Today's blog focuses on a unique, Massachusetts-only issue that divorcing couples and their attorneys should be aware of as 2018 rolls on. Here it is: the true deadline for Massachusetts spouses who want to
Include tax deductible alimony in their divorce agreement is Tuesday, October 2, 2018 - i.e. 90 days before December 31, 2018. For spouses seeking an amicable split through a Joint Petition for Divorce, the deadline is even sooner, landing Friday, August 31, 2018 - i.e. 120 days before December 31, 2018.For spouses divorced before these deadlines, alimony will remain tax deductible in their agreements and will continue to be tax deductible even in future modification cases. For those who miss the deadlines, the cost savings associated with tax deductibility will be lost.
A Pointless and Outdated Massachusetts Law Comes Back to Bite with New Alimony Rule
We have written before on this blog about the arcane, antiquated and highly pointless “nisi” rule in Massachusetts, under which divorces do not become “final” for 90 days after the judgement enters and a separation agreement is approved by the court. For those cooperative spouses who avoid litigation by filing a Joint Petition for Divorce, the wait for a “final” divorce judgment is even longer, at 120 days.
As we have previously noted, the “nisi” rule arose in the 1970’s, when laws allowing “no fault” divorce swept the country. At the time, the Catholic church held great sway in Boston, and the idea behind the 90-day “nisi” rule was this: it would allow divorcing couples who wanted to reconcile to effectively cancel their divorce within 90 days, thereby avoiding the more sinful process of divorcing then remarrying each other. From the very start, the rule was all about the label of divorce – and the sins associated with that label – than any substantive issue.
However, in today’s age of common divorce, overcrowded courts, paper-thin state budgets, and self-represented litigants who lack attorneys, the “nisi” rule’s sole impact is to clog the system with confusion and paperwork:
[T]he so-called "90-day Nisi period" is frequently criticized in Massachusetts for being a relic of a bygone era when the state sought to complicate and slow down the divorce process on moral grounds- i.e. "divorce is bad", so the state should make it more difficult to become divorced. Indeed, even if one believes that the state should slow down the divorce process, the Nisi period hardly achieves this goal -- beyond confusing people over their marital status and creating problems with estate planning and tax filing, as people mired in the Nisi period ask themselves, "am I married or divorced?" It cannot be emphasized enough that all substantive orders contained in a separation agreement - child support, custody, the division of assets, etc. - become effective and enforceable upon entry of Judgment of Divorce Nisi. (A person who thinks "I don't have to pay child support because my divorce isn't 'absolute' yet" is simply wrong, and will likely be served with a contempt.)
For most divorces, in most years, the "nisi" rule is merely annoying. In 2018, however, for parties seeking to preserve tax-deductibility in their divorce agreements, the rule poses a clear and present danger, which we explore below.
For Tax Deductible Alimony, Parties' Divorce Must be Final by December 31, 2018
We explored the potential impact new tax reform law in a recent blog. A basic view of the law is as follows:
Following the passage the Tax Cuts and Jobs Act by House and Senate Republicans, divorce practitioners are slowly realizing that the bill will dramatically impact a pillar of divorce across the United States: tax-deductible alimony. Under the new tax bill, newly divorcing spouses have until December 31, 2018, to enter an agreement that includes tax-deductible alimony. For divorces entering after that date, alimony paid will not be tax deductible.
Importantly, the bill will not affect the tax deductibility of alimony judgments entered before December 31, 2018. In addition, alimony will continue to be tax deductible for divorced spouses who modify existing alimony orders, so long as they were divorced before December 31, 2018.
In our blog, we noted that a specific concern for Massachusetts residents is the effective date of the alimony provision, found on Page 100 of the bill:
EFFECTIVE DATE. The amendments made by this section shall apply to:
(1) any divorce or separation instrument (as defined in section 71(b)(2) of the Internal Revenue Code of 1986 as in effect before the date of the enactment of this Act) executed after December 31, 2018, and
(2) any divorce or separation instrument (as so defined) executed on or before such date and modified after such date if the modification expressly provides that the amendments made by this section apply to such modification.
