What Is The Alimony Recapture Rule?
By Jennifer M. Paine
As if paying alimony weren’t bothersome already, imagine receiving an unfriendly letter from the IRS forcing you into an audit and assessing taxes for three years of income you previously deducted.
This may sound like a tax nightmare – you pay alimony, you deduct it like your CPA and attorney said, and now you have to pay taxes for it – but for many guys it is reality.
This often misunderstood and little discussed trap is called the recapture rule.
The Three-Year Alimony Tax Trap
The recapture rule forces the alimony payer, almost always the ex-husband, to report as income the alimony payments he previously deducted, which means the ex-wife is entitled to reduce from income the alimony payments she previously received.
The rule applies when the payments decrease or terminate during the first three calendars years post-divorce and :
1.) The total payments made in the third year decrease by $15,000 or more from the payments made in the second year; or
2.) The payments made in the second year and the third year are substantially less than the payments made in the first year.
Reasons other than the language of your divorce decree can cause the reduction, even reasons beyond your control, like a modification of the decree, failure to make timely payments, inability to make payments, and a modification in the amount you pay because your ex no longer needs as much from you.
For example, if in the first year you pay $30,000 in alimony, then in the second year you pay $20,000 in alimony, but in the third year you successfully motion to modify your obligation because your ex has a new job and, as a result, you only pay $4,000 in alimony ($16,000 less than the second year), you’ve triggered the recapture rule.
Be prepared to report the first year’s worth and the second year’s worth of formerly deducted alimony payments as income. And you thought you were doing yourself a huge benefit by petitioning to modify the alimony obligation in the third year.
Recapture Rule Exceptions
However, the recapture rule does not apply:
1.) For payments made pursuant to a temporary order;
2.) If the payments terminate due to you or your ex’s death;
3.) Your ex’s remarriage prior to the end of the third year; and
4.) When the total payments made each year vary, for reasons not in your control, and are tied to a business, property, variable employment or self-employment. In these circumstances, the termination and variable amounts of alimony are foreseeable and assumed.
For example, if you agree in your divorce decree to pay 10% of your income received for your alternative energy business – a business that is in a state of flux – then you would not necessarily have to recapture those payments you deducted in the first year and the second year even if, in the third year, your payment is substantially less than the first year.
As another example, if for a five year obligation in the first year you pay that $30,000, then in the second year you pay that $20,000, but, in the third year, your obligation is terminated because your ex remarriages, you do not have to recapture the payments you previously deducted even though you are paying $0 in the third year.
In the article “How To Avoid The Alimony Recapture Rule ,” I shared five tips on how to avoid the tax nightmare.
Remember, you should always talk to your CPA about your options and the best course of action for you. Nothing in this article should be construed as recommending a particular course of action intended to avoid paying taxes.
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Jennifer M. Paine is a Michigan Divorce Lawyer with Cordell & Cordell. She is licensed to practice in Michigan, and has been admitted pro hac vice in Illinois, Ohio, and the United States Court of Federal Claims.
Ms. Paine received her BA in English and Mathematics from Albion College and graduated Summa Cum Laude. She received her Juris Doctorate from MSU College of Law and graduated Summa Cum Laude.