QDRO and 401K Distribution

[mcb39]

My client (wife) was divorced in Feb 2009. 401K Distributions from husbands plan are reported on 1099-R, coded 1. Distibutions are $62900; 20% Fed tax withheld; no state tax withheld. Husband is incarcerated awaiting trial. Does the exception to the penalty apply in this case? They are supposed to file a joint return for 2009. I would have chosen to file her MFS, but delays in divorce.; and QDRO have negated this. Husband has been incarcerated since April 2008 on very serious charges. Can I protect my client from a $6290 Fed penalty and a $2076 WI penalty (under the law). Remember that this is a community property state. Of course, she is the primary breadwinner with 2 dependent children; except for this blasted 401K distribution. I am losing (more) sleep over this one. She is not only a client, but a friend which makes it worse. Spoke to her attorney last evening and he is being very defensive and patronizing. Obviously knows little about tax law. Please advise....anyone!

[jasdlm]

I assume you mean a joint return for 2008, not 2009? In whose name/SSN was the 1099 issued? I can't figure out how a distribution was made pursuant to a QDRO in 2008 when the divorce was not final until 2009. If the distribution were made to the alternate payee pursuant to a properly executed QDRO, it should be excluded. Again, however, I can't figure out how they could process a QDRO (a post-divorce proceeding) prior to the actual divorce. What am I missing? Did the attorney possibly advise an early withdrawal (non-QDRO) during the proceedings to free up cash? (Yes, this would be really poor planning, but I'm trying to figure out what might be going on.) If the 1099 is in husband's name and SSN, it is probably not pursuant to QDRO. If not pursuant to QDRO, no exception as far as I am aware.

[mcb39]

The 1099 is in HIS name and SS. Yes, the return would be for 2008. I think you are correct that the distribution was made prior to the divorce in order to free up cash so the family could pay bills that he had run up and continue to live. I also think that this is why the attorney seemed defensive and patronizing; because he is all of a sudden faced with an "oops"!

[lbbwest]

My client (wife) was divorced in Feb 2009. 401K Distributions from husbands plan are reported on 1099-R, coded 1. Distibutions are $62900; 20% Fed tax withheld; no state tax withheld. Husband is incarcerated awaiting trial. Does the exception to the penalty apply in this case? They are supposed to file a joint return for 2009. I would have chosen to file her MFS, but delays in divorce.; and QDRO have negated this. Husband has been incarcerated since April 2008 on very serious charges. Can I protect my client from a $6290 Fed penalty and a $2076 WI penalty (under the law). Remember that this is a community property state. Of course, she is the primary breadwinner with 2 dependent children; except for this blasted 401K distribution. I am losing (more) sleep over this one. She is not only a client, but a friend which makes it worse. Spoke to her attorney last evening and he is being very defensive and patronizing. Obviously knows little about tax law. Please advise....anyone!

The way the QDRO works is that it's paid out to the recipient; the recipient has the right to roll it over into his/her own IRA, no tax, no penalty. IF spouse (wife) received the funds rather than rolling it over, she is subject (if applicable) to early distribution penalties. It doesn't matter where the ex-spouse is or why. One can not be the best advocate for the taxpayer if one is emotionally involved. We are talking tax law here, not good and evil. Calm down. Look at the facts, research the law and move forward. lbb

[mgmea]

The way the QDRO works is that it's paid out to the recipient; the recipient has the right to roll it over into his/her own IRA, no tax, no penalty. IF spouse (wife) received the funds rather than rolling it over, she is subject (if applicable) to early distribution penalties. It doesn't matter where the ex-spouse is or why. One can not be the best advocate for the taxpayer if one is emotionally involved. We are talking tax law here, not good and evil. Calm down. Look at the facts, research the law and move forward. lbb

Distirbutions received by an alternate payee under a QDRO that are not rolled over to an IRA are NOT subject to the 10% early distribution penalty under exception 06 of Form 5329. The problem is that this distribution does not appear to have been done under a QDRO. If the attorney advised in writing that this was going to be a QDRO you may want to consider having the attorney pay the 10% penalty.

