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Alimony Tax Reform: Part 3

Forget it!

Forget about the alimony deduction for all new decrees or instruments post-2019. (See Part I for modification of pre-2019 alimony orders and agreement, as modification has a separate set of rules.) The deduction is gone absent a congressional miracle. That means on December 31, 2018, or before you must have alimony that qualifies under IRC Section 71 before it is repealed. The alimony must meet the terms of Section 71, pre-TCJA and pre-2019, which are as follows:

a. You must have a qualifying decree or instrument;

i. Note that this is more than an oral ruling or a claim. You must have the decree in your hands or a qualifying written agreement. Having your alimony claim pending is not going to save the deduction.

b. There can be no payment after the death of the payee spouse, which has been the subject of much Tax Court litigation.

c. The payee and payor cannot be members of the same household.

d. The payment must be in cash.

e. The recapture rules will be applicable.

f. The designated payments rule is still applicable for opting out of alimony.

I am not going into detail on these pre-2019 requirements as there is much written on pre-TCJA alimony.

 

The albatross of cash payments is lifted, and spousal support can now and should now be settled in creative ways with non-cash and non-periodic payments.

ERISA QDRO Transfers as Alimony

The first strategy for consideration for middle and higher net worth cases is the alimony provision under IRC Section 414(p) covering Qualified Domestic Relations Orders (QDRO) for ERISA plans such as a 401k plan. Let’s re-examine the definition of Domestic Relations Order (DRO) in light of the elimination of the alimony deduction.

“(1) In General

(A) Qualified domestic relations order. The term ‘qualified domestic relations order means a domestic relations order—

(i) which creates or recognizes the existence of an alternate payee’s right to, receive all or a portion of the benefits payable with respect to a participant under a plan, and …

(B) The term ‘domestic relations order’ means any judgment, decree, or order (including approval of a property settlement agreement which—

(i) relates to the provision of child support, alimony payments, or marital property rights to a spouse, former spouse, child, ….and (emphasis added)

(ii) is made pursuant to a State domestic relations law.”

Up to now, in my practice, QDROs have mostly been used in property division and occasionally to satisfy alimony or child support arrearages. But, can and should ERISA transfers be utilized by the court for lump sum alimony or in a private negotiation for lump sum alimony. There could also be annual QDROs, but there may be prohibitive administrative costs imposed by the plans. It is worth consideration in the appropriate circumstances.

North Carolina allows for alimony to be either periodic or lump sum. NCGS Section 50-16.7. So, getting a valid Domestic Relations Order for lump sum alimony under North Carolina state law can be done in either a settlement or the discretion of the judge.

Advantages under post-2018 TCJA for lump sum awards are we are free of the albatross of recapture with a lump sum, and the death of the payee spouse element is eliminated. Bye, bye alimony technicalities in the post-2018 world.

Further, IRC Section 72(t) did not change with TCJA, so the alternate payee of the QDRO can take a lump sum free of the 10 percent penalty.

Can the North Carolina Court enter a DRO for alimony? I say yes because it is the transfers of intangible personal property, which is allowed under North
Carolina General Statutes Section 50-16.7. Section 50-16.7 states alimony may be paid by title to “personal property” and personal property is not limited in the statute to tangible personal property. I submit logically both intangible and tangible personal property fall within NCGS Section 50-16.7 meaning of “personal property.”

Transfers in Stock as Alimony

As discussed earlier, all three subparagraphs of agreements and order qualify for stock in a divorce or separation settlement with carryover basis. That means that low basis stock can be transferred from one ex to the other with the transferee getting the basis of the transferor spouse. Sale of the stock would result in less tax in the hands of the lower income spouse.

North Carolina General Statutes Section 50-16.7 permit the transfer of personal property for the payment of alimony. Stock in intangible personal property, so a literal interruption of NCGS Section 16.7 would be that the court can transfer stock for the payment of alimony. Of course, this would only make sense in most situations post-2018 when the alimony deduction is lost. Remember pre-2019 alimony must be literally cash to be deductible.

Transfers of Real Property as Alimony

Because alimony post-2018 no longer must be a cash payment, settlements with the transfer of real estate should be considered, particularly given the exclusions of gain under IRC Section 121. Perhaps under the technicalities of “use” and “title,” the out spouse is no longer eligible for the exclusion for gain on sale of the residence, the spouse in the residence with the proper written decree or instrument may be able to benefit from all of the gain tax-free.

North Carolina General Statutes Section 50-16.7 allows for the transfer of title to real property as alimony. Again, this section has long been available, but not utilized because of the cash requirement for alimony for the tax deduction.

Conclusion

Perhaps the loss of the alimony deduction in the post-2018 world will be a good thing is it causes us to focus on the whole economic situation of the divorcing couple. We can focus on the macro needs, just as the need for housing or the need for more in retirement. We must think outside the box, but tax hasn’t gone away in divorce. Unrealized tax gain in stock and real estate is there for consideration. And, don’t forget the QDRO as a way to settle alimony. Dependent spouses with less income might benefit from a larger retirement account in settlement via a QDRO, so the work force job opportunities might seem more appealing. With more lump sum settlements, would people be able to get on with their life more quickly? Let’s face it; we have lots of collection problems with long-term alimony awards. Periodic payments will still be best sometimes, but explore all the options! We live in a brave new world.

 

Alimony Tax Reform

Part I | Part II (Section 1, Section 2) | Part III

 


by Carolyn J. Woodruff, J.D., CPA, CVA