The New Tax Law and Existing Prenuptial Agreements
If you have a prenuptial agreement (“prenup”), the 2017 Tax Cuts and Jobs Act (“TCJA”), now in effect, may have a serious negative impact, especially those prenups setting forth the amount of spousal support, also known as alimony or maintenance, in the event of a divorce.
As many of you probably know, one major change of the new tax law is it eliminates the alimony deduction for alimony payors finalizing a divorce after December 31, 2018 and eliminates the requirement that recipients claim alimony as includible taxable income. Therefore, under the new law, a separation agreement must be signed within the calendar year of 2018, or there must be a judgment of divorce signed in 2018 directing that alimony will be considered tax deductible in future years.
Other areas affected by the TCJA are personal exemptions, standard deduction and child tax credits, home mortgage and home equity loan interest, limitations on the state and local tax deduction, and increases in the estate and gift tax exemptions. While some provisions of the new tax law could be temporary and revert to pre-2018 laws in 2026, the alimony changes are permanent. Thus, the new tax consequences on existing prenups may be in direct conflict with the laws relied on when a couple signed their prenup. This, in turn, may result in the payor spouse suffering substantial tax consequences, while the recipient spouse would likely enjoy a significant increase in the maintenance contemplated when they signed the prenup.
This recent Bloomberg article, “Trump’s Tax Plan Could Mess Up Your Prenup” (https://www.bloomberg.com/news/articles/2018-05-23/prenups-under-attack-as-tax-law-boosts-cost-of-alimony-payments), aptly notes: “For divorcees in the top tax bracket, the change could mean they effectively pay double in post-tax costs compared to what they had previously agreed to in their prenups.” The loss of the tax savings previously available because of the payor spouse’s deduction at a higher rate effectively means that there is less collective after-tax money to use for the support of both parties and, therefore, less income available to the payor for support of the payee.
Accordingly, your prenup may no longer work the way you intended. If the fact that alimony was being taxable is important to you and did influence your agreement to pay (how much or for how long), then you may want to consider asking your spouse to sign a postnuptial agreement (“postnup”) renegotiating the alimony terms. A postnup could address the change in tax law and allow you and your spouse, for example, to equalize the difference between what you expected to pay, and what will be paid if you divorce after 2018.
However, many couples understandably are reluctant to alter their prenup by negotiating and signing a postnup. One workaround is for the postnup to contain specific language that the couple wishes the alimony provisions of their existing prenup to be grandfathered in should they divorce any time after January 1, 2019.
Some of you may think that a now unfavorable prenup can be overturned by the court. However, overturning a prenup is very difficult and rarely successful since courts are loathe to void an existing contract without extraordinarily good reason. Nevertheless, given that a prenup is a contract, overturning one is possible, especially if you can prove one or more of the following: fraud, trickery, coercion or duress, unconscionability, lack of capacity, and lack of legal counsel before signing.
Finally, there is also the issue of settlement agreements executed prior to the December 22, 2017 effective date of the TCJA. Many of these agreements include bargained-for provisions that no longer are enforceable, such as a divorced couple claiming the children as exemptions on their individual tax returns, or in what fashion the parties might divide or alternate the exemption entitlements. Because of the new law, all personal exemptions have been eliminated (in exchange for a near doubling of the standard deduction). Consequently, many parties to previously executed settlement agreements will find they are no longer able to claim a benefit that they specifically bargained for, while other parties will effectively receive a windfall.
If you have a prenup, we strongly suggest looking at the agreement to see how the new law may or will affect you. If you have any questions, speak with an attorney to determine how to discuss with your spouse renegotiating the terms of your prenup, or signing a postnup that feels equitable to both of you. We urge couples to talk about this issue when they are still happily married or only possibly considering divorce, rather than later as part of an adversarial process.
For more information on financial issues you need to be aware of, and to help minimize the negative consequences of the new tax law on your existing (or future) agreements, please contact one of our experienced attorneys for assistance.
By: Jonathan Leinheardt