FacultyFaculty/Author Profile

Matrimonial Law and Estate Planning – Prenuptials, Postnuptials and Separation Agreements Under the 2017 Tax Act


,


SANFORD SCHLESINGER: OK. Now for a total change-- well, maybe it's not a total change of pace. People will get divorced and leave the country. That'll be our subject next year.

Again, a subject which I've been asked to do and am doing this year for a very specific reason-- we've done it maybe once before-- is the relationship between matrimonial law and estate planning. It's become more and more important under the new tax act.

Unfortunately, in all due respect to our speaker, I'll say one of my experiences with matrimony-- not him or his firm because they know to call-- but a lot of matrimonial lawyers will do matrimonial work without adequate knowledge of the estate and tax aspects of what they've done. Most importantly, I know the matrimonial laws have a very strong canon of ethics about retainer agreements and all.

It should be in the retainer agreement that I must remind you to do a new will and change all your beneficiary designations. Because how many times have you seen divorces-- really nasty divorces-- and the person dies, and they never changed the beneficiary designation on an insurance policy or a pension plan? Anybody ever seen that? It's the most common thing in the entire world-- as well as drawing a new will.

As an aside, obviously, most of you know that in most jurisdictions, divorce automatically revokes a legacy. It used to be, up until about 15 years ago, divorce in Connecticut revoked your entire will. That's not the law anymore. But I was involved in a matter, and a lot of people were pretty surprised at that one.

So our next subject is matrimonial law and estate planning-- Prenuptials, Postnuptials, Separation Agreements Under 2017 Act. And our speaker is Nicholas Ferris Cohen. Nick Cohen is a partner at the firm of Cohen Clair Lans Greifer Thorpe & Rottenstreich. That must have been the long-name firm that-- no, that was Massachusetts-- that Connie Teitell was referring to today.

He's a graduate of University of Pennsylvania Law School and somebody whom I know very well. And I think we're in for a treat with this presentation. Nick you're on.

NICHOLAS COHEN: All right. Great. Good afternoon. Thank you for having me. Just give me one second to switch the slide show.

Just a question-- how many people have figured out, in light of the new tax law, whether their taxes are going up or whether they're going down this year? I've certainly given it some thought and, unfortunately, in New York state, for me the answer is they're going up.

SANFORD SCHLESINGER: Andrew convinced him to expatriate, actually, at lunch.

NICHOLAS COHEN: So notwithstanding the name of the act-- the 2017 Tax Cut and Jobs Act-- it's not necessarily a tax cut. I'm going to abbreviate as TCJA for purposes of this presentation. The big change is the tax treatment as it relates to alimony. But before we get there, I want to talk about basics of the tax changes and how they impact both individuals and corporations.

The fact is that this law impacts everybody. But with respect to matrimonial law, it impacts everyone who's married because they could potentially become divorced. It impacts anybody who's potentially marrying or considering a marriage because it will result in a change to a prenup if they're considering one and, ultimately, a divorce, should that occur. And of course, if somebody's divorcing, this is going to impact their tax and how they structure the agreement.

So let's start first with the basics of the Tax Cut and Jobs Act of 2017 as it impacts individuals. So here, we have a chart that explains the change to individual tax rates. You'll see that, as a general rule, the tax rates have gone down for individuals-- the marginal tax rates. Whereas the highest federal tax rate was 39.6%, it's now 37%.

It's important to note-- you'll see in the second column-- it only is true through 2025. So there's a sunset provision which was made necessary by, I guess, the need to pass the Senate with this bill. And the Republicans were able to pass the tax overhaul without Democratic vote because they needed only majority approval. And the reason for that is tax budget rules forbid tax legislation from adding to the federal deficit after the first decade. So it's known as the Byrd Rule, just as an aside.

So one of the big changes is to the home mortgage interest deduction. One change is that a home equity loan is no longer deductible. So interest on those loans are not a deduction for purposes of federal tax.

They have also changed the maximum allowed on a mortgage of interest that's deductible. It is $750,000 if you're married filing jointly for all mortgages taken out after December 14, 2017. The good news for somebody who has currently got a mortgage or a jumbo mortgage is that you can continue to claim your home mortgage interest on up to $1 million if you're married filing jointly.

One thing that you should keep in mind as practitioners is the impact on property values this may have and the attractiveness of buying an expensive home and financing it through a bank. So it's something to consider when you're distributing assets going forward.

Another major change relates to the child tax credit increase. This, again, expires in 2025. The new law has doubled the tax credit from $1,000 to $2,000 and has changed the thresholds at which the deduction phases out. So it's pretty significant. For a single person, $75,000 was the limit at which the tax phased out. It's now $200,000.

