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Divorce Taxation: Avoiding Penalty for QDRO Distribution Withdrawals

Leslie Barrows
 | Published: 
February 3, 2020
 | Category: 
Divorce Finances

In Divorce, Pensions are Divided Using a Qualified Domestic Relations Order (QDRO)

Divorces in Texas require the parties community property to be divided equitably, including money in 401k retirement plans and accounts. The values of 401k plans are usually valued at the date of divorce and are divided using a form called a Qualified Domestic Relations Order (QDRO). While some people receive the funds from a 401k division using a QDRO and roll that money right into their own 401k investment account. However, some people want access to the cash value of the amount they receive following the entry of the QDRO.

A Qualified Domestic Relations Order is a form that identifies the 401k plan participant and the alternate payee who should receive an equitable distribution of funds. There are general QDRO forms, and specific forms and models used by individual plan administrators. For example, see the QDRO information page on the Teacher Retirement System of Texas (TRS) on their website.

If you are the Alternate Payee named to receive your equitable share of QDRO funds, and you chose to take an early distribution before reaching the age of 59 ½ you will the owe the IRS an early distribution penalty if you do not otherwise inform them that you qualify to avoid additional taxes on qualified retirement plans by completing an additional tax form, IRS Form 5329.

Got Divorce Taxation Questions? Call Southlake Divorce Attorney Leslie Barrows (817) 481-1583.

Turbo Tax: 10 Things You Need to Know About Divorce and Taxes

Divorce Taxation Issues and Questions that Arise During Divorces

Divorce taxation comes up during negotiations about property division, financial support of parties and children, and of course, the division of retirement funds and accounts. Divorce lawyers frequently advise their clients to get divorce taxation advice from qualified tax advisor professionals. Likewise, the tax professionals refer back to the divorce lawyers when they receive questions about who should be entitled to what monies and how.

For most families with straight forward finances, determining divorce taxation answers is easy. But when there are complicated business interests, investments, and stock ownership and options, the issues of revenue and taxation are more complicated. For example, the event triggering the sale or transfer of monies and financial interests can affect tax liability depending on how and when that event takes place. In many situations, it is best when the parties can work together in a way those divorce taxation dilemmas are resolved in everyone’s favor, and not in the favor of IRS.

Generally, a 10 Percent Early Withdrawal Penalty Applies When Cashing In QDRO Money

If you were not aware of early withdrawal penalties, do not be concerned. In the realm of divorce taxation and tax laws applying to QDRO money, the laws can change from year to year and all the experts must approach tax questions and research the current laws and implications of their application.

Let’s say you want to use the money you receive from the 401k distribution to make a down payment on a home. If you can avoid a 10 percent early withdrawal penalty, you have more money to use in getting your new life going after your divorce.

A New IRS Requirement Allows a Waiver of the 10 Percent Early Withdrawal Penalty

If you are the Alternate Payee, meaning you are the one receiving money from a 401k distribution ordered in your divorce decree, you may take advantage of the opportunity to avoid a 10 percent early withdrawal penalty. For many people, this 10 percent can mean substantial savings if you want or need to cash in your QDRO award.

When you sit down to prepare your tax returns after divorcing, you can separate early distributions by completing additional IRS forms allowing you to avoid owing the 10 percent tax on those early distributions.

Now, the Alternate Payee Uses IRS Form 5329 to be Exempt from the Penalty

IRS Form 5329 applies to the additional tax on early distributions from qualified retirement plans including IRAs, modified contracts, and Roth IRAs. You should consult an independent tax advisor qualified to advise and assist with tax forms and filings. They can help you with Form 5329, to be completed and attached to the main Form 1040 or 1040NR. You can also review IRS Form 5329 and this Investopedia article, Retirement Plan Tax Form 5329 for more information and instructions on completing the forms and marking “06” on line 2 and filling in the exempt amount.

Denton and Tarrant County Divorce Attorney Leslie Barrows Can Answer All Your Divorce Taxation Questions (817) 481-1583

The Barrows Firm attorneys, paralegals, and staff welcome your questions about divorce taxation, and all other financial matters that affect you and your family now, and in the future. Principal and founding divorce attorney, Leslie Barrows has professional relationships with all the best tax experts and financial planning advisors who know how best to turn your finances in the best direction after divorce. It is likely that these divorce and financial matters are stressful and at the Barrows Firm, we do whatever we can to make the transition easier and reduce your stress level.