Nov 2019 : QDROs Present a Tax-Smart Option Following Elimination of Section 71 Alimony Deductions

View / Download November 2019 Article – PDF File

Tax Trends and Developments Column – Michigan Family Law Journal


With the elimination of taxable/deductible Section 71 payments effective January 1, 2019, using a QDRO transfer of an interest in a defined contribution plan (e.g., 401(k), 403 (b) account) by which a business owner spouse buys out the other spouse’s marital interest is a good fit in many situations.

General

In the past, Section 71 payments provided a means by which one spouse could buy out the other’s marital interest in a business with pretax dollars. But, with the 2017 Tax Cuts and Jobs Act of 2017 repeal of the alimony deduction, this method is no longer available as of January 1, 2019.
However, use of a transfer of an interest in a defined contribution plan account via a QDRO can be a “tax-smart” way to structure a business buy-out.

Example

  • H, 45 years old, owns ABC Company (ABC) which has been valued at $250,000 for his and W’s divorce settlement.
  • However, there are not sufficient other suitable marital assets to award W to offset the $250,000 business value.
  • But, H has a 401(k) account with a balance of $400,000.
  • His tax savvy lawyer proposes that H use his half of the 401(k) account to buy out W’s $125,000 interest in the business.
  • He tells H that he has the (1) business and (2) many years to replenish his 401(k) account for his future security.
  • He adds that, by using the 401(k) account, He will not need to use his personal cash or that of ABC for the buy-out.
  • Further, he states, since W no longer has the business as part of her future security, receiving additional 401(k) funds is ideal for her.
  • Since the $250,000 business value is largely after-tax and the 401(k) account is 100% pre-tax, the transfer to W must be tax affected.
  • So, assuming W federal and state tax rate will be 20%when she draws the 401(k) in the future, H transfers via a QDRO $156,250 of his $200,000 share of the 401(k) to W, the equivalent of $125,000 after-tax.

Observations

  1. Avoiding using cash for the buy-out may be particularly beneficial if H has spousal and/or child support obligations.
  2. Use of part of a 401(k) can also be used to buy-out an alimony obligation, as follows:
    • The present value of the projected stream of spousal support payments is calculated.
    • Then, the 401(k) amount is tax affected at the recipient’s tax bracket to its after-tax equivalent similar to what was done in the example.
    • The recipient can access the transferred amount from the 401(k) without the 10% penalty regardless of either parties’ age.

About the Author

Joe Cunningham has over 25 years of experience specializing in financial and tax aspects of divorce, including business valuation, valuing and dividing retirement benefits, and developing settlement proposals. He has lectured extensively for ICLE, the Family Law Section, and the MACPA. Joe is also the author of numerous journal articles and chapters in family law treatises. His office is in Troy, though his practice is statewide.

Download the PDF file below… “QDROs Present a Tax-Smart Option Following Elimination of Section 71 Alimony Deductions”
View / Download November 2019 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

Aug / Sept 2017 : In a Published Case, Court of Appeals Approves Entry of QDRO 12 Years Post Date of Divorce–JOUGHIN, No. 329993 (7/11/2017)

Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

by Joseph W. Cunningham, JD, CPA

Facts

  • H and W were divorced on April 28, 2003.
  • The Judgment of Divorce (JOD) awarded W (1) 50% of H’s pension accrued as of April 30, 2002 and (2) $23,823 from his profit-sharing plan account.
  • The JOD provided that both parties “shall cooperate” in obtaining and processing the QDROs necessary to effectuate the transfers to W.
  • For reasons not apparent on the record, the QDROs were not promptly filed. Instead, W submitted the QDROs for entry with the trial court on June 30, 2015- more than 12 years post-divorce.
  • H objected claiming that W’s submission of the QDROs for entry was an attempt to enforce the 2003 JOD and, hence, was time-barred under MCL 600.5809(3), which provides a 10-year statute of limitations applicable to attempts to enforce a noncontractual money obligation.
  • W responded that because her claim did not arise until H reached retirement age, that the statute had not yet begun to run.
  • Because H had not retired nor received any of his retirement benefits, the trial court entered the QDROs.
  • H appealed.

Court of Appeals Decision

  • The Court disagreed with the parties’ position that MCL 600.5809 applied to entry of a QDRO.
  • Rather, the Court cited a previous decision that “when a judgment of divorce requires a QDRO to be entered, the QDRO is to be considered as part of the divorce judgment.”
  • Accordingly, the Court stated that “because the QDRO is part of the judgment, it necessarily cannot be viewed as enforcing the same judgment.” *** “Instead, we hold that under these circumstances, the act to obtain entry of a proposed QDRO is a ministerial task done in conjunction with the divorce judgment itself.”
  • Thus, the Court concluded that entry of the QDROs was not time-barred
  • Judge Kathleen Jansen wrote a vigorous dissent claiming, for various reasons, that entry of the QDRO after 10 years was barred by the statute of limitations.

Comments on the Case

  • Obviously, the case is a “poster child” for the importance of preparing and processing QDROs promptly – either contemporaneous with entry of the divorce judgment or soon thereafter.
  • Based on many years’ experience of preparing QDROs for legal aid clients under a pro bono program administered by the State Bar, QDROs unfiled for years following divorce are not uncommon. This case – a rare family law published case – indicates that the passage of 10 years or more does not bar entry of a QDRO.
  • However, in Joughin, the participant had not begun to receive benefits. Had he done so, or remarried, or died, the situation would likely have been much more problematic for the alternate payee.
  • And, the Joughin judgment provision reprinted in the Court’s opinion did not provide that W’s share of H’s profit-sharing plan account would be adjusted proportionately for gains or losses of plan investments. With the sharp advance of the stock market from 2003 through 2015, W paid a high price for not timely attending to the QDROs.
  • In this regard, there is no precedent regarding whether the right to receive a proportional share of plan gains and losses passes automatically under state law with the transfer via QDRO of an interest in an account balance plan such as a 401(k) or profit-sharing plan as in Joughin.
  • Unless transferring a set dollar amount, it is highly advisable to include such a provision in both the JOD and the QDRO.

About the Author

Joe Cunningham has over 25 years of experience specializing in financial and tax aspects of divorce, including business valuation, valuing and dividing retirement benefits, and developing settlement proposals. He has lectured extensively for ICLE, the Family Law Section, and the MACPA. Joe is also the author of numerous journal articles and chapters in family law treatises. His office is in Troy, though his practice is statewide.

Download PDF file below… “In a Published Case, Court of Appeals Approves Entry of QDRO 12 Years Post Date of Divorce–JOUGHIN, No. 329993 (7/11/2017)”
View / Download Aug-Sept 2017 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)