Can I Deduct Legal Fees From My Taxes?
Demystify tax deductions for legal fees. Discover the specific criteria and nuances that determine whether your legal expenses can lower your taxable income.
Legal fees can be a significant expense, prompting many to question their tax deductibility. While the Internal Revenue Service (IRS) generally considers legal fees personal and non-deductible, exceptions exist. Legal expenses directly tied to income-producing activities or a trade or business may qualify for a deduction. Understanding these distinctions is important for taxpayers.
General Principles of Deductibility
The deductibility of legal fees depends on whether the expense is “ordinary and necessary” for a trade or business or for producing income. An ordinary expense is common and accepted in your business or activity, while a necessary expense is helpful and appropriate. Legal fees for personal matters are generally not deductible, regardless of their cost.
The Tax Cuts and Jobs Act (TCJA) of 2017 significantly impacted legal fee deductibility. For tax years 2018 through 2025, the TCJA suspended miscellaneous itemized deductions subject to the 2% adjusted gross income (AGI) floor. This means many legal fees previously deductible, such as certain investment-related or tax preparation fees, are no longer available for deduction during this period.
Despite the TCJA, some legal fees remain deductible if directly linked to specific categories. Legal expenses related to a trade or business are deductible as business expenses. Fees incurred for the production or collection of income, or the management of income-producing property, may also qualify. The nature of the claim’s origin, rather than its potential outcome, often determines deductibility.
Common Deductible Legal Fees
Legal fees incurred in operating a trade or business are generally deductible as ordinary and necessary business expenses. This includes costs for contract disputes, litigation to protect business assets, debt collection, or defending intellectual property rights. For example, a business defending against a breach of contract lawsuit can typically deduct these expenses. Such deductions are reported directly on the business’s tax return, reducing taxable business income.
Legal fees related to producing or collecting rental or royalty income are also commonly deductible. This covers expenses like drafting lease agreements, evicting non-paying tenants, or defending property rights for income-producing real estate. These expenses are directly tied to generating taxable income from property. They are typically reported alongside other rental and royalty income and expenses, thereby reducing the net taxable amount from these activities.
Specific legal fees are deductible as an “above-the-line” deduction, directly reducing your adjusted gross income (AGI). This category includes legal fees paid to obtain an award under specific whistleblower statutes, such as those administered by the IRS or the Securities Exchange Commission (SEC). Similarly, legal fees and court costs for certain unlawful discrimination claims, including employment discrimination, are deductible. These deductions are generally limited to the amount of the judgment or settlement included in gross income.
Legal Fees That Are Not Deductible
Legal fees arising from purely personal matters are generally not deductible. This broad category includes expenses for personal disputes, personal injury claims where damages received are non-taxable, or costs associated with personal reputation defense. The IRS considers these private expenditures unless the legal action directly relates to earning income or operating a business.
Legal fees related to divorce, separation, or child support are non-deductible. This rule applies even if the legal process involves the division of marital assets or income-producing property. The primary purpose of such legal action is considered personal, focusing on changes in marital status or family obligations.
Fees for drafting wills, trusts, or other estate planning activities are also not deductible. These expenses are personal, focused on asset disposition after death rather than current income production. Similarly, legal fees for defending against criminal charges are considered personal expenses and cannot be deducted, as they do not relate to a trade or business or income-producing activity.
Legal fees to acquire or defend title to property, such as real estate or certain investments, are not deductible as current expenses. Instead, these fees must be capitalized, meaning they are added to the asset’s basis. When the asset is later sold, the increased basis reduces the taxable gain or increases the deductible loss.
Reporting Deductible Legal Fees
Legal fees qualifying as ordinary and necessary business expenses are reported on the appropriate business tax form. Sole proprietors and single-member limited liability companies (LLCs) taxed as sole proprietors report these expenses on Schedule C (Form 1040), Profit or Loss from Business. Corporations report them on Form 1120, U.S. Corporation Income Tax Return, while partnerships and multi-member LLCs use Form 1065, U.S. Return of Partnership Income. These deductions directly reduce the business’s taxable income.
Legal fees related to producing or collecting rental and royalty income are reported on Schedule E (Form 1040), Supplemental Income and Loss. This schedule allows taxpayers to report income and expenses from rental real estate, royalties, partnerships, S corporations, and trusts. By including legal fees here, they directly offset the rental or royalty income, reducing the net amount subject to taxation.
Legal fees related to whistleblower awards and certain unlawful discrimination claims are reported as an adjustment to income on Schedule 1 (Form 1040), Additional Income and Adjustments to Income. These are “above-the-line” deductions, meaning they reduce your adjusted gross income (AGI) before considering itemized or standard deductions. These amounts are typically entered on Line 24 (or the equivalent line for “Other Adjustments” in the current tax year’s form), which directly contributes to a lower AGI.
Fees that must be capitalized, such as those for acquiring or defending title to property, are not reported as a deduction on a specific line item. Instead, these costs are added to the asset’s basis, which is the amount used to determine gain or loss when the asset is sold. For example, legal fees paid when purchasing a rental property would increase the property’s basis, potentially reducing the taxable gain upon its future sale. Maintaining accurate records, including invoices and receipts for all legal services, is important to support any claimed deductions or basis adjustments in case of an IRS inquiry.