And again, like the other provisions we've discussed, this expires in 2025. So as a general rule, that creates more uncertainty, unfortunately, as to what's going to happen going forward. I know in the past, there's been assumptions that nobody would try to raise taxes so that they'll always pass an extension on the cusp. So I'm not sure about that, and nobody can predict the future.

The next major change is the new credit for non-child dependents, which is, again, only available through the end of 2025. The new act allows a new $500 nonrefundable credit for dependents who do not qualify for the child tax credit. So if you have a child over 17 or elderly parents, you can take advantage of this. You cannot take advantage of it if you're claiming the credit for yourself or your spouse if you're married filing jointly.

Another major change, which I'm sure everybody's familiar with, is what's known as the treatment of SALT, or state and local taxes. I read that approximately 30% of filers under the old tax regime took advantage of the SALT deduction, which is the ability to deduct your state and local taxes from your federal returns. This is something that's now been capped at $10,000, including property taxes, importantly.

So this is a big problem for people in blue states, or high-tax states, such as in the tri-state area. Housing prices will likely go down, if they haven't already, because people who pay high property taxes will no longer get the benefit of effectively taking that as a deduction.

There is one piece of good news that I would like to cover. One of the goals of the Tax Cut Act was to simplify the code for filers. So one thing they've done is they've increased the standard deduction. They've nearly doubled it. So it's now more attractive to take the standard deduction, as opposed to itemizing.

So that will, of course, make things more simple if you don't have to go through your taxes and if you can just take a line deduction. You'll see the rates-- again, this is through 2025-- it's a pretty significant increase. It will affect a lot of people. And people who are lower incomes will, ultimately, likely take home more money as a result of the increase in the standard deduction.

There have been some changes to what you can itemize on your tax returns if you're choosing to do so as opposed to taking the standard deduction. This is, again, eliminated only through 2025, the miscellaneous itemized deductions. So we have it for the next seven years. But after that, it's anybody's guess.

So one thing I should mention is that your miscellaneous itemized deductions had to meet a certain threshold of your income. So it doesn't necessarily apply to everybody, but your unreimbursed job expenses, such as-- I've listed it on the slide. One thing that could be a common example is union dues, something that people who are union are required to contribute to the union. But they can no longer take that as a deduction.

Another example is investment expenses-- so money you pay in connection with that, tax preparation fees, what you pay your accountant to prepare your filing, fees to fight the IRS. So again, that sort of falls in the same category as tax preparation fees. The idea is you get a deduction in connection with preparing your tax returns.

Another example is hobby expenses. I found this interesting. I didn't know what that meant. And I never heard of this as a possibility. An example is somebody who's a coin collector. Let's say they have coins. They sell them on the internet, on eBay.

They must report that income under the old tax law, but they were entitled to take deductions for the expenses associated with that income. So if you took a booth at a convention or a fair, you would be entitled to deduct that from the income you generated by selling things at that fair. Now, you have to report the income that you generate from your hobby, but you're no longer allowed to deduct the expenses.

Because of the increases and changes to the itemization rule, the result is going to be that people who previously itemized deductions will now claim the standard deduction instead. So the idea is that there'll be a simplification of the code for many people.

So what are the impacts on matrimonial practice, now that we've covered the basics of the tax code as it impacts individuals? The big picture is here. Taxes are no longer deductible for the payor of alimony, and it's no longer considered income to the recipient. So we'll go through that.

The new rules-- unlike what we've just reviewed, the changes to the individual tax rate-- don't take effect until next year. This isn't true for the other provisions we reviewed, and the question becomes, why? In one respect, it's sort of a benefit to people who were divorcing at the end of last year and didn't see this change coming because it gives them an extra time to sort things out and, hopefully, come to an agreement on terms of a settlement.

I actually was doing research on this, trying to figure out if there were any viable theories as to why they had done this. I've just given you a theory. But somebody's positive that there were a lot of Republican senators plotting divorces in 2018, so the idea was we can get it in under the wire.

I have the statutes here, the revised code that took effect in December 22 of last year. This is the definition of a divorce or separation agreement. And this will be important when we come to the types of marital contracts that we're going to cover later in the presentation. But this is the provision of the code which applies.

The next slide shows the definition of alimony or separate maintenance payment. Now, in New York, we use the term "maintenance." Alimony, it's an interchangeable term. I think other states may prefer to use "alimony." That's probably more familiar to people, as a general rule.

This is the provisions of what defines alimony. The big one is that they have to not be members of the same household when the payments are made. And there is no liability to make any payment after the death of the recipient, or there's no liability to make any payment as a substitute for such payment after the death of the recipient.

Now, this is the interesting part. The amendments made by the section shall apply to any divorce or separation agreement-- as defined two slides back-- executed after December 31, 2018. So again, this gives a little cushion for people who didn't see this change to the deductibility of alimony coming.

