What is tax deductible in divorce?
On Wednesday, we talked a little bit about what to do during your divorce after you separate and your husband cuts you off from marital funds. The trouble is that money is almost always very tight during and after divorce, and it’s very rare that anyone walks away without worrying a little bit about what the financial future holds.
Since (1) divorce itself is expensive, and (2) you’ll be using the same income that used to support one household to support two, it’s a good idea to start thinking now (like, as soon as humanly possible) about how you’ll maximize the money that you do have. Looking at your income and expense sheet, like we talked about on Wednesday as well, is a good way to get a handle on how much money you’re spending and where exactly it’s all going. You’ll probably have to start thinking seriously about cutting out some of the extra little luxuries to which you have grown accustomed.
It’s not all about making cuts, though. In some cases, it’s about applying creative thinking so that you can continue to maintain your same standard of living. Depending on how much extra money you really think you’ll need to make ends meet, any number of changes may be necessary to make it possible for you to continue to live up to the same standard of living to which you grew accustomed during the marriage. It may be as simple as reducing your cable package, or calling your utility bill to see whether there are any new money saving programs available for people like you. It’s always a good idea to give your service providers a call and ask whether there is anything else available to help you save a little money that you might be able to take advantage of. (You might be well served to even tell them that you’re thinking of getting rid of the service just to see what they’ll really do to help you out when they’re pressed to do it or lose a customer permanently.)
It’s a good idea to talk to a number of different professionals, not just attorneys, to be sure that you’re achieving the best possible result in your divorce case. After all, it’s not always just about what that final divorce decree says, or what you get in your separation agreement, it’s about being able to make the changes you need to make to make your life work. Depending on your unique situation, you may want to talk to a tax attorney, a CPA, a forensic accountant, a mortgage lender, or even a business valuator to find out what is in your best interest across a number of different areas. Your attorney can certainly help recommend someone to you who would be perfect to help answer the specialized questions you’re having.
I don’t know about you, but one of my favorite times of the year is tax return time. I always make sure that I do a little extra research to make sure that I’m maximizing my deductions so that my refund is as awesome as possible. Even though I try to look into it as much as possible, I’m sure there are things that I’m missing. I’m sure there are tons of things out there that are deductions that I just don’t even know about.
If you feel that way and you’re wondering whether anything associated with your divorce is deductible on your next tax return, you’re not alone. Money is tight, and divorce is difficult, so why not take advantage of as many breaks as you can manage to find?
Divorce attorneys are, with very few exceptions, not tax attorneys, and don’t usually like to give tax related advice. I know a few things about tax, though, and I can at least help point you in the right direction and let you know what questions you need to ask to your tax adviser, attorney, or preparer.
1. Legal fees and court costs are personal expenses and are not deductible on your taxes. Legal fees are, generally speaking, any money (like a retainer) paid to the law firm in order for it to represent you. Court costs are fees charged by the court (usually, just things like filing fees) that you pay to the court to keep track of your case. Your divorce complaint, for example, costs around $80 to file in the state of Virginia (though this fee differs from court to court) and covers the costs of the courthouse, from paying the clerks and storing the documents to keeping the lights on.
2. Professional fees you pay for tax advice, or any advice designed to help you get an award of spousal support ARE deductible. Internal Revenue Code Section 212 has provided that things are deductible because tax advice facilitates the determination of taxes (which basically just means that it helps the IRS do its job and do it well), and because you getting an award of spousal support means that you will have income, which the IRS likes because then it can tax you on your income.
That’s right; spousal support is also taxable. Keep in mind that, whatever you get in spousal support from your husband is taxable as income to you, so you’ll want to ask for more than you think you’ll desperately need, because you won’t have the benefit of using all of it since you’ll have to pay taxes on the full amount you receive. You can deduct what you paid to make sure you’d be able to receive spousal support, but, ultimately, once you do receive spousal support, you’re going to be paying taxes on that amount of support because it’s income to you.
You should probably talk to your financial professional about this before you make a plan, but it's a good idea to set aside a certain amount of money each month, so that you’re not overwhelmed when tax time comes. Your CPA or tax adviser or financial planner or whoever can probably give you a good idea what your tax bracket might be, and how much money you should plan to set aside. It really will make it much, much easier on you come April 15th if you start personally withholding a little each month, particularly if you don’t have another additional source of income. Better safe than sorry, right?
3. Your husband (or ex husband, or soon to be ex husband, or whatever) can’t deduct for the legal fees he paid attempting to reduce the amount of spousal support you would be paid.
