QDRO for Tax relief

[Guest CDEsq.]

H and W are in debt up to their eyeballs. They are divorcing. H has two 401K accounts, wife has one. They want to QDRO 100% of each account to the other, and then agree to use the $$ (less withholdings) to pay off debts (mainly the house which is mortgaged to the hilt). Will the IRS look behind a marital settlement agreement to each award the other all of the retirement assets? The purpose here would be to avoid the 10% penalty on withdrawing all accounts.

[QDROphile]

You might have trouble if a recipient used some or all of the distribution for the benefit of the other person.

[jpod]

First, a marital settlement agreement is not enough to establish a QDRO; a judge needs to be involved. I am assuming by your handle that you are a lawyer involved in the case. Will you be able to find a sober State court judge to go along with all of this? If you do find one, I doubt that IRS would look beyond the 4 corners of the QDRO.

[Guest CDEsq.]

First, a marital settlement agreement is not enough to establish a QDRO; a judge needs to be involved. I am assuming by your handle that you are a lawyer involved in the case. Will you be able to find a sober State court judge to go along with all of this? If you do find one, I doubt that IRS would look beyond the 4 corners of the QDRO.

I understand that a court needs to be involved to have a QDRO entered. I was retained to prepare the Orders but am concerned about protecting myself, in the event that a penalty is imposed. As for whether our judges here are sober, that is ia different story. The money would be used to satisfy marital debts owed jointly.

[JanetM]

If this a true divorce then I don't see a problem. I have seen a few 100% QDROs and none were questioned. If this is one of those cases where they plan to get divorce, do QDROs and then remarry you have harder time if IRS does question it.

[jpod]

Janet, what do you suppose will be the basis for the IRS questioning the validity of the QDRO? Let's be precise because our guest, CDEsq., is looking for some help. If your opinion is that it doesn't smell right to you and that he should consult with an ERISA lawyer, I can accept that. But to suggest that he "might have a harder time" without stating why he would have a harder time is not helpful.

[Mike Preston]

I think the good Justice Learned Hand would have been understanding, and would have approved.

[JanetM]

jpod, we had one of these sham qdros and the IRS caught it a year after it happened when the couple filed a joint return and still owed back taxes. fact - there was speedy divorce, distribution of 100% of assets, 3 weeks later they remarried.

My advice to CDEsq I had hoped would promt them to get legal counsel. Didn't mean to annoy you by not being clear.

[david rigby]

There are other discussion threads about shams, with or without divorce.

Try the Search feature.

[Peter Gulia]

CDEsq., you mention that you seek to protect yourself:

Among some simple and usually effective ways to do so is to limit the scope of your work. For example, your engagement letter might state that your work is restricted to drafting an order that, if properly made an order of the domestic-relations court, should be approved by the plan administrator as a QDRO that it should follow under ERISA § 206(d)(3). Moreover, because the circumstances suggest that you should not assume that the divorcing person who is your client (or your client’s client) is a savvy user of lawyers’ services, you might affirmatively warn that your drafting is not an indication that an order would be a QDRO for any Federal, State, local, or foreign tax purpose. Likewise, you might affirmatively warn that you express no view about any tax treatment, and urge your client to get the advice of an expert tax lawyer.

(If anyone renders tax advice, he or she might want to (i) decline to render an opinion - in either direction, (ii) legend the writing as advice that can’t be relied on to avoid any penalty or additional tax, and (iii) explain that the IRS or another tax authority could unravel the subterfuge.)

If you were engaged, or introduced, by another lawyer, you might want to satisfy yourself that the other lawyer has given his or her client correct and thorough advice about whether what the divorcing persons want to do is in the client’s interests. In particular, I’d want to discern why and how the client considers it wise to use inalienable (and usually bankruptcy-excluded) assets to pay debts. It’s possible that there’s sensible reasoning behind such a choice, but I’d want to feel that the client received sound information and thought it through. If paying down debt is primarily about the mortgage, I’d want to feel that my client had exhausted opportunities for a reform, novation, or other relief concerning the mortgage.

If the client has no lawyer other than you, consider whether (or on what terms) you really want such a client. Even if you do a super-careful job of limiting the scope of your engagement and warning about risks and consequences, one never escapes the possibility that an unhappy former client might allege that you failed to advise him or her. Even if one can quickly defeat such a claim, it costs something. And a public record is forever. If you decide to take on a risky client, add a risk premium to your fee.

Please feel free to call me if I can help more specifically.