IRA distribution funded by community property was taxable solely to participant.

• Author: Bakale, Anthony

In Bunney, 114 TC No. 17 (2000), a case of first impression, the Tax Court ruled that an entire IRA distribution was taxable solely to the participant, even though he transferred most of the distribution to his former spouse, who owned one-half of the IRA as community property. The participant could have avoided this result by complying with the "transfer incident to divorce" provisions of Sec. 408(d)(6). The Tax Court also reaffirmed its prior ruling that the distribution of a community property interest in a retirement plan is taxed one-half to each spouse, except when Congress has specified otherwise, as it has for IRA distributions.

Sec. 219(f)(2) specifies that IRA contributions are deductible without regard to any community property laws. Sec. 408(d)(1) includes IRA distributions in the payee's or distributee's gross income, as provided under Sec. 72. Although neither "payee" nor "distributee" is defined in the Code or regulations, the Tax Court has interpreted "distributee" under Sec. 402(b)(2) as "the participant or beneficiary who, under the plan, is entitled to receive the distribution." Sec. 408(g) requires that Sec. 408 be applied "without regard to any community property laws."

Sec. 408(d)(6) specifies that a transfer of a participant's interest in an IRA to a spouse or former spouse incident to divorce is not a taxable transfer if made under a Sec. 71 (b)(2) divorce or separation instrument. The IRA is thereafter treated as the spouse's. IRS Pub. 590, Individual Retirement Arrangements, Important Changes, states that an IRA interest can be transferred by either changing the name on the IRA to the nonparticipant spouse's or by directing the IRA trustee to transfer the IRA assets to the trustee of the nonparticipant spouse's IRA. However, receiving a cash distribution and transferring it to the former spouse is not a qualifying transfer under Pub. 590. (Sec. 414(p) qualified domestic relations orders do not apply to IRKs, but transfers qualifying under Sec. 408(d)(6) achieve the same objective of shifting tax to the nonparticipant spouse.)

In Bunney, Michael Bunney's IRA was funded with community property; therefore, each spouse owned half. In 1992, the Bunneys divorced, and the divorce court ordered an equal division of the IRA. In 1993, Michael withdrew $125,000 from his IRA and subsequently transferred $111,600 to his former spouse and received her interest in their residence. Michael reported only $13,400 of the IRA...