4. Even though legal fees aren’t normally deductible, to the extent that they are (like, if you incurred legal fees in order to get an award of spousal support), they would only be deductible to you if you actually paid the cost of the legal fees yourself. If your husband was ordered to pay your legal fees (which is probably unlikely), you won’t be able to claim the money spent as a deduction on your taxes, and neither will he. Even though, technically speaking, he paid money for legal fees that went towards attempting to get a spousal support award, he can’t claim it as a deduction. The general rule is this: a taxpayer can only deduct from the costs of advice to him or her, and not for advice to the other party. Since it was money paid by him on your behalf for advice given to you, even though the advice was given for the purpose of securing a spousal support award for you, it’s not deductible. If you paid it yourself, on the other hand, it would be deductible.
5. Some parts of your legal expenses may not be deductible right this minute, but may become deductible when you sell marital assets that you receive in equitable distribution. Some of the attorney’s fees you paid can be allocated among the tax basis of the assets you receive in equitable distribution, which can increase the tax basis. You’ll have to be able to show that the fees you spent were for time the attorney spent defending title to the assets or making sure that they were obtained on your behalf.
Example: The cost of preparing (and filing) a deed with the court in order to change title in a piece of real property from your joint name to your name alone can be added to the tax basis of the property, and deducted on your taxes when the property is later sold.
6. Child support, unlike spousal support, is not income to you (if you’re receiving it), nor is it tax deductible to the person paying it. If you’re receiving child support, it is tax free, so you won’t have to claim it on your taxes, and your husband won’t get a deduction for paying it. (And vice versa, of course. If he’s receiving it, he won’t have to claim it as income on his taxes, and you won’t be able to claim it as a deduction on your taxes.)
So, how would I go about claiming a deduction for legal expenses?
If you plan to claim your legal expenses incurred in a divorce on your taxes, you should talk to a tax adviser and your attorney as soon as possible. The attorney is going to have to do a little extra work to make a reasonable allocation of the legal expenses, so that the IRS can see what was classified as deductible versus non deductible advice. Since some of these things count and some don’t, the attorney is going to have to divide that time out so that your taxes are handled appropriately. (You never know when you might get audited!)
How would my attorney show the IRS what parts of her advice to me were deductible, and what wasn’t?
Just like you need receipts to prove what you spent on other things that were tax deductible, the IRS is definitely going to want some proof (or, at least, your tax preparer is going to want some proof) that describes what legal advice you received, and then further subdivides it into what was tax deductible and what was not. There are a number of different ways an attorney can do this, but probably the best way is to write an opinion letter. The opinion letter would be based on reliable time records (like the monthly billing statements that you received when the attorney was working on your case) that described the kinds of services rendered.
Any fees that were paid by your attorney on your behalf (out of your retainer funds, I assume) would be fully tax deductible, and should show up clearly on your bill.
The best evidence of tax deductible fees is a statement that appears directly on your bills from the attorney and specifics which portion of the bill is attributable to tax advice, securing taxable support, and obtaining assets.
Where do I claim these things on my taxes?
The fees that are deductible have to be claimed as an itemized deduction on Schedule A of Form 1040. It’s simple enough, especially if you have a tax preparer helping you. You can claim them as miscellaneous deductions. You should probably also know that they are subject to the 2% income floor of adjusted gross income.
Isn’t it hard to separate the deductible legal expenses from non deductible expenses?
It may be a little difficult. Usually, when most attorneys do billing, they aren’t separating out what items are deductible and non deductible. Most of the expenses, like personal advice, anything relating custody issues, or legal action in your divorce case aren’t deductible anyway. Still, like we’ve discussed so far, some other pieces of the puzzle are deductible and, even though it may be difficult to separate the non deductible expenses from the deductible expenses, it’s certainly possible. In some cases, the deduction you receive might be sizable (and certainly well worth any additional attorney’s fees incurred in appropriately classifying the items on your billing statement as deductible and non deductible), so it would certainly be well worth any additional time, effort, and expense associated with figuring out what portion of your legal expenses would be deductible on your next income tax return.
Most family law attorneys are uncomfortable giving tax advice, but certainly encourage you to talk to someone with experience in tax and divorce if you have more specific or unusual questions. The IRS does offer some small benefits to people facing a divorce to help make life a little easier, so it’s worth asking someone with some experience whether it would be worth it for you to gather this kind of information from your attorney. This article should give you enough information to ask the right questions and at least point your tax adviser in the right direction.
If you’re ready to move forward with your divorce, please give our office a call at (757) 425-5200.