Can I Deduct Attorney Fees From a Settlement?

Receiving a settlement often introduces complex tax considerations, particularly regarding attorney fees. Understanding their tax treatment is important for individuals navigating a legal resolution’s financial aftermath. This article clarifies the current tax rules surrounding attorney fee deductions from settlements.

Understanding Attorney Fee Deductions

The deductibility of attorney fees from a settlement depends on the claim’s nature and changes from the Tax Cuts and Jobs Act (TCJA) of 2017. Before the TCJA, many attorney fees were deductible as miscellaneous itemized deductions, subject to a 2% adjusted gross income (AGI) floor. However, the TCJA eliminated most miscellaneous itemized deductions for tax years 2018 through 2025, making many attorney fees nondeductible for individuals during this period. For most settlements, such as those for personal injury or property damage, attorney fees are generally not deductible by the individual receiving the settlement. Consequently, a taxpayer might be responsible for income tax on the entire gross settlement amount, even if a significant portion was paid directly to their attorney.

Despite the general disallowance, limited exceptions allow attorney fees to be deducted “above the line,” meaning they reduce your adjusted gross income. These deductions are beneficial as they are not subject to the limitations that applied to miscellaneous itemized deductions. One primary exception applies to attorney fees and court costs paid in connection with certain unlawful discrimination claims. This category includes claims under federal, state, and local anti-discrimination laws, such as those for age discrimination, civil rights, or certain employment cases.

Other exceptions cover attorney fees related to whistleblower claims. These include awards under federal tax whistleblower programs (Internal Revenue Code Section 7623), actions brought under the federal False Claims Act, and claims made under certain provisions of the Securities Exchange Act and the Commodity Exchange Act. Additionally, fees associated with certain claims under the Social Security Act may also qualify for an above-the-line deduction. For these types of claims, the deduction for attorney fees and court costs cannot exceed the amount of the judgment or settlement included in the taxpayer’s gross income for that tax year.

Information Required for Deduction

Gathering specific documentation is important to address the tax implications of a settlement, especially when claiming an attorney fee deduction. The settlement agreement is a foundational document, outlining the claim’s nature and how proceeds are allocated among different damage types. This allocation is important because the taxability of the settlement often hinges on the “origin of the claim” and how various components, such as lost wages, medical expenses, or punitive damages, are designated.

Detailed attorney fee statements or invoices are necessary. These documents should clearly show the exact amount of fees paid and the specific services rendered, which helps substantiate the deduction if the claim falls under one of the qualified categories. Without clear documentation, it can be challenging to prove the direct connection between the fees and a deductible claim.

Taxpayers should anticipate receiving Form 1099-MISC or Form 1099-NEC from the payer of the settlement. These forms report the gross settlement amount, often including the portion paid directly to the attorney, to both the taxpayer and the IRS. Understanding which form is issued is important, as a Form 1099-NEC, for nonemployee compensation, can imply self-employment income and potential self-employment taxes, even if the settlement was not for services. Official court documents or agency filings, such as the initial complaint or the award letter, are useful for substantiating the nature of the claim and demonstrating that it qualifies for one of the above-the-line deductions.

Reporting Attorney Fees on Your Tax Return

When reporting a settlement on your tax return, the gross amount received, including any portion that went directly to your attorney, is typically considered your income. This amount may be reported on Form 1040, Schedule 1, Part I, as “Other Income” on line 8 for taxable settlements not classified as wages. If the settlement includes lost wages from employment, that portion will generally be reported on Form W-2 and included on Form 1040, Line 1a. It is important to accurately report the full gross amount as indicated on any Forms 1099 or W-2 you receive.

For the limited types of attorney fees that are deductible “above the line,” these are reported as an adjustment to income. Specifically, for qualified attorney fees and court costs related to unlawful discrimination claims, these amounts are entered on Form 1040, Schedule 1, Part II, “Adjustments to Income,” on line 24h. Similarly, attorney fees for qualifying whistleblower awards are also reported as an above-the-line deduction, reducing your adjusted gross income.

The deduction claimed on Schedule 1 cannot exceed the amount of the judgment or settlement that is included in your gross income for that tax year. After reporting the gross income and any qualified adjustments on Schedule 1, the total AGI is then transferred to your main Form 1040. Maintaining records of all settlement documents, attorney invoices, and tax forms is important, as these records provide support for the income reported and any deductions claimed in the event of an IRS inquiry.