The Tax Cuts and Jobs Act (TCJA) introduces changes to the individual tax rules that must be taken into account if you’re in the process of dissolving your marriage or are already divorced. In fact, you could be affected even if you have an existing prenuptial agreement that stipulates the amount of alimony payments if you should someday get divorced. Here are the details.

Divorces in Progress

If you’re trying to untie the knot, it’s important to recognize that, for alimony payments made under divorce agreements signed after 2018, the payer will no longer be allowed to take a tax deduction. Likewise, the spouse who receives alimony payments under a divorce agreement signed after 2018 will no longer claim alimony payments as taxable income. So, all support payments — both child support and spousal support — will be treated the same for tax purposes.

Shifting the tax burden from the recipient to the payer of alimony is significant. Why? Traditionally, the spouse who pays alimony is subject to a higher marginal effective tax rate than the spouse who receives alimony.

When divvying up marital assets, other relevant provisions of the tax law include:

Reduction of the deduction for state and local taxes (SALT). When allocating assets, new (but temporary) limits on mortgage interest deductions could make real property less desirable in states with higher property tax rates.

Liberalized rules for Section 529 plans. You can now withdraw up to $10,000 per year per child from a Sec. 529 plan to pay for tuition at certain elementary and high schools. Dipping into these funds early could cause issues if a parent earmarked them to pay for college expenses.

Reduced business tax rates. Businesses will generally pay less tax under the new tax law. In turn, the business-friendly tax environment could make business interests owned by the spouses more valuable when allocating assets.

Elimination of dependency exemptions. Spouses no longer need to decide who gets to claim the dependency exemption (only one spouse could claim in the past) — after the TCJA, no one gets to claim this.

Existing Divorce Agreements

Divorces that are finalized by the end of 2018 will not be affected by the new alimony rules. In other words, the payer can deduct alimony payments made under divorce agreements settled before January 1, 2019 — and the recipient must claim those payments as taxable income.

The new tax law does allow you to voluntarily modify an existing (pre-2019) divorce agreement to expressly provide that the TCJA rules apply. This may be desirable, for example, if the ex-spouses’ income levels have changed from when the agreement was signed.

Prenuptial Agreements

If you have signed a prenuptial agreement, check whether it stipulates alimony payments (or an alimony formula) if you get divorced. Those provisions may come back to haunt you. How? Now that the tax rules have changed, predetermined amounts may provide a windfall to alimony recipients who won’t have to pay taxes on the payments under the new rules.

It may be awkward for happily married people to modify their existing prenuptial agreements. But failure to address this issue may create an opportunity for the payer to challenge the fairness of a prenuptial agreement, possibly leading to costly litigation. A judge could, in theory, require the amount of alimony stipulated in a prenuptial agreement to be modified to reflect the parties’ intentions and tax rules when the agreement was signed.

We Can Help

Divorce can be a sensitive issue, but it’s sometimes unavoidable. Our tax professionals can evaluate how the new tax law will affect your personal situation and help ensure an equitable division of marital property. Contact us for more information.

The TCJA…So Many Changes, So Many Questions…we can help you navigate this huge tax overhaul! Need help with your tax planning? Contact any member of our Tax Services Team.