> Removing the counsel of experts rarely results in decreased costs and increased efficiency.
> Each asset’s characteristics must be considered carefully when being transferred, whether it is due to divorce, planned giving or death.
> Integrating your advisers allows them to advise on their respective areas of expertise and is typically the most efficient path to the desired result.
A recent U.S. Tax Court decision provides yet another example of how integrating your advisers can result in a far more efficient legal resolution than attempting to shortcut such matters.1 In the case, a young couple—Jeremy and Karie—decided to get divorced. In order to minimize both costs and acrimony, they decided that they would do so without the assistance of legal counsel.
Jeremy and Karie’s Divorce Agreement
Jeremy was 35 and employed while Karie was a stay-at-home mother of their four young children. They mutually agreed to the terms of their divorce including custody, visitation, child support, maintenance and division of assets. Jeremy filed their petition for dissolution of marriage with the appropriate court. It was Karie’s hope that her share of the couple’s assets would be used to settle some of her debts. One of the assets to be divided was Jeremy’s individual retirement account (IRA).
Complexities of Particular Assets
Since Karie’s 50% share of the IRA was substantially close to her car loan, Jeremy took the following steps to pay off the loan using the IRA assets: first, he withdrew the IRA assets; second, he deposited the funds into a joint bank account; third, he paid off Karie’s car loan; and fourth, he transferred the remainder of Karie’s 50% to her. Jeremy reported the entire withdrawal as a taxable distribution from the tax-deferred account on their income tax return—indicating that he understood that these were pre-tax assets on which income tax would be due—but failed to provide a valid exception or pay the early withdrawal penalty. While there are several exceptions to the early withdrawal penalty, including a distribution to an alternate payee pursuant to a qualified domestic relations order, Jeremy failed to follow the steps and meet the criteria of this exception.2
Court’s Decision
The U.S. Tax Court agreed with the 10% additional tax levied by the IRS on the early withdrawal. First, since Jeremy withdrew the assets himself, the withdrawal was not to “a former spouse who is recognized by a domestic relations order as having a right to receive” the proceeds. Second, since the withdrawal was transacted before the divorce decree was entered, it was not made “pursuant to a qualified domestic relations order.” While the transaction was in line with the intent of exception in the tax code, failing to comply with the specific requirements caused the court to side with the IRS.
Working with Your Advisers
Although Jeremy and Karie’s intentions were respectable, utilizing a divorce attorney, an estate planning attorney and a financial planner could have helped them avoid the complications and penalty they incurred. While planning for retirement accounts presents several unique challenges due to their strict deadlines and procedures, the characteristics of each type of asset must be considered carefully when being transferred, whether it is due to divorce, planned giving or death. In addition to avoiding the penalty, Jeremy and Karie’s team of advisers could have also advised them on the best assets to use to pay off debts—likely non-tax-deferred assets.
While attempting to resolve any legal matter as efficiently as possible is a sensible goal, most transactions require specific experience in order to anticipate complications and tie up loose ends. Failing to do so usually means the matter ends up in court, requiring far more time and money than if experts had been consulted and utilized in the process from the beginning. Furthermore, integrating your advisers allows them to advise on their respective areas of expertise and is typically the most efficient path to the desired result.
1. Jeremy Ray Summers v. Commission, T.C. Memo 2017-125.
2. Internal Revenue Code, Sec. 72(t)(2)(A)(i).