Jonathan Fields article, “Alimony and the TCJA: Common Misconceptions,” was published today in Massachusetts Lawyers Weekly.
Read it here.
By Jonathan Fields, Esq.
Under the Tax Cuts and Jobs Act of 2017 (TCJA), alimony will no longer be tax deductible to the payor and no longer tax includable to the payee effective January 1, 2019. The law was a shock to many, particularly divorce lawyers, most of whom had gotten quite used to the way things had been for the last 75 years. There is a saving grace in the TCJA, however — qualifying agreements and modifications can be grandfathered into the old taxability treatment subject to certain requirements. Specifically, unless the parties opt-in to the new law, the TCJA applies to “decree[s] of divorce or separate maintenance or written instrument[s] incident to such … decree[s]” executed after January 1, 2019. To unwind this legislative convolution: the old taxability provisions can apply to your qualifying pre-2019 agreement unless you both agree that you don’t want them to. Still a mouthful, but that’s the way Congress wrote it.
The biggest misconception about alimony and the TCJA, frequently repeated in the lay media, and even by legal commentators, is that the qualifying instrument must be a final divorce judgment. It does not. You do not necessarily have to have a final divorce judgment by the end of the year to be grandfathered. Lawyers, who like to be “better safe than sorry” may prefer to have a divorce judgment but, when you are fighting this issue out in December of this year without the luxury of time, it’s worthwhile to take a closer look at what is actually required.
Procrastinators can rejoice. TCJA continued the requirement from IRC s.71 that a payment made to or on behalf of a spouse or ex-spouse pursuant to a “written instrument incident to [a divorce decree]” qualifies for alimony treatment. TCJA further sets forth that such instruments are “as defined in s.71… as in effect before” TCJA. Presumably, the case law from the past several decades interpreting the clause remains relevant and binding.
So, basically, in many instances, all a couple may need to qualify for grandfathered alimony treatment is a contract by December 31, 2018 that is a “written instrument incident to [a divorce decree]” pursuant to the statute. The “contract” here is no more prescriptive than a common law “meeting of the minds” contract – except that, unlike in the common law, it must be in writing. A separation agreement signed by the parties and approved by the court should do – no need to wait for a final judgment of divorce 90 to 120 days later. A separation agreement not yet approved by the court should also suffice. But it doesn’t even have to be that formal. Two Tax Court opinions illustrate the flexibility of the “written instrument incident to a divorce” requirement.
A Tax Court Memorandum Opinion, Leventhal, T.C. Memo. 2000-92, made clear a “meeting of the minds” requirement, particularly that there be a “clear statement in written form memorializing the terms of the support between the parties.” In this case, one spouse’s written assent to a letter proposal of support by the other spouse was a sufficient writing to bring it within IRC s.71. Moreover, Leventhal tells us, it was not necessary to articulate a specific amount of support so long as “there is an ascertainable standard with which to calculate support amounts.”
A Tax Court Summary Opinion, Micek, T. C. Summ. Op. 2011-45 (2011), is also instructive for our purposes. Here, the couple separated in 1997 and entered into an oral agreement in 1999 that the husband pay the wife alimony of $1,250 per week. Later that year, the husband signed a “spousal support affidavit” agreeing, or reaffirming, the payment of alimony in the same amount. In 2003, the husband stopped paying because he became disabled and, presumably, was unable to earn income. The wife’s attorney then wrote to the husband, inquiring as to why the alimony has stopped. Think about this: there is still no divorce pending at this point, the wife hasn’t signed anything yet, and the wife’s lawyer wrote the letter described above four years after the husband started paying alimony.
A few more years go by. At some point – the opinion does not make clear when – the husband filed for divorce. Presumably satisfied that neither party had the means to support the other, the parties’ agreement incorporated in the divorce judgment mutual waivers of present and future alimony. In 2009, the IRS filed a notice of deficiency disallowing husband’s alimony deductions for the years 2000 to 2003 – the period prior to the divorce during which the husband was paying alimony to the wife. All of the payments at issue were made prior to the filing of the divorce.