There's also a second example, which I think would probably not apply, or less likely to apply. If you execute an agreement before the end of 2018 and modify it after, provided you say that the amendments apply to the modification, the new law applies. So the idea is that it's not necessarily retroactive but going forward.

So what was the old law? To qualify as deductible alimony, the following requirements had to be met. The spouses don't file jointly. The payment must be in cash, as opposed to some kind of in-kind distribution of securities, for example. The payment is to a spouse or former spouse pursuant to a divorce or separation agreement.

The instrument designates it as alimony or maintenance specifically, as opposed to equitable distribution in equitable distribution states or some other kind of payment-- child support payment, for example. There's no liability to make the payment after the death of the recipient. And it's not treated as child support or a property settlement.

So that's related to what I just reviewed. Child support is not deductible for income tax purposes. Certainly as a matrimonial practitioner, I liked the old treatment better, mostly because I'm familiar with it. But I think it's also been in place for a long time.

But what was the rationale of the old law? The effect was that it allowed a transfer of money from the spouse who has a higher tax bracket to a spouse that's in a lower bracket. Of course, this assumes that there is a spouse, the payor of alimony, that makes more money and is in a different tax bracket than the recipient of the tax code.

Effectively, there is an arbitrage, which allows the higher-earning spouse who's paying alimony to his or her ex-spouse, whereby there's a tax advantage. The effect of this-- the other effect-- was that we could structure settlements to take advantage of this tax treatment.

So the payor could deduct the payments, and the recipient winds up getting more money because the payor has more income. In other words, you could afford to give the alimony recipient more money because the payor had the benefit of taking that money as a deduction.

Under the new law, which, with respect to this provision, goes into effect after December 31, 2018, you're no longer entitled to deduct alimony payments made to your spouse or your ex-spouse. And it no longer requires the recipient to report the income for alimony that he or she receives.

SANFORD SCHLESINGER: That's for agreements dated after that date, right?

NICHOLAS COHEN: For agreements stated after that.

SANFORD SCHLESINGER: After December 31, 2018. So it's not separations. It's not divorces. It's the date on the agreement.

NICHOLAS COHEN: For the most part, yes. I guess the one wrinkle I would add is that in some states, you sign a separation agreement, and then the court has to order it. So there may be a lag. I think it's something to consider. You need an order in certain states in order for the separation agreement to be valid.

So again, the payments under existing orders and agreements are grandfathered. They can continue to be deducted by the payor and reported as income by the recipient.

AUDIENCE: Michael, I have a quick question. So if you divorce in 2018 and you have a divorce decree order signed in 2018, then any payments in 2019 still go under the old law?

NICHOLAS COHEN: Correct. Correct. So that's why there's going to be a rush to get things done. I'll get into it more as we go through the presentation.

SANFORD SCHLESINGER: But it's all in the name of tax simplification.

[LAUGHTER]

NICHOLAS COHEN: Exactly. People structuring settlement agreements, ultimately, it gives them less flexibility, arguably. It's important that, unlike most of the provisions that apply to individuals, these rules are permanent.

So the idea is that, I guess they were trying to offset some of the decrease in tax revenue that was going to be generated, or was going to be a result of the new tax law. And they were trying to offset it by increasing some money that the Treasury could collect.

So why the change? So we looked at the congressional Committee on Taxation for their explanation. And they said it was based on an old law as promulgated in Gould v. Gould in 1917, in which the court held that payments of alimony are not income to the recipient. But this explanation omits the fact that the result in the Gould case was changed by statute in 1942. So the law that's been changed was in effect for 75 years notwithstanding the Supreme Court holding in Gould.

SANFORD SCHLESINGER: But this Congress was the first to discover it.

NICHOLAS COHEN: That's right. So why the change? I mean, one obvious explanation is the federal government was losing out on revenue. Interestingly, and perhaps not surprisingly, the alimony recipients have not been as true as the payors of alimony in that they haven't been consistently reporting it as income.

So the recipient would get $100,000 under a divorce agreement or order. They were supposed to report it as income and, therefore, it would reduce the money available to them.

But they did some analysis. And the truth is everybody who was paying alimony was reporting the deduction, was taking advantage of the deduction. But not everybody receiving alimony was reporting it as income.

So the estimate for 2015 was almost $1 billion in lost revenue, which may sound like a lot. But keep in mind what we're talking about in terms of a tax cut. It's a $5 trillion bill. So this seems, in the scheme of things, to be not a particularly big pick-up, as they might say.

So the rationale continues. There was a lot of thought and there was discussion that, effectively, the old tax treatment of alimony was effectively a divorce subsidy and that a divorced couple who has a certain combined income can achieve a better tax result than a couple who's married. So the provision, according to the House Ways and Means Committee, was to rectify that and provide that spousal support should have the same tax treatment as the provision of spousal support within the context of a married couple, as well as child support, which, as I mentioned, is not tax-deductible to the payor.

