Going through a divorce is an education in many ways. One thing most learn at some point in the process is that property settlements are not a taxable event in the eyes of the IRS, but alimony is. In other words, dividing up your bank account and other assets as part of the property settlement in a divorce does not create taxable income or a tax deduction for either divorcing spouse. However with alimony, the former spouse that has to pay it can take the amount as a tax deduction while the receiving former spouse must include the amount as taxable income.
The difference in taxation of these two financial components of a divorce can create a tax incentive to treat a financial transfer one way versus the other depending on the particular financial circumstances of the divorcing couple. For example if it’s known ahead of time that the payer of alimony will be in a high tax bracket while the payee will be in a low tax bracket, there exists tax incentive to have alimony payments high, at least for a period of time, with a possible quid pro quo in adjustment of the property settlement. The IRS is well aware of this tactic and since divorce is not meant to be used as a tax planning vehicle, we are given Internal Revenue Code (IRC) section 71.
IRC section 71 specifies recapture requirements if excess alimony payments, also commonly known as “spousal support”, are front-loaded into the first three post-separation years. The purpose is to discourage divorcing spouses from improperly characterizing property settlements as alimony. If you’re considering an alimony arrangement with other than equal payments over a long period of time, check with your CPA.
Dale F. Jensen, CPA