The husband took the matter to Tax Court. The issue before the court was whether the alimony was paid pursuant to a “written instrument incident to [a divorce decree].” The Tax Court agreed with the taxpayer, finding that alimony was paid pursuant to such an instrument and, therefore, deductible to him and includible to his ex-wife. The Tax Court reasoned that (1) the so-called “spousal support affidavit” signed by the husband in combination with (2) the letter from wife’s attorney inquiring as to why he had stopped paying alimony (which evidenced her client’s understanding that alimony was to be paid) was sufficient to qualify under IRC s.71. That is, a written instrument (the affidavit) signed by one party and the letter from wife’s attorney was together a sufficient “written instrument” that evidenced the meeting of the minds between the parties.
Considering the significant time gap between the instrument and the divorce filing, it is striking that Micek did not focus on the requirement that the “written instrument” be “incident to [a divorce decree].” We might deduce from Micek that timing is not dispositive to the “incident to” requirement but that it is, rather, a sort of “totality of the circumstances” analysis. Indeed, the parties had been living separately and the husband had been paying alimony for several years and, eventually, they got around to making de jure what had been de facto. From this, it would appear a logical construction that the alimony payments at issue, though made several years before a complaint for divorce, were “incident to” a divorce.
In any event, to play it safe, the practitioner should endeavor to have the contract executed while a divorce is pending or imminent in order to meet the “incident to divorce” requirement – so, unlike Mr. Micek, nobody is relying on the Tax Court to save the day. Bottom line: a divorce judgment is not the only way, under the TCJA, to get the preferential tax treatment that alimony judgments today can enjoy.
In the context of Micek and the “incident to” discussion above, consider prenuptial or postnuptial agreements. Although there is no case law on the issue, these do not appear to be qualifying agreements pursuant to IRC s.71. They are not, in the same sense as the Micek agreement, “incident to” a divorce decree – even if one of the parties filed for divorce shortly after signing.
Two additional issues merit consideration. (1) Must a 2018 agreement contain a present award of alimony and (2) How should the practitioner handle 2018 temporary orders of alimony followed by a 2019 (or later) divorce judgment?
As for (1), it is unclear whether a 2018 agreement that contains no present award of alimony but preserves the rights of the parties to future alimony would qualify for preferential retroactive treatment. On the one hand, TCJA’s new alimony rules exempt from its application “any divorce or separation instrument” executed before 2019. That would suggest that any agreement would suffice – whether or not it includes a present award of alimony. On the other hand, elsewhere in TCJA, alimony is defined, subject to other conditions, as payments made to or on behalf of a spouse pursuant to a “divorce or separation instrument.” Arguably, read together, there needs to be a present award of alimony – actual payments must be made (or required). In light of the uncertainty, the cautious practitioner would do well to include a requirement of a present payment of alimony, if only a nominal amount, and a statement in the agreement to the effect that the parties intend the agreement to qualify for tax preferential treatment per the TCJA.
As for (2), temporary orders pose challenges when dealing with TCJA and retroactivity. If there is a 2018 temporary order of alimony followed by a 2019 divorce judgment, the temporary order is extinguished. With that, the link to retroactivity may be severed. That is not clear, of course, but it is a possibility. Therefore, the practitioner may want the judgment to incorporate the temporary order so as to preserve best as possible the benefits of a qualifying retroactive instrument.
This position is generally consistent with the IRS regulations for alimony pursuant to the Tax Reform Act of 1984 – which also dealt with the issue of the retroactive application of that law to instruments entered prior to that Act’s effective date of January 1, 1985. Those regulations (which, by the way, have been “temporary” for 34 years) made clear, for example, that if a 1985 divorce judgment incorporated without change the terms of a 1984 instrument, that 1985 judgment would be grandfathered under the then pre-existing tax law. 26 CFR s1.71-1T (Q-A #26).
The 1984 regulations do have one caveat that the practitioner may wish to consider – the subsequent judgment must incorporate the terms of the prior instrument “without change.” Clearly, we don’t know if the IRS will interpret the TCJA’s alimony provisions in the same way but it may be worthwhile to at least consider these regulations as we venture into uncharted territory. If the IRS were to adopt this position with respect to TCJA, it would certainly be problematic in the event a 2018 judgment provides for a nominal alimony payment and a post-2018 judgment calls for a larger payment.
