Distributions from a retirement or pension plan are normally taxable to the plan participant, as the distributee. However, the Retirement Equity Act of 1984 (REA) created special rules for the tax treatment of distributions governed by the Employee Retirement Income Security Act of 1974 (ERISA) under a qualified domestic relations order (QDRO) to an alternate payee who is the spouse or former spouse of the plan participant, from certain employee benefit plans that are prescribed by federal law. Under these rules, an ''alternate payee'' who is the spouse or former spouse of the plan participant must be treated as the distributee, for tax purposes, of any distribution or payment made to the alternate payee under a QDRO.

Distributee Tax Liability

The rule of distributee tax liability applies even if the parties include language in their QDRO that requires the employee party to pay all of the tax on the distribution. The nonemployee in that instance must still include his or her share of the benefits distribution on that party's income tax return and is responsible for paying the tax thereon, subject to his or her right under state law to seek reimbursement from the other party pursuant to the court order or agreement. In general, distributee tax liability will apply with respect to distributions or payments from employee benefit plans that are considered ''qualified.'' However, certain other plans may also be subject to ERISA.

Failure to Meet Requirements for a QDRO

The failure of a court order that purports to divide employee benefits to meet the strict requirements for a QDRO may subject an employee spouse to taxation on both spouses' shares of a retirement plan distribution. Similarly, if the distribution from an employee benefit plan is made before a QDRO issues, and therefore is not made pursuant to a QDRO, it will be fully taxable to an employee who initially receives the entire distribution. Thus, use of a QDRO is desirable and essential, both because it provides a means of direct payment from an ERISA employee benefit plan to a former spouse of his or her share of the benefits divided and because it makes the alternate payee the taxable distributee of that share.

Annuity Payments

If the nonemployee spouse or former spouse, as alternate payee, is to receive payments under the QDRO in the form of an annuity, then amounts distributed as an annuity are included in the recipient's gross income as received. To the extent that the participant spouse made nondeductible after-tax contributions, the alternate payee spouse enjoys equality of treatment under the QDRO with the participant spouse in that the ''investment'' is apportioned between the two spouses on a pro rata basis. This pro rata allocation is to be based on the present value of the distributions or payments to the divorced spouse and the present value of all other benefits payable with respect to the participant spouse.

The general rule for taxation of benefits is followed with regard to this pro rata allocation in that amounts paid to an alternate payee spouse are taxed to him or her with amounts retained by the participant spouse taxed to the participant. Amounts paid to any person other than an alternate payee who is a ''spouse or former spouse'' spouse will be taxed to the participant. If the alternate payee is not a spouse or former spouse, then the investment in the contract is not allocated to the alternate payee; rather, it is recovered by the participant under the basis recovery rules applicable to the participant.

Tax-free Rollovers and Mandatory Withholding

The Retirement Equity Act (REA) provides that an alternate payee may make a tax free rollover to an individual retirement account or an individual retirement annuity. In the case of an alternate payee who is neither the spouse nor former spouse of the participant, the Tax Code does not provide for rollovers. Unlike the participant spouse, a divorced spouse may not make tax-free rollovers to other qualified trusts and annuity plans. If the distribution to the ex-spouse consists of property other than money, the specific property itself must be rolled over.

A spouse or former spouse of a participant in a plan who receives a distribution under a QDRO as an alternate payee is treated as the distributee. Accordingly, unless a timely rollover of the distribution is made, the spouse or former spouse will be taxable on the distribution. Any amount that is distributed to the spouse or former spouse of the participant as an alternate payee by reason of any QDRO, however, may be rolled over in the same manner as if the distribution were made to the participant directly.

Premature Distribution Penalties

Amounts received by participants from qualified retirement plans that constitute ''early distributions'' are subject to a 10 percent penalty on the portion of the amount includable in gross income. A number of exceptions apply, including distributions that are made before the participant reaches age 59 1/2, are attributable to the participant's being disabled, constitute part of a series of substantial equal periodic payments for the life expectancy of the participant or the joint life expectancies of the participant and designated beneficiary, are paid to the participant after separation from service after attainment of age 55 for any reason, or are distributions that the participant utilizes for medical care to the extent deductible under the Tax Code. The REA provides an additional exception for payments to an ex-spouse under a QDRO. The exceptions for distributions after separation from service after attainment of age 55 or for medical expense payments do not apply to individual retirement plans. If an exception is not available, the penalty applies.