Alimony, or spousal support, consists of regular payments made by one ex-spouse to the other during or after a divorce or separation. Usually, the spouse who must make spousal support payments can deduct them from their income and in this way, reduce their income tax liability.
The recipient must declare the payments as income and pay income tax on them. However, payments that are made by one ex-spouse to another in connection with a property settlement are not tax deductible.
A property settlement agreement is an agreement between divorcing or separating spouses that divides the marital property in a way that they believe is fair. Marital property is property that the couple accumulated and earned while they were married. Property settlement agreements are not always possible if the divorcing couple cannot reach a compromise on how to best divide up the property. This means that the issues must instead be litigated in court. If the issues must be addressed in a trial, then the court orders a division of the property.
As noted above, spousal support payments, unlike payments made as part of a property settlement agreement, are tax deductible for the paying spouse. Suppose one ex-spouse mischaracterizes payments they have made as part of a property settlement agreement, calling them “spousal support” payments instead. In doing so, they would cheat the federal Internal Revenue Service (IRS), and state and local governments as well, of taxes they are entitled to collect.
The word “recapture” in the context of the Alimony Recapture Rule means giving back the tax benefits, i.e. deductions for the payment of alimony, that were improperly taken in a previous year.
In order to discourage characterizing property settlement payments as alimony for tax purposes, the Alimony Recapture Rule was enacted. The Rule is triggered if the total alimony paid in any one year is reduced significantly in the second year and by more than $15,000 in the third year. The Alimony Recapture Rule allows the government to “recapture” income tax lost to deductions that were improperly taken during the first three years after a divorce or separation is final.
Experts recommend setting up an alimony payment schedule for the first 3 calendar years after separation or divore so that there is less than a negative $15,000 difference in any of the first three years. This should avoid triggering the Alimony Recapture Rule.
An example of how the Rule could operate is as follows:
- Year 1: One ex-spouse receives $24,000 in alimony;
- Year 2: the ex-spouse receives only $2,000 in alimony;
- Year 3: Again, alimony is at least $15,000 less than in the first year. This triggers the Alimony Recapture Rule and gives rise to the implication that the first payment was actually a way to settle division of a marital asset and generate a tax benefit for the paying spouse.
Application of the Rule would convert what was a $24,000 tax deduction in year 1 for the paying ex-spouse into an unexpected additional taxable income of $24,000 in the third year. It also converts that $24,000 taxable income in year 1 to the ex-spouse who received the payment into an income tax deduction in that same third year.
What Are Some Legal Issues Associated with the Alimony Recapture Rule?
The Alimony Recapture Rule may also involve other legal issues such as:
- Modifying Alimony Payments: The parties may need to file a petition for the modification of spousal support to reflect changes in support amounts required by the Alimony Recapture Rule. The parties might need to modify a support schedule so as not to trigger the Rule;;
- Tax Fraud: One or both parties may be charged with tax fraud if they knowingly falsify tax information for the purpose of taking deductions to which they are not legally entitled. Tax fraud is a serious crime and can result in felony charges, criminal fines, and/or imprisonment.
- Tax fraud is the deliberate supply of misinformation by the taxpayer with the goal of evading tax liability. So, the crime of tax fraud can be defined as any false representation regarding income or wealth made with the intention to cheat on the amount of taxes owed.
- There are two possible forms of tax fraud. One is civil tax fraud and the penalties for that include the payment of up to 75% of the tax due as a fine. In addition, the person would owe any unpaid back taxes, and other possible penalties such as the failure-to-file or failure-to-pay penalties, as well as interest.
- Conviction of criminal tax evasion can result in jail time. The maximum penalty is usually 5 years in jail and up to $100,000 in fines. Of course, different standards of proof are used in civil and criminal cases. In civil cases, the required proof is proof by a preponderance of the evidence. In a criminal case, the standard of proof is proof beyond a reasonable doubt.
The main concern in connection with the Alimony Recapture Rule is preventing the improper characterization of property settlement payments as alimony, so that the person making the payments can claim them as a deduction on their income taxes.
For example, suppose the paying spouse owes the other spouse a sum of money for their share of a piece of property, e.g. the family home. One spouse may stay in the home and pay the other to buy out their ownership interest in it. The spouse who stays in the home may pay the other spouse in monthly installments If the spouse making the installment payments knowingly classifies the payments as alimony on a tax form in order to claim a deduction to which they are not entitled, then this could be considered a violation of federal, state or local tax laws.
Again, the Alimony Recapture Rule only applies to alimony payments made during the first 3 calendar years after a divorce or separation becomes final. Also, a payer is subject to the alimony recapture rule in the following situations:
- The alimony they pay in the second and third years after their divorce is final decreases significantly from the alimony paid in the first year, or
- The alimony they pay in the third year decreases by more than $15,000 from the previous year.
Again, if triggered, the Alimony Recapture Rule would force the alimony payer to report alimony payments they had previously deducted as income. The ex-spouse would then have to pay income taxes on it. This would mean that their ex-spouse who had received the payments would then be entitled to subtract the alimony payments received from their income.
What Alimony Payments Are Not Subject to the Recapture Rule?
The following payments from one ex-spouse to another do not count as decreases in alimony payments:
- Payments that are made because of a temporary support order;
- Payments required over a period of at least 3 years that routinely vary because pf the nature of the source, e.g. they are a fixed percentage of the paying ex-spouse’s income from a business, property, or employment, including self-employment, so the income can vary from year to year;
- Payments that decrease because of the remarriage of the spouse who receives the alimony or the death of either spouse before the end of the third year after the divorce.
If any of these circumstances are present, the Alimony Recapture Rule would not apply, even if the decreases in the value of alimony payments that trigger the Rule were to happen.
Do I Need a Lawyer for Questions Regarding Alimony Recapture Laws?
Recapture of alimony laws are complex. They involve a technical analysis of the first three years of alimony payments made after divorce. While the Alimony Recapture Rule does not apply to everyone who must pay alimony or division of property settlement payments, you may need to contact a lawyer for advice about this law, as well as any comparable state law that may exist in the state in which you live.
A qualified family lawyer can help ensure that you are fully complying with the requirements of federal, state and local tax law. Your attorney can help you avoid costly errors and can defend you in court if necessary.