Among the questions we asked in our blog reviewing the tax reform bill was how the "nisi" rule could affect the December 31, 2018 deadline for tax deductible alimony:
The first Massachusetts-specific concern to consider is how the antiquated "nisi period" will affect the effective date of the bill in Massachusetts. As we have noted in our prior blogs on the "nisi period", the Massachusetts legislature has never bothered to change the antiquated and confusing "nisi" rule, where by a typical Judgment of Divorce does not become "final" for 90 days after the Court approves a divorce agreement - or 120 days if the agreement was entered pursuant to a Joint Petition for Divorce.
A closer analysis of the "nisi" rule suggests the news is bad.
When Do You Become "Single" for Tax Purposes After a Divorce in Massachusetts
In our blog about how the "nisi" rule affects post-divorce tax-filing in Massachusetts, we noted that in most cases, the problem of whether an individual is "single" or "married" due to the "nisi" rule is generally not too serious. Indeed, the problem typically only affects Massachusetts residents who are divorced In September or later in a given year, and only impacts the spouses' tax filing status for a single year.
We also noted that the impact of the problem was limited because neither the IRS nor Massachusetts DOR seemed particularly concerned about rigorous enforcement of marital status under the quirky "nisi" rule in Massachusetts:
In practical terms, it is unclear how zealously DOR or the IRS monitor the Nisi period for Massachusetts residents filing taxes after a divorce. If one spouse files "married filing separately" - and lists the SSN of his or her former spouse - this could certainly create a red flag the other party filed individually for the same year. Conversely, if DOR or the IRS initiates an audit, the question may be asked: when exactly did you get divorced?
That being said, there is a right and wrong answer to when divorced spouses become "single" for tax purposes in Massachusetts. Way back in 1988, the Massachusetts Department of Revenue addressed the question in its unremarkably named Directive 89-3: Filing Status; Divorced, which provided:
In Massachusetts, judgments of divorce are initially issued as judgments nisi, temporary in nature, which generally becomes absolute after 90 days unless the court orders otherwise. G.L. c. 208, § 21.
While the judgment nisi is a judgment of divorce, that judgment does not change the marital status of the parties, Sheffer v. Sheffer, 316 Mass. 575 (1944), and the marriage remains in force for 90 days until the judgment nisi becomes absolute. Ross v. Ross, 385 Mass. 30 (1982). Consequently, the "decree of divorce" referred to in G.L. c. 62, § 1 (g) is the absolute judgment, not the judgment nisi.
Since the material (and tax) status of a divorced or divorcing individual depends on the nature of the judgment of divorce in effect at the close of the tax year, if the judgment nisi is in effect at that time, the taxpayer is married and must file either jointly or as married filing separately. If the judgment nisi has then become absolute, the taxpayer's filing status is "single".
In short, until your Massachusetts judgment of divorce becomes "final" - after the expiration of the "nisi" period - you remain married under Massachusetts law. And because marital status for tax purposes is a function of state marriage/divorce laws, this means one's federal marital status for tax purposes also does not become single until after the "nisi" period has run.
Why the “Nisi" Problem is a Big Deal in 2018 that Divorcing Spouses Should Not Ignore
As noted above, in most years, the problem of marital status for Massachusetts spouses who get divorced late in the year is relatively minor. If an individual who was divorced in December indicates "single" on their return for that tax year, the worst they face is if the IRS or DOR caught the problem they would need to amend their return to either file jointly with their former spouse or "married filing separately" for the year in question. If the individual ran into other tax problems, it is possible that the IRS or DOR might take a closer look at the marital status for that year. This was not a problem that practitioners commonly heard about.
It cannot be emphasized enough: 2018 is very, very different.
Here's why: If two spouses' divorce is "final" on or before December 31, 2018, that means that alimony will be permanently tax deductible for the individual and/or their former spouse. In many cases, this means that years of alimony payments will be made after the divorce. Hundreds of thousands of dollars in alimony may be deducted by the paying spouse in the years following the marriage, while the receiving spouse pays taxes on the same hundreds of thousands of dollars. If the same two spouses' divorce becomes "final" on January 1, 2019, then none of the alimony payments are tax deductible.
