Is division of an IRA a taxable event?

Generally the transfer of property from one spouse to another due to a divorce is a nontaxable exchange under IRC section 1041. IRC section 408(d)(6) further states that the transfer of an individual's interest in an individual retirement account (IRA) to a former spouse also is a nontaxable event.

Norma Cohen received a divorce in 1997 under an agreement that postponed to a later date any resolution of the financial matters. In June 1999 the Superior Court of New Jersey ordered that an IRA previously established by her ex-husband in his name should be divided equally. The IRA had assets of about $120,000. In July 1999 Cohen opened an IRA in her own name, into which her ex-husband transferred $60,000 from his IRA. Late in 1999, Cohen requested the $60,000 be withdrawn from her IRA in a check payable to her. She endorsed the check over to her ex-spouse to purchase his remaining interest in the former marital home. She did not report the $60,000 distribution on her 1999 tax return. She believed the $60,000 transfer from her ex-husband's IRA represented a distribution from his IRA that was taxable to him and a subsequent $60,000 cash transfer of marital assets to her IRA. She then had a $60,000 basis in her IRA, which made the $60,000 withdrawal from her IRA a tax-free distribution. The IRS disagreed. Cohen petitioned the Tax Court for relief.

Result. For the IRS. Cohen argued the $60,000 transfer did not satisfy the requirements of section 408(d)(6) since the court order had directed an equal division of the $120,000 IRA but had not required a new IRA be established to receive the rollover. Therefore the transfer should have been taxable to her ex-husband. The Tax Court disagreed, saying the court order clearly had instructed her ex-husband to transfer a 50% interest in his IRA to her; therefore the requirements of section 408(d)(6) were satisfied.

The taxpayer also argued the Tax Court should follow its decision in Czepiel v. Commissioner, TC Memo 1999-289, holding that an IRA transfer was taxable to the ex-husband. The Tax Court also rejected this argument. In Czepiel, the taxpayer was ordered under a divorce decree to pay his ex-wife $29,000 as a "further division of marital property." Due to financial difficulties, he withdrew funds from his IRA and paid the amount to his ex-wife. No transfer from the IRA had been required by the divorce decree. The Tax Court held that the $29,000 was taxable to Mr. Czepiel since he had received the funds from his IRA.

However, in this case, the $60,000 transfer from the IRA of Cohen's ex-husband was due to the division of the IRA ordered by the divorce decree. Therefore, the transfer was tax-free to Cohen's ex-husband, and she had a zero basis in the IRA. Cohen also had to pay the 10% penalty tax for an early withdrawal from an IRA.

* Norma A. Cohen v. Commissioner, TC Memo, 2004-227.

Prepared by Charles J. Reichert, CPA, professor of accounting, University of Wisconsin, Superior.