Easy Guide: Are Your Attorney Fees Tax Deductible?

Retaining legal counsel and paying attorney fees can be an expensive endeavor. Many taxpayers wonder if these costs can be deducted on their tax returns to help offset the financial burden. The rules surrounding the deductibility of legal expenses are complex and depend on the nature of the fees.

This guide aims to provide clarity on which attorney fees might qualify as tax-deductible expenses. We’ll overview key concepts, explain IRS guidelines, and give examples for personal and business-related legal costs. Read on to maximize your knowledge of tax deductions for attorney fees.

Understanding Tax Deductible Expenses

Expenses that qualify as tax deductions can lower your taxable income for the year. This results in you owing less money to the IRS when you file your tax return. For an expense to be deductible, it must meet certain criteria set by the Internal Revenue Service (IRS):

• The expense must be considered ordinary and necessary for your circumstances. This means it is common for your situation and required to conduct business or other activities.
• The expense has to be directly related to or associated with your work, investments, or other income-generating activates.
• You must keep proper documentation and records for the expense as required by the IRS. This includes receipts, invoices, bank statements, etc.
• There are limits on the amount that can be deducted for some expenses set by the tax code. You cannot exceed these thresholds.

With those basic principles in mind, let’s overview common attorney fees taxpayers incur.

Overview of Attorney Fees

Attorney fees refer to the costs charged by lawyers or law firms for legal services. These usually take the form of:

• Retainers – Upfront lump sum payments made to secure representation
• Hourly rates – Fees based on billable hours worked at an agreed upon price per hour
• Contingency fees – Percentage of settlement awarded to the attorney if case is won

Individuals and businesses may incur legal expenses related to many aspects of life and work, including:

• Personal issues – Wills, trusts, divorce, child support, custody battles, etc.
• Business matters – Incorporation, contracts, lawsuits, intellectual property, etc.
• Employment disputes – Wrongful termination, discrimination, sexual harassment cases, etc.
• Investments – Tax implications, regulatory compliance, lawsuits, etc.

Different rules apply when determining if these various attorney fees can be deducted on your taxes.

Are Personal Legal Expenses Deductible?

Most legal fees for personal matters cannot be deducted on your tax return. The IRS considers these nondeductible personal expenses.

For example, you cannot deduct legal costs related to:

• Drafting wills or estate planning
• Divorce and child custody proceedings
• Personal injury lawsuits
• Criminal defense fees
• Preparing and filing personal tax returns

However, there are some exceptions if the fees were paid to resolve tax-related issues or claims against your property. Nonetheless, for the most part, attorney fees for personal legal issues provide no tax benefit.

Deductibility of Business-Related Attorney Fees

If you own a business or earn self-employment income, legal fees related to your work are treated differently. IRS regulations permit the deduction of ordinary and necessary attorney fees for operating your business.

Some examples of deductible business-related legal expenses:

• Incorporation fees when forming a business
• Legal services for drafting business contracts
• Resolving landlord-tenant disputes over business property
• Settling business-related litigation
• Fees to acquire patents, trademarks, or copyrights

To claim these deductions, you must properly document the attorney fees:

• Retain copies of legal invoices and billing statements
• Keep receipts for upfront retainers or expenses
• Record payments made to the attorney or law firm

Then report these amounts as legal fee deductions on Schedule C for sole proprietors or partnership returns. The legal costs directly lower your business income for tax purposes.

Special Cases: Employment and Investment Related Legal Fees

Some legal situations fall into deduction “gray areas” when taxes are concerned. Two prime examples are employment disputes and investment-related legal costs.

For employment-related legal fees, the deductibility depends on the outcome:

• If the dispute is settled in your favor, the legal costs are deductible as an adjustment to income.
• If you lose the case, the fees are no longer deductible.

For investment-related legal fees, the expenses are deductible if they were paid:

• To resolve issues around taxable investment income or property
• To seek advice about reporting investment income properly

However, legal fees to acquire new investments are not tax deductible.

So deductibility depends on the nature of employment and investment legal issues on a case-by-case basis.

How to Claim Deductible Attorney Fees on Your Tax Return

Follow these steps to claim eligible attorney fees as tax deductions:

1. Gather documentation of legal expenses – invoices, billing statements, receipts of payment, etc.
2. Categorize fees based on deductibility criteria – personal vs business, employment/investment specifics.
3. Report qualifying legal fee deductions on the appropriate IRS forms and schedules:
   • Schedule A for fees related to employment disputes or taxable investment income
   • Schedule C, E, or F for business or self-employment legal costs
4. Retain paperwork for at least 3 years in case of an IRS audit.
5. Arrange records by tax year. The IRS prohibits deducting the same expense twice across multiple years.

Thorough documentation provides proof to the IRS that your legal deductions are valid and meet all requirements.

Common Mistakes to Avoid When Claiming Attorney Fees

It’s easy to make errors when deducting legal expenses on your taxes. Be aware of these common pitfalls:

• Claiming personal legal fees as deductions – Only business and specific employment/investment fees qualify.
• Failing to get receipts or invoices – Every deducted expense needs documentation.
• Mixing legal costs between tax years – Fees can only be deducted in the year they were paid.
• Missing deduction deadlines – Claims must be made by the tax filing deadline (usually April 15).
• Exaggerating expenses – Deductions should match your documentation.

With proper organizational habits and following IRS rules, you can avoid mistakes when deducting attorney fees.

Recent Changes and Updates in Tax Law

Tax regulations are constantly evolving, which can impact the deductibility rules for legal expenses. Some recent changes include:

• Increased difficulty in deducting employment-related legal settlements under the 2017 Tax Cuts and Jobs Act.
• Elimination of the home office deduction for business legal expenses under the TCJA.
• Added substantiation requirements for claiming legal fee deductions over $75 under the Taxpayer First Act of 2019.

It’s crucial to consult updated IRS guidance each year when deducting attorney fees. Tax professionals can explain how new rules apply to your situation.

FAQs on Attorney Fees and Tax Deductions

Are attorney fees for creating a will deductible?

No, you cannot deduct legal fees for drafting a personal will or estate planning. These are considered nondeductible personal expenses by the IRS.

Can I deduct attorney fees for getting divorced?

Unfortunately, legal fees related to divorce proceedings are not tax deductible. The IRS treats them as personal expenses even in messy cases.

If I win a lawsuit, can I deduct my attorney fees?

It depends. If the lawsuit was related to your business operations or investments, the legal costs are likely deductible. Personal lawsuit proceeds and fees are generally not deductible.

Are attorney fees deductible for filing bankruptcy?

Yes, legal fees directly related to filing for bankruptcy for your business are treated as deductible business expenses by the IRS in most cases.

Can I deduct legal fees for buying a house?

No, attorney fees associated with purchasing or selling a personal residence do not qualify for tax deductions. These fees are considered personal costs by the IRS.

Conclusion

Determining if attorney fees are tax deductible depends on several factors – the nature of the legal issue, IRS categories for deductibility, proper documentation, and following current regulations. For the majority of taxpayers, personal legal expenses cannot be deducted. But fees stemming from operating a business, resolving employment issues, or dealing with investments may qualify if strict guidelines are met. We recommend consulting with a tax professional to address your specific situation before claiming deductions for attorney fees. Use this comprehensive guide as a starting point when navigating the complex IRS rules surrounding legal fee deductibility.