Establishing an individual retirement account (IRA) is a great way to prepare for the future. Although divorces are rarely foreseeable, separating couples should be aware that dividing an IRA may result in it being subject to income taxes, penalties, or both, if not structured properly. Evidenced in TC Memo 2017-125, the Tax Court has concluded that an IRA split between a divorcing husband and wife is subject to an early distribution penalty.
In this particular case, the couple worked out their own divorce terms without an attorney. Prior to obtaining a court order showing how the martial property will be divided, the husband withdrew his IRA and gave half of it to his wife as part of their settlement. During the transaction, the husband deposited all of the IRA proceeds into their joint bank account and gave the wife her share. Subsequently, the settlement agreement was filed with the court without mention of their self-prepared agreement because the IRA had already been divided.
Unless the withdrawal meets one of a few exemptions, all IRA funds withdrawn before the age of 59½ are taxable and subject to a 10% early distribution penalty. One of these exemptions is a distribution incident to divorce, if structured properly.
IRC 72(t)(2)(C) states that this penalty does not apply to an IRA distribution that is made to an alternate payee pursuant to a qualified domestic relations order. For this code section, the order is defined as a court order to, among other elements, divide marital property rights paid in accordance with the state’s domestic relations law. An alternate payee includes a spouse or former spouse who has the right under an aforementioned order to receive the property.
In this particular instance, the IRA distribution was not made to the spouse and was not made pursuant to a court order. Because of the form of the transaction, the Tax Court determined that this distribution was subject to the 10% penalty.
Tax law is unforgiving and fraught with complexity. These surprises could have easily been avoided if the taxpayers sought out qualified advisors to assist them. If you have questions on this matter or would like to discuss your particular tax situation, please contact Aronson’s Tax Controversy Practice Partner, Larry Rubin, at 301.222.8212 or email@example.com.
Equal means equal led to the termination of Alimony in Virginia – Last week, Virginia’s Supreme Court overruled two previous lower court rulings, and determined that a same-sex relationship analogous to marriage was grounds for termination of support (Luttrell v. Cucco, Record No. 150770). The Supreme Court determined that interpreting the law to mean that “two identically-situated individuals with identical spousal awards would receive opposite treatment if one cohabits in a same-sex relationship and the other cohabits in an opposite-sex relationship” would be an untenable result.
The couple was married in 1992, separated and filed for divorce in 2007. As part of their settlement agreement, Mr. Luttrell agreed to pay monthly spousal support to Ms. Cucco for a term of 8 years which would terminate if, among other reasons, a court granted termination for cohabitation. In July 2014, Mr. Luttrell filed a motion for adjustment of the spousal support on the grounds of cohabitation. At the hearing, Ms. Cucco did not deny Mr. Luttrell’s allegations but instead pointed out that her relationship was with another woman and contended that, therefore, she was not cohabitating since both the separation agreement and the Virginia statute contemplated only a relationship between a man and a woman. The Virginia Court of Special Appeals agreed.
In 2015 the United States Supreme Court ruled in favor of same-sex marriages and in November 2015, the Virginia Supreme Court agreed to hear Mr. Luttrell’s appeal. The Virginia Supreme Court’s ruling overturning the lower court’s interpretation makes it clear that same-sex relationships are now on the same footing as opposite-sex relationships when considering cohabitation as a grounds for divorce.
In the coming weeks Aronson LLC will publish a blog series covering the tax aspects of alimony payments and the tax consequences when alimony payments are re-characterized as child support or distributions of property.
For information on how Aronson can provide assistance in estate, trust and marital disputes click here or contact Sal Ambrosino at 301.231.6272.
Filing separate tax returns this year after years of filing jointly? If you or your former spouse paid estimated taxes during 2015, the tax is generally credited to the first Social Security number shown on the prior tax return, even if an estimated tax voucher with just the spouse’s Social Security number were included with the payment. This poses difficulty in the event the estimates were intended for the person appearing as the spouse on the prior joint return because, upon filing of separate returns, the IRS records will not show the spouse has having paid in any estimates.
In contemplation of separate filings, both spouses should document and agree as to how the estimated tax payments are to be allocated. Correspondence to the IRS well in advance of the filing, stating how you both want payments to be allocated, will save the aggravation of dealing with IRS notices later. Even so, a follow-up after return filing may be necessary, which is a lot easier to do if you have already agreed upon the tax allocation.
A similar problem can arise concerning the overpayment on the prior year joint return requested to be applied to the subsequent year. By default the IRS applies this overpayment to the first Social Security number shown on that return. While IRC 6402(a) states that an overpayment is to be allocated to the spouse whose combination of tax liability and payments gave rise to the overpayment, in practice the IRS has no idea what that allocation should be. Trying to get the IRS to move the funds from overpayments can get difficult, requiring numerous letters and phone calls to accomplish the division. It may therefore be easier to treat the refund as a martial asset and offset it against the assets awarded to the spouse who benefited from the tax overpayment.
For further information or to discuss your specific situation, please contact Larry Rubin, CPA, Aronson’s tax controversy practice lead, at 301-222-8212.
Do you intend to claim your child as a dependent even though you are not the custodial parent? While you may provide more than one-half the support for the child, you are not automatically entitled to claim the dependent deduction and credits.
In a recent Tax Court decision, TC Memo 2013-280, the petitioner maintained he was entitled to the dependency deduction because he and his ex-wife had shared legal custody and the children visited him frequently. The divorce decree awarded the ex-wife full physical custody and was silent as to who claims the dependent deductions. The Court denied petitioner’s claim.
By default, the dependency deduction and various related credits are the exclusive benefit of the spouse who has physical custody for the majority of the year. A custodial parent is the parent with whom the child spends the most nights. In order for the non-custodial spouse to claim the exemption, the custodial spouse must sign an exemption release, IRS Form 8332, and provide that to the non-custodial spouse. This form then must be filed with the non-custodial spouse’s tax return.
Oftentimes, the tax aspects of divorce are not as well thought out as they should be, given various tax issues that only manifest themselves after the deal is inked. By that time it is very difficult, if not impossible, to revisit the divorce agreement. Involving a tax advisor early in the negotiation process is the best way to avoid surprises.
For further information or to discuss your specific situation, please contact Larry Rubin, CPA, Aronson’s tax controversy practice lead, at 301.222.8212.