SCOTUS Reports

Tag: Qualified Domestic Relations Order

  • Fernandez v. Comm’r, 138 T.C. 378 (2012): Taxation of Divorce-Related Retirement Distributions

    Fernandez v. Commissioner, 138 T. C. 378 (U. S. Tax Ct. 2012)

    In Fernandez v. Commissioner, the U. S. Tax Court ruled that payments received by Shannon L. Fernandez from her former husband’s disability retirement benefits under a divorce agreement were taxable income. The court rejected Fernandez’s argument that the payments should be tax-exempt under I. R. C. sec. 104(a)(1), clarifying that the tax treatment applicable to the original recipient of disability benefits does not automatically extend to a former spouse receiving a portion of those benefits via a divorce settlement. This decision underscores the narrow interpretation of tax exclusions and the importance of specific statutory language in determining tax liabilities from retirement distributions.

    Parties

    Shannon L. Fernandez, Petitioner, was represented by J. Christopher Toews. The Commissioner of Internal Revenue, Respondent, was represented by Kris H. An and Laura Beth Salant.

    Facts

    Shannon L. Fernandez received a portion of her former husband’s disability retirement benefits from the Los Angeles County Employees Retirement Association (LACERA) pursuant to a divorce agreement. The agreement, which was treated as a qualified domestic relations order (QDRO), awarded Fernandez a percentage of her former husband’s retirement benefits. During the 2007 tax year, Fernandez received $11,850 from LACERA, with $11,691 reported as taxable income on a Form 1099-R. Fernandez did not include any of this amount in her 2007 federal income tax return, leading to a deficiency determination by the IRS.

    Procedural History

    The Commissioner of Internal Revenue issued a notice of deficiency to Fernandez on December 28, 2009, determining a $3,587 income tax deficiency for 2007 due to the unreported income from LACERA. Fernandez timely petitioned the U. S. Tax Court for a redetermination of the deficiency on February 2, 2010. The case was submitted fully stipulated under Rule 122 of the Tax Court Rules of Practice and Procedure.

    Issue(s)

    Whether the $11,691 received by Fernandez from LACERA, pursuant to a divorce agreement, is excludable from her gross income under I. R. C. sec. 104(a)(1)?

    Rule(s) of Law

    I. R. C. sec. 61(a) defines gross income as all income from whatever source derived, including pensions, unless otherwise provided. I. R. C. sec. 104(a)(1) provides an exclusion for amounts received under workmen’s compensation acts as compensation for personal injuries or sickness. I. R. C. sec. 402(e)(1)(A) treats an alternate payee under a QDRO as the distributee of any distribution or payment for purposes of I. R. C. sec. 402(a) and sec. 72, but does not reference sec. 104(a).

    Holding

    The Tax Court held that the $11,691 received by Fernandez from LACERA is not excludable from her gross income under I. R. C. sec. 104(a)(1). The court found that the statutory language of sec. 402(e)(1)(A) does not extend the exclusion under sec. 104(a)(1) to an alternate payee receiving benefits under a QDRO.

    Reasoning

    The court’s reasoning focused on the strict construction of statutory exclusions from gross income. It emphasized that sec. 104(a)(1) exclusions are construed narrowly and only apply to compensation for personal injuries or sickness received by the injured party. The court noted that sec. 402(e)(1)(A) explicitly refers to sec. 402(a) and sec. 72 but does not mention sec. 104(a), indicating that Congress did not intend for the exclusion to apply to alternate payees under a QDRO. The court also rejected Fernandez’s argument that she should step into her former husband’s shoes for tax treatment, as she did not suffer the personal injury for which the disability benefits were awarded. The court found no relevant law supporting Fernandez’s position and adhered to the principle that all income is taxable unless explicitly excluded by statute.

    Disposition

    The Tax Court entered a decision for the Commissioner, affirming the deficiency determination and finding the $11,691 taxable to Fernandez.

