Child Support Order awarding 100% of the Account

[HCE]

Under our QDRO procedures, under a child support Order, the Participant is responsible for taxes owed on the QDRO distribution.  Normally, we give the Participant the option of either (1) paying the tax amount out of pocket or, (2) increasing the distribution in an amount needed to cover the taxes.  For example, if the QDRO award the AP $100, we can either distribute the $100 to the AP and have the participant pay $10 (10%) out of pocket, or we increase the distribution to $110 so that $100 can go to the AP and $10 can cover the taxes.

We recently received a child support Order that awards the AP 100% of the participant's account.  Clearly, we can't increase the distribution to cover the taxes.  Do we just send the Participant a demand for payment to cover the taxes?  What happens if the Participant refuses to pay?

[Peter Gulia]

If an order is a QDRO, the plan pays the alternate payee according to the order.

If the alternate payee is not the participant’s current or former spouse, the tax-information report treats the QDRO distribution as the participant’s (not the nonspouse alternate payee’s) distribution.

If that distributee fails to pay a Federal income tax, the distributee may explain oneself to the IRS. If that distribute fails to pay a State, local, or non-US income tax, the distributee may explain oneself to each tax authority.

If an individual anticipates income and tax more than the individual anticipates will be met through withholding from wages, the individual may file an estimated income tax return and pay an amount with such a return. Alternatively, many people find it more convenient to set tax withholdings from wages in amounts enough to meet anticipated income taxes, including taxes on nonwage income.

[Adi]

I've found this scenario comes up with some frequency. To prevent this issue in the future, consider QDRO Procedures that provide the distribution will be reduced by applicable income tax withholding elected by the P. 

[Peter Gulia]

But if a QDRO calls for the alternate payee to get 100% of the participant's account, the plan should not permit a withholding choice that would lower the QDRO distribution to less than the court-ordered amount.

[ESOP Guy]

Just asking but can the plan say the DRO isn't a QDRO because it is asking the plan to pay a larger benefit than the person has?

I mean the federal taxes is mandatory after all.   So by not making a provision with the mandatory 20% withholding they are asking the plan to pay in excess of what the benefit actually is. 

Once again, I am asking not saying this position is correct. 

Otherwise, I would think Peter is got the answer.  This person has to figure out how to account for the taxes outside the plan and distribution.   A big of enough payment that could really hurt.  If that is the case, they need to get a good CPA to help them to make a plan.  The IRS is more willing to accept installments the last few years than they used to many years ago.   A CPA should be able to guide the person through that process.  

[Peter Gulia]

A QDRO distribution to a nonspouse alternate payee is not an eligible rollover distribution, so that 20% withholding does not apply.

One doubts the pension withholding regulations require a payer to accept a participant's withholding election if there is no amount payable to the participant.

[Adi]

1 hour ago, Peter Gulia said:

But if a QDRO calls for the alternate payee to get 100% of the participant's account, the plan should not permit a withholding choice that would lower the QDRO distribution to less than the court-ordered amount.

Can the plan override the participant's choice (including lack thereof)? I'd argue no. Per Section 3405, the Plan must withhold 10% unless the participant elects otherwise. See also IRS Notice 89-25 (confirming distributions to child AP are withheld from the distribution: "Consequently, amounts shall be withheld from the distribution as if the plan participant were the payee, unless the plan participant elects not to have the withholding rules apply"). And so if a QDRO awarded the AP 100% of P's account, and P doesn't make an election, then the plan should withhold the 10% from the distribution because a QDRO can't dictate federal tax rules or otherwise award funds not available in the participant's account.

[Peter Gulia]

My guess might be wrong. And thank you, Adi, for remembering the guidance.

IRS Notice’s Q&A-3 explains “amounts shall be withheld from the distribution as if the plan participant were the payee[.]” (I cite the Notice in my QDRO chapters in Answer Books and other publications.)

But an IRS Notice is not a rule or regulation, much less one to which any court must defer.

Further, even if the Notice’s interpretation is correct, a plan’s administrator might resolve a tension (if the order is a QDRO) by putting first the child’s right to get the amount the domestic-relations court ordered.

Some fear the IRS less than the unpleasantness of explaining to domestic-relations lawyers and, worse, judges, a retirement plan’s provisions and governing law.

An alternative is finding that an order that does not “clearly specify” the amount or percentage set aside for the alternate payee to allow, clearly, for the participant’s withholding is not a QDRO.

[Nate S]

If the order says "available" balance, have the involved counsel sign a letter of understanding that the distribution amount will be net of taxes.  Otherwise, if the order requires payment of 100% of the balance, then reject it as unqualified as it requires the Plan to do something that would violate it's own governance.

