My question is whether anyone isaware of anything that indicates definitively one way or another whether a fee taken during the processing of that lump sum can be included as part of the taxable amount of the distribution, or whether it must be thought of as having occurred prior to the distribution and thus not be included in the taxable amount?

The following are examples of the options we are exploring:

Gross Funds Liquidated 2500.00


Taxable Amount 2,500.00
Non-Taxable Amount 0.00

Gross Cash Distribution Amount 2,500.00
Federal Taxes Withheld 500.00
State Taxes Withheld 0.00
Participant Paid Distribution Fee 75.00
Net Cash Distribution Amount 1,925.00


Proponents that the fee should not be considered taxable would say it should be handled as below:

Gross Funds Liquidated 2500.00
Participant Paid Distribution Fee 75.00


Taxable Amount 2,425.00
Non-Taxable Amount 0.00

Gross Cash Distribution Amount 2,425.00
Federal Taxes Withheld 485.00
State Taxes Withheld 0.00
Net Cash Distribution Amount 1,940.00


Does anyone know which way is correct?

A participant is only taxed an amounts distributed. If the fee is removed from the participant's account before distribution, then the participant should only be taxed on the amount actually received.

Here's my opinion -- I think it's wrong to include the fee in the amount distributed. I don't have any cites, but I'm sure someone else will chime in.
I believe some institutions include the fee as part of the distributed amount because it's administratively easier. Including the fee in the distribution makes it taxable and subject to penalties. Here in Wisconsin (a tax hell, according to Money Magazine), the $75 fee would be hit with the following taxes and penalties:
federal: your rate
state: your rate
federal penalty: 10%
state penalty: 3.33%

Other comments??