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Tax provisions dismantling alimony deduction demand new prenuptial planning

Author: BCNTR

Alimony, also known as spousal support or maintenance, has undergone a major change when it comes to the new tax law.

Spouses need to be aware of the new tax provisions and how it affects the money they will pay or receive, depending on whether they are providing or receiving alimony. Previously, alimony was taxable to the party receiving the money and deductible by the party who was paying the support.

Under the Tax Cuts and Jobs Act, the alimony deduction taken by the paying spouse was eliminated, while the spouse receiving the support no longer has to declare the payment as taxable income. The new rule went into effect in 2019 and affects divorces and separations finalized or modified after December 31, 2018.

This dramatic transformation on how alimony is taxed has serious ramifications for couples and their attorneys as they shape their prenuptial agreements. Prenuptial agreements entered into prior to 2019 are grandfathered into the old law. But, what remains uncertain is whether prenuptial agreements executed before December 31, 2018 that include a specified amount of periodic taxable alimony will stand as is. Will these prenuptial agreements be able to be adjusted or will the entire agreement be nullified based on the taxable alimony that is in conflict with the new law?

This development is a particularly thorny issue for high-net-worth couples who often have premarital agreements.

Many of the older agreements state that: “In the event of a divorce, Spouse A is going to pay Spouse B periodic alimony.” Furthermore, those agreements specifically state that the alimony was a payable event, with the paying spouse getting the deduction and the recipient obligated to declare the alimony payment as taxable income.

For example, prior to the tax change, if a spouse used to owe $10,000 in alimony that was a taxable event meaning that the recipient paid taxes on the alimony. The spouse paying the alimony, meanwhile, received a tax benefit.

That scenario is no longer true.

Under the new law, for couples who have not had their divorce finalized yet, the person receiving the alimony now no longer pays taxes on the money while the spouse making the payment no longer gets the tax write-off.

Losing the write-off means that a large tax savings is gone because every dollar in alimony had previously cut the paying spouse’s taxable income by the same amount. In some cases, the spouse paying alimony could pay double in post-tax costs compared to what they paid under the old system. The loss of the deduction could complicate negotiations as divorces proceed.

While those spouses with the lower incomes would appear to get more since they don’t have to pay taxes on the alimony, in actuality they may end up receiving less than they currently do. That’s because their higher-income partners may be unwilling to give as much since they will now have a significantly heavier tax burden.

As a result, the paying spouse is inclined to offer less alimony or ask a court to revise the amount specified in the prenuptial agreement because of the tax changes.

Prenuptial agreements that include an alimony provision that is linked to the old tax law, at the very least, should be revised. However, readjusting alimony arrangements to reflect the current changes in the tax law may not be an easy feat. Recipients are unlikely to agree to a deal that lowers the payments that they will receive.

A postnuptial agreement may be easier to execute than changing an existing prenuptial agreement.

If a prenuptial agreement – that provided for taxable alimony and was in place before December 31, 2018 – becomes needed, both sides need to be prepared for possible mediation or litigation. Additionally, if couples seek to modify their prenuptial agreements in 2019 or later, they will be subject to the new tax provisions.

It’s important to remember that in divorce cases, alimony may be awarded on a temporary or permanent basis for the support and maintenance of either spouse. The amount and duration of alimony is generally based upon the needs of the spouse receiving alimony and the ability of the other spouse to pay.

There are several other factors that the court may consider in determining an appropriate award of alimony. Among them are: the standard of living during the marriage, the duration of the marriage, the age and health of each party, the financial resources of each party, and the contribution of each party to the marriage (including homemaking and child care). Alimony may be awarded in cash or property, and it may be payable periodically (monthly, quarterly or annually) or in one lump sum.

With the recent changes in tax laws having the potential for nullifying prenuptial agreements that were in place prior to December 31, 2018, couples should consult with an attorney to update their prenuptial or replace it with a postnuptial agreement.

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