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George F. Bearup, J.D. Senior Legal Trust Advisor

10-Oct-18

IRAs and Community Property

Take-Away: To confirm our short telephone conversation of this morning, the tax laws pertaining to IRAs and qualified plan benefits can be a bit confusing, but in general,  community property laws are ignored when it comes to distributions from IRAs that hold community property interests.

  • Qualified Plans: Community property rules do not affect the income taxation of distributions from qualified retirement plans, e.g. a 401(k) account. Additionally, the federal law that gives a participant’s spouse certain rights to the participant’s qualified retirement benefits pre-empts state-law martial property rights, including community property rights. As such, ERISA spousal consent rules apply to distributions from qualified plan accounts when contributions were made while the participant resided in a community property jurisdiction.
  • IRAs: While IRAs are not subject to federal spousal-rights preemption rules, and thus an IRA may be classified as community property under the state law [in your case Wisconsin] in effect making both of the spouses co-owners of the IRA, for distributions from the ‘community property’ IRA, those community property rules are ignored:
  • IRC 408(g) provides that the taxation of distributions from IRAs are applied without regard to any community property laws or principles.
  • The Tax Court has ruled that distributions from the IRA are gross income solely to the title holder of the IRA under federal income tax laws despite community property principles that applied to contributions to that IRA, i.e. contributions of income earned in a community property jurisdiction by the IRA owner. Morris, 83 TCM 1104, T.C. Memo 2002-17 and Bunny, 114 T.C. 259 (2000.)
  • This rule, that assigns all income tax responsibility on distributions from the IRA solely to the named IRA owner [thus ignoring the community property spouse’s interest in that IRA] was recently ratified in Private Letter Ruling 201623001.

Conclusion: If the community property spouses were to divorce, each would have a 50% claim to the IRA that was created and funded while in the community property jurisdiction. Absent a divorce, when distributions are taken from the community property IRA, the entire IRA distribution is taxed to the spouse who is the technical owner of the IRA. Unlike a qualified retirement plan account, there is no obligation to obtain the consent of the community-spouse when a distribution is requested by the IRA owner from his/her custodian.