The Tax Cuts and Jobs Act, (The Act), has brought with it many changes that impact all taxpayers. One of the provisions of The Act that may impact many Americans is the new legislation that repealed the alimony deduction after 12/31/2018. Most people understand this provision as it relates to alimony, divorce, and the income taxation of same, but there is another potential impact of the Act that relates to divorce that people should be aware of.
Grantor trusts are frequently used in marital planning and divorce situations. In such situations, one spouse, let’s refer to him or her as the “donor spouse,” sets up an irrevocable trust for the benefit of the other spouse, let’s call him or her the “donee spouse.” During the time of marriage, the grantor, or the “donor spouse,” may hold a “power or interest” in the trust, that for tax purposes, the donor spouse to be subject to the grantor trust rules under IRC sections 671-679. The application of these rules require that the donor spouse is subject to income taxes on the trust income.
However, prior to the Act that changed if the couple is was divorced. Section 682(a) of the Internal Revenue Code, provided that if a grantor created a grantor trust for his or her spouse, then upon legal separation or divorce, the income would be taxed to the recipient, or the donee spouse.
Unfortunately, whether intentionally or by oversight, Section 682 was also repealed under the Tax Cut and Jobs Act for any divorce or separation agreement executed after 12/31/2018.
For trusts that were created before the repeal of 682, the IRS issued Notice 2018-37, which made clear that section 682 will continue to apply to couples who divorced on or before December 31, 2018.
What Happens With Trusts If the Divorce Is Granted after December 31, 2018?
Section 677(a) provides that grantor trust status exists if the grantor’s spouse may receive income without approval from an adverse party. So logically, you would assume that when a divorce occurs, there is no longer a spouse, and hence, no grantor trust issue. But IRC section 672(e)(1)(A), otherwise known as the Spousal Unity Rule, states that the grantor is considered to hold any power or interest of a spouse, and the grantor’s spouse is defined under that section as any individual who was the grantor’s spouse at the time of the creation of the trust.
This could cause serious problems and needs to be taken into consideration when negotiating current divorce or nuptial agreements for couples who have initiated, or are planning to initiate such trusts, or who are considering trusts during lifetime as part of their marital estate planning.
The IRS recognizes this potential conflict caused by the repeal of 682, and for now, is seeking guidance and comments and will, at some point, be issuing regulations or additional guidance on the impact of the repeal of 682.
How MBAF Can Help
The repeal of section 682 is just one of the many complications raised by The Act that taxpayers, and particularly married taxpayers, need to be aware of under the new tax laws.
While there are some new laws which simplify certain things for taxpayers, many add complexities. Since tax season is upon us, now is the time to be sure you are entirely up to speed, and understand how to maximize the potential benefits to be found in this tax legislation.
There may be options and opportunities that the new reforms create that you may not be aware of, as well as new compliance issues. We can help you answer any questions you may have regarding the repeal of Section 682, or any impacts of the Tax Cuts and Jobs Act.
Compliance with and understanding the changes in the tax codes regarding the Tax Cuts and Jobs Act can be complex. If you would like to benefit from our expertise in these areas, or if you have further questions on this Advisory, do not hesitate to contact our Tax and Accounting Specialists, or call us at 1-800-239-1474.