IRA garnished for child support subject to tax plus penalty.

In Vorwald, TC Memo 1997-15, the Tax Court recently ruled that the garnishment of a taxpayer's individual retirement account (IRA) pursuant to a judgment for child support arrearages was includible in his gross income and subject to the 10% early distribution penalty. Unlike qualified pension plans under Sec. 401, state law determines whether IRAs can be distributed to creditors of the IRA owner.

According to Sec. 408(d)(1), IRA distributions are included in the distributee's gross income as specified in Sec. 72. (There is an exception for amounts rolled over within 60 days.) Sec. 72(e)(2) requires IRA distributions to be included in gross income except to the extent of any nondeductible IRA contributions. Sec. 72(t)(1) imposes a 10% penalty on distributions from qualified retirement plans. There are several widely applicable exceptions to this penalty, none of which applied to the situation in Vorwald. The definition of "qualified retirement plans" for purposes of the 10% penalty includes IRAs.

Sec. 408(d)(6) allows tax-free transfers of an interest in an IRA to a spouse or former spouse pursuant to a divorce or written separation agreement. After such a transfer, the transferee spouse is the owner of the IRA and will be taxed on any distributions. However, Sec. 408(d)(6) transfers do not qualify as alimony because alimony, which is deductible by the payer under Sec. 215, must be included in the recipient's gross income under Sec. 71. IRAs are not affected by the qualified domestic relations order (QDRO) provisions of Sec. 414(p). QDROs cover the assignment of an interest in Sec. 401 and Sec. 403(b) pension plans to spouses, former spouses or children. They are an exception to the general rule of Sec. 401(a)(13) prohibiting the assignment (transfer) of interests in Sec. 401 pension plans.

In Vorwald, a $10,670 judgment payable to his former spouse Kathleen was entered against Mark Vorwald for child support arrearages. In a 1992 garnishment proceeding, a credit union was ordered to pay $8,483 from Mark's IRA to Kathleen for the child support, which it did. Mark did not become aware of the garnishment until the IRS notified him when auditing his 1992 return. The Service included the $8,483 in Mark's income and assessed the 10% early distribution penalty. (There was no evidence that he had made any nondeductible contributions to his IRA.)