What Is Recapture?
Deductions for alimony can provide a significant opportunity for tax-payer savings depending on your tax bracket – you can have almost 50 percent of your tax liability reduced by the deduction.
This means your federal tax liability could potentially double if it gets kicked out under IRS recapture rules. This makes it doubly important that you are familiar with recapture rules and the tax-deductibility requirements for alimony.
Here are the two rules you should be cautious of under recapture:
- The 3-year rule
- $15,000 limit on changes in payment
Spousal support is meant to be paid over an extended period of time. Property distributions can be paid out in any manner you prefer, but they do not get the tax deductibility benefit that alimony gets. This is the reasoning behind the 3-year rule. Under this rule, if the alimony payment is paid out in one-lump sum, you may lose the deductibility benefit by recapture. The payment term must be paid out over a minimum term of three years.
The second deduction recapture rule is that there is a cap on how much alimony payments can vary from one year to the next.
If your total settlement amount is split into co-equal payments, you do not have to worry about violating this rule. This rule is a concern for those who prefer a “step-up” or “step-down” payment plan. This is a payment plan where the payment amounts either start small and increase each payment until the balance is complete; or start with a large up-front payment and decrease with each payment, respectively.
If you chose this payment plan, just be sure that the amount paid in alimony does not vary more than $15,000 from one year to the next.
Example 1: 1st Payment $24,000; 2nd year Payment $12,000, 3rd year Payment of $0; there would be no violation of the $15,000 limit for changes in payments between calendar years
Example 2: 1st Payment $100,000; 2nd year Payment $50,000, 3rd year Payment of $0; there would be a violation of the $15,000 limit for changes in payments between calendar years.
Opting Out of the Previous Rules through Modification
While you do not have the option to opt-in to the old rules if you did not finalize your alimony settlement before December 31, 2018; if your settlement was finalized before the deadline, you have the option to modify your settlement and opt-out of the old rules.
As mentioned above, the elimination of the alimony deduction going forward will be a loss to many. However, some may benefit from the changes. This may apply to parties where the payor may now be in a lower tax-bracket and no longer need the deduction; or the recipient is currently in a higher tax-bracket, and it would no longer make sense to have the money taxed on the receiving end.
How Will Alimony Payments Affect Your Taxable Income?
For alimony payments that were executed prior to 2019, there’s no change in the federal income tax arrangement. For the support to continue to qualify as tax-deductible however, payers must still satisfy the established list of specific tax-law requirements or be subject to recapture.
Alimony payments do not have to be itemized on the payer’s federal income tax return but payment recipients must continue to include alimony payments in their taxable income. Business as usual, as the saying goes.
However, starting January 1, 2019, anyone in divorce proceedings and bargaining with their soon-to-be-ex-spouses should keep in mind that alimony payments are no longer tax-deductible due to the recent Tax Cuts and Job Act.
If your proposed divorce agreement includes multiple assets, alimony and child support, it’s a good idea to consult with a tax law professional. Call Brotman Law at (619) 330-9579 or visit www.sambrotman.com to set up a free one-hour consultation. The new rules can get complicated and the IRS is paying attention.