While it is possible to transfer some or all of an IRA account tax free to the soon to be ex-spouse pursuant to a divorce, certain rules need to be followed. In the case of Kirkpatrick v. Commissioner, TC Memo 2018-20, the taxpayer discovered that a failure to follow these procedures can be a very costly mistake.

The case in question revolved around IRA distributions made from Mr. Kirkpatrick’s IRA and their relationship to the following two provisions in a consent order related to Mr. Kirkpatrick’s divorce. The provisions are outlined by the Tax Court in its opinion:

The first reads: “ORDERED, that the Defendant shall transfer to Ms. Kirkpatrick the sum of One Hundred Thousand Dollars ($100,000.00) 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 and that the funds will not be withdraw [sic] until 2013”. The second provides: “ORDERED, that the Defendant shall pay to the Plaintiff a lump sum of Forty Thousand Dollars ($40,000.00) by 5:00 pm on September 26th, 2012 for Pendente Lite Attorney's Fees and Suit Money via direct deposit”.

Mr. Kirkpatrick took the following actions following those orders being issued, per the Tax Court opinion:

Petitioner did not transfer any money into an IRA titled in Ms. Kirkpatrick's name at any time after the consent order was entered on September 24, 2012, or before their divorce was finalized on June 30, 2014. However, he did make payments directly to Ms. Kirkpatrick throughout 2013. Petitioner, who at that time was over 59-1/2 years of age, paid the money he was ordered to pay to her through a series of checks. To make these payments, he withdrew funds from two of his IRAs held at JPMorgan Chase Bank, N.A. (JPMorgan), and transferred those disbursements to his JPMorgan checking account, from which he wrote checks to Ms. Kirkpatrick. Petitioner also wrote checks to third parties in partial satisfaction of the money he was ordered to pay to Ms. Kirkpatrick pursuant to the consent order. Petitioner did not transfer any money into an IRA titled in Ms. Kirkpatrick's name at any time after the consent order was entered on September 24, 2012, or before their divorce was finalized on June 30, 2014. However, he did make payments directly to Ms. Kirkpatrick throughout 2013. Petitioner, who at that time was over 59-1/2 years of age, paid the money he was ordered to pay to her through a series of checks. To make these payments, he withdrew funds from two of his IRAs held at JPMorgan Chase Bank, N.A. (JPMorgan), and transferred those disbursements to his JPMorgan checking account, from which he wrote checks to Ms. Kirkpatrick. Petitioner also wrote checks to third parties in partial satisfaction of the money he was ordered to pay to Ms. Kirkpatrick pursuant to the consent order.

IRC §408(d)(6) provides the following special rules for transferring an IRA balance tax free to a spouse pursuant to a divorce:

(6) Transfer of account incident to divorce

The transfer of an individual’s interest in an individual retirement account or an individual retirement annuity to his spouse or former spouse under a divorce or separation instrument described in subparagraph (A) of section 71(b)(2) is not to be considered a taxable transfer made by such individual notwithstanding any other provision of this subtitle, and such interest at the time of the transfer is to be treated as an individual retirement account of such spouse, and not of such individual. Thereafter such account or annuity for purposes of this subtitle is to be treated as maintained for the benefit of such spouse.

Mr. Kirkpatrick claimed that $140,000 of the amounts he paid to his soon to be former spouse from his IRA in 2013 were not taxable based on this provision in the law.

The Court notes that the second order (to transfer $40,000 to Ms. Kirkpatrick directly) could not be covered by IRC §408(d)(6)’s exclusion from taxation:

…[T]he order for petitioner to pay $40,000 for attorney's fees and suit money clearly is not an order for the transfer of an interest in an IRA, and the sum could have been paid out of any funds — retirement or otherwise. See Czepiel v. Commissioner, 78 T.C.M. (CCH) at 381. Petitioner has not advanced any argument about how or why IRA distributions to pay this $40,000 award should be excluded from his gross income and thus is deemed to have conceded it. See, e.g., Thiessen v. Commissioner, 146 T.C. 100, 106 (2016) (“[I]ssues and arguments not advanced on brief are considered to be abandoned.”).

So, the dispute that remains is only over the $100,000. The order did provide that this would be transferred from the taxpayer’s IRA and into an IRA for Ms. Kirkpatrick, a transfer that would be covered by IRC §408(d)(6)’s exclusion from taxation (and, presumably, was why the order mentioned doing this in a tax free manner). But Mr. Kirkpatrick did not actually do what the order required, but rather simply took funds from IRA and forwarded them to Ms. Kirkpatrick.

The Tax Court first discusses methods that do work to create a tax-free transfer from one spouse’s IRA to another pursuant to a divorce agreement:

…[T]his 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.

However, if the owner of the IRA takes a distribution from the IRA and then sends that on to the other party, that will not be protected from taxation by IRC §408(d)(6). As the Court continues:

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. See also Czepiel v. Commissioner, 78 T.C.M. (CCH) at 381 (“Petitioner did not transfer all or a portion of his interest in his IRA's to Ms. Czepiel. He received distributions from those IRA's and paid the funds distributed to him from those IRA's to Ms. Czepiel.”).

Since Mr. Kirkpatrick did not transfer an interest in the IRA, the $100,000 was also fully taxable to Mr. Kirkpatrick.

The Court then goes on to explicitly reject the implicit argument that his actions were “close enough” to what was required, and that substance should govern over form in this case. The opinion notes:

Ultimately, petitioner’s argument rests on the idea that the alleged substance of what occurred should govern and not its strict form. This we cannot accept, even if we assume — although we restate that we do not find as a fact — that the funds distributed from petitioner's IRAs did find their way into an IRA titled in Ms. Kirkpatrick's name. As the Court of Appeals for the Sixth Circuit, to which this case is appealable, articulated in Summa Holdings, Inc. v. Commissioner, 848 F.3d 779, 782 (6th Cir. 2017), rev'g T.C. Memo. 2015-119: “'Form' is 'substance' when it comes to law. The words of law (its form) determine content (its substance).” The words of the law relevant here, section 408(d)(6), are specific: “interest in an individual retirement account”. The statute does not say “assets from an individual retirement account”, or more broadly, “interest in or assets from an individual retirement account”. This Court in Bunney, Jones, and Czepiel has given effect to the will of Congress as expressed in the plain meaning, see Griffin v. Oceanic Contractors, Inc., 458 U.S. 564, 570 (1982) (“Our task is to give effect to the will of Congress, and where its will has been expressed in reasonably plain terms, 'that language must ordinarily be regarded as conclusive.'” (quoting Consumer Prod. Safety Comm'n v. GTE Sylvania, Inc., 447 U.S. 102, 108 (1980))), of section 408(d)(6) that only certain limited, direct IRA transfers qualify thereunder. Form matters. Here, all relevant sources — the Code; the caselaw; Internal Revenue Service guidance, see Bunney v. Commissioner, 114 T.C. at 265 n.6; and even the consent order in petitioner's divorce proceedings — suggest that taking distributions from IRAs and writing checks to one's spouse is not the appropriate form for a tax-free transfer of an account incident to divorce under section 408(d)(6). Thus we find that there was no transfer of petitioner's interest in the IRAs to Ms. Kirkpatrick.