Case — Taxability of Disability Retirement Benefits to Former Spouse

Thanks for sharing!

TL Case Summ

THE QUESTION

Are both spouses eligible for the same tax treatment of disability retirement benefits paid as required by a divorce agreement?

THE DISPUTE

Taxpayer Says: The benefits should be nontaxable because she received them under a divorce agreement and she should qualify for the same tax treatment as her former spouse.

Internal Revenue Service Says: The benefits are taxable to the taxpayer because she does not meet any of the exceptions available to exclude it.

THE LAW

From Internal Revenue Code Section 61(a): Defines gross income as “all income from whatever source derived, including * * * (11) Pensions”, unless otherwise provided.

From Internal Revenue Code Section 104(a)(1): Provides an exception to Section 61(a) by authorizing an exclusion with respect to compensation for injuries or sickness.

From Internal Revenue Code Section 402(e)(1)(A): Provides that an alternate payee pursuant to section 414(p) (which defines a qualified domestic relations order) who is the former spouse of the participant shall be treated as the distributee of any distribution of payment made to the alternate payee under a qualified domestic relations order (QDRO).

THE CAUSE OF THE DISPUTE

Generally, distributions from qualified pension plans are taxable income when you receive them. That’s typically true even when the payments are made to someone else, such as a former spouse.

One exception to the general rule of taxability is payments you receive due to personal injuries or sickness incurred in the course of your employment. Those payments are not taxable to you.

In addition, when a former spouse has a right to receive part of the distributions, you can use a tax law concept known as a Qualified Domestic Relations Order (QDRO), to transfer the tax burden to your former spouse. QDROs apply to qualified plans, though section 414(p)(11) of the Internal Revenue Code allows distributions from certain government plans to be treated in the same manner as those made pursuant to a QDRO.

In this case, the taxpayer’s former husband retired from the Los Angeles Sheriff’s department after suffering a service-connected disability. The payments he received qualified for the disability exception and were not taxable to him.

The taxpayer received part of the disability payments as part of the divorce agreement. She also received Form 1099-R from the retirement plan at year end. She did not report the payments on her tax return. She believed the payments were not taxable to her because they were not taxable to her ex-husband, and she received them under what was effectively a QDRO. Therefore, she should be treated, tax-wise, the same way as her former husband.

The IRS agrees the former husband’s pension was based on injuries he sustained on the job, and the distributions were not taxable to him. However, the IRS says the payments are taxable income to the taxpayer because she was not the one injured on the job.

WHAT WOULD YOU DECIDE?

Make your selection, then see “The Court’s Decision” below for a full explanation

For the or for the

THE COURT’S DECISION

Download (PDF, 14KB)

***

HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

 ***

Other posts you might enjoy

Decisions — Taxing choices Image source: Free Picture © Semen Barkovskiy Dreamstime Stock Photos   How many options can you consider before you find yourself longing for simplicity? Whatever your answer, part of the desire for less complexity comes from not wanting to make the wrong choice. That's especially true ...
Decisions — Where’s your refund? Image source: By U.S. National Archives and Records Administration, Public domain, via Wikimedia Commons Where's your refund? Possibly helping to reduce the federal budget deficit, if you failed to file a return to get an overpayment back within the applicable time period. That's because the gov...
Case — Fun and games Image source: openclipart.org (public domain image) THE QUESTION Does an organization that offers a recreational activity to achieve a charitable purpose qualify as a charitable organization? THE DISPUTE Taxpayer Says: It operates for charitable purposes because it provides relief for the p...
Case — Carry On THE QUESTION Can an IRA deduction that is disallowed due to active participant status in an employer plan be carried forward and deducted in a future year? THE DISPUTE Taxpayer Says: The 2008 IRA contribution was an “excess contribution” and should be allowable as a deduction in 2010. Intern...
Sorry, wrong answer :(
Right answer!
For the IRS. The taxpayer did not suffer an injury, and congress explicitly stated amounts received “as compensation for personal injury” when adding the code section with the passage of the Revenue Act of 1918. In the case at hand, the compensation was not for the taxpayer’s personal injury, but that of her former husband. We find no relevant law to establish taxpayer’s position; and in the absence of congressional intent we strictly construed section 104(a)(1) to conform to the general purview of section 61, that all income is taxable unless explicitly excluded. We find that the distributions are taxable income to petitioner.
Posted in Taxing Lessons Case Summaries Tagged with: