Alimony Tax Change Upends Payments in Divorce Negotiations

[Source: Bloomberg Tax]

• Prenups negotiated prior to tax law took old deductibility into account
• Attorneys question provision’s potential to raise much revenue

Divorcing couples are shrinking alimony payments and transferring securities to former spouses instead, now that they can no longer write those payments off, divorce lawyers say.

The new tax law altered the treatment of alimony, so divorce lawyers are looking for creative ways to help their clients. Before 2019, the higher-income-earning spouse in a divorce would be able to deduct those alimony payments, while the lower-income-earning recipient had to pay tax on them.

Now the higher-income spouse is barred from deducting the payment, and the recipient can exclude it from taxable income. As a result, professionals say those payments are shrinking.

“I’m using lower dollars and lower percentages,” said Linda Ravdin, a divorce attorney at Pasternak & Fidis in Bethesda, Md. “You can always look and say, ‘Are there any income-producing assets we could transfer to the spouse in lieu of alimony?’”

That is exactly what plenty of couples are exploring, she and others said. Whether the arrangement ends up better or worse for the recipient depends on facts and circumstances. It can also lead to a transfer of the tax liability back to the recipient, who may end up owing taxes on dividends and capital gains from securities, for instance, she continued.

“Generally the payment amounts are lower,” said Hubert Klein, a partner at EisnerAmper LLP in Iselin, N.J., who leads the firm’s Financial Advisory Services Group. “With the loss of tax deductibility, people look to do more asset transfers.”

Revenue Hit?

The ease of working around the change has left some suspecting the provision may not raise as much revenue as anticipated.

The Joint Committee on Taxation projected that the provision would raise $6.9 billion between 2019 and 2027. An official familiar with the law’s revenue estimates said the projection took likely resultant changes to divorce negotiations into account, as all revenue estimates sought to account for taxpayers’ reactions to new law.

“It’s interesting how it was seen as a revenue raiser,” said Brandon Keim, a tax litigation attorney and CPA at Frazer Ryan Goldberg & Arnold LLP in Phoenix, adding that the net take-home of the recipient tends to remain about the same, as they receive a smaller amount but no longer lose a chunk of it to the government.

Divorcing couples without counsel may negotiate as they would in a prior year, but if lawyers are involved, they will be sure to factor in the tax consequences, he said.

Prenuptial Agreements

Couples who have negotiated their divorces prior to the tax law change were grandfathered into the old regime, meaning the payments are still deductible to the higher earner and subject to tax for the recipient. In fact, many rushed last year to get their agreements finalized before the new rules took effect.

But couples who negotiated prenuptial agreements prior to this year may find themselves in a quandary upon entering divorce negotiations, as those prenuptial agreements often have caps on alimony that are based on deductibility, attorneys said.

“The person who argued for a lower cap will say, ‘obviously, this should’ve been a lower amount, because this was supposed to be deductible,’” said Peter M. Walzer, a high net worth divorce lawyer and founding partner of top family law firm Walzer Melcher LLP in Los Angeles and president of the American Academy of Matrimonial Lawyers. “With prenups, it will create more litigation, because the agreement no longer makes sense under current law.”

This could, in turn, lead to more litigation.

“That’s going to be an issue for the courts to decide,” said Klein. “We’re waiting on a lot of guidance for these issues.”

By Lydia O’Neal

Aug. 21, 2019, 1:46 AM