§35.11 Tax Treatment of Distribution to Alternate Payee and Participant (As It Relates to Qdros)

• Jurisdiction: Washington

§ 35.11 TAX TREATMENT OF DISTRIBUTION TO ALTERNATE PAYEE AND PARTICIPANT (AS IT RELATES TO QDROS)

Although a tax provision in a QDRO is not required, it may clarify the tax consequences for the parties. If a plan has special features such as employer stock or after-tax contributions, such features should be addressed.

[1] Inclusion in Gross Income

Any retirement benefit that does not represent a return of the participant's after-tax contributions will be subject to federal income tax. I.R.C. § 402(a). In the absence of a QDRO, the participant is taxable on distributions from the plan and may also be subject to the 10 percent premature distribution tax. I.R.C. §§ 402(e)(1)(A), 72(t)(1). If a valid QDRO is in existence, the Code treats the alternate payee who is a spouse or former spouse of the participant as the distributee with respect to a distribution under a QDRO. I.R.C. § 402(e)(1)(A). If the alternate payee is not the participant's spouse or former spouse (e.g., alternate payee is a child), the participant remains taxable on the distribution and is also subject to withholding. I.R.S. Notice 89-25, Q & A 3, 1989-1 C.B. 662; I.R.S. Priv. Ltr. Rul. 90-13-007 (Mar. 30, 1990).

Whether an order is a QDRO can have important tax consequences. In Hawkins v. Commissioner, 86 F.3d 982 (10th Cir. 1996), the Tenth Circuit reversed the tax court and held that a divorce decree and settlement agreement created a QDRO. As a result, the wife was treated as an alternate payee and was taxable on the $1 million she received from her husband's pension plan. The tax court previously ruled that the settlement agreement failed to satisfy the technical requirements of a QDRO, and that the husband was therefore taxable with respect to the $1 million distribution. In Brotman v. Commissioner, 105 T.C. 141 (1995), the tax court held that a distribution from a plan was not made pursuant to a valid QDRO and the participant was therefore liable for the income tax due on the distribution, as well as the 10 percent early distribution penalty and the 15 percent excess distribution penalty. In Clawson v. Commissioner, 72 T.C.M. (CCH) 814, T.C. Memo. 1996-446, the tax court ruled that the nonparticipant spouse who received a distribution pursuant to a QDRO was considered the "alternate payee." As such, the alternate payee was taxable on the distributed amount even though the QDRO specifications provided that the participant's spouse was obligated to pay all federal income taxes...