When are Legal Fees Tax Deductible?
Generally speaking, individuals cannot deduct legal expenses, but there are some exceptions.
Legal expenses may be deductible if they fall within the miscellaneous itemized deductions allowed by the IRS. There are two categories that legal fees may fit into: “Unreimbursed employee expenses” or “Other expenses.” You can deduct the amount of miscellaneous expenses that is more than 2% of your adjusted gross income. ( IRS Publication 529 (Dec. 23, 2016), Page 2).
- “Unreimbursed employee expenses”:
Under this category, you can deduct legal fees related to doing or keeping your job. For example, in a recent Tax Court Summary Opinion (T.C. Summary Opinion 2017-2), a taxpayer was allowed to claim a deduction for legal expenses she incurred in a lawsuit between the taxpayer and her employer over whether she could keep her $612,000 bonus even after being terminated. The employer’s claim was dismissed by the court and the taxpayer was allowed to keep her bonus, but it cost her nearly $81,000 in legal expenses by the end. The Tax Court decided the legal expenses arose from the taxpayer’s status as an employee, and could be claimed as unreimbursed employee expenses on her tax return.
- “Other expenses”:
This category includes expenses that you pay (1) To produce or collect income that must be included in your gross income, (2) To manage, conserve, or maintain property held for producing such income, or (3) To determine, contest, pay, or claim a refund of any tax.
You can usually deduct legal expenses that you’ve paid in attempting to produce or collect taxable income (e.g., attorney fees incurred to evict a tenant from a rental property, to collect unpaid wages, investment income, and unpaid alimony), or that you pay in connection with the determination, collection, or refund of any tax (e.g. tax advice your attorney gives when formulating an estate plan).
A special rule applies to legal expenses related to an unlawful discrimination claim. Attorney fees and court costs you pay to bring an unlawful discrimination lawsuit may be deductible as an adjustment to your income rather than as a miscellaneous itemized deduction. (IRS Publication 525 (Jan. 23, 2017), Page 29). The purpose behind this deduction is to encourage victims of unlawful discrimination to step forward and to bring lawsuits by reducing the financial strain on the victim/plaintiff.
- Examples of legal expenses that are NOT tax deductible:
You can’t deduct personal legal expenses such as those for the following:
- Obtaining custody of children.
- Legal defense in a civil lawsuit or criminal case that’s not work-related.
- Damages for personal injury (except certain whistleblower claims and unlawful discrimination claims).
- Help in closing the purchase of your home or resolving title issues or disputes.
- Preparation of a will.
- Property claims or property settlement in a divorce.
Tax deductions for legal expenses can be difficult to navigate and the Tax Code is subject to change. If you’re concerned about whether you’ll be able to deduct some of all of your legal expenses from your taxable income, ask your attorney if any of the fees he or she will charge will be tax deductible.