Pursuant to a Property Settlement Agreement entered into in 1980, 75% of Mr. Strand’s military retirement pension payments were payable to Mrs. Strand.
In 2004 and 2005, Mrs. Strand received $12,621 and $12,952 respectively. The Defense Finance and Accounting Services (DFAS) issued Mrs. Strand a 1099-R, but she did not report the amounts on her tax returns. The IRS issued a notice of deficiency for each year. Mrs. Strand filed a petition disputing the deficiencies.
Generally, amounts received from pension accounts are taxable under section 61(a)(11). Mrs. Strand makes three arguments against including the the payments in gross income. The third argument will not be addressed in this post.
The first argument is that 2004 and 2005 is the first time since 1986 – when the payments started – that she has been required to include the amounts in gross income. The Tax Court rejects the first argument because “each tax year stands on its own and must be separately considered.” Further, “It is well settled…that the Commissioner cannot be estopped from correcting a mistake of law, even where a taxpayer may have relied to his detriment on that mistake.”
Second, she argues that the payments are divisions of property thus excludable from income under section 1041. Section 1041 states that no gain or loss shall be recognized on a transfer of property between spouses under a divorce agreement. For example, if H and W agree, as part of their divorce, that W gets 100% of H’s stock in General Electric, then under section 1041 W does not have to recognize gain on receipt of GE stock. W does, however, have a capital gain when she sells the stock. Her gain will be equal to the sale price less H’s basis. Sec. 1041(b). H’s basis in the GE stock is generally what he paid for it. Sec. 1012.
The Tax Court first points out that section 1041 is inapplicable because the property settlement occurred prior to section 1041’s enactment. Relying on prior case law, however, the Court holds that when Mrs. Strand received an interest in her ex-husband’s military retirement account she recognized no gain or loss. But, a pension is “simply a right to receive a future income stream from the retiree’s employer.” Since neither she nor her ex-husband had basis in that “income stream”, the payments from the account are taxable.
Qualified Domestic Relations Orders
It is worth pointing out that the pension payments, like the ones here, are also taxable today to Mrs. Strand under section 72 and section 402(a).
Mrs. Strand is considered an “alternate payee” under section 402(e)(1). An alternate payee is a spouse or former spouse who receives retirement distributions under a qualified domestic relations order (“QDRO”). As such, she is treated as “the distributee of any distribution payment made.” Under section 402(a), amounts distributed to a distributee are taxable to the distributee under section 72.