Family Law Disputes and the Deductibility of Legal Fees

I was talking with a colleague the other day about how she manages the accounting side of her practice and it reminded me about the deductibility of legal fees for certain family law issues, and the importance for lawyers of tracking that portion of their fees if their clients wish to claim the deduction.

The basic idea with all income tax deductions is that they reduce the amount of income tax you pay by reducing your taxable income. Most employees have provincial and federal income taxes deducted off each paycheque automatically, so that tax they have to pay at the end of the year already paid. If your taxable income is reduced, then you've overpaid your taxes and you get a refund. Refunds are good. If you haven't overpaid your taxes, you'll at least have to pay less taxes.

Legal Costs in Family Law Disputes

Happily for people embroiled in family law disputes, the federal Income Tax Act lets you deduct some but not all of the money you're spending on your lawyer. The Canada Revenue Agency's Income Tax Interpretation Bulletin IT-99R5 sets out the basic rule, which I think comes from s. 8 of the act, that:

Except where there is a specific provision in the [Income Tax Act] dealing with legal or accounting fees ... legal and accounting fees are deductible only to the extent that they 

(a) are incurred for the purpose of gaining or producing income from a business or property, and 

(b) are not outlays of a capital nature.

Here are the rules applicable to family law matters:

¶ 4. "Legal costs to prosecute or to defend most tort, contract or other civil claims arising in the ordinary course of business will generally be deductible." (Torts include claims for damages for assault, battery, negligence, malicious prosecution and so on.) If you are successful, you can deduct your legal fees minus any legal costs you are awarded and actually receive. 

¶ 17. Legal costs of getting a divorce, establishing a right to spousal support under the Divorce Act or obtaining an increase in spousal support are not deductible.  

¶ 17. Legal costs of getting an order for child support are deductible. The costs of obtaining an increase in child support are not deductible. 

¶ 21. Payors' costs of addressing a claim for support are not deductible. 

¶ 18. Legal costs of defending against the reduction of support are deductible.  

¶ 21. Payors' costs of reducing support or terminating support are not deductible. 

¶ 18. Legal costs of enforcing an existing right to support are deductible. An existing right of child support or spousal support may come from a separation agreement, a court order or the legislation on family law matters. Child support is an existing right under the Divorce Act. 

¶ 20. However, legal expenses of getting a lump-sum payment other than for arrears are not deductible. 

¶ 21. Legal expenses relating to custody or access are not deductible.

Suggestions for Parties

If you have hired a lawyer to negotiate, apply for or enforce child support or to enforce an agreement or order for spousal support, you should tell your lawyer right away that you want to claim this deduction if your lawyer doesn't bring it up him- or herself. Your lawyer will need to write a letter to the CRA stating the amount of his or her fees that relate to those claims — you will file this letter with your income tax return — and it will be much easier for the lawyer to write the letter if the lawyer tracks his or her time on these issues right from the beginning, instead of having to review your file and make a guesstimate.

Practice Suggestions for Lawyers

If you are a lawyer representing or about to represent someone in negotiating, applying for or enforcing child support or in enforcing an agreement or order for spousal support, you should consider:

1. Raising the issue of these tax deductions in your retainer letter so your client is aware of them from the start.
2. Maintaining a separate yearly tally of your hours and disbursements incurred in relation to these issues, as you bill for your time or incur those expenses, so that you have an accurate record for your letter to the CRA. 
3. Providing the client with an annual statement, in January or February, around the time T-slips are due, setting out the amount of your fees and disbursements related to these issues. 

You may wish to take these steps this regardless of whether the client mentions his or her wish to claim these deductions when you are retained; clients often ask for an accounting at tax time, and you do not want to put yourself to the trouble of a file review to calculate the client's deduction or to the risk of making a guesstimate to CRA.

Update: 7 July 2014

See the comments to this post for an important point raised by a reader which suggests that the CRA document referenced above may not reflect current CRA policy on the deductibility of legal fees. Stay tuned while I figure this out...

Lawyers' Magazine Publishes Rates Survey

Canadian Lawyer has published its 2012 survey of lawyers' fees (PDF), which includes reports on the rates charged for common family law activities, broken down by region and size of firm.

How Your Lawyer Charges You

This seemed like an appropriate follow up post to my article about the cuts to legal aid.

By the Hour

Family law lawyers bill for their services by the hour. Other lawyers, like the lawyers who handle personal injury and wrongful dismissal claims, bill on a contingency basis, meaning that they work for a percentage of the settlement; family law lawyers don't do this, we bill by the time spent working on your file.

"Working on your file" encompasses a lot of different activities, as broad as the phrase suggests. In addition to the obvious things, like time spent in court or attending mediation, family law lawyers bill for reading letters and writing them, making telephone calls and taking them, researching legal problems, drafting court documents, consulting experts and giving instructions to them, and so on.

The amount of a lawyer's rate is usually, but not always, related to things like the length of time the lawyer has been practicing and the hourly rate of the other members of the lawyer's firm. When you're hiring a lawyer, make sure you get his or her hourly rate and the rates of any other members of the firm who might wind up working on your file.

Retainers

Most family law lawyers work on a retainer basis. "Retainer" has a lot of different meanings. In this context, it means an amount of money the lawyer asks you to pay up front. As time goes by, the lawyer will bill you for his or her services and pay the bill by withdrawing money from your retainer. When, after a number of bills, the retainer is empty, the lawyer will usually ask you for another retainer payment. Essentially, your retainer is security for the lawyer's future fees.

The size of the retainer the lawyer asks for will depend on a lot of things, including the perceived complexity of the file, urgency, the amount of work the lawyer thinks he or she will have to do in short order, and the number of court appearances the lawyer anticipates in the near future. When a trial is looming, the lawyer will ask for an extra retainer roughly equal to the working hours the lawyer expects the trial to consume. Unless the lawyer says so, the amount of the retainer requested is not a flat rate, quote or estimate of the total cost of resolving your file.

The retainer you give to your lawyer is your money. If your file concludes or your and your lawyer part ways before your retainer is exhausted, you will get the balance of your retainer back.

Flat Rates

Sometimes a family law lawyer will agree to work for a fixed fee. There aren't very many legal activities in family law that are suited for flat rates, but those that leap to mind are: simple divorces, separation agreements, marriage and cohabitation agreements, relative adoptions, and giving independent legal advice about an agreement.

Initial Consultations

Unless the lawyer advertises that your first meeting with him or her is free, expect to be charged for the consultation at the lawyer's usual hourly rate. Relatively few lawyers, and even fewer family law lawyers, offer free initial consultations. Never assume that your first meeting is free.

Remember that family law lawyers bill for for their time. You would expect to pay something when the mechanic puts your car up on the hoist or your plumber diagnoses a problem with your washing machine; lawyers are doing pretty much the same thing when you meet with them for legal advice, and you'll get a bill for their services just like your would from your mechanic or your plumber. If you have any questions about whether there will be a charge for the lawyer's time and advice, ask up front.

Lawyers' Magazine Publishes Rate Survey

Canadian Lawyer has published its 2009 survey of lawyers' fees, which includes the rates charged for common family law activities broken down by region and size of firm.