IRA Distribution after Divorce: Is it Subject to Income Tax and 10% Excise Tax?

The US Tax Court in Rosenberg v. Commissioner, TC Memo 2019-124 has ruled that an IRA distribution, made after a couple divorced, was taxable and subject to the 10% excise tax because: (1) no exception to the 10% excise tax applied and (2) the Court did not find any equitable exception to taxing the distribution.
Legal Background.  Distributions from a traditional IRA are subject to income tax when distributed unless the amount is distributed to another IRA or other qualified retirement plan in a trustee-to-trustee rollover.  Distributions from an IRA are also subject to a 10% excise tax unless an exception applies.  Three common exceptions to the excise tax are: (a) when the distribution is made to another IRA or qualified retirement plan; (b) when the distribution is made to a recipient who is older than age 59 ½; or (c) when the distribution is made because of a qualified domestic relations order.
Facts of the Case. In 2014, a Judgment with Property Order attachment was entered dissolving Mr. Rosenberg’s marriage to his former spouse. It provided that his former spouse must pay him $10,000 out of his former spouse’s retirement account.
In 2015, Mr. Rosenberg’s former spouse transferred retirement funds to him. Instead of withdrawing the funds from her retirement account and making a cash payment to him, she arranged for those funds to be transferred from her retirement account to a new IRA that Mr. Rosenberg opened for this purpose.  Within seven days of the transfer he withdrew the funds and closed the new IRA.  Mr. Rosenberg did not report this amount on his 2015 tax return as income.  The IRS determined that the distribution was subject to income tax and to the 10% excise tax.
Mr. Rosenberg did not argue that the IRA withdrawal was not income or that any statutory exception to excise tax applied.  Instead, he argued that the Tax Court should (a) disregard entirely his IRA account and the intermediate steps of the transfer from his former spouse’s retirement account to his IRA and his immediate withdrawal from that account; and (b) treat the transaction instead in substance as a payment of cash from his former spouse to him as prescribed by the Property Order.  Mr. Rosenberg reasoned that his former spouse interposed the intermediate steps over his objection, and he did not think the transfer of the money to the “temporary” IRA account would convert his property settlement into a retirement distribution includable in his gross income or subject to the 10% excise tax.
Decision. The Tax Court agreed with the IRS that the distribution was subject to income tax and the 10% excise tax.  The Court said Mr. Rosenberg credibly testified regarding the intent of the Property Order, but his understanding that his former spouse would withdraw the funds from her retirement account and transfer them directly to him could not overcome the fact that the funds were in fact transferred from her retirement account to his IRA and he then withdrew them from his IRA. The Court said it would not use common law doctrines to fashion an equitable exception to the statutory scheme.
This case highlights the fact that taxpayers should consult competent legal and tax advisers when dealing with any transfer of cash or property whether resulting from sale, purchase, gift, bequeath, divorce settlement or other voluntary or involuntary transfer.
If you have any question about the tax consequences of any distribution of transfer of cash or property in divorce or any other circumstance, please consult one of the divorce or tax attorneys at PS&E at 937-223-1130 or Jsenney@pselaw.com.