A party paying maintenance often looks forward to the day when maintenance terminates or significantly decreases. If the modification occurs within the first three years of payment, however, the payor may be subject to the scrutiny of the IRS, namely the Internal Revenue Code Section 71 “recapture requirements.”
“The recapture rule” may be triggered” when a maintenance obligation decreases or terminates during the first three years of payment. If you are subject to this rule, you have to include in your income part of the maintenance payments you previously deducted in prior years. Your ex-spouse may deduct the maintenance payments he or she previously included as income.
Parties are subject to this rule in the third year of paying maintenance if, in the third year, payment decreases by more than $15,000.00 from the second to third years or the payments made in the second year and third year are substantially less than the payments made in the first year. The three-year period starts with the first calendar year you make a payment qualifying as maintenance. The second and third years are the next two calendar years, whether or not payments of maintenance are made during those years.
The purpose behind the recapture rule is to discourage divorcing spouses from trying to disguise a non-deductible property settlement as deductible maintenance payments. “Recapture” means to give back or to adjust for a tax benefit that was improperly taken at an earlier time.
If you think you may be subject to the recapture rule, your family law professional can help you determine if the rule is triggered and perform a recapture computation. Careful planning now could prevent an avoidable tax issue later.