Generally, the division of property, including cash, between divorcing spouses has no
immediate federal income or gift tax consequences. Such transfers are considered
tax-free gifts between the spouses. However, the tax-free transfer rule does not
apply to transfers of balances in IRAs. If an IRA owner withdraws funds from his or
her IRA and gives it to his or her spouse (or anyone else for that matter), the
withdrawal is taxable to the IRA owner and tax-free to the receiving spouse (or
whoever receives the distribution).
Fortunately, there is an important exception to this rule - transferring an
individual's interest in an IRA to a spouse or former spouse pursuant to a divorce
decree or separate maintenance agreement is not taxable to either spouse. This
spousal exception applies to Roth IRAs, SEP accounts, and SIMPLE IRAs because they
are all considered IRAs for this purpose.
The exception applies to spouses only. A distribution or transfer to anyone other than
a spouse or former spouse, even if pursuant to a divorce, generally is taxable to the
The IRA transfer is tax-free to both spouses only if it is specifically required by a
decree of divorce or separate maintenance agreement (or a written instrument incident
to such a decree). Thus, the couple must eventually divorce or legally separate.
Transferring an IRA under any other type of order, such as a temporary alimony or
support order, is not tax-free.
Example: Transferring an interest in an IRA. In connection with his
pending divorce, Ted has agreed to transfer his IRA to his spouse, Amy. The transfer
to Amy must be made pursuant to their divorce decree (or a written instrument
incident to the divorce); otherwise, it will be taxed to Ted. Also, a transfer made
to anyone other than Amy, such as to their children, will be taxable to Ted.
If the transfer is taxable to Ted, he must include that amount in taxable income.
Furthermore, if Ted is under age 59½, the 10% penalty tax on premature
distributions may apply.
An IRA interest transferred under a decree of divorce or separate maintenance
agreement is thereafter treated as the recipient spouse's IRA for all purposes.
Therefore, the recipient spouse can manage the transferred money as he or she sees
fit and continue deferring taxes until withdrawals are taken from the IRA. At that
point, the recipient spouse will owe any federal income tax on the withdrawals; plus,
the 10% penalty tax on premature distributions may apply if he or she is under age
59½ at the time of the withdrawal.
The safest way to accomplish a divorce-related IRA transfer is through a
trustee-to-trustee transfer. If the IRA trustee will not make a payment to the
spouse's or ex-spouse's IRA, the transferor spouse can roll over the funds to a new
IRA in his or her name and then assign ownership (and change the name) of the new IRA
to the receiving spouse.
This publication is distributed with the understanding that the author, publisher and
distributor are not rendering legal, accounting or other professional advice or
opinions on specific facts or matters, and, accordingly, assume no liability
whatsoever in connection with its use. The information contained in this newsletter
was not intended or written to be used and cannot be used for the purpose of (1)
avoiding tax-related penalties prescribed by the Internal Revenue Code or (2)
promoting or marketing any tax-related matter addressed herein. © 2014