Most people know that there is a deduction allowed for the amounts you pay to have your taxes prepared by a professional. Does that same rule apply to fees paid to an attorney to plan your estate? The answer is not as straight forward as you might think it should be. The tax law provides that expenses paid or incurred by an individual in connection with the determination, collection, or refund of any tax is deductible; it doesn’t matter if that tax is a federal, state, or local tax. How does this apply to an estate plan? If you are reading this, you know that any good estate plan will consider both the tax and non-tax aspects of one’s estate.
So how do you know how much of the amount paid for your estate plan you can deduct on your tax return? Thankfully, the courts have ruled that the tax planning portion of the attorney’s fees paid for estate planning services is deductible for tax purposes. But how is an average person supposed to know what to deduct?
The courts have attempted to define what is deductible when there is not a clear invoice indicating what is tax related. In the most notable court case on the issue, the court chose to use substantiated tax hours to determine the deductible percent of the invoice. The court compared the tax hours to the total hours represented on the invoice to form the allocation. In that case, and several cases afterwards, they used a 20% allocation for purposes of the deduction when substantiation was not produced. Alternatively, when the taxpayer substantiates the deduction with supporting information, such as an hourly allocation or an itemized invoice based on a good faith allocation, the deduction has been generally accepted by the IRS.
If you are stuck doing your own allocation, here are some things to consider when calculating the tax deduction. Attorney’s fees paid in connection with drafting a credit shelter trust, formulating generation skipping tax provisions, marital deduction planning, tax apportionment planning, or income tax basis provisions are deductible expenses. Additionally, time spent on IRA matters may also constitute tax advice because they may relate to the proper apportionment of estate tax in connection to the IRA or planning for required minimum distributions. Alternatively, time spent drafting a will or dispositive provisions have been found to be non-tax related and therefore not deductible.
Before you put yourself through the ringer to do a calculation to determine the deductible amount, make sure the deduction will result in tax savings. Many times, these deductions do not result in tax savings due to the 2% floor on these expenses. Meaning, only the amount of these expenses that exceed 2% of the taxpayer’s adjusted gross income is deductible for tax purposes. If you find that you have enough expenses to qualify for the deduction you may also find yourself in Alternative Minimum Tax (AMT), which is hitting a greater percent of the population each year. If you find yourself in AMT you will likely see no tax savings on your tax returns as a result of these expenses.
As with most things in tax, it’s always a good idea to talk to your tax advisor when identifying what is deductible and what is not deductible. Additionally, you should ask your estate planning attorney to itemize the invoice so your advisor can make a good faith estimate of the deductible portion.