case study

Case Study

Alimony Recapture

Editor:
Albert B. Ellentuck, Esq.
Of Counsel
King and Nordlinger, L.L.P.
Arlington, VA

Editor’s note: This case study has been adapted from Tax Planning for High Income Individuals, 3d Edition, by Anthony J. DeChellis, Douglas L. Weinbrenner, Catherine A. Roeder and Patrick L. Young, published by Practitioners Publishing Company, Fort Worth, Tex., 2002 ((800) 323-8724; www.ppcnet.com ).

Facts: Bob and Maggie Kensington divorced in February 2003; Maggie was awarded alimony under their divorce decree. Bob pays Maggie $45,000 in alimony in 2003, $25,000 in 2004 and $15,000 in 2005. Issue: Is Bob subject to alimony recapture?

Analysis

To prevent divorcing parties from disguising property settlement payments as alimony, payments that fail a mathematical test must be recaptured if they were deducted as alimony. A spouse who takes an alimony deduction in one year may have to recapture it by recognizing taxable income in a later year. Under Sec. 71(f)(1), a recipient spouse who recognized alimony income in one year may get an additional deduction in a later year. The Code focuses on short-term payments made for only three years after a divorce, without regard to a payments nature.

When Does Recapture Occur?

For payments made under a divorce or separation instrument executed after 1986, recapture can occur under Sec. 71(f)(6) only in the third post-separation year. A "post-separation year" is any calendar year beginning with the first calendar year in which alimony is paid under a final divorce or separate maintenance decree (or a related written instrument) or separation agreement (not a temporary support order or interlocutory decree). The second and third post-separation years are the first two calendar years following the first post-separation year. Thus, for Bob and Maggie, 2003 is the first post- separation year; 2004 and 2005 are their second and third post-separation years, respectively.

How Is Recapture Computed?

Recapture is determined by comparing the alimony payments made in the third post-separation year to those made in the first and second years. If the first- and second-year payments exceed certain amounts, the sum of each years excess is recaptured in year three.

Excess second-year payments are computed before excess first-year
payments. Under Sec. 71(f)(4), excess second-year payments are payments made during the second year that exceed those made during the third year by more than $15,000.

Under Sec. 71(f)(3), the first-year payment to be recaptured is the amount by which such payments exceed $15,000, plus the average of the unrecaptured second-year payments, plus the third-year payments. Using the exhibit at left, Bob must recapture $10,000 of the 2003 (first-year)
payment.

Exceptions

Sec. 71(f)(5) provides three exceptions to alimony recapture. First,
payments made under a temporary support order or other decree are not alimony for recapture purposes. Second, payments that fluctuate based on a fixed percentage of income from a business, property or compensation for employment (or self-employment) are not alimony for recapture purposes, unless the payer is obligated to make such payments for at least five years. Finally, if alimony payments terminate before the end of the third year due to death of either spouse or remarriage of the recipient spouse, alimony recapture does not apply.

Conclusion

The recapture rules are strict and must be carefully considered when negotiating alimony. To avoid recapture, first-year payments should not exceed second-year payments by more than $7,500; second-year payments should not exceed third-year payments by more than $15,000. The alimony payment schedule should include some alimony payable in the third year. Finally, payments should be started late in the first year, so that fewer payments are made in that year and more in the second year.