Deduction of early years' divorce payments.

For a taxpayer in the midst of a divorce settlement, the proper tax advice on structuring the settlement may provide tax benefits for years to come. Neither property settlements nor child support are deductible for income tax purposes. However, if a payment is classified as alimony, the spouse paying the alimony receives a deduction for the amount paid in computing adjusted gross income under Sec. 215 (a). (For purposes of this discussion, alimony includes separate maintenance.)

Sec. 71 (f) provides anti-front-loading rules that partially treat early years' excessive payments as property settlements. These rules recapture and recharacterize alimony as property settlements, to the extent the alimony paid in the early years is deemed to be excessively front-loaded. This recharacterization treats the excess payments as deductible by the payee spouse and includible in the payor's gross income when the excess is recaptured in the third "post-separation year" (Sec. 71 (f) (1)).

When analyzing a proposed divorce settlement to maximize income tax deductions for the payor spouse, it is important to remember that the anti-front-loading rules operate on a three-calendar-year basis (Sec. 71 (f) (6)). The three-year period begins with the first calendar year in which the payor spouse pays alimony to the payee spouse. This year is referred to as the first "post-separation year." Only excess payments made in the first and second post-separation years are recaptured.

Example 1: Computation of Excess Payments

H and W are divorced on Jan. 2, 1996 H will pay $60,000 alimony to W
in 1996, $30,000 in 1997, and $10,000 in 1988. The excess payments
recaptured in 1998 will be $32,500, computed as follows:

1997 (second year) excess payments

1997 alimony payments                              $30,000
Less:
 1998 alimony payments                  $10,000
 Statutory allowance                     15,000     25,000
Excess Payments                                    $ 5,000

1996 (first year) excess payments

1996 alimony payments                              $60,000
Less:
 1997 alimony payments                  $30,000
 Reduction for 1997 excess payments      (5,000)
  Balance                                25,000
1998 alimony payments                    10,000
  Total                                 $35,000

 Average ($35,000 [divided by] 2)        17,500
 Statutory allowance                     15,000     32,500
Excess payments                                    $27,500

Total excess payments

For 1997                                           $ 5,000
For 1996                                            27,500
Total recaptured in 1998 (third year)               32,500

The excess payment for the second post-separation year are the excess (if any) of that year's alimony payments over $15,000 plus the third year's alimony payments. The excess payments for the first year are the excess (if any) of that year's alimony payments over $15,000, plus the average of the alimony paid during the second year, less any excess payments for such year, and the alimony paid during the third year. This statutory formula, prescribed by Sec. 71 (f) (3) and (4), is illustrated in Example 1 above.

The effect of this statutory formula is exemplified in the following example:

Example 2: Under a divorce settlement proposed for 1996, H would make a $250,000 alimony payment to W in that year and no payments in 1997 or 1998. Consequently, $235,000 would be recaptured in 1998. However, there would not be any recapture if the alimony was paid as follows:

1996    $ 93,333
1997      85,833
1998      70,834
Total   $250,000

In addition, the divorce settlement should contain a "termination upon death" provision, stating that H's liability for payments will terminate at W's death. If W accepts this three-year payout, it is possible to substantially reduce H's income tax by structuring his alimony payments within Sec. 71 (f)'s parameters.