SCOTUS Reports

Tag: Section 72

  • 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.

  • Woodford v. Commissioner, 71 T.C. 991 (1979): Tax Treatment of Disability Retirement Benefits Before Normal Retirement Age

    William I. Woodford and Madge L. Woodford, Petitioners v. Commissioner of Internal Revenue, Respondent, 71 T. C. 991 (1979)

    Disability retirement payments received before normal retirement age are treated as wages or payments in lieu of wages, subject to tax under section 105(a) rather than as a recovery of employee contributions under section 72(d).

    Summary

    William I. Woodford, a retired federal employee, received disability retirement payments before reaching the normal retirement age of 70. He sought to exclude these payments from his gross income both as sick pay under section 105(d) and as a recovery of his contributions to the Civil Service Retirement Fund under section 72(d). The Tax Court held that these payments could not be split for tax purposes and were taxable as wages under section 105(a), thus disallowing the exclusion under section 72(d). Additionally, the court ruled that these payments constituted earned income, disqualifying Woodford from claiming a retirement income credit under section 37. This decision clarifies the tax treatment of disability retirement benefits received before normal retirement age and impacts how such benefits are reported on tax returns.

    Facts

    William I. Woodford retired from the Internal Revenue Service at age 67 after 29 years of service. Initially, his retirement was classified as nondisability, but it was later reclassified to disability retirement effective November 4, 1974. In 1975, he received $10,879 in disability retirement benefits and excluded $5,200 as sick pay under section 105(d). He also sought to exclude an additional $5,679 as a recovery of his contributions to the Civil Service Retirement Fund under section 72(d). Woodford and his wife also claimed a retirement income credit of $228. 60 for 1975.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in the Woodfords’ 1975 federal income tax and disallowed the exclusion of the $5,679 and the retirement income credit. The Woodfords petitioned the Tax Court, which upheld the Commissioner’s determination, ruling that the disability retirement payments were taxable under section 105(a) and constituted earned income, thus disallowing the claimed exclusions and credit.

    Issue(s)

    1. Whether petitioners are entitled to exclude from their gross income the $5,679 in excess of the sick pay exclusion as a recovery of their contributions to the Civil Service Retirement Fund under section 72(d)(1).
    2. Whether petitioners are entitled to a retirement income credit under section 37 for 1975.

    Holding

    1. No, because the disability retirement payments in excess of the sick pay exclusion are treated as wages under section 105(a) and cannot be excluded under section 72(d)(1).
    2. No, because the disability retirement payments constitute earned income under section 37(d)(2)(B), disqualifying petitioners from the retirement income credit.

    Court’s Reasoning

    The Tax Court applied sections 105(a) and 105(d) to determine that the disability retirement payments were wages or payments in lieu of wages, taxable under section 105(a) and not subject to exclusion under section 72(d). The court relied on section 1. 72-15(b) of the Income Tax Regulations, which states that section 72 does not apply to amounts received as accident or health benefits, and on the DePaolis and Brownholtz cases, which established that such payments cannot be split for tax purposes. The court also found that these payments were earned income under section 37(g), thus disqualifying the Woodfords from the retirement income credit. The decision reflects the policy of taxing wage continuation benefits provided by untaxed employer contributions during periods of absence due to sickness.

    Practical Implications

    This decision affects how federal employees and other taxpayers report disability retirement benefits received before normal retirement age on their tax returns. It clarifies that such benefits are taxable as wages under section 105(a) and cannot be excluded under section 72(d) as a recovery of contributions. Taxpayers must be aware of the limitations on exclusions and credits, such as the retirement income credit, when receiving disability benefits. This ruling may influence the structuring of retirement plans and the tax advice given to employees considering disability retirement. Subsequent cases have followed this precedent, reinforcing the tax treatment of disability retirement benefits before normal retirement age.