The alimony recapture rule is a potential tax consequence when alimony is paid for a period of fewer than three years and when there are dramatic drop-offs in the amount paid from year to year.
There are times when alimony may be paid by one spouse to another for a very short period of time. When this happens, the payor of alimony risks the possibility of having to report so-called phantom income.
Phantom income includes excess deductions that were taken in years one or two after the divorce is final.
These rules were put in place to prevent divorcing couples from turning a non-deductible property settlement payment into deductible spousal support payments.
There’s a calculation that looks at the alimony difference between what was paid
in year two compared to year three, and
in year one compared to an average of years two and three.
With this calculation, if the resulting amount is positive, the amount gets reported on the taxpayer’s third-year tax return.
Payments that are not looked at as part of the recapture rule are payments
made prior to a final divorce,
based on a fixed percentage of some variable income, and
that terminate because of death or marriage.
If the payor were to lose his or her job in year two and didn’t have a payment in year three, the payor would be subject to the recapture rule, even if the circumstances were beyond his or her control.
To avoid the alimony recapture rule, avoid structuring payments for fewer than three years. In cases where fewer than three years is appropriate, consider the following alternative: spread the same total dollars over a longer period of time; start the first payments later in the year, and avoid structuring payments that decrease by more than $15,000 in the first three years.
Susan A. Moussi, CPA, CFP®, CDFA, CFT
SMD Tax & Divorce Financial Planning Consultants, Inc. Phone: 614.429.4172 email@example.com