    Significance/Impact

    Fernandez v. Commissioner clarifies the tax treatment of retirement benefits distributed pursuant to divorce agreements and treated as QDROs. It reinforces the principle that tax exclusions must be explicitly provided by statute and cannot be inferred from provisions designed for other purposes. This decision has implications for the tax planning of divorcing parties who receive portions of their former spouse’s retirement benefits, emphasizing the need to consider the tax implications of such distributions carefully. It also highlights the limitations of QDRO protections in altering the tax treatment of retirement benefits for alternate payees.

  • Mitchell v. Comm’r, 131 T.C. 215 (2008): Taxation of Distributions Under Qualified Domestic Relations Orders

    Mitchell v. Commissioner, 131 T. C. 215 (2008)

    In Mitchell v. Commissioner, the U. S. Tax Court ruled that military retirement payments received by a former spouse under a Qualified Domestic Relations Order (QDRO) are taxable as income to the recipient. The court clarified that the tax consequences of such payments are determined by federal law, not the terms of the QDRO. This decision has significant implications for how divorce agreements involving military pensions are structured and taxed.

    Parties

    Larry G. and Maria A. Walton Mitchell, Petitioners, v. Commissioner of Internal Revenue, Respondent. The case was heard by Judge Joseph Robert Goeke of the United States Tax Court.

    Facts

    Maria A. Walton Mitchell was married to Bobbie Leon Walton, who served in the U. S. Air Force. They divorced in 1986, and Walton retired from the military in 1990. In 1991, Maria petitioned the California Superior Court for her interest in Walton’s military retirement pay, resulting in a court order that awarded her a portion of his net disposable military retirement pay, as defined under the Uniformed Services Former Spouses’ Protection Act. This order was recognized as a Qualified Domestic Relations Order (QDRO). Maria began receiving monthly payments from the Defense Finance and Accounting Service (DFAS) in 1991, and in 2001, she received $5,126. The Mitchells did not report this income on their 2001 joint federal tax return, leading to a notice of deficiency from the IRS.

    Procedural History

    The IRS issued a notice of deficiency to the Mitchells for the 2001 tax year, determining that the $5,126 received by Maria was taxable income. The Mitchells filed a petition with the U. S. Tax Court, contesting the deficiency. They had previously litigated a similar issue for the 2000 tax year, which was resolved in an S case (Mitchell v. Commissioner, T. C. Summ. Op. 2004-160). The current case was designated as a regular case, and the Commissioner asserted collateral estoppel based on the prior S case decision. The Tax Court, however, chose to decide the case on its merits without addressing the collateral estoppel issue.

    Issue(s)

    Whether distributions received by Maria A. Walton Mitchell pursuant to a Qualified Domestic Relations Order from her former husband’s military retirement pay are includable in her gross income for federal tax purposes?

    Rule(s) of Law

    The Internal Revenue Code imposes a tax on the taxable income of every individual (26 U. S. C. § 1). Gross income includes all income from whatever source derived, unless otherwise excluded (26 U. S. C. § 61(a)), and specifically includes amounts derived from pensions (26 U. S. C. § 61(a)(11)). Military retirement pay is considered a pension within this definition. Under 26 U. S. C. § 402(a), a pension distribution is normally taxed to the distributee, and under 26 U. S. C. § 402(e)(1)(A), the spouse or former spouse is treated as the distributee with respect to distributions allocated pursuant to a QDRO.

    Holding

    The Tax Court held that the $5,126 received by Maria A. Walton Mitchell in 2001 for her interest in her former husband’s military retired pay is includable in her gross income and thus subject to federal income tax.

    Reasoning

    The court reasoned that federal law, not state law or the terms of the QDRO, determines the federal taxation of property interests. The court cited several cases to support the principle that tax liability attaches to the owner of the property. The court further noted that the QDRO in question defined Maria’s interest as a portion of the “net disposable military retirement pay,” which was calculated after deducting certain amounts, including federal, state, and local income taxes withheld from the total pay. However, the court clarified that this definition only pertains to the calculation of the property interest, not its tax consequences. The court rejected the argument that the payments were subject to double taxation, as there was no evidence that taxes were withheld from Maria’s portion of the payments. The court also addressed the issue of collateral estoppel, which was raised by the Commissioner based on a prior S case decision on the same issue for the 2000 tax year. The majority chose not to address this issue, deciding the case on its merits instead. In a concurring opinion, Judge Holmes argued that decisions in S cases should have collateral estoppel effect in subsequent litigation between the same parties, despite the lack of appealability.

