TAX ADVICE from Julian Block

renowned tax advisor and Larchmont neighbor, Julian Block, provides help for Gazette readers

Legal Fees For a Divorce: What Is Or Is Not Deductible

(October 9, 2003) Generally, the IRS refuses to allow a tax deduction to ease the pain for a couple who split and incur legal fees and other costs to obtain a divorce, separation or decree of support. You, might, though, be able to salvage a deduction for the part of the expenses specifically allocable to tax advice in connection with a divorce or separation, as well as for legal fees to obtain taxable alimony. Here is a rundown of the rules.

NONDEDUCTIBLE EXPENSES: The IRS bars any deduction for the cost of personal advice, counseling and legal action in a divorce. For example, a husband gets no write-off for the cost of resisting his wife's demands for more alimony or to set aside an ante­nuptial property agreement.

These expenses are nondeductible even though they are partly incurred in arriving at a financial settlement or to combat a claim to income-producing property. This restriction has been upheld by the Supreme Court.

More than one taxpayer has learned the hard way that the courts will not bend these rules to permit a deduction for divorce fees. In one case, a court threw out a deduction by a company for legal expenses paid on behalf of its principal shareholder in a divorce action in which 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 in its affairs would have jeopardized its continued success.

Nor would another court 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.

FEES FOR ALIMONY: 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 under "miscellaneous deductions" at the bottom of Schedule A of Form 1040.This break is available for the original proceeding by which she procures taxable alimony, as well as for any subsequent proceeding 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, short for adjusted gross income. AGI is the amount listed on the last line of page one of Form 1040 after reporting salaries and other sources of income and claiming certain deductions such as alimony payments and money placed in traditional IRAs. The AGI amount is before itemizing and claiming dependency exemptions.

To keep the math simple, suppose a woman with an AGI of $100,000 has miscellaneous outlays of $9,000. The 2 percent floor shrinks the deduction to just $7,000 -- what is left after the $9,000 is offset by $2,000, which is 2 percent of $100,000.

CAUTION: In no event can she 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.

FEES FOR TAX ADVICE: Subject to that 2 percent benchmark for miscellaneous expenses, she gets to deduct fees that cover tax research and advice on such items as home sales and other property transfers and dependency exemptions for the children. But she can do so only if the bill specifies in a reasonable way how much is for tax counseling. Moreover, no deduction at all for her payment of her spouse’s legal fees, even if they are for tax advice only. The deduction is allowed just for advice on her own tax problems.

ALLOCATING FEES BETWEEN TAX AND NON-TAX MATTERS: Does your attorney's services include coun­seling on taxes? Remind the attorney to prepare a bill that breaks down deductible and nondeductible charges. That way, assuming you overcome the 2 percent hurdle, you are able to substantiate your deduction in the event of an audit.

According to an IRS ruling, the agency will accept a lawyer's allocation of his or her fee between tax and nontax 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 (Revenue Ruling 72-545).

CAUTION: You suffer a partial disallowance of your allowable write-off for most itemized deductions, including fees for tax advice and other miscellaneous expenses when AGI is above a specified amount that is adjusted annually to reflect inflation -- $139,500 for 2003. The disallowance is 3 percent of the amount by which AGI exceeds $139,500.

Put another way, every $1,000 of AGI above $139,500 causes the loss of $30 in total deductions. No miscellaneous deductions are allowed if you are subject to the alternative minimum tax.

ADULT EDUCATION COURSES:Want Julian’s answers to your questions about the tax pitfalls of divorce? And for a nominal cost that is just a fraction of what you would pay to meet with a qualified tax professional on a face-to-face basis? Enroll in his adult education course, “Divorce And Taxes.” You can sign up for his one-evening course during the fall of 2003 at these locat ions:

NEW YORK CITY. The New School, 66 West 12th St., Monday, Sept. 29, 8:00 P.M. $45. Registration. 212-229-5690.

WHITE PLAINS, NY. White Plains Continuing Education. White PlainsHigh School, 550 North St., Wednesday, Nov. 12, 7:30 P.M. $35 for residents; $40 for nonresidents. Registration. 914-422-2333.

IRVINGTON, NY. Inter-Village ContinuingEducation. IrvingtonHigh School, Tuesday, Oct. 14, 7:30 P.M. $25. Registration. 914-693-6300, ext. 2283. Director@intervillage.org.

VALHALLA, NY. WestchesterCommunity College. Monday, Oct. 20, 7:00 P.M. $30. Registration. 914-785-6830. Continuinged@sunywcc.edu.

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