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Unless the withdrawal meets one of a few exemptions, all IRA funds withdrawn before the age of 59½ are taxable and subject to a 10% early distribution penalty.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.
Taxpayers received an early gift last week when the Protecting Americans from Tax Hikes (PATH) Act of 2015, also commonly referred to as the “extenders tax act,” was signed into law. This legislation permanently allows IRA participants over age 70½ to make annual tax-free distributions from their IRAs for charitable purposes.
Beginning immediately, a taxpayer, via direct transfer by the IRA trustee, can give up to $100,000 per year to the charitable organization of their choosing tax-free. The amount so distributable can count toward meeting a participant’s “minimum required IRA distribution,” but the amount so distributed will not be included in the participant’s Adjusted Gross Income.
Furthermore, since this IRA distribution is not included as income, no itemized deduction can be claimed for the corresponding charitable deduction.
In layman’s terms, the passage of PATH provides taxpayers an advantage by lowering their Adjusted Gross Income (AGI). A lower AGI results in a lower threshold for claiming various items on your individual tax returns, such as medical deductions, child tax credits, inclusions in income for example, Social Security, Roth IRA contributions, and the Obamacare 3.8% surtax on net investment income.
For more information and practical commentary regarding the PATH Act, review Accounting Today’s recent article or contact Aronson’s Tax Services Group at 301.231.6200.
In June 2014, the Supreme Court ruled unanimously that individual retirement accounts (IRAs) inherited by a taxpayer are not protected in bankruptcy proceedings. In the case of Clark v. Rameker the courts have acknowledged that, while bankruptcy code is intended to protect the retirement accounts of debtors, it is not intended to protect inherited IRAs.
Three key factors distinguish traditional IRA accounts from inherited IRA accounts: :
The Supreme Court decision effectively confirmed that the inherited IRA funds are freely consumable by the beneficiaries and, therefore, should not be treated as retirement funds under the bankruptcy exemption.
Since the court’s decision onJune 12th, many financial advisors are helping their clients design strategies that minimize income tax liability and protect their assets.
While many experts believe that the ruling will not apply to spousal beneficiaries who can roll the inherited IRA accounts over to their own name, some believe that the courts will eventually challenge the exemption of spousal rollovers, making the funds subject to bankruptcy creditors.
Where federal exemption is not available, some bankruptcy debtors may seek protection from state laws. Several states, including Alaska, Arizona, Florida, Missouri, North Carolina, Ohio, and Texas, have adopted laws officially exempting inherited IRA accounts from bankruptcy.
For individuals who do not want to rely on state laws or do not reside in such jurisdictions, estate planning attorneys recommend the alternative use of a trust as the beneficiary of an inherited IRA. In fact, some believe that the accumulation trust will become a popular option, from an asset protection standpoint, as the trustee can opt to hold the funds and not make the distributions. The downside, of course, is that accumulating the distributions at the trust level will have less favorable tax treatment, since the top tax bracket (39.6%) for trusts in 2014 will be reached at just $12,500 of taxable income.
For majority of beneficiaries, the risk of liability and creditors may be low, but a conversation with advisors should be considered if asset protection is the ultimate priority.
For more information about the tax issues surrounding IRAs or other retirement accounts, please contact your Aronson tax advisor or Anatoli Pilchtchikov at 301.231.6200.
Early this year, the U.S. Tax Court made a surprise ruling (Bobrow v. Commissioner) related to the 60-day IRA rollover rules. The ruling, which came as a shock to individuals and practitioners alike, completely contradicted the IRS’ previous position, the instructions in Publication 590 and years of practice.
Prior to the ruling, individuals could take distributions from their IRAs and, if they deposited the amount(s) or some portion thereof back into an IRA within 60 days, not have a taxable distribution. Previous guidance held that an individual could have multiple 60-day rollovers in a 12-month period if they had multiple IRAs. The new guidance now aggregates all IRAs for purposes of the 12-month period, meaning that an individual can only do one 60-day rollover in a 12-month period, regardless of the number of IRA accounts they hold. Trustee-to-trustee transfers are not affected by the ruling. This change will not impact many individuals, but it will certainly affect those that have become accustomed to using their IRAs for short-term loans.
Initially there was some level of hope that the IRS would reaffirm their 30-year position. However, such hope faded when they followed up with Announcement 2014-15, which postpones the Bobrow decision until January 1, 2015. The new rules apply to rollovers that take place after January 1, 2015.
If you have any questions, please contact Mark Flanagan of Aronson LLC’s Specialty Tax practice at 301.231.6257.
Are you at least 70½ years old and required to take out required minimum distributions (RMD) from your IRA? Are you also contemplating charitable donations before year-end? Through the end of 2013, you can make charitable donations up to $100,000 directly from your IRA and have it count toward your RMD.
Though this provision has existed in past years, it did not have much of an impact. For 2013, however, it very well may save you some tax. For 2013 and future years, the itemized deduction and exemption phaseouts are back. These, and the new “Obamacare” surtaxes, are based on your adjusted gross income.
Making charitable donations out of the IRA keeps your RMD out of your adjusted gross income, thus lowering the adverse effects of these phaseouts and surtaxes. You don’t get a charitable deduction, but the RMD is not included in income. Note that such a contribution must be completed by the end of this year. This may be the last chance to take advantage of this provision, as Congress has not extended this provision beyond 2013.
For further information or to discuss your specific situation, please contact your Aronson tax advisor at 301.231.6200.