[fmsinc]

My thoughts: 

1.  Reject the QDRO and let the parties or the judge figure out how the Plan is supposed to withhold taxes on Plan account money that must be distributed in full.   

2.  Pay out 100% of the Plan account to the "Alternate Recipients" (as we call them in Maryland) per the QDRO and issue a 1099-R to the Participant, and don't worry about withholding on the theory that the alternate recipient are not receiving taxable retirement benefits and is not a party to the tax consequences imposed on the Participant and should not have the amount ordered reduced.   See IRC 402(e)(1)(A) - "For purposes of subsection (a) and section 72, an alternate payee who is the spouse or former spouse of the participant shall be treated as the distributee of any distribution or payment made to the alternate payee under a qualified domestic relations order (as defined in section 414(p))".  The spouse or former spouse is NOT the distributee of payments made to the child c/o a parent.  And this is consistent with the law that makes child support not taxable to the recipient parent.   The same would be true in the case of a Participant in pay status with respect to a defined benefit plan.  

Recognize that this issue will likely become a bigger problem for custodial parents under the SECURE act when Participants need not elect an immediate lump sum distribution and elect some other distribution option.  One company I know is making available the following options for its 401(k) Plan as of 1-1-22.

Single Lump Sum Payment Option.
Partial Lump Sum Payments Option 
­Fixed Periodic Amount Option 
Partial Lump Sum with Fixed Periodic Amount
Fixed Time Frame Option 
­Fixed Percent Option 
Life Expectancy Option
50% Joint and Survivor Annuity for married Participants only (not divorced?) whereby the Plan purchases an irrevocable 50% joint and survivor annuity from an insurance company.

Uncertainties: 

When can such elections be made?  Before or only after retirement?  Before or after divorce?   

Will such an election be superseded by a QDRO? 

Will  State law preempt the SECURE act? 

Given that a lump sum distribution is an option, and that a QJSA is an option, would a separate interest allocation be an option as well since IRC 414(p)(2)(B) - (D) neither mandates or restricts the use of a shared or a separate interest allocation, and since 29 USC 1955(d) requires that a QJSA be the actuarial equivalent of a single life annuity for the Participant.  The plan says "no".  But I say that she should be able to get 50% (or time rule share) of the lump sum in the form of a separate interest annuity.

See attached interesting case. 

David
 

Knight v. IBM Attorney Comment.pdf Knight v. IBM - Complaint.pdf

[QDROphile]

My recommendation is to close the barn door before the horse gets out and provide in the QDRO procedures that an order will not be qualified if it does not expressly address the withholding issue. If the QDRO procedures do not address the situation, it may be possible to disqualify based on an inability to interpret the order, as has been suggested. The fiduciary may choose to interpret the order with respect to withholding, and make qualification contingent on that interpretation. Disagreement can be resolved under the claims procedures or by resubmitting a modified order. The fiduciary might choose not to extend itself because the interpretation is going to favor somebody, probably with respect to an issue that was not properly considered in the domestic relations proceeding because of ignorance of the tax law.

[fmsinc]

May I ask where it says in the IRC that the Plan is required to withhold a distribution made to anyone other than the Participant or a spouse or former spouse pursuant to a QDRO?   

IRC 402(e)(1)(A) states -

"For purposes of subsection (a) and section 72, an alternate payee who is the spouse or former spouse of the participant shall be treated as the distributee of any distribution or payment made to the alternate payee under a qualified domestic relations order (as defined in section 414(p))".  

The spouse or former spouse is NOT the distributee of payments made to the child c/o a parent.  If you are not paying taxable income you don't have to withhold. 

 I would be happy to stand corrected.  

David

[rocknrolls2]

In my view, the best result would be to lobby to eliminate this arcane relic of the tax law so that the nonspouse alternate payee is responsible for his or her own tax withholding and any order providing for 100% of the participant's account balance becomes the alternate payee's account balance, subject to such withholding as well as repeal the exception to the mandatory 20% withholding requirement.

But, unless someone has some great contacts in Congress, the IRS or the Treasury Department, and such orders generally have to be followed, I vote for determining that the order is disqualified unless the alternate payee signs a written consent to allowing the order to become qualified the account is subject to income tax withholding on the part of the participant.

 

[Adi]

2 hours ago, fmsinc said:

May I ask where it says in the IRC that the Plan is required to withhold a distribution made to anyone other than the Participant or a spouse or former spouse pursuant to a QDRO?   

IRC 402(e)(1)(A) states -

"For purposes of subsection (a) and section 72, an alternate payee who is the spouse or former spouse of the participant shall be treated as the distributee of any distribution or payment made to the alternate payee under a qualified domestic relations order (as defined in section 414(p))".  

