Tax consequences of QDRO payments and payment of DB from "net" annuity payments.

>There is no question that, except for defined benefit plan payments made to a spouse or former spouse for child support, the amount paid to a spouse or former spouse via a QDRO (as alimony or as an allocation of property) is taxable income to the alternate payee.  But I cannot find the section of the IRC or the Regs that say that.  It is set forth in IRS Publ. 504 and 575, but the source is not stated. 

Whoops. I just found https://www.law.cornell.edu/cfr/text/26/1.61-11#:~:text=CFR-,§ 1.61-11 Pensions.,income unless excluded by law.

Any other citations?    

>For the first time is 38 years of preparing QDROs I have an attorney for the Participant insisting that the allocation of a defined benefit  plan be computed with respect to the "net" (not the gross) annuity payments paid to the participant, that is, net of the participants state and federal tax  withholding, Social Security and Medicare taxes, health insurance and life insurance premiums, and the cost of the survivor annuity.

I pointed out that we NEVER use "net" since the amount is subject to manipulation by the participant and because is forces the alternate payee to pay part of the participant's taxes (what the hell?), but I have been looking for a learned treatise, or law review article, or even  caselaw, that sets forth a better and more authoritative argument. 

Anybody?

Thanks, 

David  

IRC 402(e)(1)(A)

Quote

(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)).

On 7/8/2024 at 12:39 PM, fmsinc said:

"net" (not the gross) annuity payments paid to the participant, that is, net of the participants state and federal tax  withholding, Social Security and Medicare taxes, health insurance and life insurance premiums, and the cost of the survivor annuity

There should be no SS or Medicare taxes on DB pension annuity, nor insurance. As you note, tax withholdings are just that and can be manipulated. The cost of the survivor annuity (the difference between the straight life annuity and joint & survivor option) is determinable as of the commencement date. I have not seen that done but I don't think that means it can't be done.

How about you inform the attorney for the participant that a proposed order with that calculation would fail to qualify under IRC section 414(p)(3)(A).  If the attorney can figure out how to express the desired results, mathematically within the plans procedures for calculating and distributions, then the plan will comply with simple steps and functions. The client, the plan cannot be called upon to figure out and implement the after tax results that are desired, at least as you have described.

I didn't want to confuse the issue, but this is FERS retirement annuity.  

At OPM "self only annuity" means the full and unreduced annuity. 

"Gross annuity" is the "self only annuity" less the cost of the survivor annuity (10%/month of the "self-only annuity).

"Net annuity" is defined at 5 CFR 838.103 as -

"Net annuity means the amount of monthly annuity payable to a retiree or phased retiree after deducting from the gross annuity any amounts that are—

(1) Owed by the retiree to the United States;

(2) Deducted for health benefits premiums under 5 U.S.C.8906 and 5 CFR 891.401 and 891.402;

(3) Deducted for life insurance premiums under 5 U.S.C. 8714a(d);

(4) Deducted for Medicare premiums;

(5) Properly withheld for Federal income tax purposes, if the amounts withheld are not greater than they would be if the retiree claimed all dependents he or she was entitled to claim;

(6) Properly withheld for State income tax purposes, if the amounts withheld are not greater than they would be if the retiree claimed all dependents he or she was entitled to claim; or

(7) Already payable to another person based on a court order acceptable for processing or a child abuse judgment enforcement order.

Unless the court order expressly provides otherwise, net annuity also includes any lump-sum payments made to the retiree under 5 U.S.C. 8343a or 8420a."

I am sorry if it took you off track.

Thanks for the cites. 

I did find one case, Chiarello v. Internal Revenue Service, Case No. 4-06cv-163-BE, United States District Court, N.D. Texas, Ft. Worth Division (2006) - citing 26 CFR § 1.61-11 - https://www.law.cornell.edu/cfr/text/26/1.61-11
 

David

That’s OK. I spend most of my time in the ditch, and none of my time contemplating FERS.

DSG, it’s unclear whether the other spouse’s lawyer is ignorant or trying a negotiation ploy. Either way, you won’t fall for it.

Consider drawing on your deep experience with the different law that governs the Federal Civil Service Retirement System and the Federal Employees Retirement System and their regimes for a court order acceptable for processing (COAP). 5 U.S.C. §§ 8339(j)(4), 8419; 5 C.F.R. §§ 831.601 to 831.685, 838.101 to 838.1121.

An attempt to specify a former spouse’s shares by reference to a factor other than a percentage of the employee annuity would get rejected as not a COAP.

And even if one were to imagine that the former spouse’s COAP-paid benefit might be the employee’s income, an attempt now to negotiate the former spouse’s fixed percentage of the employee annuity by using assumptions about the employee’s marginal income tax rates for Federal, State, and local income taxes is nonsense because not only might incomes changes but also any of the tax rates might change. What might Maryland’s income tax rates be in 2034, 2044, or 2054? What if the former employee retires to Texas? What if the US decreases Federal income tax rates?