Ordinarily alimony is deductible from the payor’s gross income, and includable in the recipient’s gross income, for income tax purposes. Thus there is some tax advantage to paying alimony. But, that advantage can be eliminated if you don’t pay heed to the IRS’ Alimony Recapture Rule (I.R.C. § 71(f)). If you are caught in the recapture trap, expect that all or a portion of the income that you deducted in previous years will be “recaptured” and applied as income to you.
The Rule only applies to the first three tax years following the divorce. It exists to prevent a spouse from avoiding taxes on payments that are actually not alimony but rather are property transfers. For example, if you know you owe your spouse $50,000 in a property transfer, you may try to characterize that payment as alimony so as to deduct it from your income in the year that it is paid, thus reducing your overall tax burden for that year. Such a scheme could trigger the alimony recapture rule.
In applying the rule, only the first three years of alimony payments are looked at. If payments in the third year are at least $15,000 less than the payments in the second year, then there is a recapture problem. Or, if the average of the payments in the second and third years is at least $15,000 less than the payment in the first year, there is a recapture problem. There are some exceptions, though, so be sure to discuss this with your attorney before agreeing to a situation where payments drop significantly over the first three years of alimony.