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Dividing Property In Divorce Tax Traps – Part 6 In Series



DAVID ELLIS - Dividing Property In Divorce Tax Traps – Part 6

(Part 6 is continuation of series, links to all parts are provided at end of this blog post. This valuable series on Dividing Property In A Divorce Tax Traps has been updated for the Tax Cuts And Jobs Act (TCJA) and the Cares Act. This series is provided by David Ellis of Ellis & Ellis CPAs in Pasadena, CA.) 

2. How QDRO (Qualified Domestic Relations Order) Distributions are Taxed

a)The alternate payee assumes the same rights and responsibilities as the plan participant. When a distribution is made to a plan participant’s spouse or former spouse, it is taxed to such spouse or former spouse.[1]

Tax Trap Alert: When distributions are made to a dependent of a plan participant, they are not taxed to such dependent, but rather they are taxed to the plan participant.[2]

b)Basis is allocated on a prorated formula between the participant and the participant’s spouse or former spouse according to present value formulations.[3]

c).QDRO distributions not subject to early withdrawal penalty. Age of the alternate payee does not matter for QDRO distributions. No early withdrawal penalty [4]

Tax Trap Alert: Although QDRO distributions from qualified plans are not subject to the 10% penalty for early withdrawal, the same does not hold true for IRA’s, SEP’s, or SIMPLE plans regardless of any domestic relations court order.[5]

Tax Trap Alert: In the author’s experience, it is not unusual for an alternate payee to rollover distributions under a QDRO into an IRA. Assuming the alternate payee does not meet the age (or one of the other exceptions), subsequent distributions from the IRA will be subject to the 10% early withdrawal penalty. Practitioners should take care to call this tax pitfall to the clients’ attention prior to the rollover of the QDRO distribution into an IRA.

Example: Fred and Ethel are recently divorced. Pursuant to a QDRO, Ethel receives $100,000 from Fred’s 401k. The $100,000 is included in Ethel’s gross income, but is not subject to the 10% early withdrawal penalty in spite of the fact that Ethel has not reached the age of 59 1/2 years. Assume the same set of facts presented above, however instead of taking the QDRO distribution directly, she rolls it over into an IRA. If no exceptions apply so long as Ethel is under the age of 59 1/2, subsequent withdrawals will be subject to the 10% early withdrawal penalty.

Note: Taxpayers in need of immediate cash flow may be able to avoid the 10% early withdrawal penalty by taking advantage of the substantially equal periodic payment provisions of Internal Revenue Code Section 72(t)(2)(A)(iv)

3.Dividing Other Types of Plans

a) United States Government Employee Retirement Plans are not subject to

QDROs.[1]

b)  Federal Retirement Plans are divided by a Court Order Acceptable for

Processing “COAP” which must be submitted to the Office of Personal

Management in Washington.[2]

Tax Trap Alert: Part of the current Federal Employee retirement plan regimen consist of Thrift Savings Plans (TSP), which are Defined Contribution plans somewhat similar to 401k plans. This part of the retirement plan cannot be divided by a QDRO. Instead a court order is necessary, which should be submitted to the TSP service center in Fairfax, Virginia.

c) Armed Forces Retirement Plan

The governing document for the division of Retirement plans for members of the United States military is the Uniformed Services Former Spouses Protection Act

(USFSPA).

  • Retirement plans under USFSPA are divided by court order
  • Spouses must have been married a minimum of ten years while serving spouse was on active duty for ten years

Tax Trap Alert: Military retirement pay is not a qualified plan. As such, the rules governing qualified plans and QDRO’s are not applicable. Division of the retirement benefits is achieved by filing a court order(or legal separation agreement) with the Defense Finance and Accounting

Service. The agency’s website is www.dfas.mil  wherein further information may be found.

d) Other Types of Tax Exempt Plans

Employees of State, Local, and other Not for Profit entities such as IRC Section 501(C) (3) Charities, may be covered by other types of Plans governed under IRC Section 401(a), 403(b) or 457. As a general rule, these plans are divisible by use of a QDRO, however there are exceptions.  Practitioners should give serious consideration to the use of an expert in this area, and at a minimum consult the Plan Administrator of any State/Local government entity or Not for Profit organization as to proper procedure and language for dividing the plan’s benefits.

4.Individual Retirement Account (IRA) Transfers

(Discussed In Upcoming Part 7 of Series)

Go To Part 1 In Series

Go To Part 2 In Series

Go To Part 3 In Series

Go To Part 4 In Series

Go To Part 5 In Series

Have a question? Contact David Ellis, Ellis & Ellis CPAs.

All Tax Practitioners And Taxpayers Welcome To Contact David With Questions.

(All footnotes will be posted at end of series! This material is for informational purposes only and is not a substitute for tax advice from a qualified professional and the author assumes no liability whatsoever in connection with its use.  No advisor/client relationship exists.)

David Ellis is the managing partner of Ellis & Ellis, CPAs, Inc. located in Pasadena, California. He has over 25 years of experience in the practice of Divorce, Trust/Estate, and other family tax matters. He is an advisor in matters pertaining to Trust, Estate, and Corporate Taxation to the Los Angeles County Office of the Public Guardian. The firm also provides other general tax services and IRS representation. He earned his Bachelor’s Degree from the University of Southern California in Communication Arts and Sciences. He is a frequent writer and speaker on various tax subjects, and has provided continuing education services to other CPAs and tax professional in the area of Divorce, Trust, and Estate Taxation. An article that he recently co-authored entitled The Tax Consequences of Dividing Marital Property can be found in the December 2014 issue of Practical Tax Strategies, a national professional tax publication.

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