    Disposition

    The Tax Court entered a decision in favor of the Commissioner, affirming the deficiency determination for the 2001 tax year.

    Significance/Impact

    This case clarifies that distributions from military retirement pay to a former spouse under a QDRO are taxable to the recipient as gross income, regardless of the QDRO’s terms regarding the calculation of the distribution amount. It underscores the principle that federal tax law governs the taxation of property interests, not state law or divorce agreements. The case also raises questions about the collateral estoppel effect of decisions in S cases, which could impact the efficiency of litigation in the Tax Court by potentially allowing relitigation of settled issues. Practitioners and divorcing parties should be aware of these tax implications when structuring divorce agreements involving military pensions.

  • Brotman v. Commissioner, 106 T.C. 172 (1996): Collateral Estoppel and the Determination of Qualified Domestic Relations Orders

    Brotman v. Commissioner, 106 T. C. 172 (1996)

    Collateral estoppel applies to preclude relitigation of the determination of a qualified domestic relations order (QDRO) under ERISA, but not to the tax-exempt status of the related pension plan.

    Summary

    In Brotman v. Commissioner, the Tax Court addressed the application of collateral estoppel concerning a qualified domestic relations order (QDRO) and the tax implications of a pension plan distribution. Petitioner Brotman challenged a QDRO, previously upheld by a District Court, arguing it did not meet the statutory requirements under ERISA and the Internal Revenue Code. The Tax Court held that collateral estoppel barred relitigation of the QDRO’s validity but did not extend to the issue of the plan’s tax-exempt status, which had not been previously litigated. This decision clarifies the distinction between the determination of a QDRO and the separate issue of a plan’s tax qualification, impacting how attorneys should approach similar cases involving pension plan distributions and tax implications.

    Facts

    Matthew T. Molitch’s ex-wife, petitioner Brotman, was to receive $350,000 from Molitch’s pension plan under a court order entered by the Court of Common Pleas for Montgomery County, Pennsylvania, on January 7, 1988. The order was intended to be a qualified domestic relations order (QDRO) to avoid tax consequences for Molitch. Brotman received and partially rolled over the funds into an IRA. She later challenged the order’s validity as a QDRO in the U. S. District Court for the Eastern District of Pennsylvania, but the court upheld it. The IRS then determined a deficiency in Brotman’s 1988 federal income tax, prompting her to contest the QDRO’s validity in the Tax Court.

    Procedural History

    Brotman filed a complaint in the U. S. District Court for the Eastern District of Pennsylvania, seeking to reverse the QDRO and retain tax benefits. The District Court granted summary judgment in favor of the defendants, affirming the order as a valid QDRO. Brotman’s motion for reconsideration was denied, and she did not appeal. Subsequently, the IRS issued a notice of deficiency against Brotman, leading to her petition in the Tax Court, where the Commissioner moved for partial summary judgment based on collateral estoppel.

    Issue(s)

    1. Whether collateral estoppel precludes Brotman from relitigating the issue of whether the order entered by the Court of Common Pleas for Montgomery County, Pennsylvania, is a qualified domestic relations order (QDRO) under ERISA and the Internal Revenue Code.
    2. Whether collateral estoppel precludes Brotman from litigating the issue of the tax-exempt status of the Clark Transfer Profit Sharing Plan.

    Holding

    1. Yes, because the issue of whether the order was a valid QDRO under ERISA was identical to the issue under the Internal Revenue Code, and it was decided by a court of competent jurisdiction.
    2. No, because the issue of the plan’s tax-exempt status was not litigated in the prior proceeding and is a separate issue from the determination of a QDRO.

