Before TCJA (Tax Cuts and Jobs Act) alimony payments were deductible to the payor and taxable to the recipient.
In the Post-TCJA era (2018 and beyond) alimony payments are not deductible (for the payer) nor reportable (by the recipient).
Divorcing couples seem to prefer the pre-TCJA outcome to its post-TCJA counterpart. At least the alimony payor prefers it.
There was a degree of financial equitability about the pre-TCJA outcome that was hard to fault. The payor’s post tax expenditure matched the recipient's post tax receipts – give or take the difference between their tax brackets. It was easy to negotiate the difference – except when intransigence and the urge to get-even got involved.
The post-TCJA outcome shifts the entire tax burden from the alimony recipient to the payor. For average about-to-be-former couples, that’s a 50-75% shift in transaction costs… Gee, I can think of no reason the (disgruntled and already angry) former-spouse-payor would be upset by that – can you? It makes an ugly negotiation even uglier.
My afternoon began with a seemingly simple question from my client’s attorney: Is there some way to mimic, in whole or in part, the pre-TCJA tax allocation under post-TCJA rules?
After a bit of a grock (and a validating rummage through Google and my tax research & planning services) I realized there is:*
If the marital estate includes appreciated assets, income generating assets, and/or assets that will continue to appreciate, trade a portion of the alimony obligation for the assets.
In effect, buy down the alimony obligation by giving the alimony recipient a bigger portion of the marital assets and future income from them. If done subject to a QDRO or court order, there should be no tax on the initial asset transfer. The recipient assumes the asset basis and pays the tax when they convert the asset.
OK, bright guy, is there an “exchange rate” between assets and alimony: Specifically, what would it cost (in appropriate asset terms) to duplicate the pre-TCJA tax result for the payor's and recipient's 2019 through God-Only-Knows-When tax returns?
My naïve (but correct) first reaction: Of course, there is! “Just” set the present value of the payor’s targeted tax savings equal to the present value of the tax difference between the old law and new law.
Turns out, that’s easy to say, and difficult to accomplish: Imagine an equilibrium in which 1) both participants must be accommodated, 2) neither knows the other’s parameters (discount rate, expected duration of alimony payments,** expected disposition date of assets), 3) those parameters may change over time, and 4) there is uncertainty about several exogenous factors (market performance, reinvestment risk, future tax rates, whether DT will index capital gains).
Given the nebulousness of some of it and the impossibility of an absolute (analytic) solution (too many variables, too few equations and constraints) – I tried several artificially constrained Monte Carlo Simulations to get some idea of what the solution set would look like.
The solution set is the interior (or what passes for the interior) of an n-dimensional “object” floating in the sea of possible n-dimensional outcomes – where n is the number of simulated variables. For the topologically inclined, the “object” does not appear to be convex, compact, or connected. In two variables/dimensions, it looks like somebody scribbled on my screen. In three variables/dimensions, it looks like something you would have Steve McQueen kill with his flame thrower.***)
So the answer is: There are too many “correct” answers none of which is very much better than any other answer – the lawyers will have to negotiate.
The lawyers like that kind of solution…
So – that’s how I spent 5 ½ (OCD dominated) hours this afternoon: What have you been up to?
*) Mathematically, anyway. Whether a Family Court would accept this arrangement is something I can’t predict.
**) Alimony payments usually terminate if the recipient re-marries. I can’t count the number of times I’ve heard one partner say: “I’ll never get married again! I’ve had it!” To which the other partner replies: “Hah – you’ll be remarried within six months!”
***) See The Blob 1958 Film, starring Steve McQueen, Definitely not the high point of his career.