In the months ahead, while many labor to complete agreements by year’s end, we can hope for clarifying guidance from the IRS. In the meantime, especially in the gray areas, practitioners would do well to let clients know, in writing, where there are uncertainties as to whether their agreements will be grandfathered.
Under the Tax Cuts and Jobs Act of 2017 (TCJA), alimony will no longer be tax deductible to the payor and no longer tax includable to the payee effective 1/1/19. The law was a shock to many, particularly divorce lawyers, most of whom had gotten quite used to the way things had been for the last 75 years. There is a saving grace in the TCJA, however — qualifying agreements and modifications can be grandfathered into the old taxability treatment under certain conditions.
The biggest misconception, frequently repeated in the media, or ignored even by legal commentators, is that the qualifying instrument must be a final divorce judgment. It does not. You do not necessarily have to have a final divorce judgment by the end of the year to be grandfathered. Lawyers, who always prefer to be “better safe than sorry” may prefer to have a divorce judgment but, when you are fighting this issue out in December of this year without the luxury of time, it’s worthwhile to take a closer look at what is actually required.
Procrastinators rejoice! The TCJA retained the provision from IRC s.71 regarding a “written instrument incident to [a divorce decree]” and, presumably, all the case law from the past several decades interpreting that provision.
So, basically, in many instances, all a couple may need to qualify for grandfathered alimony treatment is a contract by December 31, 2018 that is a “written instrument incident to [a divorce decree]” pursuant to the statute.
The “contract” here is no more prescriptive than a common law “meeting of the minds” contract – except that, unlike in the common law, it must be in writing.
A separation agreement signed by the parties and approved by the court should do – no need to wait for a final judgment of divorce 90 to 120 days later. A separation agreement not yet approved by the court should also suffice. But it doesn’t even have to be that formal. Two Tax Court opinions, Micek and Leventhal below, illustrate the flexibility of the “written instrument incident to a divorce” requirement — but a detailed discussion of them is beyond the scope here.
Preferably, you would want to execute the contract while a divorce is pending or imminent so that it can meet the “incident to divorce” requirement. (The “incident to divorce” requirement, by the way, is why prenuptial or postnuptial agreements likely would not be qualifying agreements.)
In any event, a divorce judgment is not the only way to get the preferential treatment. Word of caution to do-it-yourselfers: don’t do this without lawyers! And for more guidance, these Tax Court cases should be a good start, Micek, T.C. Summ. Op. 2011-45, Leventhal, T.C. Memo. 2000-92.
Another fascinating report from the UK firm Penningtons Manches gives a global perspective on the alimony laws of different countries. UK (England and Wales), UK (Scotland), Ireland, Singapore, Nigeria, Germany, New Zealand, Finland, France, Russian Federation, Japan, Israel, United Arab Emirates. Also briefly discussed: the divorce laws of Texas and California.
A brief excerpt follows:
There are many common threads in family law across jurisdictions but also some very significant differences – particularly the wide variation in approach to spousal maintenance (or alimony). In Scotland, Sweden, Finland and New Zealand, financial independence for both spouses is at the heart of the court’s approach and the obligation to maintain a spouse is not imposed, save for a short period or in exceptional circumstances. But there are jurisdictions at the other end of the spectrum which provide ex-spouses with generous and long lasting income.
Read the report here.
Female breadwinners are ponying up for their exes more than ever.
A recent American Academy of Matrimonial Lawyers (AAML) survey found that more than four in 10 lawyers (45%) had seen an increase over the past three years in women being on the hook for alimony, aka spousal support or maintenance. Meanwhile, 54% said they’d seen a rise in mothers paying child support…
Is alimony a possibility for clients who divorce after age 65? What are the issues in guardian initiated divorces? How to tackle Medicaid planning? These were some of the topics discussed at MassBar Educates Panel, “Gray Divorce: Representing the Elderly Divorce Client”. Jon fields joined elder law attorneys Steven Cohen and Patricia Keane Martin on the panel to discuss the unique issues in representing elderly clients in divorce. With life expectancies on the rise and older people the biggest demographic for divorces, gray divorce is no longer a niche subject. Please click on the link to find out more about the event and MassBar Educates program.
