I Feel Your Pain

I’ve been tough on my family law colleagues when it comes to taxes. The Section 71(b)(1)(D) and 71(c)(2) miscues have been painful to watch. But when the client doesn’t follow what is clearly the right advice, what is the poor family lawyer to do?

Here’s John R. Kirkpatrick, 2018 T. C. Memo. 20, filed 2/22/18. That’s Doc John R, as he’s an MD.

In an acrimonious untangling from ex-Mrs Doc John R, the State Court entered an interim spousal maintenance order, requiring Doc John R to transfer $100K from his IRA “…directly (and in a non-taxable transaction) into an IRA appropriately titled in Ms. Kirkpatrick’s name within fourteen (14) days of the entry of this Order….” 2018 T. C. 20, at p. 4.

Of course, ex-Mrs Doc John R doesn’t have an IRA titled in her name, but apparently nobody hastens to make sure that she does, and Doc John R doesn’t try to do a trustee-to-trustee.

Instead, he draws down his IRA and sends ex-Mrs Doc John R his own checks during the year between interim decree and final divorce. Doc John R says it’s the same thing.

Only neither the statute nor the case law says it is. And as for what the State Court said in its decree, Federal tax law overrules State law, per the Supremacy Clause of the Constitution.

Judge Laro: “We agree with respondent that petitioner does not fall within the section 408(d)(6) exclusion from gross income and that the disputed distributions from his…IRAs should be included in his gross income.  As noted above, this Court has held that for section 408(d)(6) to apply, two requirements must be met: (1) there must be a transfer of the IRA participant’s interest in the IRA to his spouse or former spouse, and (2) the transfer must have been made under a section 71(b)(2)(A) divorce or separation instrument.  Bunney v. Commissioner, 114 T.C. at 265.  As the Court observed in Bunney, two commonly used methods of transferring an interest in an IRA are to (1) change the name on the IRA to that of the nonparticipant spouse or (2) direct the IRA’s trustee to transfer the IRA assets to the trustee of an IRA owned by the nonparticipant spouse.  Id. at 265 n.6.  In Bunney we rejected the idea that taking a distribution from an IRA and then making a payment to one’s spouse qualifies as a transfer of an interest in that IRA. Id. at 265.  We further clarified in Jones v. Commissioner, 80 T.C.M. (CCH) at 77-78, that the section 408(d)(6) exception is limited and that ‘interest’ is not synonymous with the money or other assets held in an IRA–indeed, that the withdrawal of funds from an IRA extinguishes the owner’s interest in that IRA or the appropriate proportion thereof.” 2018 T. C. Memo. 20, at pp. 15-16.

In law, form is substance. Congress said “interest” in the IRA, not “interest or money.”

Now second-guessing is a well-beloved indoor sport. The two-week deadline for the transfer may well have been unrealistic, given the need for the battling Kirkpatricks to act together after she “kicked him out of the house” and he moved to another State (2018 T. C. Memo. 20, at p. 3). And how well Doc John R was dealing with business matters at such a time may have indicated a need for closer oversight by his attorneys. Careful tax planning was surely evident; but it is too often the case that a brilliant play comes in from the bench and gets shredded on the field. Especially when the quarterback has been recently sacked.