QDROs

by on June 7, 2010

Today TaxMama hears from Mona in the TaxQuips Forum with this problem. “I recently started to receive a QDRO check from another state.  How do the income taxes get handled? Do I pay the issuing state or the state I live in?”  http://taxmama.com/forum/taxquips/qdro-taxes/

Dear Mona,

Your question brings up several issues I’d like to discuss with TaxMama’s family. First, to answer your question:

You are living in and receiving the money in your state.  You only pay taxes where you live. Several years back, as a result of certain aggressive states, like California, Federal legislation was passed prohibiting the state where the payments were issued from taxing recipients in other states.  So you only need to deal with one set of taxes.

Second, let me explain the QDRO and why it’s important. It stands for Qualified Domestic Relations Order. These Orders are generated in the course of a divorce when one spouse is required to share a retirement account with the other spouse.

The purpose of the QDRO is to allow the split, without forcing either spouse to pay taxes on the withdrawal. In other words, the spouse drawing the money out of his/her account isn’t taxed on the early withdrawal – and also avoids the early withdrawal penalties. The spouse receiving the money may roll it directly into his/her IRA account and not pay taxes on the money until they use it. OR, they may draw all the money and pay taxes on it – but avoid the early withdrawal penalties.

Remember, the only way to avoid these penalties is by court order. A civilized divorcing couple who simply agree to split the retirement funds will lose this tax benefit. You MUST get this done through the courts or an appropriately empowered agency in the state of the divorce.

Third, there is rarely a reason to draw all the money at once. Roll it into an IRA and only draw upon it when needed. Or if money is needed immediately to live on or pay off debts? Draw that part of the money immediately. Roll the rest into an IRA.

Perhaps with the right job, or taking in roommates, you can get by quite well – and still leave the rest of the money in savings.  Why pay taxes early?

And remember, you can find answers to all kinds of questions about QDROs, and other tax issues, free. Where? Where else? At www.TaxMama.com.

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