[jasdlm]

Agree with mgmea. Distributions received by an alternate payee under a QDRO coming from a qualified plan (NOT an IRA) that are 'distributions pursuant to divorce' are exempt from the penalty.

However, unfortunately, in this case it is pretty clear that the distributions are not pursuant to the QDRO and not paid to the alternate payee. Sorry, Marilyn. This one's ugly, but it looks like the penalty is not going to be avoidable.

Did the attorney specifically tell your client that the withdrawal would not be subject to the penalty?

[mcb39]

Agree with mgmea. Distributions received by an alternate payee under a QDRO coming from a qualified plan (NOT an IRA) that are 'distributions pursuant to divorce' are exempt from the penalty.

However, unfortunately, in this case it is pretty clear that the distributions are not pursuant to the QDRO and not paid to the alternate payee. Sorry, Marilyn. This one's ugly, but it looks like the penalty is not going to be avoidable.

Did the attorney specifically tell your client that the withdrawal would not be subject to the penalty?

When I spoke to him last evening, I asked him who had arranged this withdrawal. He said that he had and sounded quite proud of himself for having gotten these moneys for his client. When I said, "But, what about the penalty?" He said, "What Penalty?" and that is when he started to get defensive. He said that he works from 5 in the morning until 7 at night and I said that had nothing to do with any of this. (As if we don't know what working long hours is about!) I have found on numerous occasions that unless an attorney is a specific "Tax Attorney", they know very little about tax law. Which is why I have asked this board for insight, because I'm not going to get it from him. I am quite sure that part of the reason that he rushed the 401K distribution was so that she would have money to pay attorney fees.

[mcb39]

I would also like to add that my client is very naive when it comes to taxes and money management because her husband always handled everything and was (as we now know) pretty secretive about it. I am not emotionally involved. I just want to do the best job that I can for a client who just happens to be a friend who trusts me. I wanted this divorce to go through before the end of 2008. She filed the day after he was arrested and simultaneously lost his job. Due to the nature of the charges, she has not been allowed to talk about the details. The attorney told me last night that he would fax me a copy of the settlement, etc; but so far nothing. I am going away for the weekend and will not be dwelling on this as I have many other returns that need my attention. I will, however, have access to this board. Thank you all for your interest, advice and support.

[zeke]

Marilyn - You state in your OP that she is "supposed to file jointly". I would examine the question "or what?".\

z

[mcb39]

Marilyn - You state in your OP that she is "supposed to file jointly". I would examine the question "or what?".\

z

The "or what" would be MFS because she could file HOH with 2 children. However, I am not sure it would make a great deal of difference with this being a community property state. If she hadn't gotten the 1099 for the 401K dist as well as his minimal W2, we could have maybe said that she did not have access to his info; however that would not be the truth at this point. I asked the attorney if there was any ruling on how they were supposed to file and that is when he said he would fax me the information, which he has not done. I would have liked to go MFS and let HIM bite the bullet for the 401K but am not sure that I would be able to do that now.

[lbbwest]

Agree with mgmea. Distributions received by an alternate payee under a QDRO coming from a qualified plan (NOT an IRA) that are 'distributions pursuant to divorce' are exempt from the penalty.

However, unfortunately, in this case it is pretty clear that the distributions are not pursuant to the QDRO and not paid to the alternate payee. Sorry, Marilyn. This one's ugly, but it looks like the penalty is not going to be avoidable.

Did the attorney specifically tell your client that the withdrawal would not be subject to the penalty?

Sorry, typed too fast. Thoughts not coherent. Let me rephrase.

IF QDRO was correctly done AND distribution was from Ex-husbands plan to wife NO PENALTY, if she rolled into her IRA no TAX.

IF QDRO not done correctly and distributed in EX-husband's name/social COULD BE subject to penalty as community property state could be on joint return.

