Navigating the Recapture Rules for Spousal Support

This is the fourth post in the Frequently Asked Tax Questions in Family Law Cases series. This series is intended to answer questions family attorneys frequently ask us regarding tax issues.

Question: A dependent spouse needs significantly more spousal support for a year or two prior to being able to return to work full time, and little or no maintenance thereafter. Will the decrease from year one to year three trigger a disallowance of the deductibility by the payor under the recapture rule?

Answer: It depends. IRC § 71 and IRS Publication 501 explain what payments are subject to the recapture rules and how to calculate that amount. It is important to take that guidance into account prior to setting spousal support payments that could trigger the recapture rules. The IRS’s focus in these cases is pursuing taxpayers who are attempting to disguise property settlements as spousal support. The recapture rules reclassify those spousal support payments as property settlements, thereby disallowing their deductibility.

Two of the most common scenarios that trigger the recapture rules are when, in the third post-separation year, the spousal support paid in that year decreases by more than $15,000 from the second post-separation year. The recapture rules state that any excess payment of more than $15,000 is recaptured and the payor cannot deduct that excess.

The other scenario that triggers the recapture rules is when, in the third post-separation year, the payments made in the first post-separation year exceed the average of the payments in the second and third post-separation years by more than $15,000. Again, the excess over $15,000 is recaptured and the payor’s deductibility of that excess is disallowed.

If both of these computations result in recapture, the amount recaptured under the first computation is subtracted from the second year payments for purposes of making the second computation.

When structuring spousal support payments that could be construed as property settlement payments, and therefore might trigger the recapture rules, fully develop the facts of the case to reduce the chances that the IRS successfully excludes the payments from recapture.

One of the more common reasons for fluctuating payments is in the situation relating to an income producing property or business revenue stream. In this situation, developing a case history to confirm the justification for the fluctuating payments is very important. Explain why the income or revenue stream was so erratic. Perhaps there were capital improvements that had to be made. Or perhaps revenues were just not as high as normal.

Regardless of the reason, developing the case history contemporaneously makes it easier to defend the fluctuations at a later date. Unfortunately, without developing that case history, taxpayers might find it difficult to explain to the IRS why those payments are not disguised property settlements subject to the recapture rules.