A recent case in the Tax Court decision, Lucas, T.C. Memo. 2018-80 held that legal and professional fees related to an investment advisory firm partner’s divorce do not qualify as business expenses. The Tax Court determined that they were instead nondeductible personal expenses.
One of Mr. Lucas’ arguments was that the millions in legal and professional fees he incurred were non-business profit seeking expenses deductible under Sec. 212, purportedly because they were incurred in order to fight his wife’s claim to his earnings. Sec. 212 allows a deduction for ordinary and necessary expenses related to
- producing income
- managing, conserving, or maintaining property held for the production of income, or
- determining, collecting, or refunding any tax
Until the recent tax changes, such amounts were reported on Schedule A.
The court found that Mr. Lucas’ legal fees failed the “origin of the claim” test. This test requires the fees to have originated with a profit seeking activity in order to be deductible. Said otherwise, the claim cannot have originated from a personal activity, The Tax Court concluded that Mr. Lucas’ legal expenses, incurred to dispute claims derived from a marital relationship, were of a personal nature regardless of whether his income-producing property would be affected by his divorce. Notably, while such personal expenses are not deductible, professional fees incurred to collect taxable alimony are specifically allowed as an exception.
The question of when legal and professional fees may be deductible often arises in various contexts. This related article further discusses how the origin of the claim test affects tax implications for legal fees and litigation awards.