QDRO & Child Support

[Guest cjk]

The plan received a DRO that names the former spouse as the "alternate payee" but indicates that the money is for child support and further states that the participant will be responsible for the federal income taxes on the money.

It is my opinion that whoever is named as "alternate payee" will determine who is responsible for the federal income tax regardless of what the QDRO may state. I use for my rationale IRC §402(e)(1)(A) and Clawson v. Commissioner.

It is my opinion that if the retirement plan money is to be used for child support and the participant is to be responsible for the taxes, then, the child(ren) would need to be named as the "alternate payee."

I am receiving strong push-back on my position. I am looking for input from others who may have had a similar experiencve. I am continuing my own research but would appreciate any direction that anyone could provide.

[QDROphile]

If the alternate payee is the spouse or former spouse the participant will not have the distribution included in income as far as the plan is concerned. If the alternate payee is not a spouse or former spouse, the income will be attributed to the participant as far as the plan is concerned. Whether or not other tax law can change the ultimate tax liability among the individuals is beyond me and is beyond the plan.

Assuming you get this straightened out and the intended result is that the participant is the lucky taxpayer, you should pay attention up front to withholding. The distribution is not rollable, so the 20% rule does not apply. Unless you settle withholding before the distribution (such as by terms of the order), an uncooperative participant may be able to elect 100% withholding.

[Guest Harry O]

Why swim against the current when you don't have to?

The QDRO says the spouse is the AP. It can say the money is to be used to take a cruise or buy a big-screen TV but that doesn't mean that the spouse is not the AP. You can accept the court's designation, don't fight it.

Since the spouse is the AP, handle withholding just like you would a normal spousal QDRO. It is income to her.

Query whether the spouse should get a new lawyer since naming the kids as the AP would have shifted the tax burden back to the employee.

[mbozek]

There are two separate issues: 1. is there a valid qdro- a spouse can be an alternate payee under IRC 414(p). A qdro can provide for payment of child support -414(p)(1)(B). 2. taxation of the payments. Under IRC 71(a)/215 payments of alimony or seprate maintenance are taxable to the recipient and deductible to the payor. However, child support is not taxed to the recipient nor deductible by the payor. Frequently divorce decrees stipulate the taxation / deductibility of the payments by defining it as either alimony or child support. However, the taxation of the payments is not a matter subject to review by the Plan admin for a valid QDRO under IRC 414(p).

[Appleby]

It appears that the QDRO provides conflicting options.

Harry O is right, the assets can be used for anything. The key factor is “ who is the alternate payee”. Since it is the spouse, then it is the spouse who should be responsible for adding the amount into income and paying taxes. However, the courts confuses the issue by stating that the participant is responsible for paying taxes, since the participant would be so responsible only if someone other than the spouse is the alternate payee. If I were the participant, I would seek clarification…

[Guest Harry O]

Apple pointed out the provision of the QDRO I failed to address -- the statement that the participant is responsible for the taxes.

As I said before, I believe that the plan can take the position that the spouse is the alternate payee. This means the spouse is taxable on the distribution. I would view the language in the QDRO as nothing more than the court ordering the employee to reimburse the spouse for any taxes incurred. A court doesn't have the power to re-write the federal tax laws and impose tax on the employee. The IRS is obviously not bound by this.

That said, it is probably a good idea to tell the employee and AP what you plan to do -- pay AP, report as income to spouse (assuming no rollover), and let employee and spouse figure out how the employee will pick up the spouse's tax. This will hopefully spur the parties to re-structure the QDRO in a more efficient manner.

[Appleby]

Very diplomatic Harry

[mbozek]

Before the PA decides to tax the spouse for amounts that are designated as non taxable child support under IRC 71(a)/215 in the dro and incure the wrath of contempt of ct, perhaps you should have the dro reviewed by counsel to read the entire document. In divorce ct orders it is not unusual for payments of child support which are not taxable income to the child to be paid to the custodial spouse who is the guardian of the minor since the minor cannot receive the payments. The only difference in taxation of retirement distributions is that payments to a spouse are taxable to the spouse under IRC 402(2(e)(1) whereas payments to a child are taxed to the employee under the assignment of income doctrine. If the QDRO provides that the spouse is receiving the payments in her custodial capacity as the guardian of the child, payments are taxed to the employee under assignment of income doctrine. See Darby v. Comm, 97 TC 51. In Stahl v. Comm., TC Memo 2001-22, the Tax Court held that a lump sum payment from an ESOP to a spouse as back child support payments was taxed to the employee and not the spouse. There is no rewrite of the income tax laws since child suport payments from a retirement plan are taxed to the employee.

[Guest Harry O]

cjk said that the QDRO designated the spouse as the alternate payee. Payments from a qualified plan are taxed to the "distributee" per section 402(a). Section 402(e)(1) provides that the alternate payee under a QDRO is the "distributee" for purposes of section 402. Thus, it appears that there would be a re-write of the tax laws to tax the employee rather than the spouse. The plain terms of the QDRO seem to give the plan more than enough ammunition to treat the payment as income to the spouse. The plan should let the spouse and the IRS fight it out instead of attempting to decipher the deeper meaning of the QDRO.

But your point is well-taken. cjk should get legal assistance and make sure that the QDRO really does name the spouse as alternate payee. If it does, I would return to my recommendation and tell the parties how the plan will report the payment and then wait and see if they want to revise the QDRO.