The message for divorcing couples is clear. If your divorce agreement will include provision for the payment of alimony, deductible to the paying spouse and taxable, as income, to the recipient spouse, you need to have an executed divorce agreement by December 31, 2018. Beginning in 2019, the tax treatment of alimony, in effect since 1942, will be upended. Spouses paying alimony will no longer be entitled to deduct their payments and spouses receiving alimony will no longer be taxed on the income.
As a direct consequence of this change, alimony laws, different in each state, will need to be revised. Formulas, as well as payment sums, devised under old tax law, will no longer be applicable. Yet even as the political debate begins, few have raised questions about the fate of pre-nuptials and post-nuptials based on pre-2019 tax treatment of alimony. Without dwelling on the reasons for this omission, the message is clear. Those engaged in the creation of pre-nuptials and post-nuptial agreements need to be conscious of the new tax law. And, too, those with existing pre-nuptials and post-nuptials based on old tax law, need to be proactive in modifying their agreements.
Let us consider the story of John and Jane Green, a second marriage for both. Jane had been divorced and John was a widower. Neither had thought that a remarriage was in their future. Interestingly John and Jane had known each other and had even socialized, while married, as part of a wider circle of friends who belonged to a nearby tennis and swim club. Fate must have played the role of cupid. The club was hosting a tournament for couples; one of the women got sick and Jane was recruited to take her place as John’s partner. And, so, you guessed it, John and Jane began their journey to becoming a couple. One year later, John proposed and Jane accepted. John, however, had a pre-marital stipulation. He wanted them to enter into a prenuptial agreement. “After all, he explained, “We both have children whose inheritance rights need to be protected. Clearly one of us will die before the other.”
Without hesitation, Jane agreed that their children’s inheritance should be spelled out. “But why?“ she asked, “Do we need a pre-nup? Wouldn’t wills be sufficient?”
“Well, no,” said John, “what if the unthinkable happened? What if we were to divorce? One never knows what will happen, right?”
Despite misgivings and not without a bit of resentment, Jane agreed to the pre-nup. After months of intense discussion, an agreement was reached. Given that John’s assets and income were significantly greater than Jane’s and that Jane would be relinquishing alimony from her former husband, terms were structured for John to pay alimony to Jane in the event of divorce. And, naturally the alimony terms were based on the expectation that alimony would be deductible to John and taxable to Jane.
Fortunately in 2018, John and Jane are still married with no indication of an impending divorce. But, and the “but” is the question with which we began this whole John and Jane saga, what if they were to divorce? And, to push the thesis a bit further, what if they wished to uphold the pre-nuptial agreement they had struggled so hard to fashion? What would happen to the alimony component of the agreement? We cannot presume that John’s and Jane’s agreement would be grandfathered under pre-2019 tax law since it was never submitted to a court for approval. Then too, let us admit that Jane would benefit greatly from the inversion of the tax laws. Spousal support payments would not be taxable to her. John would be the disadvantaged party since the terms that he had negotiated would not be implemented, at least not with respect to alimony.
Hopefully John and Jane will create a post-nuptial agreement that takes into account the change in the tax laws. Hopefully in refashioning the calculation of alimony, they will be able to resurrect the reasoning and intent underlying their original objectives. Hopefully they will be able to accomplish this task without damaging their relationship. But, and once again the “but,” is the question, the passage of time and change in circumstances may not augur well for replicating past negotiation stances and approaches.
We are not here to ponder whether prenuptial and post-nuptial agreements drafted under pre-2019 tax law will hold up in court. Couples engaged in the creation of agreements or those with existing agreements need to be proactive. If their pre-nuptials or post-nuptials do not already contain terms for the modification of formulaic or numerical alimony specifications, they should execute the revision now. Clearly, the optimal time to address modifications is when divorce is not looming on the horizon, when a couple is still thinking of their “forever” relationship.
Mediation offers the forum of choice for couples dealing with the crafting of, or the revision of, pre-nuptial and post-nuptial agreements. An experienced and skilled mediator helps couples to focus on their objectives and priorities without the rancor of conflict. Reason and rationality offer the best option for the creation or revision of pre-nuptial and post-nuptial terms while preserving your present and future relationship—married or divorced.