The Tax Cuts and Jobs Act of 2017 (“TCJA”) did away with the long-standing provision allowing for deductions of alimony payments by the payor. Specifically, the TCJA adopted the prior definition of “alimony and separate maintenance payment” under the Internal Revenue Code but eliminated deductibility for any “divorce or separation instrument” executed after December 31, 2018. This change grandfathered the tax treatment for alimony agreements prior to 2019. As a consequence, the economic considerations relating to divorce, alimony, and disposition of marital property has changed dramatically. Furthermore, it is not likely that prenuptial agreements executed prior to 2019, but relating to divorces finalized in 2019 or later, will preserve these deductions.
The changes implemented by the TCJA, at least with respect to alimony, did not take effect for more than one year after its passage. This provided time to the IRS, practitioners, and potentially affected taxpayers to react to the changes. Still, some taxpayers and their advisors were not aware of these changes or, for a host of other reasons, were not able to address previously executed prenuptial agreements. Many of these agreements contained provisions relating to alimony and were negotiated on the premise that alimony payment had been, and would always be, deductible to the payor. Unfortunately, these agreements, at least with respect to the tax treatment of alimony, are likely no longer controlling.
Agreements between two private parties generally will not bind the Internal Revenue Service as to the tax treatment of transactions. This is particularly true when the tax result called for by such an agreement is not permitted under the tax laws. For this reason, even though prenuptial agreements may bind a party to pay alimony, it may not define the Internal Revenue Service’s treatment of that item. (The change regarding the deductibility of alimony potentially calls into question the enforceability of certain prenuptial agreements; however, that analysis is beyond the scope of this article.)
But will prenuptial agreements providing for alimony and executed before 2019 be grandfathered under the prior treatment? The answer depends on whether a prenuptial agreement can be considered a “divorce or separation instrument.” While there is no precedent for dealing with this type of situation in this context (as the timing of the agreement and whether the prenuptial agreement was a divorce instrument or was merely incorporated into a divorce instrument was largely irrelevant under prior tax law), a strict interpretation of this language likely dictates that prenuptial agreements should not be grandfathered. In particular, “divorce or separation instrument” under I.R.C. § 71(b)(2) means: (1) a decree of divorce or separate maintenance or a written instrument incident to such a decree, (2) a written separation agreement, or (3) a decree requiring a spouse to make payments for the support or maintenance of the other spouse. Prenuptial agreements do not appear to fall within this definition as each category requires a separation or divorce to be effective.
Still, some practitioners have argued that a prenuptial agreement is potentially “incident” to a divorce decree and could grandfather desired deductions for alimony payments. They point to Treas. Reg. § 1.71-1(b)(6), Ex. 2 as support for grandfathering prenuptial agreements dealing with alimony. That example provides:
If, however, the [divorce] decree were modified so as to refer to the antenuptial agreement, or if reference had been made to the antenuptial agreement in the court’s decree or in a written instrument incident to the divorce status, section 71(a)(1) would require the inclusion in [the payee’s] gross income of the payments received by her after the decree.
While this example references prenuptial agreements, it does not refer to a prenuptial agreement as an instrument incident to divorce. Further, as the normal definition of “incident” is to result from or be a consequence of something, the chance for success of this argument may prove difficult. Specifically, how can a prenuptial agreement be considered incident to a divorce decree if there is no certainty that any divorce will ever occur (until after the tax treatment changed)? While untested, it appears that this language was intended to capture documents that were executed to implement a decision of a court (where such was not explicit in the decree itself). Furthermore, from the standpoint of equity and administration, there is little to justify disparate tax treatment between those who do and do not execute in basic tax planning. For instance, why should a taxpayer be able to preserve such treatment for a divorce that may never occur, or may not occur until 2050? This seems not only unfair but counter to the underlying purpose of the statute.
In sum, there seems to be little reason for the Internal Revenue Service or the courts to interpret the TCJA as allowing prenuptial agreements to circumvent the change to the tax laws and to preserve deductibility of alimony payments. Those taxpayers with prenuptial agreements who were either unaware of the changes to the alimony provisions, or were unable to negotiate changes, should consult with a tax advisor. In light of the elimination of a significant tax planning mechanism, other tax planning opportunities should be explored. Rosenberg Martin Greenberg, LLP is experienced in all aspects of federal and state tax laws, including tax planning for divorce, audits of divorced spouses and payments related to divorce, addressing prior compliance issues, white collar criminal litigation, and more. Please contact Brandon Mourges at 410.951.1149 or firstname.lastname@example.org for a free consultation.