What is the Alimony Recapture Rule?

As if alimony payments—whether you’re paying them or trying to collect them—are not bothersome enough already, many individuals find themselves too close for comfort with the IRS when what is known as the Alimony Recapture Rule is levied against them. Beyond the inconvenience of a tax audit prying into the last three (3) years of previously-deducted income, this little-discussed rule can have serious financial consequences on the alimony payer who has decreased or terminated their alimony payments in the three years immediately following divorce.

Alimony payments can decrease for a number of reasons: maybe the language of the divorce decree dictates it. Or maybe a court ruled to modify the divorce decree. Perhaps the former spouse receiving the alimony had a change in circumstances and no longer needs as much financial support from the payer. In many other cases, it is simply an inability or failure to make alimony payments that contributes to the invocation of the alimony recapture rule.

Why Does the Alimony Recapture Rule Exist?

The purpose of the alimony recapture rule is to discourage a divorcing alimony payer from improperly characterizing his or her property settlement payments as alimony payments for tax purposes.

What does this mean? Property settlement payments differ from alimony by definition and in the effect they have on your taxes. A property settlement agreement occurs when the divorcing parties are able to negotiate a mutual agreement for the division of property out of court before the divorce is finalized. A property settlement agreement divides the marital property—that is, property the couple accumulated and earned whilst married—in a way that is equitable, or fair. Property settlement agreements are not always possible if the divorcing couple cannot reach viable compromises on how to best divide up the property, meaning that the issues will instead be litigated out in court.

Alimony, on the other hand, is a form of spousal support. It can take the form of periodic payments or a lump sum, and can provide support for a dependent spouse who does not make as much money but became accustomed to a certain standard of living during the marriage. Alimony can also be ordered in North Carolina as a punitive measure if the supporting spouse was at fault in the demise of the marriage.

Alimony payments, unlike payments made as part of a property settlement agreement, are tax deductible for the paying spouse. If a husband mischaracterizes payments he was making pursuant to a property settlement agreement with his ex-wife, he would have stiffed both 1) his former wife out of alimony to which she was entitled, as well as 2) the IRS out of taxes to which the government is entitled. “Recapture” in this context means the adjusting for or giving back of tax benefits that were improperly taken at an earlier time.

What Does the Alimony Recapture Rule Do?

A payer is subject to the alimony recapture rule in the following circumstances:

  1. The alimony he or she pays in the second and third years post-divorce decreases “significantly” from the alimony paid in the first year, or
  2. The alimony he or she pays in the third year decreases by more than $15,000 from the previous year.

Because alimony is not tax deductible, the rule forces the alimony payer to report alimony payments he or she had previously deducted for tax purposes as income. This means that their ex is then entitled to reduce the alimony payments he or she previously received from income.

What Decreases in Alimony are NOT Subject to Alimony Recapture?

The following do not count as decreases in alimony payments:

  1. Payments that are made pursuant to a temporary support order
  2. Payments required over a period of at least three (3) years that routinely vary because they are a fixed part of your income from a business, property, or employment (including self-employment).
  3. Payments that decrease because of the remarriage of the spouse receiving alimony or death of either spouse before the end of the third year after divorce.

If you have been contacted by the IRS and are undergoing an audit related to alimony recapture, or have another family law issue such as separation/divorce, child custody or equitable distribution, please contact one of our experienced family law attorneys at Arnold & Smith, PLLC today. We are an aggressive civil and criminal litigation firm with offices in Charlotte, Mooresville and Monroe that are dedicated to helping our clients solve a wide range of family law issues through comprehensive settlement negotiation (when possible) and litigation. Contact us today for a consultation with one of our skilled family law attorneys.