No Equitable Exception to the IRA Early Distribution Tax

Retirement jar

Summers v. Commissioner1 is an important case on early distributions from a retirement plan. 

The court had to address whether Summers could be charged the 10 percent additional tax from Internal Revenue Code Section 72(t)(1) for early distributions on qualified retirement plans.

Exception Claimed

Summers claimed an exception from this tax under IRC Section 72(t)(2)(C). This option relates to a distribution to an “alternate payee” through a qualified domestic relations order (QDRO). Summers split his individual retirement account half to his wife on their divorce. However, with the former wife requiring money right away, the parties agreed to this division before divorce finalization.

Summers took $17,378 from his IRA and wrote a check for $8,618 to satisfy his former wife’s liability on an automobile loan. He sent $71 to make up for the equal division in a later transfer.

Additional Tax Sustained

Deficiency notice IRS determinations receive the presumption of correctness, but the challenger can try to rebut that presumption.2 Summers had the burden of proof as Section 72(t) relates to an “additional tax,” not a “penalty” or “addition to tax” under IRC Section 7491(c).

Qualified retirement plans include IRAs pursuant to IRC Sections 408(a) and 4974(c)(4). Section 72(t)(1) adds an additional tax of 10 percent on early distributions from such qualified retirement plans.

Section 72(t)(2) defines exceptions from this tax. Summers relied on Section 72(t)(2)(C), distributions made “to an alternate payee pursuant to a [QDRO] (within the meaning of section 414(p)(1)).” Section 414(p)(8) considers an “alternate payee” to include a spouse or former spouse considered to have a right to receive all or part of benefits under a domestic relations order plan. Section 414(p)(1)(B) determines that a domestic relations order constitutes any judgment connected to marital property rights made under state rules.

The split of half the IRA with his former wife could have worked to qualify for a Section 72(t)(2)(C) exception regarding her share. Summers himself failed to qualify. The IRA distribution went directly to Summers. He deposited the check in a jointly owned account. He then transferred half the proceeds to her. Eventually, she received the benefits of half, but the original transaction was all the distribution to Summers, not his former spouse, defined more specifically under Section 414(p)(8).

In addition, the transfer failed to occur under a QDRO. Judicial resolution was precluded on account of his early division of the IRA assets before the final divorce decree. The decree, then, mentioned that “[n]either party has a retirement, pension, deferred compensation, 401(k) Plan and/or benefits.” Consequently, an IRA distribution had no chance of being made “pursuant to” that order.

Exact compliance is necessary with Section 72(t)(2)(C) for its exception to apply. The court had no right to use equity to subvert the Congressionally enacted legislative framework. Thus, the 10 percent additional tax was sustained.