Deductible Costs of Divorce, Gift Tax, and Student Loans

1040$20smallGIFTS AND LOANS

Exceptions to Gift Tax and Property Settlements: Generally, there is no federal gift tax on transfers of property between spouses.  (See IRC Section 1041).  However, the transfer of property between spouses must qualify under one of the following exceptions: (1) it is made in settlement of marital support rights[1]; (2) it qualifies for the marital deduction; (3) it is made under a divorce decree; (4) it is made pursuant to a written agreement, and the divorce occurs within a specified period; and (5) it qualifies for the annual exclusion.[2]

Student Loan Interest Deduction: Many times, a spouse has student loans that they will be paying during and after the divorce is finalized.  The family law practitioner should be aware of the benefits of student loan interest that may be deducted by the spouse for tax purposes.  A spouse can claim the deduction in student loan interest if: (1) interest was paid on a qualified student loan in the given tax year; (2)  a spouse is legally obligated to pay interest on a qualified student loan; (3) the spouse’s filing status is not married filing separately; (4)  the spouse’s modified adjusted gross income is less than a specified amount which is set annually, and; (5)  both spouses, if filing jointly, cannot be claimed as dependents on someone else’s return.  (See IRS Topic 456, Student Loan Interest Deduction).

DEDUCTIBLE COSTS OF DIVORCE

Tax Advice and Alimony: While a spouse cannot deduct the court costs and legal fees for getting a divorce, there are two possible deductions your client may be entitled to receive in connection with a divorce: (1) fees for tax advice; and (2) fees to obtain or collect alimony.  A spouse must itemize their deductions to obtain these deductions and both are subject to the 2% limit.

  1. Tax Advice: Pursuant to Publication 504, you can deduct fees for advice on federal, state, and local taxes of all types, including income, estate, gift, inheritance, and property taxes provided that the time spent for the tax advice related to the divorce is itemized on the attorney billing statements.
  2. Establishing or collecting Alimony: A spouse receiving alimony must include the funds in the spouse’s gross income for tax purposes.  Therefore, you can deduct the fees paid to establish or collect an alimony award, provided the time spent on obtaining or collecting alimony is itemized on the attorney billing statements.

[1] The value of the property transferred cannot be more than the value of the marital support rights.

[2] The annual exclusion for 2011 was $13,000.  However, the annual exclusion is $136,000 for transfers to a spouse who is not a US citizen provided the gift would otherwise qualify for the gift tax if the spouse were a US citizen.