What Types of Legal Fees are Tax Deductible?

There are so many tax deductions, which benefit so many different people and situations, that a typical taxpayer may expect that every possible expense is deductible. In practice, the answer to that question is “sometimes”. An excellent example of this question in action is legal fees. A legal fee is not deductible by itself, but only if it fits another deductible purpose.

In very general terms, three types of legal fees should be deductible:

  1. Those related to your job
  2. Those related to collection of taxable income
  3. Those related to tax advice. Please note that personal legal expenses often do not meet this requirement.

Legal work related to employment is generally deductible, since it is about the production of income. However, there is a clear difference between working for an employer and being self-employed. The self-employed individual may deduct almost all legal fees related to their business. This can include routine work like incorporation papers or more serious issues like lawsuits. The employed individual is not responsible for the corporation as a whole and the legal issues they may have related to work are limited. Examples include suing for back wages or defending yourself against a work-related lawsuit.

Legal work regarding tax advice is generally deductible, including routine tax advice or representation in a tax case.

The distinctions can be tricky. Here are some examples:

  • Legal fees to help collect taxable alimony are deductible, but those to collect child support are not, since child support is not taxable income.
  • For a social security case, deduct the legal fees only if the social security income is taxable. Most, but not all, social security recipients pay no tax on their benefits.
  • Fees related to back wages are deductible, but not for Workers Compensation or tax-free injury settlements, since that income is not taxable.
  • Suing for damages to a rental or income property you own does generate deductible legal expense, but if the damage is to your personal residence then there is no deduction.
  • Everyday legal expenses of a business are deductible, but not attorney fees paid to acquire business assets.

A complete summary of cases is too long to list here. IRS Publications 17, chapter 28 and the instructions to IRS Form 1040, Schedule A are good places to begin research on this subject.

When these fees turn out to be deductible, the actual place to deduct them depends on each situation. Business owners and the self-employed use Schedule C, line 17. Income property owners use Schedule E, line 10. Individuals must itemize to receive any actual benefit from this deduction, which goes on Schedule A, line 23 and is subject to a limitation of 2 percent of Adjusted Gross Income.

Anyone with legal expenses should ask their attorney to itemize their charges to separate deductible and non-deductible expenses. Even when this is done, a qualified tax preparer should be consulted for the actual tax return filing.