How to deduct legal fees in divorce?
Legal fees in connection with a divorce or separation are treated specially for tax purposes. The overall rule regarding the deductibility of legal fees in divorce are that general legal fees relating to a divorce or separation are nondeductible personal expenses. However, with careful planning and careful documentation on the attorney’s part, a portion of the fees may be deductible under one or more of the following approaches to planning for legal fee deductions.
Deductible Legal Fees in Divorce
You cannot deduct the costs of counseling, litigations, or personal advice. However, in some circumstances, taxpayers are permitted to deduct fees that are associated with the collection of alimony payments.
Divorce Legal Fee Deductions
- Capitalization of legal fees. To the extent legal work is involved in acquiring marital assets in a divorce or separation, the allocable part of the fee can be added to the basis of the assets acquired. While this is not as favorable as a deduction, it should save taxes when the assets are eventually disposed of.
- Tax advice. The payment of legal fees for tax advice is deductible as an itemized deduction. In many divorces and separations, the tax aspects of divorce play a key role in the arrangements made. Tax consequences must frequently be analyzed and explained to the parties. A lawyer that has itemized bills for this means that a client may be able to deduct it on their tax returns.
- Collection of taxable alimony. Legal fees incurred for the collection of taxable income are deductible. Taxpayers can deduct that portion of legal fees in divorce relating to getting alimony. This covers the legal work involved in setting up the alimony payments. This could mean deducting the fees related to drafting the divorce or separation agreements. It also covers the legal fees incurred to enforce collection, if payments are missed or there are other issues.Remember though, that legal fees incurred by the paying party to resist alimony claims are nondeductible personal expenses.
One of the most difficult elements in obtaining tax benefits from legal fees in connection with divorce is showing which part is deductible. The taxpayer must be able to show the portion of the legal fees deductible. If one bill is provided with no details, the legal services will not be taxable.
The following advice and services may be allocated to tax planning
1. Costs of structuring a property division to produce desired tax effects, i.e., advice re: rollover residence, the one-time tax exclusion of capital gain for taxpayers 55 and over, etc.
2. Costs of determining the adjusted basis of assets in the property settlement.
3. Costs of planning an alimony trust or annuity agreement to avoid some of the restrictions on deductible spousal support.
4. Costs of estate planning that assure proper estate and gift tax consequences for the payment or receipt of support or property division.
5. Costs of preparing a settlement agreement to assure deductible support payments during the separation period.
6. Costs of maximizing the deductible portion of spousal support or of minimizing the taxable portion of spousal support.
7. Costs of allocating dependency exemptions.
8. Costs of obtaining advice regarding the tax consequences of divorce or separation instrument or of gathering information for and preparation of tax returns.
9. Costs of drafting a QDRO and submitting it to the plan administrator for approval and enforcing the QDRO. (These may also be deductible as fees incurred to produce taxable income.)
The best approach is to make an attorney separate out, document, and itemize the time spent on each of the above three categories and to itemize the bill.