The Tax Cuts and Jobs Act of 2017 (TCJA) turned 18 months old on June 22. With the enactment of the TCJA came significant and some unexpected changes to the Tax Code. The changes impacted tax brackets, the corporate tax rate, standard deductions, personal exemptions, mortgage and home equity loan interest deductions, the alternative minimum tax and other significant sections of the Tax Code. The results have created mixed responses from taxpayers, accountants, tax lawyers and other financial professionals. As only limited guidance has been promulgated, uncertainly remains with a variety of these new code provisions.

While many taxpayers began to feel both the benefits and detriments of the TCJA during the 2018 calendar year and certainly at the time of the filing of their 2018 returns, a large majority of the divorcing population are just beginning to truly encounter the significant effects of this legislation. The main reason, among others, is the loss of the ability to shift income through the inclusion and deduction of alimony, spousal support and alimony pendente lite payments.

Under the appropriate circumstances, alimony has been recognized as deductible for the paying spouse and includible for the receiving spouse for more than 70 years prior to the start of 2019. Further, spousal support and alimony pendente lite, the two types of support available for dependent spouses going through a separation or divorce, also long includible and deductible, suffered the same fate.

The shifting of income through alimony has commonly been used as a significant tool for family lawyers, masters and judges alike to assist clients and litigants in settling their divorce matters. Simply put, the higher earning spouse would pay alimony, but it would ultimately be at a discounted rate based on their tax bracket. The recipient spouse would have to include the alimony in their income at their lower tax bracket, which would cost them significantly less than the other spouse. While neither spouse was generally elated with the arrangements, the net effect was that the parties kept more income, albeit divided among them, and the taxing authorities received less. The taxing authorities, apparently unhappy with this arrangement, proposed the TCJA which was signed into law on Dec. 22, 2017. As a result, on Dec. 31, 2018, the income shifting that occurred through the payment of alimony, spousal support and alimony pendente lite would be no longer allowed for agreements and orders executed on or after Jan. 1, 2019, with certain exceptions for agreements and orders entered before that date.

In response to the TCJA, family lawyers began to contemplate solutions to this newly created tax problem that was certain to make settlement and litigation more difficult. Based on the language of the TCJA, the sentiment became clear that it was in many litigants' best interests to resolve their divorce, equitable distribution and support issues prior to the expiration of 2018. The common thinking, which appears at this point to be accurate, was that as long as an agreement was executed or an order was entered before Jan. 1, 2019, the previous rules with respect to alimony, spousal support and alimony pendente lite would remain valid for those litigants who were a part of those agreements, at least temporarily. This provided a reasonable solution and some degree of certainty which comforted both clients and the lawyers tasked to represent them.

Those litigants who were able to get their divorce and alimony agreements finalized prior to Jan. 1, 2019, appear to have preserved the tax shifting nature of the previous alimony rules for the duration of the obligations. As long as the alimony obligations contained in those agreements are not modified in the future, they appear to be safe from losing the benefit of the tax shifting.

Those who did not finalize an agreement prior to the end of 2018 will face a different, more uncertain result, which may or may not be beneficial to their interests depending on how the negotiations are finalized or how orders are handed down. One likely certainty is that the Treasury Department will benefit with an increased tax pool created by these cases.

While family lawyers were working to finalize agreements in 2018, case plan for those matters which could not be resolved and develop solutions for future cases, the Domestic Relations Procedural Rules Committee, was preparing a proposal for the Pennsylvania Supreme Court's approval to address the anticipated consequences of the TCJA.

Following a year of intense labor to get the rules revised, the Supreme Court on Dec. 28, 2018, entered an order amending the Pennsylvania Rules of Civil Procedure with the new rules becoming effective on Jan. 1, 2019.

While the new rules address such issues as the child tax credit, allocation of additional expenses in support orders, allocation of orders, certain conference procedures, what documents litigants are required to bring to conferences and treatment of such government benefits as public assistance and social security, at the core of the changes were significant revisions to the formulas involved in determining spousal support and alimony pendente lite.