Mea culpa mea culpa mea maxi culpa

[jasdlm]

lbb - great to see you! I was wondering where you were this year! I just saw you on here the last day or two. Now if Jainen would just 'reappear' we'd have the whole crew!

Hope your season is going well.

[lbbwest]

lbb - great to see you! I was wondering where you were this year! I just saw you on here the last day or two. Now if Jainen would just 'reappear' we'd have the whole crew!

Hope your season is going well.

It's great to see all the familiar faces...errr names, Jainen gone? Shocked.

[kcjenkins]

Well, we know know this was NOT any sort of WDRO, just him withdrawing funds. Personally, I'd file her HOH, since he 'abandoned' her in the first half of the year, and I'd ignore his income. I'd prepare a MFS return for him, as well, which I would mail to him with postage-paid envelopes to mail them in. Clearly he can not pay, but filing on time will minimize his penalties, and protect the wife as well. I'd ignore the CP issue from the date she filed for divorce.

[ljwalters]

If this is a community property state, Wife would be required to caim 1/2 the income of each up until the date of seperation. If the mony was distributed from the 401K after date of seperation she MIGHT not be liable for this tax or penalty.

linda and buddy

[BulldogTom]

Check the community property laws in your state. If this was in CA, it would be a non-issue, because community ends when the couple separates with no intention of reconciling. So, if this client was in CA instead of WI, the income would go to the husband only.

I don't know the laws in WI, but you should check out when community ends in your state.

Tom

Lodi, CA

[mcb39]

Well, we know know this was NOT any sort of WDRO, just him withdrawing funds. Personally, I'd file her HOH, since he 'abandoned' her in the first half of the year, and I'd ignore his income. I'd prepare a MFS return for him, as well, which I would mail to him with postage-paid envelopes to mail them in. Clearly he can not pay, but filing on time will minimize his penalties, and protect the wife as well. I'd ignore the CP issue from the date she filed for divorce.

KC we discussed this at the time that it first happened (the separation). She filed for divorce the next day. Of course, they had to make it take nearly a year to actually happen. Postponement after postponement with him trying to contest. I have always wanted to file her HOH and him MFS. However, at that time I had no idea how they were handling the 401K issue because she is not supposed to discuss any details. I wonder now about the ethics of filing that way since we do know his income. It was actually the attorneys who arranged the withdrawal of the 401K, much to their advantage it appears. I sure don't want to do the wrong thing here as she has been through enough already. Her attorney told me to prepare it both ways and fax the results to him. I really don't want to put any of this in his hands now as it will just put more feathers in his nest. The X husband really only had less than 4 months of earned income in 2008 and the 401K thing happened long after the fact. I appreciate your input.

[Kea]

Aren't IRAs and 401(k)s considered separate property even in community property states? I'm not sure where I think I heard or read this - it's just one of those random pieces of info floating around the back of my head. (I really need to get in there and clean that out.)

[kcjenkins]

25.15.5.9.2 (05-01-2005)

Equitable Relief

If the requesting spouse (RS) does not qualify for traditional relief under the first sentence of IRC 66©, then the Service will consider equitable relief under the second sentence of IRC 66©.

Relief is available for both deficiency cases and underpayment cases.

The Service issued a revised guidance on the relief provision in Rev. Proc. 2003-61, 2003-32 IRB 296. Rev. Proc. 2003–61 is effective for relief requests filed on or after November 1, 2003. In addition, this revenue procedure is effective for requests where a preliminary determination letter has not been issued as of November 1, 2003. Rev. Proc. 2000–15 is still effective for all other requests for relief. For information on the factors to consider when determining whether equitable relief should be granted see IRM 25.15.3.8.2 . These guidelines should be applied in a consistent and nondiscriminatory manner. Decisions to grant relief should not be based on the subjective personal and social beliefs of the IRS employee or any other inappropriate grounds.

