Can Attorney Fees Be Written Off On Taxes?
Decipher the tax rules for deducting attorney fees. This guide clarifies deductibility principles, qualifying situations, non-deductible cases, and essential reporting.
Attorney fees are a significant expense, and their tax deductibility is not straightforward. Tax law sets specific criteria, primarily based on the legal matter’s direct connection to income-producing activities or a trade or business.
General Principles of Deductibility
The Internal Revenue Service (IRS) permits deduction of “ordinary and necessary” expenses for trade or business or income production. An “ordinary” expense is common in an industry; a “necessary” expense is helpful and appropriate, though not indispensable.
Tax deductions fall into two categories: “above-the-line” adjustments to income and “itemized deductions.” Above-the-line deductions reduce gross income to adjusted gross income (AGI), affecting eligibility for tax credits and other deductions. All taxpayers can use these adjustments.
Itemized deductions are claimed on Schedule A (Form 1040) and subtracted from AGI to determine taxable income. Taxpayers itemize only if their total deductions exceed the standard deduction. The TCJA of 2017 suspended most miscellaneous itemized deductions, which previously included many legal fees.
Specific Deductible Scenarios
Attorney fees are deductible when directly related to income-generating activities or a business. Legal fees for operating a trade or business are deductible as ordinary and necessary business expenses, including contract disputes, intellectual property protection, or defending against business lawsuits. Legal expenses for managing rental property are also deductible.
Certain legal fees are permitted as above-the-line deductions, directly reducing AGI. Fees for unlawful discrimination claims, like employment discrimination lawsuits, can be deducted up to the judgment or settlement amount included in income.
Attorney fees for whistleblower awards qualify for an above-the-line deduction. This includes legal fees for federal tax whistleblower actions (IRS awards) or SEC/CFTC whistleblower programs. Deductions are limited to the award amount received in the same tax year.
Legal fees for tax advice or return preparation are not deductible as miscellaneous itemized deductions after the TCJA. However, legal expenses for resolving tax issues related to a business (Schedule C), rental income (Schedule E), or farm income (Schedule F) can be deducted on those schedules. Business-related tax advice may still be deductible, unlike personal tax advice.
Non-Deductible Fees
Many legal fees are not deductible, often considered personal expenses or capital expenditures. Legal fees for personal matters like divorce, child custody, or personal injury lawsuits are not deductible. These are personal living expenses unrelated to income-producing activities.
Fees for defending against civil or criminal charges are not deductible unless directly arising from a trade or business. Legal costs for criminal defense unrelated to business operations do not qualify. Legal expenses for non-income-producing activities are also not deductible, including breach of promise to marry suits or general personal property claims.
Legal fees to acquire or improve property are capital expenses, not immediately deductible. Attorney fees for purchasing a home are added to the property’s cost basis, reducing taxable gain upon sale. These costs are part of the asset investment. Legal fees for estate planning, such as preparing a will, are also personal expenses and not deductible.
Documentation and Reporting
After determining deductibility, taxpayers must keep thorough records. This includes attorney invoices, service descriptions, and related court documents or settlement agreements. Records must clearly link the legal expense to the income-producing activity or deductible scenario. The IRS recommends keeping tax records for at least three years, or longer for certain situations.
Business-related legal fees are reported on the appropriate business income form:
Sole proprietors and single-member LLCs report expenses on Schedule C (Form 1040) under “Legal and professional services.”
Legal fees for rental properties are reported on Schedule E (Form 1040).
Those for farm income are reported on Schedule F (Form 1040).
Partnerships report legal expenses on Form 1065.
Corporations report legal expenses on Form 1120.
Above-the-line deductions for employment discrimination and whistleblower awards are reported on Schedule 1 (Form 1040), “Additional Income and Adjustments to Income.” Attorney fees for unlawful discrimination claims and IRS whistleblower awards are reported here. This schedule captures income and deductions not directly on the main Form 1040.