Again, the problem is that you've got to think about it realistically. There are additional expenses that two people living in separate households have that an intact couple doesn't. So housing expenses is the most obvious. The recognition in the old tax law was that you have the same pot of income, but you have more expenses, so let's try to structure something that works to everybody's advantage.

However, under the new code, the idea is that you're married, you pay taxes on your income, and then you and your spouse get to spend it. So why shouldn't the same treatment be true for divorced couples? It's essentially treating it as a gift, as opposed to the old law, which was treating the alimony as a split of the pot of money into two income streams.

AUDIENCE: It it's a gift, does it use up the annual [INAUDIBLE]?

NICHOLAS COHEN: I don't believe so. I don't believe so. I'm using it as analogy. Well, is your question--

AUDIENCE: Is the payment of alimony now a gift--

NICHOLAS COHEN: No.

AUDIENCE: --from one unmarried person to another?

SANFORD SCHLESINGER: No. It's a legal obligation.

NICHOLAS COHEN: Yes. That's correct.

SANFORD SCHLESINGER: It's still a legal obligation. It may not be income tax-deductible or income tax-includible. It's income tax-neutral, actually, but it's not a gift. Because I certainly don't think there's donative intent.

[LAUGHTER]

NICHOLAS COHEN: So again, in view of these realities, some people started asking questions as to why there was this change, which, as I've said, is relatively minor in the scheme of things. And here was Kevin Drum, who writes in-- Mother Jones is, I guess, a left-leaning publication.

He says, "The only thing I can come up with is that evangelicals think that the current law encourages divorce, which they disapprove of. Maybe more people will stay married if they realize they're going to have to support two separate households on the same amount of money as before." Again, it's just a theory. Yes, sir?

AUDIENCE: I'm not sure I agree with your statement that a $1 trillion increase in taxes is a drop in the bucket of a $5 trillion--

NICHOLAS COHEN: Sorry, it was $1 billion. The question relates to the amount of money that the Treasury estimates it will pick up as a result of this change in the law being-- if I misspoke, it's about $1 billion estimated. So we've got a $5 trillion tax cut. So do the math. It's a relatively small-- a very relatively small-- percentage.

SANFORD SCHLESINGER: What's $1 trillion among congressmen?

NICHOLAS COHEN: Correct.

AUDIENCE: A billion here, a billion there.

NICHOLAS COHEN: So the problem with the new law, as I mentioned, is there's just a less pot of money to divide. Assuming, again, that there's a disparity in the marginal tax rates of the couple, or ex-couple, the payor's income is still taxed at that higher rate. There's sort of a trap here.

Most states-- New York and Pennsylvania do, for example, I don't think New Jersey does-- but there's a formula that states apply to come up with a presumptive amount of alimony or maintenance that the payor is obligated to provide. Now, again, it's presumptive, so it's not necessarily applied. And particularly with high-income individuals, the court has discretion to depart from it.

In New York, the cap on income that the court will consider for purposes of running the formula is $184,000. So a lot of people, in Manhattan particularly, make more than that. So the courts have the ability to adjust the numbers and look at the guidelines but not necessarily follow them. But the guidelines aren't necessarily accounting for this new tax treatment.

So what's the impact? Well, I think that one of the big things is there's just going to be less alimony awarded. So that certainly hurts the recipient. But it hurts the person who's paying, too, because it hits them a lot harder if they're paying $100,000 that's tax-deductible, as opposed to $100,000 that they have to pay taxes.

I think if you litigate a case, hopefully, courts will take account for this in fashioning an award to account for the increase in the payor's liability. But we don't know what's going to happen. I did some research, and this is all so new, I'm not aware of any case law, at least in New York, with respect to how they're going to treat, how they're going to count.

What I can tell you is that one of the factors in New York that courts are obligated to consider when making an award of spousal support is the tax consequences to each party. So there is a method by which a New York court can account for this new tax treatment and make a departure from the guidelines. Other states may have different rules, in which case, if they're applying rote guidelines, the result may be different than what was the intention.

I guess I should mention that there are some potential ways that courts, if they're not considering the tax treatment, they can award alimony for less time, a shorter period of time. But again, that hurts the recipient of alimony. The state formula in New York considers your gross income, not your after-tax income. So the result is that it's going to become harder to apply it, or apply it fairly.

So on the next slide, I've done an example of what the impact of this new law would be on a couple that divorces under agreement that takes effect after 2018. We're assuming that there's $500,000 in wages, that there is income to each spouse in investment income of $12,500. And we're going to use the new standard deduction for single filers.

So let's go to the next chart. You'll see the column on the left, if alimony is deductible-- taxable at federal level-- that's how it used to be. And then on the right, it explains how it is now.

