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A friend of mine has a business opportunity and in order to fund some initial costs would need to supplement his funds a little. He has no W2 employment income and likely only a small amount of 1099 contract work.

Say for an example, there is $5,000 of 1099 income in this year, and he takes a $5,000 distribution from his IRA, would the Standard deduction and personal exemption drop his taxable income to zero? Would the net effect of this distribution just be the $500 early distribution penalty?

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    'contract work' on 1099-MISC is earned income (net of related expenses), even though it is not on W-2. In particular, it is subject to SE tax (unless under $400) and supports EITC (if otherwise eligible) and permits IRA contributions (although that's irrelevant to your friend's particular situation). Other kinds of 1099 like interest, dividends, and (net) capital gains -- and pensions and IRA distributions -- are not considered earned. – dave_thompson_085 Feb 10 '17 at 23:20
  • @dave_thompson_085 edited to clairify i meant employee W2 income not "earned income" – quid Feb 11 '17 at 0:11
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+100

IRA distributions are reported on line 15b on the standard form 1040. That is in the same Income section as most of your other income (including that 1099 income and W2 income, etc.). Its income is included in the Line 22 "Total Income", from which the Personal Exemption (calculated on 6d, subtracted from the total in line 42) and the Standard Deduction (line 40 - also Itemized Deduction total would be here) are later reduced to arrive at Line 43, "Taxable Income".

As such, yes, he might owe only the 10% penalty (which is reported on line 59, and you do not reduce this by the deductions, as you surmised).

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