Kostecke CPA

Are Legal Expenses Tax Deductible? What Are the Guidelines?

Are Legal Expenses Deductible?So, are legal expenses tax deductible? If you are going through a lawsuit, a divorce, or a business situation in which you are paying legal fees, you may be able to get a tax benefit. Sometimes you can take a deduction, but when?

Expenses That are Tax Deductible

There are a couple rules of thumb on this.

  1. First, you can deduct legal fees for actions taken to increase taxable income. For example, if you have a royalties contract with a publisher and you find out that they are not paying you in accordance with the contract which would bring in more taxable income to you, you can deduct the costs of that lawsuit. In this case, you may be in business and you can take this as a business expense right on Schedule C or your corporate return. If this is a hobby, then your legal fees may be deducted on Schedule A itemized deductions as a miscellaneous deduction subject to 2% of AGI.

    How about legal fees for an estate plan? Some of these fees would be deductible if they are related to maximizing taxable income and reducing taxes on the estate. The attorney doing this work should bill you in a manner that allows this part of the estate planning fees to be deductible.

  2. The second rule is you can deduct legal fees related to doing or keeping your job. Let’s say your business partner accuses you of stealing money from the company, and of course you are innocent. You can deduct the legal costs to defend yourself on Schedule A as a miscellaneous deduction subject to 2% of AGI. If you commit a crime not related to your business, however, your legal fees are not deductible.
  3. The third rule is you can deduct legal fees related to a discrimination lawsuit. The employer can deduct his/her legal fees as a business expense, and the employee bringing the lawsuit can deduct their legal fees, up to the amount awarded, on the front of the return as an adjustment to income.
  4. The fourth rule is you cannot deduct legal fees for personal matters, such as adoption or divorce. However, if you need to defend a position you take on your tax return that the IRS does not agree which, you can deduct those legal expenses on Schedule A as a miscellaneous deduction subject to 2% of AGI. These legal costs related to your taxes are considered tax preparation fees.

Legal Expenses Deductible in Many Circumstances

The good news for individuals with legal fees is you may have a deduction you can take on your Schedule A as a miscellaneous deduction. The bad news, however, is if you are subject to Alternative Minimum Tax (AMT) these deductions will not help you.

Businesses with deductible legal expenses can take their deduction right on their Schedule C or their corporate tax return as an offset to income like any other business deduction.

 
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