The Tax Cuts and Jobs Act has eliminated the tax treatment of alimony that has been in place for more than 75 years. Under the old law, alimony is deductible from the income of the payor and includible in the income of the recipient, provided the parties comply with the specific requirements of the Internal Revenue Code (I.R.C.). Effective January 1, 2019, under the Tax Cuts and Jobs Act, parties will no longer have the option to enter into an agreement for taxable alimony nor will court-ordered alimony be deductible from the payor’s income and includible in the recipient’s income. Some alimony obligations created prior to January 1, 2019, may receive alimony tax treatment under the old law; others may not.
An existing premarital agreement may provide for a predetermined amount of alimony, in the event of divorce, and for it to be deductible to the payor and includible in the income of the recipient (deductible-includible alimony). What effect does the new law have on such an agreement? The new law has upended the tax planning of these agreements for anyone who separates on or after January 1, 2019, or who separates before that and does not obtain a separation agreement or a court order prior to that date.
To obtain deductible-includible alimony under the old law, the payments must be made in accordance with a divorce or separation instrument. I.R.C. Section 71(b)(2) defines a divorce or separation instrument as: “(A) a decree of divorce or separate maintenance or a written instrument incident to such a decree, (B) a written separation agreement, or (C) a decree . . . requiring a spouse to make payments for the support or maintenance of the other spouse.” A separation agreement is an agreement made in connection with an existing or planned marital separation; a premarital agreement is not a separation agreement, according to regulations issued by the Treasury Department.
A premarital agreement providing for deductible-includible alimony typically states that the parties will obtain a divorce or separation instrument before the payor begins making payments in order to get the intended tax treatment. The elimination of alimony treatment applies to divorce or separation instruments executed on or after January 1, 2019. This means that parties with a premarital agreement providing for deductible-includible alimony who separate and obtain a divorce or separation instrument on or after January 1, 2019, will not get the tax treatment they bargained for. Rather, alimony will neither be deductible from the income of the payor nor includible in the income of the recipient.
Parties with a premarital agreement who have already entered into a separation agreement, or who are already divorced, can receive the tax treatment of the old law. Those who enter into a separation agreement and divorce in 2018 will be able to utilize the old law and have deductible-includible alimony. There is some uncertainty about deductibility where parties sign a separation agreement in 2018 and divorce in 2019 or thereafter.
Parties with a premarital agreement providing for deductible-includible alimony and who have no plans to divorce may nevertheless want to consider amending their agreement to take account of this radical and unexpected change in the tax law.