Category: Compensation & Employee Benefits; Individuals
Subject: Qualified Domestic Relations Order (QDRO)
Title: Section 72(t) Penalty on QDRO Distributions
IRC Sections: 72(t)
Filename: 1251.html
Date Produced: 07/95

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Issue
Are qualified domestic relations order (QDRO) distributions from a qualified plan to the former spouse of the plan participant subject to the 10% early withdrawal penalty tax under Section 72(t)?

Answer
Provided the distribution is from a qualified retirement plan and not an IRA, the 10% penalty tax does not apply.

Discussion
Section 72(t) imposes a 10% penalty tax on early withdrawals from qualified retirement plans and individual retirement accounts. Various exceptions apply. Section 72(t)(2)(C) provides that the penalty tax does not apply with respect to alternate payees under a qualified domestic relations order as defined in Section 414(p)(1). Section 72(t)(3)(A) goes on to say that the exception does not apply (in other words the penalty tax is imposed) with respect to QDRO distributions from an individual retirement account.

The scope of Section 72(t) does not limit its effect to plan participants only. If that were the case, there would be no QDRO rules in Section 72(t) because QDRO payments are not made to plan participants themselves. Moreover, the first sentence Section 72(t) announces its scope..."if any taxpayer receives any amount...". [Emphasis added.]

Section 72(t) was enacted by the Tax Reform Act of 1986. The Committee Reports clearly state that QDRO payments to alternate payees are exempt from the penalty tax.

Notice 87-13, 1987-1 CD 432, was issued to clarify various points in connection with the penalty tax. It clearly provides that the penalty tax does not apply to QDRO payments to alternate payees.

You mentioned IRS Publication 504, Divorced and Separated Individuals, which contains the following excerpt under the headings Qualified Domestic Relations Order, Rollover Distributions.

If you receive an eligible rollover distribution under a QDRO as the plan participant's spouse or former spouse, you can generally roll it over tax free into an individual retirement arrangement (IRA) or another qualified retirement plan. This applies to taxable distributions other than required distributions (generally, distributions that must begin once you reach age 70 1 ÷ 2) and certain long-term periodic payments. You can choose to have the distribution paid directly to the new plan. If any part of the taxable distribution is paid to you, 20% will be withheld for federal income tax. You can still make a tax-free rollover to another plan or an IRA within 60 days, but for a complete rollover you must add funds from another source equal to the tax withheld.

If you roll over only part of the taxable distribution, you cannot use the special lump-sum distribution rules to figure the tax on the part you keep. If you are under age 59 1 ÷ 2, any taxable distribution you keep may be subject to an additional 10% tax on early distributions. [Emphasis added.]

The foregoing text implies that some QDRO distributions are subject to the 10% penalty tax under Section 72(t). I agree. Since QDRO distributions from an IRA are explicitly excluded from the exception to the penalty rules, such distributions would seem to be the logical object of the contingency set forth in the text above, "... may be subject to an additional 10%...".

You also mention IRS Publication 575. I see nothing in that publication inconsistent with the conclusion stated above. In fact, the publication explicitly states the conclusion that QDRO payments to alternate payees are not subject to the 10% penalty tax except for QDRO payments with respect to individual retirement accounts.