3650 / When are IRA funds transferred between spouses or incident to a divorce treated as taxable distributions?
Planning Point: It is especially important for clients to revisit IRA beneficiary designations upon divorce. The U.S. Supreme Court recently upheld a Minnesota law that operates to revoke a life insurance beneficiary designation in favor of an ex-spouse upon divorce. In that case, the policy owner’s two children from a prior marriage claimed that they, not the owner’s ex-spouse, were the rightful beneficiaries and the Supreme Court agreed. While this case involved life insurance policies, it is important to remember that it could also impact a client’s IRA.3
Where an individual rolled over his interest in a tax sheltered annuity to an IRA, pursuant to a qualified domestic relations order (“QDRO”) ( Q 3909), the subsequent transfer of the IRA to the individual’s spouse was considered a “transfer incident to a divorce” and, thus, nontaxable to either spouse.4
A taxpayer was liable for taxes on a distribution from his IRA that he subsequently turned over to his ex-wife in satisfaction of a family court order because it was not a “transfer incident to divorce” and the family court order was not a QDRO because it did not specifically require the transfer of assets to come from the IRA.5 A transfer of funds between the IRAs of two spouses that does not come within the divorce exception is a deemed distribution despite IRC provisions that provide that no gain is recognized on transfers between spouses.6
The transfer of a portion of a husband’s IRA to his wife to be placed in an IRA for her benefit that was the result of a private written agreement between the two that was not considered incident to a divorce was not eligible for nontaxable treatment under IRC Section 408(d)(6).7