    Court’s Reasoning

    The Tax Court applied the doctrine of collateral estoppel, which prevents relitigation of an issue already decided by a court of competent jurisdiction. The court found that the definitions of a QDRO under ERISA and the Internal Revenue Code were virtually identical, making the issues identical for collateral estoppel purposes. The court rejected Brotman’s arguments for exceptions to collateral estoppel, such as a change in controlling facts or legal rules and special circumstances, finding no basis to doubt the fairness of the prior litigation. However, the court distinguished the issue of the plan’s tax-exempt status, noting that it was not litigated in the District Court and was a separate issue from the QDRO determination. The court cited cases like Martin v. Garman Constr. Co. and Richardson v. Phillips Petroleum Co. to support its conclusion that different issues require different evidence and are not precluded by collateral estoppel.

    Practical Implications

    This case underscores the importance of distinguishing between the determination of a QDRO and the separate issue of a pension plan’s tax qualification. Attorneys should be aware that while a prior determination of a QDRO’s validity under ERISA may preclude relitigation of that issue in tax court, it does not extend to the plan’s tax-exempt status. This decision impacts how legal professionals should approach cases involving pension plan distributions, QDROs, and tax implications, ensuring that they address each issue separately and consider the potential for collateral estoppel. The ruling also highlights the need for clear and precise legal arguments when challenging a QDRO’s validity and the tax consequences of plan distributions.

  • Rodoni v. Commissioner, 105 T.C. 29 (1995): Requirements for Tax-Free Rollovers from Qualified Plans to IRAs

    Rodoni v. Commissioner, 105 T. C. 29 (1995)

    A tax-free rollover from a qualified plan to an IRA must be to an IRA established for the benefit of the employee who received the distribution.

    Summary

    Mario Rodoni received a lump-sum distribution from his employer’s profit sharing plan and transferred it to his wife, Donna Rodoni, who deposited it into her IRA within 60 days. The court held that this transfer did not qualify as a tax-free rollover under IRC sections 402(a)(5) or 402(a)(6)(F). The key issue was whether the IRA could be established in the name of someone other than the employee receiving the distribution. The court ruled that for a rollover to be tax-free under section 402(a)(5), the IRA must be for the employee’s benefit, and under section 402(a)(6)(F), a qualified domestic relations order (QDRO) must be in place before the distribution. The decision underscores the strict requirements for tax-free rollovers and the necessity of QDROs in marital property divisions involving retirement plans.

    Facts

    Mario Rodoni received a lump-sum distribution of $307,204. 46 from Sunset Farms, Inc. ‘s profit sharing plan on February 5, 1988. He immediately handed the check to his wife, Donna Rodoni, who deposited it into a joint account. Within 60 days, Donna transferred the funds into her own IRA. The Rodonis were in the process of a divorce, and a Marital Settlement Agreement was executed, which was later incorporated into their Judgment of Dissolution of Marriage entered nunc pro tunc to December 31, 1988. The agreement specified that Donna was to receive the community property interest in the profit sharing plan.

    Procedural History

    The IRS determined a deficiency in the Rodonis’ 1988 federal income tax due to the lump-sum distribution. The Rodonis petitioned the U. S. Tax Court, arguing that the transfer to Donna’s IRA qualified as a tax-free rollover. The Tax Court held that the transfer did not meet the requirements for a tax-free rollover under sections 402(a)(5) or 402(a)(6)(F).

    Issue(s)

    1. Whether the transfer of a lump-sum distribution from a qualified plan to an IRA in the name of the employee’s spouse qualifies as a tax-free rollover under IRC section 402(a)(5).
    2. Whether such a transfer qualifies as a tax-free rollover under IRC section 402(a)(6)(F) when made pursuant to a domestic relations order.

    Holding

    1. No, because the rollover must be to an IRA established for the benefit of the employee who received the distribution, not the spouse.
    2. No, because the lump-sum distribution was not made by reason of a qualified domestic relations order (QDRO).

    Court’s Reasoning

    The court interpreted section 402(a)(5) to require that the IRA be established for the benefit of the employee receiving the distribution. The legislative history emphasized the purpose of promoting portability of pension benefits for the employee’s retirement. The court rejected the argument that an employee could roll over funds into any individual’s IRA, including a spouse’s, as it would contradict this purpose. For section 402(a)(6)(F), the court found that a QDRO must be in place before the distribution to qualify as tax-free. The Rodonis’ Judgment of Dissolution did not meet the QDRO requirements because it was not presented to the plan administrator before the distribution and did not clearly specify the necessary details about the distribution. The court also rejected the Rodonis’ argument of substantial compliance with these statutory provisions, noting that the requirements were substantive and essential to the statute’s purpose.

