Often times, clients ask whether they can deduct attorney’s fees paid in connection with their divorce or family law case from their federal income taxes. Generally, the answer is no. Attorney’s fees are not typically tax deductible. Exceptions exist, however, for attorney’s fees paid for tax advice and for the production or collection of income.
Section 212 of the Internal Revenue Code allows taxpayers to deduct attorney’s fees paid for tax advice. Thus, to the extent you can show that the fees paid were incurred for tax advice, you may be able to deduct them. Sometimes, during divorce proceedings, people consult with accountants or tax attorneys to evaluate the possible tax ramifications of a potential property settlement. Fees paid for such services would qualify as tax deductible attorney fees.
The second category of tax deductible attorney’s fees consists of fees paid for the production or collection of income. Typically, this factor arises in cases involving a dispute over spousal maintenance, either the right to receive spousal maintenance payments or an effort to increase a spousal maintenance obligation. Because the basis for deducting attorney’s fees is tied to the future generation of income, attorney’s fees paid to resist or reduce spousal maintenance payments are not tax deductible.
It is also important to understand that both categories of deductible attorney’s fees – those paid for tax advice and those paid for the production or collection of income – are deductible as miscellaneous itemized deductions, subject to the 2% of AGI limitation. In other words, the itemized deductions are allowed by the IRS only to the extent that the “aggregate of such deductions exceeds 2 percent of [a person’s] adjusted gross income.” Attorney fees are not deductible for purposes of the alternative minimum tax. See IRC § 56 (b)(1)(A)(i).
The cost of obtaining a specific piece of property (e.g., an interest in a home or a business) should generally be capitalized – added to the basis of the property. Although this does not produce an immediate tax deduction, it does increase the depreciation of the asset (if the asset is depreciable) and will decrease the gain (or increase the loss) when the property is sold.
Deducting attorney’s fees is a complicated issue. Please be sure to discuss this issue (and any other tax related issues you may have) with your tax advisor.
by Robert W. Gadtke