But It Does Save the Chop

Unlike that lizard of the television advertisements, Form 5329 doesn’t save Bilal Ahmed, Docket No. 23807-15, filed 12/15/16, 15% or even 10%. The latter is the Section 72(t) tax or addition to tax or whatever it is, when what he claims is a QDRO (Qualified Domestic Relations Order) permitting him a tax-free takeaway from his IRA fails to convince IRS or Judge Goeke.

But it does save Bilal the 20% substantial understatement chop on the 10% early withdrawal thingy, in this off-the-bencher, which Judge Goeke, modest as always, doesn’t bother to designate.

Bilal is ordered by CA Sup Ct to draw down his IRA to pay off the credit card debt that burden Bilal and his community-property soon-to-be-ex. Of course, they’re supposed to split the taxes, but neither IRS nor Tax Court enforces State Court decrees.

Judge Goeke notes that Bilal filed the Form 5329 discussing the claimed exemption from tax based on a claimed QDRO. But Bilal’s decree utterly crashes on Section 414(p)(2), none of whose tests the decree satisfied. And Bilal never tipped off the plan administrator, thus falling foul of Section 414(p)(6).

Judge Goeke: “It’s undisputed that the Petitioner did not provide the order in question to the administrator of his IRA and it is also clear from the order, itself, that it does not meet the requirements of Subsection 414(p)(2) as described above.

“Respondent [IRS] correctly points out that Petitioner was required to submit the order to the plan administrator in order to be subject to the statutory exception under Section 72(t)(2)(C). Given this and other inadequacies of the order in question, there’s no question that the Petitioner’s position that he was exempt from the application of Section 72(t) is incorrect.

“The order was not a qualified domestic relations order and the inadequacies of the order are not mere technical failures. The order is intended to ensure the credit card debt of the marital community of Petitioner and his former spouse is satisfied and he was ordered to receive the money initially himself, not to transfer the money to his spouse.

“He testified that remaining amounts after the satisfaction of the credit card debt, which was to his benefit as well as to his former spouse, were used to pay obligations of himself as well as his former spouse in legal fees [sic]. Use of the funds in this manner is not consistent with a statutory exception as a policy matter in addition to the technical inadequacies of the order and Petitioner’s failure to provide the order to the plan administrator.” Order, at p. 9-10.

So Bilal’s IRA draw is taxable all the way, he’s under 59-1/2 on the draw date so the 10% thingy applies, and he’s in the zone for the five-and-ten ($5K or 10%) chop. IRS has burden of production, and has satisfied it.

But here comes the Magic Paper to save whatever is left of the day for Bilal.

“In this regard, we believe it is important that the Petitioner filed the appropriate form with respect to the early withdrawal from the IRA. While the Petitioner incorrectly claimed that the withdrawal was exempt, his assertion that the withdrawal was exempt we believe was in good faith given the rather complex nature of the law regarding the treatment of qualified domestic relations orders.” Order, at pp. 11-12.

Takeaway—When in doubt on an IRA draw, at least on a QDRO, send in the Form 5329. Yes, I know, it’s an invitation to Examination, but the 1099-R will set off bells anyway if it doesn’t show up on the 1040. And if the petitioner looks honest but bewildered, it might save the chop.

Second takeaway—Family lawyers, beware. Watch out for the QDRO trap when detaching IRAs from spouses. Re-read Section 414(p)(2) and the regs.