So you'll see that the payor, who was earning $500,000 plus $12,500, was paying $107,000 in federal taxes, while the recipient was paying about $28,000. Now, under the new law, the same person who is earning $512,500 is now paying $154,000. And the recipient, who's getting the benefit of $125,000 in alimony payments, is paying $450 in taxes.

So it evens things out for those purposes. The net impact on the Treasury is $18,000 of pick-up-- increase in revenue that they can count on. So this is a couple who makes a half million dollars or so. And $18,000 is not an insignificant amount of that money. So there's a real impact on people who are trying to get divorced.

So what can you do when you're structuring agreements going forward to mitigate the effects of the new tax law? I believe that there is less flexibility because the old law was sort of a win-win. There was more money for the recipient to receive because the payor was able to take advantage of the tax deduction.

So we'll review the types of marital contracts-- settlement agreements, prenuptial agreements, postnuptial agreements, and separation agreements. In New York, I'll mention that separation agreements are sort of a thing of the past. They're used synonymously with the term settlement agreement.

When New York had fault laws, you alleged fault in order to obtain a divorce. One way you could avoid having to make allegations of cruelty or adultery or abandonment was to execute what was known as the separation agreement. And after a year of living pursuant to that agreement, you could convert it into a divorce. So that was a way to avoid the ugliness of some complaints, somebody filing a verified complaint that says how horrible their spouse was.

But let's start with settlement agreements. I'm sure people are familiar with them. They lay out the terms of the divorce-- the property division, spousal support, if any, custody if there are children, child support, debt division, and any other financial or marital issues. So what are your options, in light of the elimination of the tax arbitrage that we used to have?

You could decrease the child support awarded to the recipient of the alimony, assuming that they are, in fact, responsible, or the custodial parent. This could be difficult to achieve in front of a court. There are guidelines that I think every state has. In New York, they've been in effect since 1989. The federal government, I believe, insisted that they be put into place for child support in order to obtain money for social services from the federal government.

So to give you an idea of how important it is in New York, if you reach an agreement on child support, you are required to put language-- and it can take pages of an agreement-- that says I'm acknowledging what the child support guidelines would award in this case, but I'm knowledgeably and knowingly departing from those guidelines in favor of the current agreement because of XYZ reasons-- because I have capacity to earn, because we exceeded the cap, or similar explanations. But the point is that the court specifically required that everybody who's executing an agreement be made aware of what the child support guidelines would provide.

And the same thing if you reach an agreement in non-litigated cases. Let's say you are able to reach an agreement, and you just go to the court to get it rubber stamped so that you can get a divorce without a fight. A court is still likely to look at the award of child support for fairness. So that's something to keep in mind. Although it's an option, it may not be particularly appealing to courts.

A second option is simply just to award less equitable distribution to the recipient of the alimony. So the equitable distribution, which applies in most states-- in every state but the community property states-- is the idea that marital assets-- assets and earnings acquired during the marriage-- are divided fairly, or equitably, at divorce.

So this doesn't necessarily mean equal. But it takes into account each party's respective contributions to the marriage, including child-rearing, supporting somebody's career-- if there's a homemaker, for example. And it's just based on what the assets are in most states.

But in Connecticut, for example, who's at fault may be a factor in deciding what's equitable, as far as an award of the assets. So who cheated on who may be something a Connecticut court might look at.

A third idea is to adjust the distribution of a retirement account. One option that divorcing couples have is to transfer portions of a retirement account that's titled in one spouse's name into another spouse's name. So you're not penalized from a tax perspective when you do this.

In addition, there's potentially some tax arbitrage because the person who's got the retirement account in his or her name is shipping off an account that they would have had to pay higher taxes on than the person who's receiving the IRA or retirement account, assuming they're in different tax brackets. So it's a way to potentially arbitrage, as I've said before.

SANFORD SCHLESINGER: Nick, two questions.

NICHOLAS COHEN: Yes. Sorry. Yes, sir?

AUDIENCE: If you do the IRA technique-- I don't quite follow it. So if the payor spouse gives to the payee spouse the IRA account--

SANFORD SCHLESINGER: Or any pension, right?

NICHOLAS COHEN: Correct. A retirement.

SANFORD SCHLESINGER: Undo a QDRO? Would that be--

NICHOLAS COHEN: A QDRO would be, I think, a 401(k). But an IRA you don't-- it depends on the plan administrator.

AUDIENCE: And the tax is payable by the payee spouse only?

NICHOLAS COHEN: There's no tax-- the question is--

AUDIENCE: Or the money's withdrawn from the account?

NICHOLAS COHEN: The tax is only paid when it's withdrawn.

SANFORD SCHLESINGER: The question was, is it a taxable event when you transfer a pension benefit from spouse A, whose pension it is, to spouse B, who's the recipient?

NICHOLAS COHEN: The answer is no. The income taxes are only paid when there is money taken from the account.