Simple question: What happens if the IRS discovers that an alimony payor has been improperly deducting alimony payments - to the tune of hundreds of thousands of dollars in deductions - over the last ten years? Answer: Very bad things.
There are lots examples of "alimony tax deductions gone wrong" in other contexts. Here are just a few:
What happens if a former spouse tries do deduct "extra" alimony payments that were not specified in a divorce agreement? The former spouse must pay back taxes (not to mention interest and penalties) when the issue is discovered by the IRS.
What happens if a former spouse prepays alimony before it comes due, then seeks to deduct the alimony? Deductions for premature payments may be rejected by the IRS, resulting in back taxes owed.
What happens if a former spouse falls behind on alimony, then makes a lump-sum payment in exchange for the termination of alimony under a complaint for modification? The IRS might consider lump sum payment as tax deductible, if the lump sum payment was less than the arrearage owed.
What if alimony payments are recharacterized as child support by the IRS/DOR? There are a variety of rules prohibiting parties from substituting tax-deductible alimony as child support that are set out under 26 U.S.c. § 71(c). If the IRS/DOR decides a former spouse's alimony payments were really child support, the paying spouse might not just owe huge back taxes - the recipient spouse might be entitled to an equally huge refund for all of the taxes he or she paid on the support over the years.
What about the so-called "alimony recapture rule"? Three years after a divorce, the paying spouse can have all of their alimony deductions rejected by the IRS or DOR if (a.) the payments made in the 3rd year are $15,000 less than the payments made in the 2nd year, or (b.) payments made in the second year and the third year are substantially less than the payments made in the first year. While there are some exceptions to the rule, those who receive a notice for alimony recapture often face a terrifyingly large bill for back taxes.
The Nightmare Scenario: Discovering Your Alimony Was Not Tax-Deductible Years Down the Road
It is easy to see why the 2018 deadline for tax deductible alimony is so dangerous. Imagine the scenario. It is mid-November, 2018. You are midway through a divorce where you know that you will end up paying alimony. You read online that starting on January 1, 2019, alimony will no longer be tax deductible.
You check your tax bracket, do the math, and realize that the loss of deductibility will increase the cost of alimony payments in a huge way, leaving significantly less money for both you and your soon-to-be former wife. You hustle to reach an agreement and appear before a judge on December 15, 2018. You agree to pay $60,000 per year in alimony at a rate of $5000/month. The agreement is final, the judge declares you are divorced, and no one explains the significance of the moment when the judge says, “your divorce will be final in 90 days. There is nothing else you need to do, this will happen automatically. Good luck to you." After leaving court, you make sure to make your first $5000 in December, just to prove you beat the 12/31/18 deadline if anyone ever asks.
In the years that follow, you pay alimony diligently based on the terms of the agreement. But then something unfortunate happens. A clever agent at the IRS or DOR realizes that Massachusetts has this quirky “nisi" rule that means that anyone divorced after September 2018 (for joint petitions) or October 2018 (for complaints for divorce) was not eligible for tax deductible alimony because they technically did not become divorced until 2019.
Our clever IRS/DOR agent knows there was a nationwide scramble in late-2018 as divorcing spouses everywhere rushed to enter agreements before the December 31, 2018 deadlines. They begin examining tax returns and quickly identify every Massachusetts tax payer who began deducting alimony payments in 2018. (Our agent is smart. She realizes that she can even determine when a taxpayer probably started paying alimony in 2018 by comparing the alimony deducted in 2018 versus the amount deducted in future years. If a payor deducted $5000 in alimony in 2018, then went on to deduct $60,000 in alimony for the next three years, our agent feels confident that the tax-payer made his or first alimony payment in December of 2018.)
Five years have passed, and you have paid $305,000 in alimony, and deducted the same amount. Meanwhile, your wife has received $305,000 in alimony and paid taxes on this sum as ordinary income in her much lower tax bracket.
