Are Divorce Legal Fees Still Tax Deductible?May 22, 2018
The impact of the Tax Cuts & Jobs Act of 2017 (“TCJA”) on family law issues remains a hot topic. This blog will discuss the extent to which the TCJA impacts the tax-deductibility of legal fees paid by a client in divorce or divorce related representation.
Although the TCJA lowered tax rates for most individuals, the tradeoff is a reduction in the availability of itemized deductions. As an example, “Miscellaneous Itemized Deductions” have been eliminated for tax years 2018-2025. This category of deductions includes legal fees related to producing or collecting taxable income that is not related to a trade or business. An example of such fees is legal fees paid by a client to obtain an order of alimony or spousal support. Currently, the spouse paying alimony is allowed a deduction for the alimony paid, and the recipient is required to include the alimony in income. As the alimony received currently constitutes taxable income to the recipient, the deduction for legal fees paid to obtain the alimony has been allowed as a Miscellaneous Itemized Deduction. This will no longer be true when filing 2018 tax returns due to the elimination of Miscellaneous Itemized Deductions effective for the 2018 tax year.
In addition, the TCJA provides that for decrees of divorce and legal separation entered on or after January 1, 2019 (or entered before, but modified after, if the modification expressly provides that the amendments made by the TCJA apply to the modification), the spouse paying alimony will no longer be able to deduct alimony payments and alimony payments will no longer be taxable income to the recipient. Therefore, the deduction for legal fees incurred in the production of taxable income would have been lost for some taxpayers even without the elimination of Miscellaneous Itemized Deductions, due to the change in alimony treatment to “not taxable income” under the TCJA.
The loss of this deduction will also impact the treatment of legal fees awarded by a court in a suit to enforce an alimony order. In prior years, the award of such fees would have been treated as the receipt of income, but an offsetting deduction would have been available if legal fees exceeded 2% of adjusted gross income. Under the TCJA, awards of legal fees will still be treated as taxable income (for divorce and separation agreements entered into before January 1, 2019), but there will be no offsetting deduction.
All family law clients are strongly encouraged to talk through the potential impact of these tax law changes with their accountants and tax advisors in order to avoid surprises when completing their tax returns in future years.
About the Author: Tony Sayess