SANFORD SCHLESINGER: That is not a taxable event. But the person receiving it has the same tax consequences, ostensibly, as the one who gave it.

NICHOLAS COHEN: Is there a second? Yes, sir?

AUDIENCE: Could you structure a settlement agreement in such a way that the paying spouse is paying, let's say, expenses of the payee spouse that would otherwise be deductible but for the fact that, I guess, it would be another way of paying alimony but not calling it alimony? In other words, if the paying spouse is going to pick up the mortgage of the payee spouse, he or she would normally have an income tax deduction, putting aside everything else with the change in the law. Or is it because it's an obligation it's not available for a tax deduction?

NICHOLAS COHEN: The question is whether somebody, in lieu of paying maintenance in cash or money order or check, whether they can pay expenses on behalf of the recipient of the alimony. And the answer is no because of the requirements that alimony, A, must be made in cash directly. So it would be a clever way to sneak around, but it's not going to work. Yes, sir?

SANFORD SCHLESINGER: Excuse me. One, your example I don't think meets the definition of alimony. But now, if we're divorced and I voluntarily pay your expenses, guess what that's called? A gift. At that point, we do have a gift.

NICHOLAS COHEN: Yes?

AUDIENCE: Can the paying spouse create a trust for the benefit of the children to get around the child support and make [INAUDIBLE]. He might lose his exemption but he might want to be willing to do that anyway.

NICHOLAS COHEN: That's more of a question for Sandy.

SANFORD SCHLESINGER: Thanks a lot. I don't know whether you can satisfy support obligation with a trust. No, I know this definitively. The answer is yes if the court will so order it. In other words, you can create a trust, I think, to satisfy a support obligation, as long as the terms of the trust satisfy what would be the support obligation.

NICHOLAS COHEN: Sorry, yes?

AUDIENCE: On this question, so if one spouse has an IRA or a 401(k) and, prior to the divorce being finalized, that spouse transfers a portion of his or her retirement account into an exact same kind of account for the other spouse, there's no tax consequences on either way? The giving spouse, that's not a taxable event to him?

NICHOLAS COHEN: Correct. The question is if there's a payment made in-kind of a retirement account from one spouse to the other, does the person who's doing the transferring have to pay tax on it?

AUDIENCE: Does the recipient spouse, whenever that person takes the money out, would have the same tax--

NICHOLAS COHEN: Correct. Correct. So this is an option, the transfer of a retirement account when you're dealing with older people, or people over 59 and 1/2, who have the ability to withdraw from IRAs without penalty. But if you have people who have not obtained that age, you're not going to get the benefit of an income stream immediately.

So that's one of the issues. It's a 10% penalty for an early withdrawal. So if you need cash immediately, it's not going to work. But at the same time, if somebody can afford to wait and hold off on receiving the money, they can enjoy the benefit of the tax-deferred growth within the account over time. And then, when the withdrawals become available without a penalty, they then have an income stream. So let's talk about prenuptial agreements, which are problematic under the law.

SANFORD SCHLESINGER: How many of you do prenups? OK. Quite a few.

NICHOLAS COHEN: OK. Well, this is particularly important. So it's not covered by the grandfather provisions in the new tax code. So let's say you got married in 2017. You negotiated spousal support, equitable distribution, how a family business might get treated.

You assume that that alimony would be deductible to the payor and taxable to the recipient. So there were assumptions. You made adjustments in the negotiation terms to account for that. And again, it offered a tax advantage treatment.

But now, if you get divorced in 2019, you can't override and can't contract around the law. So you have to consider revisiting. Not all prenups have spousal maintenance or alimony provisions.

But sometimes you leave it. You say, OK, we'll reserve that and leave it up to a court based on income. But it can be a problem for people negotiating under one regime and suddenly find themselves operating in a new regime.

So what do you have to do in that case? You can try to revisit and renegotiate the agreement, the prenup, thereby creating a postnup. But it can be a tough conversation to have with your spouse-- hey, we agreed on something, it turns out under the new tax law that I'm getting the short end of the stick, and you're getting a benefit that we never envisioned would happen-- that's a tough conversation.

SANFORD SCHLESINGER: Nick, that is the understatement in the history of the Western world. I see half the people out there smiling and shaking their heads. It's hard enough to negotiate a prenup when the incentivization is you're going to get married. A postnup is usually, in my experience, a prelude to a divorce, OK?

And now, I come here and say, we're now going to renegotiate in contemplation of tax reform. And the spouse says, why don't we wait till January 1, 2026 and see what happens? You know who spoke to a lawyer.

NICHOLAS COHEN: That's exactly the point. There's also other issues that postnups-- financial disclosures have to be included, for the most part, because of a fiduciary duty between spouses, whereas with the prenup, that's not necessarily the case.