How do you know if mediation or litigation is right for you? What are some of the ways the needs of affluent families affect the cost and planning process of divorce? What is a Certified Divorce Financial Analyst?
Jon Fields joins Kelli Adams, Financial Counselor, CFP®, EA to answer some of these questions in GW & Wade’s “ask the experts” interview, focusing on the hidden costs of divorce.
“If your balance sheet contains more than a few basic assets—your bank accounts, your home, your car—the cost of your divorce will probably be affected. Stock options, restricted stock, trusts, executive compensation packages, business interests: assets like these require more nuanced negotiations. You’ll want to make sure your lawyer has experience dealing in complex financial instruments.” -Jon Fields
Please click on the link to read the full interview.
The Massachusetts Supreme Judicial Court in Curt Pfannenstiehl v. Diane Pfannenstiehl recently came to an important decision regarding how Massachusetts treats spendthrift trusts in divorce. By doing so, the court overthrew the controversial decisions of the lower courts, which would have radically adjusted the way trusts are viewed in Massachusetts. The function of these trusts is to protect beneficiaries from outside creditors and overspending, so it may be a relief to many that the Massachusetts Supreme Judicial Court has chosen to interpret the trust as the settlor intended it, rather than, as the lower courts did, viewing it as “property” that can be divided as a marital asset in divorce.
The case concerned a husband and wife who had an arrangement during the marriage to fund their daily living expenses from the husband’s trust. The husband’s income wasn’t sufficient to cover these expenses, and the wife had given up her career in order to look after the couple’s children. The couple used the trust to fund their lives year to year.
The Appeals Court relied upon the trusts “ascertainable standard” to determine that the trustees were “required” to make distributions to the husband Curt Pfannenstiehl. The reasoning behind this was that the trust was to provide for the welfare of the beneficiaries, and during the marriage, it was used to provide for the family’s living expenses. However the court’s interpretation seemed extreme, given that trustees generally have discretion in their distributions rather than being compelled to pay out. In addition, the Massachusetts Supreme Judicial Court disagreed with the lower courts’ opinion that the trust was a certain interest for Curt, instead viewing it as too speculative to be considered “property”. The Supreme Court also disagreed that Curt was entitled to a quantifiable fraction of the trust (the lower courts valued his interest as a simple 1/11th piece because it was shared with 11 other people) because of the history of how the trustees used their discretion to make unequal payments or no payments at all, and of course, the spendthrift clause, which means the trust isn’t supposed to benefit creditors or ex-spouses in the first place.
It was a good thing for Curt Pfannenstiehl that the courts ruled the way they did. When after trial, he was ordered to pay his ex-wife Diane approx. $1.4 million that he didn’t have and couldn’t earn, he was prosecuted for contempt after he couldn’t pay the judgement, and put in shackles. The Appeals Court reversed based on inability to pay, and the Supreme Court eventually decided not to treat the trust as marital property, but there was a brief moment when the protection the trust had seemed to offer Curt evaporated. Pfannenstiehl v. Pfannenstiehl shows that divorce has the potential to derail even the most painstaking plans parents have made for future generations. Thankfully, even in such a fraught situation, the courts have chosen to acknowledge that the original purpose of such a trust is to provide for future generations, and that this should be safeguarded.
Sheryl Dennis is an expert in matters of trusts and estates. With over 24 years of experience in family law helping families resolve complex issues, Sheryl is the right choice for people looking to navigate sensitive family law issues related to estates, inheritances. Please contact Fields and Dennis today to see how we can help.
The AICPA/AAML National Conference on Divorce is an annual event that offers unparalleled opportunities to gain comprehensive insights on the financial aspects of divorce in the company of some of the Country’s top Divorce Attorneys and Chartered Public Accountants. As well as offering the advantages of a forum to network and learn from peers, expert speakers have previously presented on topics as diverse as Intellectual Property, healthcare and issues specifically encountered by women and LGBT couples. Jon Fields will be attending this year’s conference in New Orleans, May 2016. Fields and Dennis LLP looks forward to the insights this event will doubtless bring, as we anticipate returning to our practice with new perspectives and deeper professional insights on some of the most pressing and complex issues that our clients face.