Avoid the Tax Trap of “Front-Loading”

Alimony is often one of the most important provisions in a divorce settlement. Normally, the person paying alimony (“payor”) expects to be able to deduct the payments for tax purposes, and the person receiving alimony (“payee”) expects to report the alimony payments as income. Unfortunately, poor drafting and lack of knowledge of the Internal Revenue Code results in tax consequences that were not anticipated by either party. The term for the unintended tax consequence is “recapture.” It results from what is typically referred to as “front-loading” of the alimony payments.

An explanation of the recapture rules is beyond the scope of this blog. However, a simple example will illustrate how the expectations of the parties and the actual tax treatment by the Internal Revenue Service can be significantly different.

Assume for this hypothetical that payee was in need of more alimony initially, but less in subsequent years. Therefore, the parties negotiate a settlement that requires payor to pay alimony as follows: In year #1, the alimony payments are $60,000 ($5,000 monthly), in year #2 the alimony payments are $48,000 ($4,000 monthly), and in year #3 the alimony payments are $12,000 ($1,000 monthly). Under this arrangement, payor expects to be able to deduct on his or her income tax return, over the course of three years, $120,000. Assuming the payor has an effective tax rate of 35% (Federal and State taxes), the payor expects a tax savings on these alimony payments of approximately $42,000 over the three-year period. Unfortunately, because of the manner the payments were structured, there will be a total “recapture” of approximately $46,500 that will apply to the payor. This means that in year #3, payor will be required to include in his or her income $46,500 that he or she expected would not be taxed. Applying the payor’s effective tax rate of 35%, results in an unanticipated tax of approximately $16,275.

As this example illustrates, it is very important that you have knowledgeable counsel advising you during the divorce process.

As with any other issues arising from your separation or divorce, you should consult with a North Carolina Family Law Specialist. Feel free to contact me, Monty Beck, Western North Carolina Family Law Specialist to discuss your separation or divorce.

Coward, Hicks & Siler, PA, is a general practice law firm, whose lawyers are authorized and licensed to provide legal services in the State of North Carolina. We serve clients throughout western state, in Franklin, Sylva, Murphy, Cherokee, Bryson City, Waynesville, Highlands, Cashiers, Cullowee, Robinsonville, Brevard, Asheville and surrounding townships.

The main content of this site is updated as necessary to ensure accuracy. Blog posts are accurate as of the date of publication and are updated with new posts in the event of changes in the law. All material found on this website is primarily intended for the purpose of marketing, and to allow visitors to compare the services offered by Coward, Hicks & Siler with those offered by similar law firms.

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    705 W. Main Street
    Sylva, NC 28779
    Phone: 828-586-2147
    Facsimile: 828-586-2605

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    211 Cashiers School Road
    P.O. Box 1918
    Cashiers, NC 28717
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    Franklin, NC 28734
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