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How to Determine Whether Your Legal Fees Are Tax Deductible
Legal fees related to the collecting of income or collecting, acquiring, or calculating tax may be deductible on your federal income taxes, in a variety of both business and non-business related scenarios. Keep reading to learn which legal fees are deductible and which are not.
Identifying Business-Related Legal Expenses
Determine if the fees are personal legal fees or business fees.The general rule of thumb is that legal expenses may be deducted for anything revolving around producing or collecting taxable income, and calculating, collecting, or acquiring a refund of any tax. Business-related legal fees are the most commonly deductible legal fees, though a variety of non-business related legal fees are also available.
- If you are unsure whether your legal fees are personal or business fees, ask yourself if you would have incurred the expense if you were not conducting business.
Perform an origin of the claim test.This test is widely accepted by courts throughout the U.S. use it to determine whether or not legal fees are a business-related expense. To perform this test, you need to look at the origin and character of the legal fee. Then you will need to determine whether the fee arose from a personal or a capital transaction. In other words, was this fee part of a business or personal activity?
- For example, legal fees from a divorce proceeding are personal, but legal fees paid to defend your company's reputation are business related.
Learn what business legal fees qualify.Business fees are those that are incurred while carrying on a trade or conducting business. While there is a fair amount of wiggle room in these definitions, to qualify as a business legal expense, the expense and the consultation must be:
- Ordinary and necessary. Ordinary expenses are those that are common and acceptable in your line of business. Necessary expenses are those that are helpful and appropriate for your trade.
- Reasonable in amount. Expenses must "resemble a reasonable and proximate relation to the production or collection of taxable income or to the management, conservation, or maintenance of property held for the production of income."
- Fees must have been paid by the person who received counsel, and incurred while carrying on a trade or engaging in business. If someone else paid your legal fees, you're not able to deduct those fees on your taxes.
Distinguish between the more difficult cases.In some cases, such as home-based or self-employed family businesses or expenses, it can be difficult to differentiate between legal fees that are deductible and personal expenditures. If the fee is both a personal and business expense, allocate the appropriate percentage of the expense to personal expenses, and the remaining sum to business expenses.
- For example, legal fees incurred to maintain a home-based office within your personal residence would qualify as deductible.
- As another example, if you paid 0 to have your personal and business taxes prepared, with each return costing the same amount, then you would have 0 in personal legal expenses and 0 in business legal expenses.
Consider IRS approved factors to help you determine if a deduction allocation is reasonable.If you are having trouble determining how much you can deduct, consider these factors to help you decide:
- time required of legal counsel
- difficulty of the tax questions presented to legal counsel
- amount of tax involved
- legal fees customarily charged in your locality for the legal services performed
- favorable or unfavorable outcome obtained as a result of the legal services
Determine if your legal fees were related to producing or collecting taxable income or getting advice.These types of legal fees are deductible as a business-related expense. You can deduct legal expenses incurred in your attempts to produce or collect taxable income as well as legal fees you pay in connection with the determination, collection, or refund of any tax.You can also deduct legal expenses that are related to:
- performing your job
- maintaining your employment
- defending yourself against criminal charges that arose out of the performance of your trade or business
- related to divorce tax advice when the legal billing specifies the reasonable allocation of fees toward tax advice
- collection of taxable alimony
Know the difference between contingent and non-contingent legal fee agreements.A contingent legal fee agreement is when a client cannot pay all or part of the attorney’s legal fees up front, so the attorney takes a percentage of the client’s award if the case is won. A non-contingent legal fee agreement is when a client pays the attorney’s legal fees up front.
- Contingent attorney fees are not deductible, but non-contingent attorney fees may be deductible. Before deducting these fees, talk to a tax specialist to determine if the fees are deductible based on the details of your case.
Identifying Deductible Personal Legal Expenses
Decide whether or not your personal legal fees had to do with collecting income.Personal legal fees are subject to the same requirements as business legal fees. They must be incurred in the service of collecting taxable income for them to be deductible, though not necessarily "business" or "trade" related income.
Eliminate the possibility that your personal legal fee falls under a category that is non-deductible.Examples of legal services provided for personal legal expenses that are not deductible include:
- child custody proceeding
- breach of promise to marry lawsuit
- civil or criminal charges resulting from a personal relationship
- personal injury damages awarded - except whistle-blower claims and unlawful discrimination claims
- perfection of title to real property for personal use or any defense thereto, including preparation of title
- preparation of a last will and testament or any codicil thereto
- property claims or property settlement in a divorce proceeding regardless of whether or not the legal proceeding relates to the loss of income-producing property
- campaign expenses for any candidate running for office - including qualification and registration fees for primary elections
- legal fees incurred for the defense of charges arising from participation in a political campaign
Talk to your lawyer.Legalese is difficult to understand and even harder to negotiate come tax time. You may be confused about whether or not your legal fees may have been in some way related to income. If you're not sure, the best person to ask is always your lawyer.