The spouse or former spouse is NOT the distributee of payments made to the child c/o a parent.  If you are not paying taxable income you don't have to withhold. 

 I would be happy to stand corrected.  

David

See IRS Notice 89-25 for guidance. Specifically:

Q-3: What withholding rules apply to qualified plan distributions to nonspouse alternate payees?

A-3: Section 3405 of the Code provides that federal income tax must be withheld from all designated distributions unless the individual elects not to have withholding apply. In general, a designated distribution is any payment or distribution from or under an employee deferred compensation plan but does not include the portion of a distribution which it is reasonable to believe is not includible in gross income.

Section 402(a)(9) of the Code provides that, for purposes of section 402(a)(1) and 72, any alternate payee who is the spouse or former spouse of the participant shall be treated as the distributee of any distribution or payment made to the alternate payee under a qualified domestic relations order as defined in section 414(p). The withholding rules therefore are applied as if the spouse or former spouse were the employee. However, there is no similar provision for distributions to nonspouse alternate payees. Therefore, distributions to a nonspouse alternate payee during the lifetime of the participant are not includible in such payee's gross income, but instead are included in the gross income of the plan participant. Consequently, amounts shall be withheld from the distribution as if the plan participant were the payee, unless the plan participant elects not to have the withholding rules apply.

[fmsinc]

I think this is the workaround: 

The IRC clearly requires the withholding of 10% for child support QDROs, but some Plan Administrators are not aware of that and send 100% to the  Alternate Payee (who should be the child or the "mother and next friend" of the child) and runs a risk (thought to be minimal) that the IRS will pay them a visit. 

1st, send 100% to the IRS and send a 1099-R to the Participant with ZERO in Box 4 (Federal withholding), 14 (State withholding) and 17 (Local withholding).  The language of the instructions for Box 4 says: 

"Box 4. Shows federal income tax withheld. Include this amount on your income tax return as tax withheld, and if box 4 shows an amount (other than zero), attach Copy B to your return. Generally, if you receive payments that aren’t eligible rollover distributions, you can change your withholding or elect not to have income tax withheld by giving the payer Form W-4P."

This clearly suggests that there is a possibility that Box 4 of the 1099-R could be ZERO.

2nd - the QDRO must contain a provision that affirmatively requires the Participant (or a trustee appointed by the Court to act on behalf of the Participant) to fill out Form W-4P and follow the instructions for that form that say: 

"Choosing not to have income tax withheld. You can choose not to have federal income tax withheld from your payments by writing “No Withholding” on Form W-4P in the space below Step 4(c). Then, complete Steps 1a, 1b, and 5. Generally, if you are a U.S. citizen or a resident alien, you are not permitted to elect not to have federal income tax withheld on payments to be delivered outside the United States and its possessions."

3rd - add all of the forgoing to the plan documents.

At the end of the day the attorney for the payee parent must be instructed to add the language above to the QDRO.  Plan Administrators will have a QDRO, a 1099-R, a W-4P, and amended Plan language to protect them. 

David

 

[Nate S]

1 hour ago, fmsinc said:

1st, send 100% to the IRS and send a 1099-R to the Participant with ZERO in Box 4 (Federal withholding), 14 (State withholding) and 17 (Local withholding).  

100% to the IRS???

[Adi]

On 8/26/2022 at 6:57 AM, fmsinc said:

2nd - the QDRO must contain a provision that affirmatively requires the Participant (or a trustee appointed by the Court to act on behalf of the Participant) to fill out Form W-4P and follow the instructions for that form that say: 

"Choosing not to have income tax withheld. You can choose not to have federal income tax withheld from your payments by writing “No Withholding” on Form W-4P in the space below Step 4(c). Then, complete Steps 1a, 1b, and 5. Generally, if you are a U.S. citizen or a resident alien, you are not permitted to elect not to have federal income tax withheld on payments to be delivered outside the United States and its possessions."

3rd - add all of the forgoing to the plan documents.

At the end of the day the attorney for the payee parent must be instructed to add the language above to the QDRO.  Plan Administrators will have a QDRO, a 1099-R, a W-4P, and amended Plan language to protect them. 

David

 

I question this approach. As between the parties, sure, the Participant could be liable directly to the Alternate Payee for not following through with the withholding election required by the QDRO. But I think it's unlikely Plan terms/a state court order trump the Plan's obligation to comply with federal law (sec. 3405), which requires the Plan to withhold 10% unless the Participant elects otherwise.  Your proposed approach would have the Plan's terms take that right away from the Participant, arguably adding an additional requirement for an order to be qualified.