    Practical Implications

    This decision emphasizes the strict requirements for tax-free rollovers from qualified plans to IRAs, particularly the necessity that the IRA be established in the name of the employee receiving the distribution. For practitioners, it is crucial to ensure that any rollover complies with these requirements, and that any marital property division involving retirement plans includes a QDRO that is presented to the plan administrator before any distribution. The ruling affects how attorneys draft marital settlement agreements and QDROs, ensuring they meet statutory specifications to avoid tax consequences. Subsequent cases have cited Rodoni in upholding the need for strict adherence to rollover rules and QDRO requirements.

  • Hawkins v. Commissioner, 100 T.C. 51 (1993): Requirements for a Marital Settlement Agreement to Qualify as a QDRO

    Hawkins v. Commissioner, 100 T. C. 51 (1993)

    A marital settlement agreement must clearly specify the required elements under Section 414(p) to be considered a qualified domestic relations order (QDRO).

    Summary

    In Hawkins v. Commissioner, the court examined whether a marital settlement agreement between Dr. Arthur C. Hawkins and Glenda R. Hawkins qualified as a QDRO under Section 414(p) of the Internal Revenue Code. The agreement allocated $1 million from Dr. Hawkins’ pension plan to Mrs. Hawkins as part of their divorce settlement. The court held that the agreement did not meet the statutory requirements for a QDRO because it failed to clearly specify the necessary details such as the designation of Mrs. Hawkins as an alternate payee and the precise terms of the distribution. The ruling emphasized that for a document to qualify as a QDRO, it must explicitly and unambiguously meet the criteria set forth in the statute, impacting how future marital settlement agreements involving pension plans should be drafted.

    Facts

    Dr. Arthur C. Hawkins and Glenda R. Hawkins were divorced in January 1987. Their marital settlement agreement included a provision for Mrs. Hawkins to receive $1 million from Dr. Hawkins’ pension plan. This payment was made in installments from January to March 1987. Dr. Hawkins later attempted to have the agreement recognized as a QDRO to shift the tax liability to Mrs. Hawkins, but the New Mexico district court denied his motion. The Tax Court reviewed whether the agreement met the requirements of Section 414(p) to be considered a QDRO.

    Procedural History

    The case began when the IRS determined tax deficiencies for both Dr. and Mrs. Hawkins related to the pension plan distribution. Dr. Hawkins filed a motion in New Mexico state court for a QDRO nunc pro tunc, which was denied. The case then proceeded to the U. S. Tax Court, where both parties filed cross-motions for summary judgment on the issue of whether the marital settlement agreement constituted a QDRO.

    Issue(s)

    1. Whether collateral estoppel precludes Dr. Hawkins’ claim that the marital settlement agreement satisfies the requirements of Section 414(p)?
    2. Whether the language in the marital settlement agreement satisfies the requirements of Section 414(p) to qualify as a QDRO?
    3. Whether evidence of petitioners’ intent should be considered in determining if the agreement is a QDRO?

    Holding

    1. No, because the New Mexico district court’s decision did not actually and necessarily determine that the marital settlement agreement was not a QDRO.
    2. No, because the agreement did not meet the statutory requirements of Section 414(p), specifically failing to clearly specify the required elements of a QDRO.
    3. No, because the court’s decision was based solely on the language of the agreement, making the intent evidence irrelevant.

    Court’s Reasoning

    The court focused on the statutory requirements of Section 414(p), which mandates that a QDRO must clearly specify the names and addresses of the participant and alternate payee, the amount or percentage of the participant’s benefits to be paid, the number of payments or period to which the order applies, and the plan to which the order applies. The marital settlement agreement in question did not explicitly designate Mrs. Hawkins as an alternate payee or specify the terms of the distribution with the required clarity. The court rejected Dr. Hawkins’ argument that the agreement’s language was sufficient, emphasizing that a QDRO must be clear and specific to avoid ambiguity and litigation, as stated in Commissioner v. Lester, 366 U. S. 299 (1961). The court also noted that the proposed QDRO submitted to the New Mexico court contained the necessary language, contrasting with the executed agreement. No dissenting or concurring opinions were noted in the case.

