We have talked recently about the impact the change in the tax law enacted at the end of 2017 will have on divorce. One area we have not yet addressed – the impact the change has on prenuptial agreements.
More and more couples are utilizing prenuptial agreements to not only protect separate property brought into the marriage but also to fix terms as to maintenance in the event of divorce.
The new tax law radically changes the impact of paying and receiving maintenance with regard to net family income. For divorces happening for filings starting January 1, 2019, the spouse paying maintenance will no longer be able to deduct any maintenance on federal income tax.
Currently, a spouse with a high maintenance obligation receives a generous tax deduction by reducing taxable income by the full amount of maintenance. If a spouse pays $100,000, that is a savings of roughly 40% or $40,000. That tax savings expands net family income and allows for more generous maintenance awards.
On the other side of the ledger, the new tax law no longer treats maintenance received as income, so the recipient will find a new tax benefit. However, because the income of the maintenance recipient tends to be in the lower tax bracket, the savings to the recipient does not offset the loss to net family income.
How does this affect prenuptial agreements?
Prenuptial agreements are contracts, and contracts are bargains that the parties enter into because they find them mutually beneficial. A party will agree to pay a certain sum in maintenance in exchange for something else in a division of property.
Fixing maintenance in a prenuptial agreement gives the parties some certainty about finances in the event of divorce. But in all likelihood the amount agreed upon depends on the assumption that the party paying the maintenance will be able to deduct that sum for federal income tax purposes.
Now that the law has changed, the expectations of each party to the contract have changed, what the law calls a case of mutual mistake. When this happens, courts generally void the contract or at least the provision of the contract dependent on the mutual mistake.
So, what this means for people with prenuptial agreements in happy marriages is that they have a big problem – one of the key elements of the prenuptial agreement likely is mistaken and could void the provision on maintenance. At a minimum, it takes the certainty and ease of the prenuptial agreement and puts it in limbo and will be subject to litigation.
What should a married couple do?
On the one hand, they could fix the agreement so that it accurately reflects the numbers with the new tax law. But that could be risky as it opens up Pandora’s Box – rewriting one provision could lead to rewriting others and that could lead to acrimony in an otherwise happy marriage. Not necessarily a great strategy.
On the other hand, they could leave it alone, hope the law gets repealed before they ever get divorced or that they will litigate it at the time should they end up filing for divorce. That may seem the preferred strategy for now, but it takes all the certainty away and could put the entire agreement in jeopardy.
Each prenuptial agreement must be evaluated on its own terms and through consultation with your attorney. But the change in the law should be one you should at least consider discussing with your attorney and how you might want to proceed.
If you have any questions regarding prenuptial agreements and the new tax law, contact us – we can help.