The rules related to withdrawals of IRA funds (and other funds in defined contribution accounts) are strict and often harsh to the unwary. On September 19, 2019, the U.S. Tax Court issued an Order in Rosenberg v. Commissioner that emphasizes this point. As part of a divorce order, Mr. Rosenberg’s former spouse was ordered to pay him $10,000 from the former spouse’s retirement account. Instead of paying the money directly to Mr. Roseberg, his former spouse transferred it into a new IRA for him. He then withdrew the money from the IRA and closed the account.
Two issues came before the Court: (1) was the withdrawn money included in Mr. Rosenberg’s gross income, and (2) did the 10% early withdrawal penalty (applicable to certain withdrawals from IRAs before age 59 1/2) apply. The Court concluded the answer was yes on both accounts. Strictly speaking, pulling money out of an IRA will create gross income to the extent the contributions to the account were not previously included in gross income (i.e. non-deductible contributions). These were not. Transfers incident to a divorce can escape this rule, but in this case Mr. Roseberg’s former spouse interposed the IRA. Second, withdrawals before age 59 1/2 that don’t meet one of roughly 15 or so exceptions are subject to an additional 10% tax penalty. Mr. Rosenberg was not 59 1/2 and no other exception applied.
The Court noted that Mr. Rosenberg testified convincingly that the intent of the divorce order was that he would receive the money directly and that his former spouse created the new IRA over his protest. The Court, however, was unwilling to ignore the strict statutory scheme applicable to IRA withdrawals in order to rescue him from its harsh results.
The take away is, carefully consider withdrawals from IRAs before taking the money. The rules are strict and the chance of the Court saving mistakes is low.