    Practical Implications

    This decision underscores the importance of drafting marital settlement agreements with precision when they involve pension plan distributions. Attorneys must ensure that such agreements explicitly meet all the criteria under Section 414(p) to qualify as a QDRO, particularly in designating an alternate payee and specifying the terms of the distribution. The ruling impacts how tax liabilities are assigned in divorce proceedings involving retirement plans, requiring clear and unambiguous language to avoid disputes and litigation. Subsequent cases have continued to reference Hawkins for its interpretation of QDRO requirements, influencing legal practice in family law and tax law. This case also highlights the necessity of considering the legal implications of pension plan distributions during divorce settlements, affecting both legal practice and the financial planning of divorcing couples.

  • Karem v. Commissioner, 102 T.C. 429 (1994): Taxation of Lump-Sum Distributions Under Community Property Law

    Karem v. Commissioner, 102 T. C. 429 (1994)

    Community property laws do not affect the taxation of lump-sum distributions from qualified pension plans under section 402(e) of the Internal Revenue Code.

    Summary

    In Karem v. Commissioner, the Tax Court ruled that Robert L. Karem could not exclude half of a lump-sum pension distribution from his taxable income, despite a Louisiana court’s consent judgment partitioning the distribution as community property. The court held that under section 402(e)(4)(G) of the IRC, community property laws are ignored for the purpose of calculating the separate tax on lump-sum distributions. The court also determined that the consent judgment did not qualify as a Qualified Domestic Relations Order (QDRO), and thus could not affect the distribution’s tax treatment. This decision underscores the primacy of federal tax law over state community property laws in the context of pension distributions.

    Facts

    Robert L. Karem received a lump-sum distribution of $98,253. 52 from the D. H. Holmes, Inc. Pension Plan in 1987. He was divorced from Barbara Wiechman Karem in 1985, but their community property was not partitioned until 1988. A consent judgment in 1988 directed that half of the distribution be paid to Barbara. Karem reported only half of the distribution as taxable income on his 1987 tax return, arguing that the other half belonged to Barbara under Louisiana community property law. The IRS determined a deficiency and sought to tax the full amount of the distribution.

    Procedural History

    The case was assigned to a Special Trial Judge, whose opinion was adopted by the Tax Court. The IRS issued a notice of deficiency, and Karem challenged this determination in the Tax Court. The court’s decision was rendered in 1994.

    Issue(s)

    1. Whether Karem could exclude half of the lump-sum distribution from his taxable income under Louisiana community property law.
    2. Whether the consent judgment partitioning the community property was a Qualified Domestic Relations Order (QDRO) under section 414(p) of the IRC.

    Holding

    1. No, because section 402(e)(4)(G) of the IRC mandates that community property laws be ignored when calculating the tax on lump-sum distributions.
    2. No, because the consent judgment did not meet the statutory requirements of a QDRO, as it was rendered after the distribution and did not direct the plan administrator to make payments to Barbara.

    Court’s Reasoning

    The court applied section 402(e)(4)(G) of the IRC, which states that community property laws are to be disregarded when calculating the tax on lump-sum distributions. The legislative history of ERISA supported this interpretation, emphasizing equal treatment of all distributees regardless of state law. The court also determined that the consent judgment did not qualify as a QDRO because it was rendered after the distribution and did not direct the plan administrator to pay Barbara directly. The court cited Ablamis v. Roper and Darby v. Commissioner to support its conclusion that without a valid QDRO, state community property laws cannot affect the taxation of pension distributions. The court concluded that Karem was the sole distributee of the lump-sum distribution and thus liable for the tax on the full amount.

