Legal Fees For A Divorce: What Is Or Is Not Deductible
By Julian Block
Generally, the IRS refuses to allow a tax deduction to ease the pain for a couple who split and incur legal fees and other costs to obtain a divorce, separation or decree of support. You, might, though, be able to salvage a deduction for the part of the expenses specifically allocable to tax advice in connection with a divorce or separation, as well as for legal fees to obtain taxable alimony. Here is a rundown of the rules.
Nondeductible expenses. The IRS bars any deduction for the cost of personal advice, counseling and legal action in a divorce. For example, a husband gets no write-off for the cost of resisting his wife's demands for more alimony or to set aside an antenuptial property agreement.
These expenses are nondeductible even though they are partly incurred in arriving at a financial settlement or to combat a claim to income-producing property. This restriction has been upheld by the Supreme Court.
It is not enough, the Supreme Court noted, that the outcome of a suit or claim may be loss of the income-producing property; the suit or claim against the property must also arise or originate out of the husband's profit-making activities, not from a purely personal matter. The wife's claims in a divorce action arise from a purely personal marital relationship, not from anyone's income-producing activities.
More than one taxpayer has learned the hard way that the Tax Court will not bend these rules to permit a deduction for divorce fees. In one case, the court threw out a deduction by a company for legal expenses paid on behalf of its principal shareholder in a divorce action in which his wife sought to acquire an interest in his stock. The company got nowhere with its argument that the wife suffered from mental problems and that her intrusion in its affairs would have jeopardized its continued success.
Nor would the court approve a husband's medical deduction for attorney's fees for a divorce that was recommended by his psychiatrist. The husband failed to prove that had it not been for the illness that the divorce was supposed to cure, he would not have incurred the fee.
TIP. There is no deduction for legal fees incurred in a divorce action to retain ownership of income-producing assets, such as a building. But those fees can increase the basis of the building for purposes of figuring gain or loss on a later sale.
Fees for alimony. The portion of legal fees specifically paid (usually by the wife) to collect alimony that is taxable to her can be included, just like the cost of preparing her return, with her other itemized deductibles under "miscellaneous deductions" on Schedule A of Form 1040.This break is available for the original proceeding by which she procures taxable alimony, as well as for any subsequent proceeding to increase it or collect arrears.
But these legal fees and most other miscellaneous deductions are allowable only to the extent that their total in any one year exceeds 2 percent of her AGI, short for adjusted gross income. (AGI is the amount listed on the last line of page one of Form 1040 after reporting salaries and other sources of income and claiming certain deductions such as alimony payments and money placed in traditional IRAs. The AGI amount is before itemizing and claiming dependency exemptions.)
EXAMPLE. For someone with an AGI of $50,000 and miscellaneous outlays of $4,500, the 2 percent floor shrinks the deduction to just $3,500 -- what is left after the $4,500 is offset by $1,000, which is 2 percent of $50,000.
CAUTION. In no event can she deduct the cost of obtaining income that is not taxable to her -- say, back child support or temporary alimony while a joint return was still being filed. Nor can a wife who seeks no change in an alimony arrangement write off the cost of a suit to acquire assets awarded her ex-husband in a former divorce action or money he received in exchange for those assets.
Fees for tax advice. Subject to that 2 percent benchmark for miscellaneous expenses, you get to deduct fees that cover tax research and advice on such items as property transfers and dependency exemptions for the children.
But you can do so only if the bill specifies in a reasonable way how much is for tax counseling. Moreover, no deduction at all for your payment of your spouses legal fees, even if they are for tax advice only. The deduction is allowed just for advice on your own tax problems.
Allocating fees between tax and non-tax matters. Does your attorney's services include counseling on taxes? Remind the attorney to prepare a bill that breaks down deductible and nondeductible charges. That way, assuming you overcome the 2 percent hurdle, you are able to substantiate your deduction in the event of an audit.
According to an IRS ruling, the agency will accept a lawyer's allocation of his or her fee between tax and nontax matters where the attorney allocates primarily on the basis of the amount of time attributable to each, the customary charge in the locality for similar services and the results obtained in the divorce negotiations (Revenue Ruling 72-545).
This was made expensively clear to Howard Goldaper. He was charged $6,975 by a divorce lawyer whose fee statement allocated $2,750 for such tax services as valuation and analysis of his deferred-compensation plan and other executive fringes. At filing time, Goldaper took a tax-advice deduction for the $2,750. But his return never made it past the computers. The IRS disallowed the entire deduction on the ground that Goldaper failed to prove that his outlay was for tax advice.
Goldaper decided to take the dispute to the Tax Court. Unfortunately for him, neither the bill nor testimony by the attorney provided specific information as to how much time was spent on tax counseling. The Tax Court concluded that he was entitled to a deduction of only $750.