When couples split up, it’s still common for one party to make support payments to the other. Sometimes this continues until the death of the party receiving support; sometimes it ends after a set term of years. Whatever the alimony arrangement, the tax treatment of the payments from the view of both parties becomes important. IRS statistics (https://www.irs.gov/pub/irs-soi/soi-a-inpd-id1802.pdf) show that deductions for alimony payments by taxpayers in 2016 (the most recent year for statistics) totaled more than $12 billion. But as a result of the Tax Cuts and Jobs Act of 2017 (TCJA), new tax rules apply to divorce instructions executed after 2018 and may change planning for divorcing couples going forward.
Tax treatment for pre-2019 divorces
Spouses who divorced prior to 2019 do not have any new tax treatment for alimony payments that continue to be made. Assuming that payments meet the Tax Code definition of alimony (Code Sec. 71), they are fully deductible by the payer-spouse as an adjustment to gross income (no itemizing is required) and fully taxable to the recipient-spouse. This is so even if a pre-2019 divorce instrument is modified after 2018, as long as it does not specifically say that TCJA rules explained below apply.
Payments of child support are not deductible by the payer-spouse or taxable to the recipient-spouse on behalf of the couple’s child.
Tax treatment for post-2018 divorces
Alimony payments made pursuant to any divorce or separation instrument executed after December 31, 2019, are not deductible by the payer-spouse or taxable to the recipient-spouse. In effect, the payments are treated the same as child support payments have always been treated (i.e., not deductible and not taxable).
Due to the change in the tax treatment of alimony for post-2018 divorces, some couples may seek alternative arrangements to satisfy the need of one party for support. For example, one spouse may consider transferring some or all of a traditional IRA account to the spouse in need of support. As long as the transfer is made pursuant to a decree of divorce or separate maintenance, the spouse transferring the IRA is not taxable on the amount transferred; the recipient-spouse pay taxes when and to the extent distributions are taken from the account.
Some divorcing couples have used “alimony trusts” to provide for the support of one of the spouses. The spouse who is being supported is taxable on the income from the trust to the extent he or she is entitled to receive it (Code Sec. 682). This rule has been repealed by the Tax Cuts and Jobs Act, effective December 22, 2017.
The IRS has made it clear (Notice 2018-37), however, that pre-TCJA tax treatment continues to apply to trust income payable to a former spouse who was divorced or legally separated under a divorce or separation instrument executed on or before December 31, 2018. If the instrument is modified after this date, the old tax treatment continues to apply unless the modification provides that the changes made by TCJA apply.
Beneficiary designations Usually, spouses who have been designated as beneficiaries for various financial assets, such as life insurance, continue to be beneficiaries unless new designations are made. However, because there is a belief that new designations are unintentionally overlooked after divorce, more than half of the states have enacted so-called “revocation on divorce” of existing beneficiary designations. These laws, which vary somewhat in certain states, are based on a 1990 amendment to the Uniform Probate Code (https://repository.law.umich.edu/cgi/viewcontent.cgi?article=2053&context=articles). The effect of the law is to pass assets to a contingent beneficiary if there is one named or to the person who would inherit the asset under state law.
There had been a question of whether such a law violates Article 1, Section 10 of the U.S. Constitution, which says states shall pass no laws impairing the obligation of contracts. However, the U.S. Supreme Court, in an 8-1 decision, has upheld Minnesota’s law (Sveen v. Melin, S.Ct., 6/11/18). The case involved a spouse who was named the beneficiary of her former spouse’s life insurance policy. The couple divorced and he died nine years later without having changed the beneficiary designation on the policy. State law provided for revocation on divorce, so his two children claimed to be beneficiaries of the proceeds.
Justice Kagan, writing the opinion for the majority, said that the law does not substantially impair the relationship created by the contract and, in fact, effectively reflects the policyholder’s intent. As such, the policyholder’s two children were entitled to the proceeds of the life insurance policy even though the former spouse was designated as the beneficiary of the policy. Under state law, if a policyholder wants to retain the former spouse as beneficiary, he or she need only notify the insurance company of this intent.
The revocation-on-divorce laws generally apply unless a governing instrument, divorce (including a legal separation), and annulment of a marriage expressly provides otherwise. For example, in New York, under EPTL 5-1.4, revocation-on-divorce applies to:
1. “disposition or appointment of property made by a divorced individual to, or for the benefit of, the former spouse, including, but not limited to, a disposition or appointment by will, by security registration in beneficiary form (TOD), by beneficiary designation in a life insurance policy or (to the extent permitted by law) in a pension or retirement benefits plan, or by revocable trust, including a bank account in trust form,
2. provision conferring a power or power of disposition on the former spouse, and
3. nomination of the former spouse to serve in any fiduciary or representative capacity, including as a personal representative, executor, trustee, conservator, guardian, agent, or attorney-in-fact.”
Revocation-on-divorce laws do not apply to ERISA-protected assets (see Egelhoff v. Egelhoff, S.Ct., 532 US 141 (2001)); ERISA preempts state law. Assets within ERISA’s purview include 401(k) plans and other qualified retirement plans as well as employer-provided group-term life insurance. A former spouse who has been a designated beneficiary remains as such unless this is changed. Of course, because retirement plans are marital assets, the disposition of them usually occurs in the course of a marital settlement. For example, a divorce decree may include a qualified domestic relations order (QDRO) directing the trustee of the retirement plan to transfer some or all of the employee’s account to the former spouse. The employee-spouse is not taxable on benefits transferred to the spouse pursuant to a QDRO.
It appears that the revocation-on-divorce laws apply to IRAs because these accounts are treated like other financial accounts; they are not ERISA-protected accounts. In Florida, for example, the revocation-on-divorce law specifically applies to IRAs (F.S. §732.703).
Divorce planning in 2019 is certainly more complicated than prior to TCJA. Not only does the new tax treatment for alimony come into play, but also changes in income tax rates, tax breaks for a couple’s child, and various state laws.
Executive Editor Sidney Kess is CPA-attorney, speaker and author of hundreds of tax books. The AICPA established the Sidney Kess Award for Excellence in Continuing Education in his honor, best-known for lecturing to over 700,000 practitioners on tax. Kess is senior consultant for Citrin Cooperman, consulting editor to CCH and Of Counsel to Kostelanetz & Fink.