Divorce is hard, and the IRS isn't going to make it any easier. The IRS generally says "no" to tax deductions that might ease the pain of divorce. In certain circumstances, however, you might be able to salvage a deduction for the portion of expenses specifically allocable to tax advice in connection with a divorce or separation, as well as for legal fees to obtain taxable alimony. Here are some rules that are helpful to know.
Nondeductible expenses. The IRS prohibits any deduction for the cost of personal advice, counseling and legal action in a divorce. For example, there's no write-off for what a husband spends to resist his wife's demands for more alimony or to set aside a prenuptial property agreement.
These expenses are nondeductible even though they're partly incurred in arriving at a financial settlement or to combat a claim to income-producing property. This restriction has been upheld by the US Supreme Court. It's not enough, the 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 spouse's profit-making activities—not from a purely personal matter. The spouse'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 US Tax Court won't bend these rules to permit a deduction for divorce fees. In a noteworthy 1965 decision, the court threw out a deduction by a company for legal expenses paid on behalf of Clark Hartwell, its principal shareholder, when, in a divorce action, 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.
The court also was unwilling to approve Joel Jacobs' medical deduction for attorney's fees for a divorce that was recommended by his psychiatrist. Joel failed to prove that had it not been for the illness that the divorce was supposed to cure, he wouldn't have incurred the fee.
There's 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 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 adjusted gross income.
In no event can a spouse deduct the cost of obtaining income that's 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 to her ex-husband in a former divorce action or money he received in exchange for those assets.
Legal fees for tax advice. Subject to the 2 percent benchmark for miscellaneous expenses, you get to deduct fees that cover tax research and advice about 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, there's no deduction at all for your payment of your spouse's legal fees, even if they're for tax advice only. The deduction is allowed just for advice you receive about your own tax problems.
Allocating fees between tax and non-tax matters. Do 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 two percent hurdle, you're able to substantiate your deduction in the event of an audit. According to IRS Revenue Ruling 72-545, the agency will accept a lawyer's allocation of his or her fee between tax and non-tax 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.
Some years ago, Howard Goldaper was charged $6,975 (today, that fee would be substantially more) 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 he 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 court's 1977 decision limited his deduction to only $750.
Keep in mind that no miscellaneous deductions are allowed if you're subject to the alternative minimum tax.
About the author:
Julian Block writes and practices law in Larchmont, New York, and was formerly with the IRS as a special agent (criminal investigator) and an attorney. More on this topic is available from "Julian Block's Tax Tips for Marriage and Divorce," available for Kindle at Amazon.com and as a print copy at julianblocktaxexpert.com.