Alternate payee subject to income tax on 401(k) distribution received under QDRO

An alternate payee was subject to income tax on a distribution from her former spouse’s 401(k) plan that was made pursuant to a qualified domestic relations order (QDRO), according to the U.S. Tax Court. The payee could not avoid income tax liability because she failed to roll over the distribution and had no basis in the participant’s 401(k) account.

Under a QDRO established incident to a divorce decree, a taxpayer became the alternate payee of her former husband’s 401(k) account. The terms of the QDRO also required the alternate payee to pay any income tax obligation arising from distributions from the 401(k) plan.
In 2009, the alternate payee received a $103,000 distribution from the administrator of the 401(k) plan. The administrator issued a Form 1099-R to the payee reflecting the distribution and withheld federal and state income taxes.

The payee did not roll over the distribution within 60 days of receipt, which would have deferred income tax liability. However, she reported the distribution on her 2009 income tax return as nontaxable pension annuity income. The IRS, subsequently, issued a deficiency notice for 2009, maintaining that the distribution was includible in the payee’s gross income. The IRS also assessed a $4,731 accuracy-related penalty.

Appealing the deficiency and accuracy-related penalty, the payee argued that the 401(k) distribution was in payment of a debt owed to her by her former husband. According to the payee, because the debt created basis in the 401(k) account that exceeded the amount of the distribution, she was not required to include the distribution in her gross income.

Initially, the Tax Court noted that an alternate payee who receives a distribution from a plan pursuant to a QDRO is subject to tax on the distribution as the distributee. In addition, a taxpayer who receives the distribution as a transfer of property incident to a divorce does not have basis in the former spouse’s retirement plan. The payee, the court explained, received her ex-husband’s adjusted basis, which, because he made contributions to the plan on a tax-deferred basis, was zero. The payee’s erroneous belief that her ex-husband’s debt to her created basis in the 401(k) plan was not sufficient to avoid tax on the distribution for which she was liable under the terms of the QDRO.

Source: Weaver-Adams v. Commissioner (TC).

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