A postnup, like a prenup, can't be written on the back of a napkin, so you have to get lawyers involved. You have to get it notarized and acknowledged. So it's not an easy conversation, and it's not going to be easy to accomplish.

Again, I should note that if you're in a postnup or prenup context, you cannot contract or make child support obligations in advance of your marriage or during your marriage. That's something the courts, at least in New York, have to decide. So you can't go in and do a postnup and say, we have two kids. I'm going to pay you X dollars in child support. That's something that's deferred to the court.

So a postnuptial agreement, which we covered, is after marriage. So why do people do postnups? Do people in this room do postnups? The same people who do prenups do postnups? Yes. OK. Why do they happen? It seems sort of like an odd thing to be talking about contemplating divorce after you're married, assuming you're in a happy relationship.

SANFORD SCHLESINGER: Ah.

[LAUGHING]

That's the assumption.

NICHOLAS COHEN: Yes, exactly. Sometimes it could be that one partner had an affair, and it's sort of a make-up payment. There could be somebody inheriting assets or a business, or a liquidity event that is nearest to one spouse's benefit, and they want to protect that.

I've heard of examples where a family is transferring a closely-held business to the second generation, and they insist that the second generation execute a postnup in order to protect it from the spouse. So it's a precautionary measure in that regard.

It could be a change in job. One spouse, you negotiated a prenup, and you assumed certain income would be the case. And somebody changes jobs and suddenly is making a lot more money or quits working on Wall Street to do something that pays significantly less. So maybe they'd want to revisit their obligations.

Or if a couple has children and they're both working prior to the children, one of the spouses may say, hey, I want to stay home. I'm giving up my career, or at least, for the short term, giving up my career. My earning potential will be less as a result. Let's have a postnup so I can make sure that I'm provided for in the event of divorce.

This slide covers what I've already covered there. There's a fiduciary duty between spouses. They'll be more closely scrutinized, and you cannot contract around the new tax law in a postnup. So you have to figure if you're doing a postnup today, assume you're going to hang in there for four months and negotiate on that basis.

The last marital contract is a separation agreement. If you execute it before the end of the year, you can take advantage of the old tax treatment. This is an alternative to a divorce. Sometimes couples are figuring out what they want to do, but they don't want to live together, at least until things settle.

But you remain married, and you can't go out and find a new spouse. Maybe you can have a girlfriend or a boyfriend, but you can't go to town hall and get married. But you can settle all of the financial issues like with a divorce.

The last topic I'm going to talk about is business valuations. And I imagine as trust and estate lawyers, it's something you run into, as well. In a divorce, if one spouse owns a business, the other spouse who's non-title can nevertheless have a claim to a portion of the value of that business. And even though they haven't worked directly for that business or on behalf of that business, they may have supported the titled spouse during the infancy of the business.

So somebody launches a business. They have no income. It takes a few years to get it off the ground. The other spouse may be working at their old job and supporting the title owner of the business. So this is a make-up, a recognition of that.

Similar with raising children, giving up a career to support a spouse, there are valid reasons-- and plenty of reasons-- why in a divorce, a spouse who is not part of the business, or an owner of the business, will get a portion of the value. So most likely, I should mention, they're not going to split the business between two spouses under the rationale that if you can't stay married, you can't be business partners. But who knows?

So what impacts the value of the business? It's the reduction in the corporate tax rate, which, for the most part, most of the changes are permanent. Here, I have a slide which shows the old tax rates, which shows that for most mid and large corporations, the highest tax rate was 35%. However, now, the corporate income tax rate has been reduced. It is now at a flat 21% tax rate.

So unlike the individual provisions of the tax law, this is not a temporary change. So it's good for business, I guess. So the idea is that you now have a more valuable business to distribute. And we'll talk about how to figure out how valuable the business is in a second.

But what's estimated to be the result of this change is that there's a 15% to 20% enhancement of value in the business interest. So there is suddenly more money available to distribute and more to fight about, unfortunately.

Some postnups and prenups have a formula in advance of a divorce setting forth how evaluation is going to be done. So if you used that formula two years ago before you knew about the corporate tax rates going down, somebody may luck out. Again, you can revisit it, I suppose, just like anything else. But it's going to be an awkward situation.

The other issue that relates to the tax rate is how are you going to model and do evaluation? I think the takeaway is you have to talk to an evaluator about what method they're going to employ in valuing the business. I think, most likely, you're going to see not an income-based but instead a discounted cash flow analysis.

There are also, I should mention, some sunset provisions in the corporate tax code-- phasing out depreciation, for example. So you're going to have to make some assumptions in connection with this model. Because the law, as much as the tax cut has been permanent, may change. So this is an important consideration for matrimonial practitioners, as well as people who are doing T&E.

