Tax Brake with Robert G. Nath, Esq.

After 25 years of marriage, Husband and Wife divorced. They agreed, as part of the decree, that Wife would get the benefit of Husband's military privileges, including PX, medical and, most importantly, half the retirement pay. So Wife got $13,000 in 1997 but did not include that on her tax return.

Why? The money was a “nontaxable division of property,” according to her. The theory is that the Internal Revenue Code allows for such divisions of property without tax (correct), and since the retirement money is “property,” it was not taxable (incorrect).

In 2000, Congress enacted the Uniformed Service Former Spouses' Protection Act. This law was intended to overturn the effect of a Supreme Court decision that did not allow military retirement benefits to be allocated to the non-earning spouse in a divorce. As a result of that act, the benefits can be divided if state law says they can.

In this case, Virginia law allowed for division, treating the property as belonging to Wife. But Wife's reliance on the tax provision that postpones taxes on divided marital property was simply inapplicable to actual cash. So Wife had to pay tax on the money.

The outcome of this case seems clear enough: If you get actual money, you must pay tax. This is different from other situations in which, for example, Wife is awarded rights to a pension nest egg or retirement plan assets. There, if the parties use a “qualified domestic relations order,” they can avoid taxation on the act of transfer, but of course if a benefit in cash is later paid, that would be taxed to the Wife.

So the caution in these cases is: plan carefully and be prepared to pay tax if you get the cash.