Your Prenup Might Be in Jeopardy as Tax Law Kills Alimony Break
(Bloomberg) -- President Donald Trump’s tax overhaul could wreak havoc on prenuptial agreements across the country -- and maybe even his own.
Prenups often contain provisions about how much a partner would pay in alimony, also known as spousal support. The agreements can be thrown out if judges deem them unfair, signed too quickly or under duress. Now the tax revamp offers another avenue for challenges because courts will likely have to consider how the law has changed since the contracts were created. Starting in 2019, payers will be no longer be able to deduct their alimony payments.
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.
“We made a deal, and now Congress messed it up,” said Linda Ravdin, a partner at law firm Pasternak & Fidis, who’s written reference books about premarital agreements.
Divorce lawyers are in an awkward position and weighing whether to alert happily married clients with decades-old prenups of the change. Ravdin said she was concerned that an unexpected letter or call from a divorce attorney could be unwelcome. Instead, she put the information in an emailed client newsletter.
The obvious fix for married couples is to amend their agreements, but that’s almost always a bad idea, said Christopher Melcher of Walzer Melcher who specializes in the divorces of ultra-wealthy Californians.
“It’s doubtful that anyone would want to mess with that thing” if they’re happily married, Melcher said. “It would open up a huge can of worms.”
While Trump told New York Magazine in 2006 that his prenup with Melania Trump made his marriage stronger despite being a “hard, painful, ugly tool,” he didn’t disclose any details of the agreement. A White House spokeswoman didn’t respond to a request for comment.
There aren’t hard numbers, but it’s fair to say that prenups have become more popular in recent years as younger Americans delay marriage, and the divorce rate has skyrocketed for people over 50 who often use prenups if they remarry. More than 60 percent of divorce attorneys said they had seen a rise in the number of clients seeking prenups in the previous three years, while just 1 percent reported a drop, according to a 2016 survey by the American Academy of Matrimonial Lawyers.
Some prenups may specify that in the event of divorce, one spouse is owed, say, $10,000 a month for half the length of time the couple was married. Other agreements set alimony based on a formula, such as a percentage of the payer’s income. Child support is often calculated in tandem with alimony. If agreements aren’t amended to factor in the tax changes, it will be up to divorce attorneys to settle -- or judges to decide -- whether the amounts or formulas still stand for couples who divorce starting next year.
Even if both parties agree to an adjustment in alimony, they’ll need to agree on exactly how much to cut the payers’ obligations. Divorcing couples could end up hiring rival accountants as expert witnesses to sway judges.
“No one knows the outcome of that kind of dispute,” Ravdin said. “When you go to court, it’s like rolling the dice.”
For those in the top income-tax bracket -- the likeliest to have a prenup -- being able to deduct the payout from taxable income had been a big saving because every dollar in alimony reduces the payer’s taxable income by the same amount. Top earners in high-tax areas like California and New York City can face marginal tax rates close to 50 percent. Without the deduction, a spouse who agreed to write a $10,000 check each month could be on the hook for what is effectively almost $20,000 in pre-tax income.
“Folks already don’t like paying alimony, so doubling the effective cost would be painful,” said Chris Chen, a financial planner who specializes in divorce-related matters at Insight Financial Strategists.
Republican lawmakers said they eliminated the alimony deduction to end what they called a “divorce subsidy” under the old law. The change, which raises an estimated $6.9 billion over the next decade, doesn’t affect divorces and separation agreements finalized before the end of 2018. Starting next year, the newly divorced won’t be able to deduct alimony payments, but recipients will get the money tax-free (previously, the payments had to be reported as part of their taxable income).
Ultimately, the change could hurt alimony recipients. Payers could plead with judges to revise their obligations given the new law -- a valid legal argument given that many prenups specifically mention that the payments are intended be deductible. Those potentially reduced payments are likely to overpower the benefit recipients get from being able to receive the payments tax-free because they tend to be in lower tax brackets than the payers.
Divorce attorneys have already been warning that killing the alimony deduction could make splitting up more acrimonious.
Alimony deductibility “eases the pain of making the support payment,” Melcher said. “When that goes away, it makes it harder. There is less money to spread around.”
©2018 Bloomberg L.P.