a week, so they can do something about our penalizing tax code in a like period of time. With the widespread Tea Party movement, now is a good time to get rid of the early retirement penalty along with the rest of the onerous tax code and replace it with a fair tax.
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