Question: My wife and I just completed a long, drawn out divorce during which I paid both her attorneys’ fees and mine. She claimed an interest in my business which is my sole source of income. I wound up keeping my business, but she received a number of valuable assets and alimony. If I had not kept my business, I would have lost my income. Is there any way I can deduct these attorneys’ fees?

Answer: Generally speaking, since the termination of a marriage is a personal matter, payments of legal fees in connection with a divorce are not deductible; however, as with most general rules, there are exceptions:

1) If the payment of legal fees is related to the production or collection of taxable income, the portion of the fees allocated to that purpose may be deducted from the payor’s adjusted gross income. Here, it is highly unlikely that you would be able to deduct the fees involved in keeping your business as part of a property settlement. Unless you received alimony from your former wife, this exception would not apply to you. On the other hand, if your wife paid her attorneys, the portion of her fees allocated to those services which produced taxable income for her would probably be deductible.

2) If the payment of legal fees is related to tax advice in conjunction with the marital settlement, the portion of the fees allocated to that purpose may be deducted from the payor’s adjusted gross income. The portion allocated to tax-related advice in connection with the financial issues of your divorce may be deductible

If you are entitled to a deduction of a portion of your attorneys’ fees, however, your deduction will be limited to the extent that the amount deducted exceeds two percent of your adjusted gross income.

On the other hand, legal fees that are not deductible may be added to the cost basis of any property involved in your settlement. Since you kept your business, the value of the legal services attributable the protection, preservation or acquisition of your business or investment property can be allocated on a pro rata basis among the various properties as capital expenditures. This means that if you sell your company in the future, you could pay less capital gains taxes.

The amounts you paid to your former wife’s attorney are not deductible to you; however, had you paid those amounts directly to her under a properly worded agreement, you may have been able to deduct your payments to her as alimony. And, since your former wife received taxable alimony, she, in turn, may have been able to deduct the deductible amount you paid to her.

Because the amount of fees paid in many divorces today is substantial in many cases, the question of deductibility of these fees should be raised and determined before the marital agreement has been signed and before the judge has inked the decree rather than after.

And one more word of advice: Divorce is a transition that requires a new estate plan – wills, durable powers of attorney, and sometimes trusts. For that reason, estate planning should be part and parcel of the divorce process from start to finish. Generally speaking, fees charged for tax related advice in connection with estate planning should be tax deductible.

SoloFact: Oftentimes when the division of a business is part of the divorce process, the valuation of the business entity may include an added premium called “goodwill.” Depending on your state of residence, the courts may or may not recognize “goodwill” as divisible property.