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Lessons from the Tax Court: Hands-off alimony payments

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in Small Business Tax,Small Business Tax Deduction Strategies

Do you have to tap into your qualified retirement plans or IRAs to pay unexpected expenses like alimony? There’s a “right way” and a “wrong way” to do it.

Here’s why: Distributions are hit with an extra 10% penalty tax, on top of the regular income tax you owe, if you receive the cash before age 59½. But there are a number of exceptions carved out in the tax law. For instance, payments made pursuant to a “qualified domestic relations order” (QDRO) are exempt from the 10% penalty.

New case: A taxpayer was ordered by a family court judge to withdraw funds from his qualified retirement plans so he could pay alimony to his ex-wife. In 2009 he received distributions totaling more than $50,000. The IRS assessed the 10% penalty tax, but the taxpayer argued that he qualified for the tax law exception.

Now the Tax Court has sided with the IRS. It said that the exception didn’t apply because the taxpayer didn’t use a QDRO and the distributions were paid directly to him instead of an alternative payee. (Hartley, TC Memo 2012-311)

Tip: Stick to the strict letter of the law. Don’t ­hesitate to obtain guidance from an attorney or tax pro.

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