Avoiding Recapture oF Front-loaded Payments
Special rules apply to accelerated payments of alimony or separate maintenance that may result in their unintended recapture and additional income tax for the payer. The authors explain the alimony recapture rules of IRC section 71(f) and provide an algorithm and spreadsheet for calculating the maximum amount of front-loading attainable without triggering recapture.
When marriages dissolve, two issues arise concerning the amount and timing of alimony or separate maintenance payments. In many cases, extensive negotiation determines the amount, but the timing of payments often receives cursory consideration. Consequently, the typical divorce or separation agreement provides for level monthly payments.
There are situations in which both the payer and recipient would benefit by accelerating-or "front-loading"-alimony payments. While this may at first seem counterintuitive, because the payment of alimony is typically both deductible to the payer (IRC section 215) and includable to the recipient (IRC section 61), both parties may benefit from frontloaded payments if the payer's marginal tax rate is higher than the recipient's. Front-loading may also be desirable if the payer expects a decline in marginal tax rate in subsequent years and the recipient prefers to receive the payments as soon as possible.
The requirements for a payment to a former spouse to qualify for tax purposes as alimony or separate maintenance are straightforward:
* The payments must be received under a divorce or separation instrument [IRC section 71(b)(1)(A)] and must not be child support [IRC section 71(c)].
* The former spouses cannot be members of the same household at the time any payment is made [IRC section 71(b)(1)(C)].
* The divorce or separation instrument must not designate the payments as child support or as not includable in the recipient's gross income [IRC section 71(b)(1)(B)].
* No liability exists for the payer to make any payment for any period after the death of the recipient [IRC section 71(b)(1)(D)].
* The former spouses must not file a joint return together [IRC section 71(e)].
Although a payment must satisfy all of the above requirements in order to be classified as alimony, IRC section 71 does not require that such payments be equal in amount. Nevertheless, excessive front-loading of payments leads to the recapture of the "excess" amount in the third year following the agreement or decree of divorce or separation. The recaptured amount is included in gross income of the payer and is allowed as a deduction toward adjusted gross income of the recipient [IRC section 71(f)].
Alimony Recapture Under IRC Sedan 71 (f)
The Tax Reform Act of 1984 introduced the alimony recapture rules, which applied to payments made under decrees, agreements, or instruments executed in 1985 or 1986. Congress enacted the rules out of concern over the net loss of revenue that excessive front-loading could produce. The recapture rules currently found in IRC section 71(f) apply to divorce or separation payments made under decrees, agreements, or instruments executed after December 31, 1986. Without section 71(f), a payer could more easily disguise a nondeductible property settlement as deductible alimony. The current rules simplify the computation of recapture and shorten the recapture period. …