One day, you receive a notice. The IRS/DOR wants a copy of your Judgment of Divorce and Separation Agreement to verify your eligibility for tax deductible alimony. Then the nightmare begins. You look to your former wife for help, but you quickly learn that she has also heard a rumor: that she might be entitled to a large refund for taxes she paid over the last five years on your alimony payments. You turn to the court for help, but the judge says he or she cannot turn back time. Maybe you receive a modification on your future alimony - in consideration of your new tax bill- but then again, maybe not. Meanwhile, the IRS/DOR sends a second notice, this time calculating your interest and penalties, which nearly double the amount you owe.
What Might Change Between Now and December 31, 2018 in Massachusetts?
This blog is, by its very nature, speculative. The nightmare scenario I describe might not come to pass for a variety of reasons. For example, although DOR addressed marital status under the “nisi rule" in Directive 89-3, this was written in 1988 and has hardly been subject to rigorous scrutiny since. The "nisi" rule has been an inconvenience for years, but never a huge problem. Perhaps the DOR and/or courts might reinterpret the rule, given the unique circumstances faced by divorcing spouses in the Commonwealth.
Another possibility is that the legislature will eliminate the highly pointless “nisi" statute, G.L. c. 208, § 21, and will amend the joint petition statute, G.L. c. 208, § lA, to eliminate the equally pointless 30-day waiting period for joint petitioners, during which the judge (supposedly) grapples with whether the parties really mean they want to be divorced. Of course, there are few activities more pointless than hoping that Massachusetts legislature will change a pointless law.
Only last month, State Senator William Brownsberger (D-Middlesex) arrogantly killed an alimony reform bill without allowing a vote, even after the bill unanimously passed the Massachusetts House. This is the state where adultery by a married person - something generally ignored by most probate court judges in divorce cases - is still punishable with prison time as a felony in a dusty state statute, no one has bothered to change. Indeed, we are talking about the same state - which prides itself on inclusiveness and liberal toleration - that still criminalizes sodomy between consenting adults as a "crime against nature" that is punishable "by imprisonment in the state prison for not more than twenty years" (The fact that the statute’s language has never been changed, despite this 1974 case calling it unconstitutional as written, doesn’t help the legislature here.) Sex between unmarried adults also remains illegal in Massachusetts, as is blasphemy.
(The man in charge of repealing outdated morality laws in Massachusetts? You guessed it, Will Brownsberger, who recently told MassLive, “Certainly these laws do tie into values, so changing them can get people excited.” Not exactly a brave voice for change, I think we can agree.)
In ordinary times, counting on the Massachusetts state legislature to fix an outdated law is an exercise in futility. Of course, this being Massachusetts, it is always possible that the legislature may act if sufficiently motivated. Given the zeal with which the legislature appears to dislike the tax reform bill recently passed by DC Republicans, perhaps changing the "nisi" law can be recast as an attempt to "counter" the negative effects of the GOP tax bill on Massachusetts constituents.
This sounds like a stretch, I know, but if it gets the job done ...
Final Thoughts: Deadline Affects Future Alimony Payments Too
Assuming no legislative miracles occur, I will leave you with this thought: the December 31, 2018 deadline does not only effect current alimony payments. The deadline also affects the tax deductibility of future alimony payments. For example, many long-term marriages result in agreements that do not include any current alimony because, at the time of the divorce, all of the parties' incomes are being used to calculate child support. After the children are emancipated, however, a former spouse may file a Complaint for Modification seeking alimony.
Parties whose divorces are "final" before January 1, 2019 are eligible for tax deductible alimony in the future (i.e. after filing a modification), even if there is no current alimony order at the time of the divorce. In short, if there is any possibility that alimony might ever be paid following your divorce, it could be worth accelerating your settlement timetable to beat the fall deadlines that will start hitting even before the summer of 2018 comes to a close.
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About the Author: Jason V. Owens is a Massachusetts divorce lawyer and Massachusetts family law attorney for Lynch & Owens, located in Hingham, Massachusetts.