For agreements and orders finalized prior to Dec. 31, 2018, the formula remains unchanged and spousal support and alimony pendente lite remain taxable to the recipient and deductible by the paying party. Even upon a subsequent modification the support would retain its tax shifting attributes under the “old rules” unless the parties agreed to use the new formula. The issue of losing the benefit of the tax shifting for these agreement and orders would only occur once an agreement was reached or an order was entered for alimony after Jan. 1, 2019. Since it would technically be a new agreement or order, the alimony would not be tax deductible nor includible and as such the alimony would cost the paying party more and cause the recipient to receive less. This creates an inability to take advantage of the tax arbitrage once enjoyed and makes the difference in the benefit each spouse will receive harder to reconcile in order to reach a settlement.

For new agreements reached or orders entered after Jan. 1, 2019 (assuming it is not a modified agreement or order on a modification of a pre-Jan. 1 order), a new formula applies which attempts to account for the fact that the spousal support or alimony pendente lite will no longer be subject to tax shifting. This new formula requires the calculation of spousal support or alimony pendente lite first, even in cases which also involve child support. The “new rules” reduce the percentage amount a paying spouse needs to pay a recipient spouse on the differential of their income. By way of a simple example, under the “old rules” if one spouse makes $5,000 per month after taxes and the other makes $1,000 per month after taxes and they have no children, the paying spouse would have to pay 40% of the net difference of the parties' incomes in monthly support. In this scenario $5,000 to $1,000 multiplied by 40% equals $1,600 per month. The paying spouse would deduct $1,600 per month or $19,200 per year from their yearly taxes and the recipient would have to claim these monies as income.

Under the “new rules” using the same incomes, you would take 33% of the paying party's income, or $1,650 in this example, minus 40% of the recipient's net income, or $400 in this example, and you would come up with $1,250 in support for the recipient spouse. This support would not be deductible for the paying spouse nor includible to the recipient spouse. In this example, the paying spouse pays $400 less per month under the “new rules” but gets no deduction, the recipient receives $400 less per month, but pays no tax on the $1,250 received. While on its face it appears that each party is in a similar situation as under the “old rules,” it is deceiving, as the receiving spouse likely would have paid little to no taxes on these monies under the “old rules” due to their limited income per year. Now they lose almost 25% of their monthly support, while the paying spouse, paying maybe a similar net amount, has to pay more to the government and less to their spouse. The fairness of these results seems to disproportionately impact the recipient spouse as the support obligation grows, but this notion is not necessarily scientific. Further, while alimony is not formulaic and is a secondary remedy to equitable distribution, litigants can also expect to see lower awards on both ends based on the TCJA.

These unexpected results are not just limited to a recipient spouse. An additional area of concern for clients and lawyers alike relates to the area of prenuptial agreements. A prenuptial agreement executed before Dec. 31, 2018, is not effective in providing the parties to the agreement with the favorable tax shifting of alimony provided in the previous version of the Tax Code. Even if valid in Pennsylvania, the attempt to proscribe what tax consequences will occur in these agreements are certainly not binding on the Internal Revenue Service. As such, the recipient in this case will likely receive a windfall and the paying party will not receive one of the benefits of their bargain. While the couple remains happily married, now is a good time to revise the prenuptial agreement before a party receives unfavorable and certainly unintended results.

As case law develops on these issues and greater guidance is provided by the Department of the Treasury, we will gain more clarity regarding some of the more ambiguous issues. Until then, make sure clients understand the uncertainty of these taxing times.

Jonathan T. Hoffman is a member in Cozen O'Connor's family law group in the West Conshohocken office. Hoffman's practice consists of a wide range of domestic relations matters including, divorce, custody, equitable distribution, prenuptial/postnuptial agreements and protection from abuse actions. He earned his law degree and LL.M in taxation from Villanova University School of Law.