Your New York pre-nup may be a ticking time bomb. Because of last year’s changes to the tax law, a divorce could be much more costly than you bargained for in your prenuptial agreement. The good news is that you still have time to disarm the bomb.
Historically, maintenance in New York (alimony everywhere else) has been tax deductible to the payor and taxable as income to the recipient. With the enactment of the new tax law in December 2017, this changed.
The Tax Law Changes the Deductibility of Maintenance
Starting on January 1, 2019, maintenance will no longer be deductible by the payor spouse unless, before December 31, 2018, the parties entered into a separation agreement or a court granted a judgment of divorce providing for the payment of alimony. Maintenance obligations that arose before that date will be grandfathered and remain deductible.
If, before December 2017, you entered into a prenuptial agreement that provided for the payment of maintenance (either a specific of maintenance or a formula for calculating the maintenance payment), it was likely on the then existing law that allowed for the alimony deduction. But, if you divorce after December 31, 2018, the maintenance payment will not be deductible; so, the actual cost of this payment will be much higher than you bargained for.
Your prenuptial agreement, which was supposed to provide for a fair settlement in the event of a dissolution of the marriage, may result in a windfall for the recipient and a significant and unanticipated liability for the payor.
What Are New York Courts Going to Do?
What New York courts are going to do with these agreements is uncertain. On the one hand, courts will hold parties to their contractual obligations. If they bargained for a specific maintenance payment, the judicial policy might be to hold parties to their bargain. On the other hand, there is a mutual mistake; both parties assumed that the maintenance payment would be, as it historically was, a deduction to the payor and income to the recipient.
What Do I Do?
You entered into a pre-nup to eliminate the uncertainty of divorce. But, this significant and unanticipated change in the law up-ended your divorce planning.
One way to eliminate the uncertainty surrounding the change in the tax law would be to amend the pre-nup in a post-nuptial agreement. The parties could address this change in the law and provide for a new “tax neutral” maintenance payment.
Of course, all cures have unintended side effects. Proposing a post-nup could cause result in the reconsideration and the re-negotiation of other pre-nup provisions - everything could be on the table. In cases where the marriage is already in trouble, re-visiting the pre-nup could, itself, result in a divorce.
If you have a pre-nup that needs to be reviewed or revised, contact me. Let's diffuse the bomb.