If it is inequitable to hold the RS liable for any unpaid tax or deficiency, the Secretary may grant relief. The equitable relief provision under IRC 66© is available for spouses domiciled in a community property state, who did not file a joint return and who do not qualify for the traditional relief under the first sentence of IRC 66©, and who meet the following threshold requirements:

The RS must apply for relief no later than two years after the Service’s first collection activity after July 22, 1998, with respect to the RS

The non-requesting spouse (NRS) must not have transferred assets to the RS as part of a fraudulent scheme, and, in addition, if disqualified assets were transferred, relief can only be granted to the extent the income tax liability exceeds the value of those assets

The RS did not file or fail to file the return with fraudulent intent

If Rev. Proc. 2003–61 applies, then the income tax liability from which the RS seeks relief must be attributable to an item of the NRS, unless an exception applies. See IRM 25.15.3.8.2.1(4) for the exceptions

If all the above threshold requirements are met, the guidelines in Rev. Proc. 2003–61 or Rev. Proc. 2000–15 should be followed in determining whether to grant relief. If the decision is made to grant relief, the item of community income is included in the gross income of the NRS and not in the gross income of the RS. However, any additional assessments made against the NRS must be made in accordance with the deficiency procedures of IRC 6212 and IRC 6213. Where IRC 66© is asserted against the other spouse, it must be clearly reflected in the notice of deficiency

25.15.5.10 (03-21-2008)

Requesting relief under IRC § 66©

A RS seeking relief from the operation of community property law under IRC 66© must request such relief in a statement signed under penalties of perjury or Form 8857, Request for Innocent Spouse Relief. The statement must state why relief is appropriate and include the NRS’s name and taxpayer identification number (TIN).

[SCL]

i have a problem with this discussion (a problem that was immedietally questioned but not answered).

divorce in 2/09?...and payments that relate to the 2008 tax return? (or the 2009 tax return?)

[mcb39]

i have a problem with this discussion (a problem that was immedietally questioned but not answered).

divorce in 2/09?...and payments that relate to the 2008 tax return? (or the 2009 tax return?)

Divorce in 2/2009; Return for 2008 Separation in 4/2008 Divorce filed for in 4/2008 Thank you!

[jasdlm]

SCL - that's what the whole issue is about . . . the distribution was not made pursuant to a QDRO because it was pre-divorce. Marilyn mistyped in her original post . . . she means the 2008 tax return.

[BulldogTom]

I am still unclear on one point. Did the spouse (your taxpayer) recieve any of the money? If she has constructively recieved the cash, I think the penalty is valid. If all the funds went to the incarcerated spouse or his attorney, then I think you have a good case for relief.

Tom

Lodi, CA

[mcb39]

I am still unclear on one point. Did the spouse (your taxpayer) recieve any of the money? If she has constructively recieved the cash, I think the penalty is valid. If all the funds went to the incarcerated spouse or his attorney, then I think you have a good case for relief.

Tom

Lodi, CA

My understanding is that she has access to the funds to pay bills that she was left with. I know that prior to the divorce, she had to have signed permission from him to spend or sell anything (other than her wages.) I am waiting for someone to get me a copy of the divorce settlement. Her attorney promised to fax it to me, but he has not. I know that she had to pay both attorneys out of these funds. I so appreciate all of the interest and input I have received in this matter. The more I read about WI community property laws, the less inclined I am to think that she has an "out".

[lbbwest]

My understanding is that she has access to the funds to pay bills that she was left with. I know that prior to the divorce, she had to have signed permission from him to spend or sell anything (other than her wages.) I am waiting for someone to get me a copy of the divorce settlement. Her attorney promised to fax it to me, but he has not. I know that she had to pay both attorneys out of these funds. I so appreciate all of the interest and input I have received in this matter. The more I read about WI community property laws, the less inclined I am to think that she has an "out".

I agree with you. Using a cut and past from KC's cut and paste "in addition, if disqualified assets were transferred, relief can only be granted to the extent the income tax liability exceeds the value of those assets"

It sounds like your client had "constructive receipt of those funds." lbb