We are often asked by our clients how legal fees in connection with a divorce are treated for tax purposes. Although we do not provide tax advice, and we certainly are not tax experts, there are some general issues you should discuss with your Certified Public Accountant (“CPA”) or a tax advisor to obtain specific advice. If you do not have a regular CPA or tax advisor, please contact us and we will be happy to provide a referral:
- The payment of legal fees for tax advice is a legitimate tax deductible expense for federal income tax purposes. In many divorces, the tax aspects of the divorce play a key role in the structuring of a settlement and the ultimate arrangements made between the parties. Thus, the possible tax consequences of one’s divorce must frequently be analyzed and considered. It is for this reason that we urge you to seek competent tax advice as we proceed through your divorce case. We urge you to retain such a tax expert at the earliest possible date so you, your tax expert, and the attorneys in this law firm can work together as a team as we work to finalize your divorce. To the extent you incur fees for professional services relating to the tax aspects of your divorce, such fees are tax deductible to you.
- Legal fees incurred for the collection of taxable income are deductible. Under this tax principle, taxpayers can deduct that portion of the legal fees in the divorce action that relate to receiving alimony. This covers the legal work involved in obtaining and setting up the alimony payments, whether by way of a marital settlement agreement or a divorce decree. It also covers the legal fees incurred to enforce collection of an alimony award, if payments are missed. See IRS Publication 529. Conversely, however, the legal fees incurred by the paying party to resist an alimony claim are treated as a nondeductible personal expense. Thus, only the party who receives an alimony award is entitled to deduct the portions of his or her legal fees attributable to obtaining the alimony award. The party who is obligated to pay alimony to his or her former spouse is not entitled to deduct any portion of his or her legal fees incurred in litigating the alimony issue.
- You cannot deduct legal fees and court costs for getting a divorce. See IRS Publication 504. To the extent legal work is involved in acquiring marital assets in a divorce, the allocable part of the fee can be added to the basis of the asset acquired. While this is not as favorable as a tax deduction on your federal income tax return, it should save taxes when you eventually dispose of the asset.
One of the most difficult elements in obtaining tax benefits from legal fees in connection with your divorce is establishing what part of the legal fee to allocate to the deductible work. The burden is on the taxpayer to provide the IRS with a precise allocation of the tax deductible work. Therefore, if you only have a billing statement that does not itemize the legal work performed, you may not be allowed any deduction. The best approach is to specifically request that your CPA or tax advisor separate out, document, and itemize the time spent on each of the above three categories, and to itemize his or her billing statements accordingly. If requested, we will attempt to accomplish this for our clients.
This post is not intended to discuss every possible tax consequence or tax consideration that may arise in your divorce case. Because every case is unique, your situation may present other opportunities that need to be considered for tax purposes. It is for this reason that we urge you to consult with a CPA or tax specialist as soon as possible to discuss these tax-related issues.
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