    Practical Implications

    This decision clarifies that state community property laws do not affect the federal taxation of lump-sum distributions from qualified pension plans. Practitioners must ensure that any division of pension benefits intended to impact tax liability is executed through a valid QDRO before the distribution is made. This ruling impacts how attorneys handle divorce settlements involving pension plans in community property states, emphasizing the need for QDROs to effectuate tax benefits. Subsequent cases have followed this precedent, reinforcing the importance of federal law in pension distribution taxation.

  • Darby v. Commissioner, 97 T.C. 51 (1991): Taxation of Pension Distributions in Divorce Settlements

    Darby v. Commissioner, 97 T. C. 51 (1991)

    The participant in a qualified pension plan, not the former spouse, is taxed on the full amount of a lump sum distribution, even when part of it is paid to the former spouse under a divorce decree.

    Summary

    Lewis Darby was fully vested in his employer’s profit-sharing plan when he divorced in 1976. The divorce decree required him to pay $75,000 to his former wife, Yolanda, representing her share of his plan interest. Upon retirement in 1983, Darby received a lump sum distribution from the plan and paid the remaining $52,970 owed to Yolanda. The Tax Court held that Darby, as the plan participant, was the distributee of the entire distribution and must include it in his income under Section 402(a)(1). No part of the payment to Yolanda was excludable from Darby’s income under Section 72, as it did not constitute an investment in the contract.

    Facts

    In 1976, Lewis Darby divorced Yolanda Darby. At the time, Lewis was a fully vested participant in Sears’ tax-qualified profit-sharing plan. The divorce decree mandated Lewis to pay Yolanda $75,000, approximately half the value of his interest in the plan, at $60 per week until fully paid or until his death or retirement, when the balance would be due as a lump sum. Lewis assigned to Yolanda the portion of his interest in the plan necessary to satisfy this obligation. Lewis retired in 1983, received a lump sum distribution of $182,481. 39 from the plan, and paid the remaining $52,970 to Yolanda.

    Procedural History

    Lewis Darby filed a tax return for 1983, excluding the $75,000 paid to Yolanda from his income. The IRS determined a deficiency, leading Darby to petition the U. S. Tax Court. The Tax Court ruled in favor of the Commissioner, holding that Darby was the distributee of the entire lump sum distribution and must include it in his income.

    Issue(s)

    1. Whether Lewis Darby properly excluded from income the portion of the lump sum distribution he paid to Yolanda under the divorce decree, on the basis that she was the distributee for purposes of Section 402(a)(1).
    2. Whether all or any portion of the amount paid to Yolanda is excludable from Darby’s gross income under Section 72.

    Holding

    1. No, because Lewis Darby, as the plan participant, was the distributee of the entire lump sum distribution under Section 402(a)(1), and not Yolanda.
    2. No, because the payment to Yolanda did not constitute an investment in the contract under Section 72, and thus no part of it was excludable from Darby’s income.

    Court’s Reasoning

    The Tax Court reasoned that under Section 402(a)(1), the distributee of a qualified plan distribution is the participant or beneficiary entitled to receive it under the plan, not necessarily the recipient. The court examined the legislative history of the Retirement Equity Act of 1984 (REA ’84) and the Tax Reform Act of 1986 (TRA ’86), which clarified that a former spouse receiving a distribution under a qualified domestic relations order (QDRO) would be treated as the distributee. However, these amendments did not apply retroactively to Darby’s case. The court also noted that the distribution consisted entirely of employer contributions, which were not includable in Darby’s income if paid directly to him, thus not constituting an investment in the contract under Section 72. The court rejected Darby’s argument that the payment to Yolanda constituted a basis adjustment under Section 72(g), as it was not a transfer of the plan interest itself but a payment for her interest in the marital estate.

    Practical Implications

    This decision clarifies that in divorce settlements involving pension plan distributions, the plan participant remains the distributee for tax purposes, unless a QDRO is in place. Attorneys drafting divorce agreements should consider including QDROs to shift tax liability to the former spouse receiving the distribution. The ruling also underscores the importance of understanding the tax implications of property settlements, as payments made from a pension plan distribution are not treated as an investment in the contract, and thus are not excludable from the participant’s income. This case has been cited in subsequent cases involving the taxation of pension distributions in divorce, reinforcing the principle that without a QDRO, the participant bears the full tax burden of the distribution.