The Internal Revenue Service draws a firm line between personal expenses and the costs of earning or managing your income. Spending money to make money can result in tax deductions because there’s something in it for the IRS -- you’re taxed on that income. However, personal spending isn’t deductible. Divorce costs are personal so they generally don’t affect your taxes, but there are a few exceptions.
Attorney Fees and Court Costs
Divorce costs can include attorney fees, court filing fees, expert fees and the costs of appraising property. You’re paying these things to end your marriage, and ending your marriage is a personal endeavor. It probably isn’t going to result in income the IRS can tax you on, even if you’re fighting over who gets the family business. After all, the business will presumably keep earning money no matter who owns it, so divorce costs relating it don’t earn any tax breaks under IRS rules.
In the spirit of fairness, the IRS doesn’t tax the same income twice -- once when a spouse earns it and again when the other spouse who receives it as support. Alimony is deductible to the paying spouse because he doesn’t have the use of that money. He doesn’t even have to itemize on his taxes to claim this deduction -- it’s subtracted on the first page of Form 1040, an “above the line” deduction that determines a taxpayer’s adjusted gross income. However, the receiving spouse must claim the alimony as income. The rules for what qualifies as alimony are somewhat strict: spouses can’t reside in the same home or file a joint tax return, and the alimony has to be in the form of money, not property. Your divorce decree or separation agreement must specifically state that it’s alimony, because other payments such as child support or property settlement payments aren’t tax deductible.
If you’re paying a lawyer and you run up court costs because you’re seeking alimony, these expenses are tax deductible -- you’re fighting for income that you’ll eventually be taxed on. If you have to hire a vocational expert to prove to the court that you can’t support yourself on what you’re able to earn, this is tax deductible, too. So are accountant fees if you need the help of a professional to prove and establish the extent of your spouse’s income. The spouse who pays alimony can’t deduct any of the costs of litigation, however. Some costs associated with dividing retirement benefits are deductible because they, too, relate to income. Ask your attorney to separate deductible and non-deductible charges on your invoices so you have proof for the IRS if it becomes necessary.
The 2-Percent Rule
You must itemize to claim deductions associated with your divorce litigation. They fall into the miscellaneous category on Schedule A, reserved for work-related expenses and costs you must pay to earn income. This category is subject to a 2-percent rule. You can only deduct those costs to the extent that they exceed 2 percent of your adjusted gross income.
Property settlements are typically tax-neutral, but if you end up selling property you receive in the divorce, you may be liable for capital gains tax at that time. This would depend on the property’s basis and the type of property, so speak with an accountant -- the property you’re receiving may not be such a great deal after all if there are negative tax implications. If you hire a professional to guide you, this is considered tax advice, which usually is deductible.