Generally, the Internal Revenue Service says "no" to tax deductions that might ease the pain of divorce. The agency has no sympathy for the legal fees and other costs incurred by a couple who split--whether it's a divorce, separation or decree of support.
In certain circumstances, however, a divorced or separating client might be able to salvage a deduction for the portion of expenses specifically allocable to related tax advice, as well as for legal fees to obtain taxable alimony. Following are some of the rules that are helpful to know.
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 pre-nuptial property agreement.
These expenses are nondeductible even though they are partially incurred in reaching a financial settlement or fighting a claim to income-producing property. It is not enough, the Supreme Court has 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 (or wife's) profit-making activities--not from a purely personal matter.
There is no deduction for legal fees incurred in a divorce action to retain ownership of income-producing assets, such as a building, either. But those fees can increase the basis of the building for purposes of figuring gain or loss on a later sale.
More than one taxpayer has learned the hard way that the Tax Court will not bend its 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 into its affairs would have jeopardized its continued success. The court also was unwilling to 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.
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 on the "other expenses" line. This break is available for the original proceeding in which she procures taxable alimony, as well as for any subsequent proceedings 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.
In no event can a wife 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.
Subject to the 2 percent benchmark for miscellaneous expenses, clients can deduct fees that cover tax research and advice about such items as property transfers and dependency exemptions for children. But they can do so only if the bill specifies in a reasonable way how much of it is for tax counseling. Moreover, there is no deduction at all for payment of a spouse's legal fees, even if they are for tax advice only.
Do your client's attorney's services include counseling on taxes? Remind the attorney to prepare a bill that breaks down deductible and nondeductible charges. That way, assuming your client overcomes the 2 percent hurdle, you have a record in the event of an audit. According to IRS Revenue Ruling 72-245, 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 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 fringe benefits. At filing time, Goldaper took a tax-advice deduction for the $2,750. But the IRS disallowed the entire deduction on the ground that he had failed to prove that his outlay was for tax advice. He took the dispute to the Tax Court. However, 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.
Julian Block is a syndicated columnist and attorney based in Larchmont, N.Y. His books include Marriage And Divorce: Savvy Ways For Persons Marrying, Married Or Divorcing To Trim Their Taxes To The Legal Minimum. Information about his books is at www.julianblocktaxexpert.com.