- It's always best to discuss these matters before you talk to your lawyer about hiring them and taking on fees. Know what you'll be able to deduct before you hire on for representation and counsel.
Learn the common non-business deductions.Depending on your personal situation and legal fees, a lot goes into determining whether or not they'll be deductible. In general, though, a variety of deductions are commonly awarded. These include the following deductions, which may be made in most cases:
Look for the "gray-area" cases.Some expenses, like those related to income-production may not actually be trade or business related, so they can't be strictly "personal" or "capital" expenses. These are still deductible, however. Examples of this include legal fees:
- Related to the "management, conservation, or maintenance of property held for the production of income," or fees paid related to the "determination, collection, or refund of any tax."
- If you own property, say, and needed to consult a lawyer to clear your legal title to a house that you use as a home office, you may be able to claim a deduction based on those fees. The best way to find out is to ask your lawyer.
Claiming Your Deductions
Use Form 1040.If the legal expense is a business expense, you may deduct it on IRS Form Schedule C (Form 1040), line 17 or Schedule C-EZ (Form 1040 or 1040-EZ).
- If the expenses are personal, you can itemize the expenses on the same form, or take the standard deduction, depending on your situation. If you will not itemize expenses, personal legal fees are not tax deductible.
Claim your deductions by filling out the form.You can find the current standard deduction for your filing status by looking at the left hand margin on line 40 of . The best way to decide whether you will take the standard deduction or will itemize expenses is to fill out , and see which gives you the largest deduction. To fill out Schedule A:
- Fill in your medical and dental expenses on line 1, and then follow the instructions for lines 2 - 4.
- Fill in lines 5 - 8 with the amounts you paid for the listed taxes, then add the amounts together to complete line 9.
- Fill in lines 10 – 14 with the amount you paid for the types of interest listed, then add the amount together and complete line 15.
- Provide information about your charitable gifts and casualty and theft losses on lines 16 – 20.
- Include your total personal legal expenses on line 21 and/or line 22.
- Follow the instructions for lines 23 – 29 to calculate your total itemized expenses.
Categorize personal expenses.If you will itemize expenses, determine if the personal legal expenses fall under one of the following two categories. If the expense does not fall under one of these categories, it is not a deductible legal expense.
- Unreimbursed employee expenses. If the legal expense was related to your employment and your employer did not reimburse you, you can deduct it on Schedule A (Form 1040), line 21 or Schedule A (Form 1040NR), line 7, so long as it was ordinary and necessary expense.
- Tax preparation fees. If the expense was for preparation of income tax returns, you may deduct it on Schedule A (Form 1040), line 22 or Schedule A (Form 1040NR), line 8.
QuestionIf I paid legal fees in 2015 and received a settlement in 2019, is there a way to include both in one year for tax purposes?wikiHow ContributorCommunity AnswerIf you itemize, you can deduct your legal fees at the time that you declare the taxable income.Thanks!
QuestionAre the fees for setting up a living trust deductible?wikiHow ContributorCommunity AnswerNo. See Method 2, number 2 - in this website. The living trust is not involved in income production; it's involved in the dispersal of a decedent's property.Thanks!
QuestionI have a building, of which I occupy 40% and 60% is a rental. I was sued for construction access by the neighboring building. I lost the suit, and the fees incurred were substantial. Can I deduct the fees associated with this suit?wikiHow ContributorCommunity AnswerThanks!
QuestionCan I claim the charges and expenses that I pay to my financial manager on my taxes?wikiHow ContributorCommunity AnswerPossibly. You should consult an accountant about this, as it is dependent on numerous factors.Thanks!
Can legal fees be for wrongful termination and to recover lost wages be claimed on your taxes?
I know many of itemized deductions for 2019 disappear. Is there an argument for continuing to deduct legal fees related to a defamation lawsuit, half paid in 2019 and 2019?
I lost a case in Idaho. A judgement for legal fees was placed against me. Those fees are being taken from my paycheck through garnishment. Are they tax deductible?
Are legal fees deductible to transfer title of my home to my children?
Can I deduct my lawyer fees to negotiate a spousal support review? I receive spousal support from my husband for 10 years now. I have never deducted any legal fees over these 10 years.
- If you are unsure about any of your expenses or how to properly complete any tax forms, you should consult with a Certified Public Accountant (“CPA”), tax attorney, or an Internal Revenue Service (“IRS”) Enrolled Agent (“EA”).
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