Question: My wife and I are in the final stages of uncoupling our family and finances. We own a small business (corporation) that I will continue to operate, and I will purchase her stock. We are also in the process of dividing the six rental houses we are purchasing, our IRAs and other retirement accounts, our stock portfolio, and the value of our home.

Additionally, I have been required to hire another lawyer to prepare my new estate plan.
Needless to say, the fees that we both have paid –and still owe – to lawyers and accountants are not small. I did not realize there were as many tax questions involved. Is there a way that the fees can be deducted so I will be able to save on my income taxes next year?

Answer: As those who have gone through divorce have learned, tax issues permeate nearly every facet of a matrimonial case. Whether the fees are deductible or not is one issue, but so is the alternative minimum tax (AMT) that most folks never hear about until they divorce. Because these are two major issues in many divorces, due to space limitations we will address the deductibility of matrimonial-related fees this week, and the AMT in our next column.
Generally, the fees and expenses paid to professionals such as attorneys, CPAs, and appraisers in connection with matrimonial matters are not tax deductible. However, there are exceptions when your expenses meet the criteria established by the Internal Revenue Code. For example, ordinary and necessary expenses incurred in the conduct of your business are deductible, as are those you incur to produce taxable income and for tax advice. Another section of the Internal Revenue Code allows, where appropriate, expenses to be capitalized, that is, added to the cost basis of a particular asset.

The reason for these rules is that personal expenses are not deductible, and this issue has generated a lot of tax litigation that has produced varied results from case to case. For example, while matrimonial fees are not a legitimate business expense and not deductible by the business, if the business is joined in a matrimonial action, it may be that the fees incurred in the corporate defense will be deductible, depending on the particular facts. In one case, while a husband who owned corporations was in the hospital, his wife brought a divorce action and was able to take possession of his corporations, fire the employees, and with her boyfriend, take cash and assets belonging to the corporation. The legal fees expended by the husband to recover control of his businesses were deductible because they were necessary to assert his rights to the corporate assets and income and, therefore, were tied to profit-seeking activities.

Some other examples of fees and expenses that have been determined to be deductible include: 1) the portion of fees and expenses incurred to defend against actions that interfered with a corporation’s business activities; 2) fees resulting in the production or collection of taxable income; assisting with the management, conservation, or maintenance of property held for the production of income, or the determination, collection, or refund of any tax; and/or in connection with getting and collecting taxable spousal support.

It is important to remember that when deductible, these attorneys’ fees and expenses are deductible as miscellaneous itemized deductions on your tax return, meaning they are deductible only to the extent they exceed two percent (2%) of your adjusted gross income. They are also subject to phase-out provisions if your adjusted gross income exceeds a certain amount. And lastly, the deduction of lawyers’ and experts’ fees is subject to the alternative minimum tax, meaning that the deduction may well vanish if the amount is considerable in relation to other amounts on your tax return. Click on useful links to find IRS publications on the deduction of attorneys’ fees. And be sure to tune in next week when we will explain how the alternative minimum tax can impact unsuspecting divorcing couples.