So I guess the takeaway is you should advise your clients, or if you know somebody who has a prenup or a postnup, that if their agreement has support provisions, you should advise them to revisit them and consider what the impact will be on their existing agreement, or what they thought they were giving up and getting under an old agreement and how that's going to change going forward. And even if they don't account for support provisions, you may want to take a look to account for the fact that other provisions are premised on the prior tax treatment.

And I guess the biggest takeaway is try to get settlements done this year. It's going to be a busy few months for matrimonial practitioners who--

SANFORD SCHLESINGER: Notice the smile.

NICHOLAS COHEN: --trying to get-- well, it's good and bad, I guess-- but you're trying to get in under the wire. And it will keep things interesting. So does anybody-- you have a question?

SANFORD SCHLESINGER: Yeah, we have a question online. Can you review the rules relating to what portion of an inheritance received by one spouse during the marriage is considered part of the marital estate absent a pre- or postnuptial agreement?

NICHOLAS COHEN: OK. Well, you heard the question. That would be considered separate property if you inherit money.

SANFORD SCHLESINGER: Unless you commingle it.

NICHOLAS COHEN: Subject to a lot of qualifications. But my advice, if you're inheriting some money, is keep it in a segregated account. Do your best to, rather than actively participate in its management, have somebody else manage it for you. Because the other spouse may have a claim to a portion of the appreciation of the inherited assets.

But the last thing you want to do is if you get $500,000 from when your father passes away, to put it in your joint bank account. Because then the money is all mixed up, and you've waived your rights to your inheritance, and your spouse is going to have an equal claim to it.

SANFORD SCHLESINGER: Question.

NICHOLAS COHEN: Yes, sir?

AUDIENCE: If you've written a prenup for a client, do you have an obligation to now tell him that there are problems?

SANFORD SCHLESINGER: That's a good question. Well, the question is, if you've done a prenup or a postnup, do you have an obligation to tell your client of the change in the law?

NICHOLAS COHEN: I don't know the answer--

SANFORD SCHLESINGER: Beth, do you have a--

AUDIENCE: --question whether that person is still your client was enough to let you--

[INTERPOSING VOICES]

SANFORD SCHLESINGER: Yes, Beth, we have to go back to yesterday's lecture on ethics. And the question is, have you terminated your relationship with your client? By the way, if you do it for one client, you better make sure you do it for every prenup or postnup you've drawn. I think it's very dangerous stuff here.

NICHOLAS COHEN: Most of our retainer agreements for prenups will say, or should say, that the relationship terminates upon the execution of an agreement. So that would eliminate the need for alerting everybody whose prenup you've written in the past 30 years.

SANFORD SCHLESINGER: We're trust and estates lawyers. Our rules for retainer agreements are very different from theirs. If you don't have it-- am I correct?-- if you don't have a retainer agreement, you're in trouble.

NICHOLAS COHEN: That's right. You have to have a retainer agreement. You have to have a statement of clients' rights.

SANFORD SCHLESINGER: I mean, there are very strict rules for matrimonial lawyers. We should have retainer agreements. But it's my understanding if you don't have one, your claim is for your fees in quantum meruit is the-- it's not what matrimonial lawyers have. Because matrimonial lawyers, historically, had very serious conflicts of interest between the spouses and stuff like that. So in the last few years, very, very strict rules on retainer agreements.

NICHOLAS COHEN: Correct. Any other questions?

SANFORD SCHLESINGER: OK. Thank you very much, Nick.

NICHOLAS COHEN: All right. Thank you.

[APPLAUSE]

SANFORD SCHLESINGER: OK. I saved-- unfortunately, I guess-- a very complicated subject, a very important subject, for last. Because it's income taxation of trust and estates, which has really become a very significant subject. Very good. Thank you.

One thing I wanted to repeat before people start running for the breaks-- just one minute-- it's very important that we get the reviews for this year. We try, as everybody who's come many times, we try new topics every year, new speakers every year. We listen to what you tell us. We try.

This year, we put on international. We put on matrimonial. Obviously, certain things came off, like life insurance, retirement plan benefits, have come off. There's only 12 sessions.

I would like to know specifically, would somebody like a panel discussion next year on change of domicile, both domestically and not domestically-- because that's come up several times as a tangential issue around here but not as a direct one-- and possibly getting somebody from New York State Department of Taxation and Finance, as long as he or she comes with a bodyguard? OK. So enjoy your break. We'll come back at 3:45. Nice job.

NICHOLAS COHEN: Thank you, sir. Thanks for having me.

SANFORD SCHLESINGER: Oh, my pleasure.

Share
Email

  • FOLLOW PLI:
  • twitter
  • LinkedIn
  • YouTube
  • RSS

All Contents Copyright © 1996-2018 Practising Law Institute. Continuing Legal Education since 1933.

© 2018 PLI PRACTISING LAW INSTITUTE. All rights reserved. The PLI logo is a service mark of PLI.