Legal and professional fees in divorce case not deductible as business expenses

By David Matthew, CPA, J.D., LL.M.

Editor: James A. Beavers, CPA, CGMA, J.D., LL.M.

The Tax Court held in Lucas, T.C. Memo. 2018-80, that a taxpayer could not deduct legal and professional fees incurred during his divorce that were not related to his business or attributable to the production of taxable income.


Sky Lucas was an active partner in Vicis Capital LLC, an investment advisory partnership. Vicis received management and performance fees for its management of several investment funds. Vicis, vis-à-vis Lucas and his partners, elected to defer some of the management and performance fees earned during 2006, 2007, and 2008 from one of the funds. As a result of the 2008 financial crisis, the partnership began to liquidate and finally wind down operations in January 2010. The deferred fees were distributed to Vicis from the fund in February 2010.

Lucas's wife, Margaret, filed for divorce in January 2008. After the divorce filing, but before the divorce was finalized, Lucas received almost $47 million in distributions. The family court determined that approximately $4.7 million of the distributions represented the deferred compensation attributable to Lucas's pre-divorce earnings and was therefore a marital asset subject to equitable distribution.

In 2010 and 2011, Lucas incurred over $3 million in legal and professional fees related to the divorce action. He deducted these expenses as legal and professional fees on his 2010 Schedule A, Itemized Deductions, and on his 2011 Schedule E, Supplemental Income and Loss. The IRS disallowed the deduction for the expenses, claiming that they were nondeductible personal expenses

Lucas filed a petition in the Tax Court challenging the IRS's determination. He argued that the expenses were deductible as business expenses under Sec. 162(a) and reportable on Schedule E or, in the alternative, as litigation costs incurred as nonbusiness profit-seeking expenses under Sec. 212 and reportable on Schedule A.

The Tax Court's decision

The Tax Court held that Lucas could not deduct the legal and professional fees because they were personal rather than business expenses.

As the court explained, Sec. 162(a) generally allows for the deduction of ordinary and necessary expenses of carrying on a trade or business. For purposes of Sec. 162, the Supreme Court has said that an activity is a trade or business if the taxpayer is "involved in the activity with continuity and regularity and . . . the taxpayer's primary purpose for engaging in the activity . . . [is] for income or profit" (Groetzinger, 480 U.S. 23, 35 (1987)). A taxpayer with ordinary and necessary expenses of carrying on his or her business will report Sec. 162 expenses either on Schedule C, Profit or Loss From Business, or Part II of Schedule E if the taxpayer is reporting unreimbursed expenses related to passthrough income from a company in which he or she actively participates.

Sec. 212 allows an individual to deduct all of the ordinary and necessary expenses paid or incurred in (1) producing income; (2) managing, conserving, or maintaining property held for the production of income; or (3) determining, collecting, or refunding any tax. A taxpayer with legal expenses that are deductible as Sec. 212 expenses reports them on Schedule A.

Sec. 262 disallows deductions for personal, living, or family expenses. Attorneys' fees and other costs paid in connection with a divorce, separation, or decree of support are generally personal expenses and not deductible (Regs. Sec. 1.262-1(b)(7)). However, the regulations contain exceptions to this general rule, including an exception for costs attributable to the taxpayer's profit-seeking activities, attributable to tax advice, or incurred to collect taxable alimony (Regs. Sec. 1.262-1(b)(7)).

To determine whether legal fees are deductible under Sec. 162 or 212, the Supreme Court in Gilmore, 372 U.S. 39 (1963), devised the "origin of the claim" test. Under this test, for legal fees to be deductible, they must have originated in the profit-seeking activities and not out of personal activities. In determining the source of claims, if the claim could not have existed "but for" a personal activity, the expense of defending it is a personal expense and not deductible. Using this test, the Court held that legal expenses paid to defeat claims arising from a marital relationship were personal and nondeductible and that it is irrelevant whether the taxpayer's income-producing property would be affected by the outcome of the divorce proceeding.

Applying the origin-of-the-claim test to determine the source of the claim giving rise to his legal expenses, the Tax Court determined that Lucas's spouse's claim for his interest in Vicis and the deferred distributions to Vicis clearly arose from the marriage as, but for the marital relationship with Lucas, she would have no legal claim to the property or interest in the partnership.

Regarding Lucas's claim that he was entitled to deduct the expenses as business expenses, the Tax Court found he had not proved that they were otherwise deductible under Sec. 162(a) or Sec. 212 because, in the divorce, Lucas was neither trying to obtain alimony from his spouse nor resisting an attempt by her to interfere with his ongoing business activities. Furthermore, the distributions at issue in the divorce case were made during the winding down of business operations, when Lucas was no longer engaged in any business activity related to the partnership. The court found that he did not establish the expenses were related to winding down the business or would have been ordinary and necessary expenses of carrying on the trade or business.

Lucas also argued he was entitled to a deduction because his case was similar to Hahn, T.C. Memo. 1976-113, where the taxpayer's legal fees were held to be deductible under Sec. 212 because they were incurred to secure income from jointly owned property over which the ex-husband had taken possession. The Tax Court disagreed, as the taxpayer in Hahn would have incurred legal expenses securing her rights to income from jointly owned business property regardless of her marital relationship, whereas Lucas's spouse had no claim over his interest in Vicis and the deferred distributions to Vicis outside the marital relationship. Lucas's expenses were thus incurred defending his ownership in Vicis and in the distributions from equitable distribution in a divorce action and were not related to the actual ongoing business of the investment partnership.


While the court in Lucas discussed and distinguished the narrow applicability and exceptions to Sec. 212, it should be noted that as a result of the law known as the Tax Cuts and Jobs Act, P.L. 115-97, the miscellaneous deductions to which Sec. 212 applies and that are reported on Schedule A are suspended through 2025. The immediate applicability of Lucas would be the analysis of whether the origin of the claim is related to business activity reported on Schedule C or Schedule E, rather than the nonbusiness income-producing activities reported on Schedule A.



David Matthew, CPA, J.D., LL.M., is a supervising senior accountant with SingerLewak LLP, in Woodland Hills, Calif. For more information about this column, contact


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