Tax liability to Participant?

[Guest beppie_stark]

Participant and AP have agreed to QDRO terms, however AP wants Partic to report the distribution as his taxable income. She is returning to school and doesn't want the 1099 income to mess up the availability of financial aid. So it is more than just a question of who pays the taxes.

I have never seen a QDRO written in this manner. Does anyone think this would be permissible?

[david rigby]

Note the "shall" in IRC 402(e):

(e) Other rules applicable to exempt trusts

(1) Alternate payees

(A) Alternate payee treated as distributee

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)).

...

Perhaps the alternative payee should investigate whether such income would be counted in determining financial aid. If this is a lump sum distribution, the AP may also wish to investigate whether to receive it in the form of direct IRA rollover.

[Mike Preston]

Participant and AP have agreed to QDRO terms, however AP wants Partic to report the distribution as his taxable income. She is returning to school and doesn't want the 1099 income to mess up the availability of financial aid. So it is more than just a question of who pays the taxes.

I have never seen a QDRO written in this manner. Does anyone think this would be permissible?

What you have described is illogical. A QDRO is an order of the court. If the court wants the money to come out of the plan, then they have to authorize it by way of the QDRO unless the participant is otherwise entitled to a distribution. So, if they want what you describe, check to see if the participant can get at the money without a QDRO. If so, then part of the divorce decree should instruct the participant to make a withdrawal and turn the money over to the ex-spouse. But that isn't a QDRO.

[Kimberly S]

I agree with David.

If they were to follow Mike's suggestion, it would likely end up structured as alimony that would still be taxable to her. Why would he want to pay the tax?

[QDROphile]

But you cannot escape Mike Preston's conclusion that a QDRO cannot deliver what the individual wants. Distributions pursuant to a QDRO have pre-established tax consequences.

[Guest mjb]

Participant and AP have agreed to QDRO terms, however AP wants Partic to report the distribution as his taxable income. She is returning to school and doesn't want the 1099 income to mess up the availability of financial aid. So it is more than just a question of who pays the taxes.

I have never seen a QDRO written in this manner. Does anyone think this would be permissible?

What you have described is illogical. A QDRO is an order of the court. If the court wants the money to come out of the plan, then they have to authorize it by way of the QDRO unless the participant is otherwise entitled to a distribution. So, if they want what you describe, check to see if the participant can get at the money without a QDRO. If so, then part of the divorce decree should instruct the participant to make a withdrawal and turn the money over to the ex-spouse. But that isn't a QDRO.

Under the ERISA nonalienation rules benefits cannot not be paid to another person without the consent of the participant. The only exceptions are distributions pursuant to a QDRO and seizure under federal law such as for failure to pay taxes or for restitution to pay federal fines. ( See Boggs case.) If benefits are paid under a QDRO to a spouse AP, IRC 402(e) mandates that the spouse be taxed as the payee. Payments made to a child under a QDRO will be taxed to the participant under the assignment of benefits rule.

[IRA]

Why can't the AP justs defer the distribution until after she finishes her schooling? Or does she need the money now?

[jpod]

If the parties have sufficient other assets, a solution may be for the AP to give up any interest in the P's retirement plan in exchange for a lesser amount which she would receive tax-free as part of a property settlement.

But, putting that aside, I am having a difficult time believing that a 1099R showing a distribution of retirement plan assets in connection with a divorce will prejudice the AP in connection with her financial aid search. Is it the fact that she would have funds available that hurts her? If so, why would funds via a retirement plan distribution hurt her but cash from any other source not hurt her (or is she really afraid that she can't "hide" a 1099R but she can hide other assets not reported on a 1099)? I can understand how a 1099-MISC showing non-employee compensation, and thus perhaps a regular source of income, might be a problem, but why a 1099R? Would it make any difference via the financial aid if the 1099R shows that the retirement plan distribution was rolled over to an IRA?

[Kimberly S]

Financial aid is usually based on the prior year's taxable income. A 1099-R that doesn't show a rollover, increases taxable income. A larger interest in other assets, such as the marital real estate, does not increase taxable income.

[Bird]

Financial aid is usually based on the prior year's taxable income.

...and assets, and retirement plan assets usually don't count. The system is messed up, but that's way off topic.

[jpod]

Sorry, I still don't believe that retirement plan assets would be treated any different than any other asset. The fact that the retirement plan assets might be moved in such a way that triggers a taxable event is merely a legal nuance, but they shouldn't be treated any differently that other assets.

[masteff]

Sorry, I still don't believe that retirement plan assets would be treated any different than any other asset. The fact that the retirement plan assets might be moved in such a way that triggers a taxable event is merely a legal nuance, but they shouldn't be treated any differently that other assets.

Whether or not they should be treated differently is not the same as whether they are treated differently...

This FAQ item from the Dept of Education has a general list of what investments are and are not included in on the FAFSA form; retirement plans ARE excluded from the investments that are reported. http://www.fafsa.ed.gov/help/fotw33c.htm

[Guest mjb]

Sorry, I still don't believe that retirement plan assets would be treated any different than any other asset. The fact that the retirement plan assets might be moved in such a way that triggers a taxable event is merely a legal nuance, but they shouldn't be treated any differently that other assets.

Whether or not they should be treated differently is not the same as whether they are treated differently...

This FAQ item from the Dept of Education has a general list of what investments are and are not included in on the FAFSA form; retirement plans ARE excluded from the investments that are reported. http://www.fafsa.ed.gov/help/fotw33c.htm

M:

The discussion is not about investments; its about distributions which will be counted as taxable income to the recipient. I dont know if reciept of payments which are taxed to another person reduces financial aid.

[masteff]

M:

The discussion is not about investments; its about distributions which will be counted as taxable income to the recipient. I dont know if reciept of payments which are taxed to another person reduces financial aid.

Sorry if I created confusion... the post I responded to specifically used the word "asset", not "distribution" or "income".

As to "if reciept of payments which are taxed to another person reduces financial aid"... it depends on how you interpret the last line of Worksheet B of form FAFSA. It reads: "Money received, or paid on your behalf (e.g., bills), not reported elsewhere on this form." If you deem this transaction to be a property settlement, then it probably would not count as being "received" (but rather something to which an ownership interest was already attached).

But regardless of that... unless the former spouse is going to immediately spend it all then she will have to report the cash on line Q43.

That goes back to IRA's question above of does she need the money now?

Form FAFSA: http://www.fafsa.ed.gov/fafsaws89c.pdf

[IRA]

It seems to me if she is taking a distribution now (directly or indirectly) then the money should be considered when her financial aid is determined. After all, she will have the money, won't she? If she is not, i.e., deferring or rolling it over, then it should not. But I'm not, of course, a finanical aid expert. I think your question is more about financial aid and less about QDROs. Is she trying to figure out how she can lie to her financial aid office, or do the financial aid rules permit something like this?

[masteff]

then the money should be considered when her financial aid is determined. After all, she will have the money, won't she?

A vast majority of financial aid begins by completing the Department of Education's form FAFSA...

If she immediately spends the money on a car or household furnishings or her half of the credit card debt, then it's not an asset for line Q43. Otherwise, she reports it. She can spend down her cash immediately before completing the form, yes it's w/in the rules.

Form FAFSA line Q43 says (emphasis added):

As of today, what is your (and your spouse’s) total current balance of cash, savings and checking accounts? (Q43)