Are Attorney Fees Tax Deductible?

Tax deductions, especially when it comes to legal expenses, can be tricky to understand. Knowing which legal fees you can deduct is key to making the most of your tax return and minimizing what you owe. Much different from settlements, legal fees have their own set of tax rules. This guide breaks down when lawyers’ fees are deductible and when they aren’t, helping you navigate these rules confidently and make smarter financial decisions.

What Are Tax Deductible Lawyers’ Fees?

Not all lawyers’ fees are eligible for tax deductions. The IRS has strict guidelines on which types of legal expenses qualify. Generally, legal fees can be tax deductible if they are incurred for business purposes, related to earning or collecting taxable income, or tied to matters related to the production or maintenance of income-producing assets.

Examples of Tax-Deductible Lawyers’ Fees

Certain legal fees can be deductible if they relate to business or income-producing activities. For instance, business-related legal fees, such as those incurred for legal advice, drafting contracts, defending business-related lawsuits, or ensuring compliance with regulations, are often deductible as they are necessary for the operation, maintenance, and establishment of a business. 

Similarly, legal fees tied to employment matters, like seeking unpaid wages or negotiating severance packages, may be deductible when the income in question is taxable. 

Additionally, if you own rental property, legal expenses associated with the management and upkeep of that property—such as eviction processes or lease drafting—can also be deducted, as these fees are directly related to generating rental income.

Non-Deductible Lawyers’ Fees: What to Avoid

While some legal fees are deductible, others are not. Understanding which legal expenses fall outside the IRS guidelines for tax deductions is crucial to avoid making incorrect claims.

Examples of Non-Deductible Legal Fees:

Legal fees tied to personal issues, like divorce, child custody disputes, or personal injury cases, usually can’t be deducted unless they directly impact your business or income. Similarly, criminal defense costs, even if they arise from business activities, generally don’t qualify for deductions. 

As for estate planning, while it’s important for future financial planning, fees associated with drafting a will or setting up a trust are considered personal expenses and are not tax-deductible.

How the IRS Categorizes Legal Expenses

The IRS differentiates between personal and business legal expenses when determining deductibility. Here’s how they classify these categories:

• Business Legal Expenses: Expenses that are considered necessary and ordinary for the operation of a business are usually deductible. The IRS allows business owners to write off expenses that directly relate to business income, operations, or compliance with regulations.
• Personal Legal Expenses: These expenses are typically not deductible unless they directly relate to generating income or maintaining income-producing assets. The IRS is clear that any legal fees incurred for personal matters do not qualify.

Deductible Lawyers’ Fees for Individuals: What You Need to Know

While most business-related legal fees are deductible, individual taxpayers also have some opportunities to deduct legal fees. However, the criteria are strict:

Fees Related to Producing or Collecting Taxable Income

If you incur legal expenses while trying to produce or collect taxable income, you may qualify for a deduction. For instance:

• Fees paid to collect taxable alimony after a divorce are deductible because they relate directly to taxable income.
• Legal fees associated with disputes over property ownership that generates rental income could also be deductible, as they are tied to income production.

Legal Fees for Tax Advice

Legal fees paid for tax advice related to tax planning, compliance, or disputes with the IRS may also be deductible. If you engage a lawyer to assist with an IRS audit or to contest a tax ruling, these expenses are typically eligible for deduction.

Legal Fees Incurred for Whistleblower Cases

If you are a whistleblower and incur legal expenses in connection with your claim that results in a monetary award, you may be eligible to deduct those fees. The IRS allows for deductions if the legal costs directly relate to the pursuit of a reward for reporting a violation of the law.

Deducting Legal Fees as a Business Expense: Guidelines for Business Owners

For business owners, deducting legal fees is often more straightforward. The IRS permits businesses to deduct legal expenses necessary for the operation of the business, provided they are ordinary and reasonable. Examples include:

• Contract Drafting and Review: Legal fees paid to draft or review business contracts, including those with clients, vendors, or employees, are deductible as they are necessary for maintaining business operations.
• Defense Against Lawsuits: If your business is sued, legal fees paid for defense are typically deductible, as they relate directly to the business’s survival and operations.
• Regulatory Compliance: Expenses incurred to ensure that your business complies with local, state, or federal regulations, such as fees for zoning law advice, are also deductible.

Changes in the Tax Law Affecting Legal Fee Deductions

Tax laws change frequently, and it is essential to stay up-to-date with the latest regulations to ensure that you maximize your deductions correctly. The Tax Cuts and Jobs Act of 2017 (TCJA) impacted the deductibility of legal fees for individuals significantly. Under this law:

• Miscellaneous Itemized Deductions: Many types of legal fees that were previously deductible under miscellaneous itemized deductions are no longer eligible. This includes some employment-related legal fees and expenses related to tax planning.
• New Limitations: The TCJA suspended these deductions until at least 2026, which means that individuals need to be particularly cautious when attempting to deduct legal fees.

Steps to Ensure Your Legal Fees Are Deductible

To make the most of available deductions, it is crucial to follow the proper steps:

1. Document Everything: Keep detailed records of all legal expenses, including invoices and receipts. Make sure these records clearly indicate the purpose of the legal service and how it relates to your business or taxable income.
2. Consult a Tax Professional: Given the complexities of tax laws, consulting with a certified tax professional or accountant can ensure that you correctly categorize and deduct your legal expenses.
3. Review IRS Guidelines: Familiarize yourself with IRS publications, such as IRS Publication 529 and IRS Publication 535, which offer guidance on miscellaneous deductions and business expenses. These resources provide essential information on how to claim your deductions properly.

Common Mistakes When Deducting Legal Fees

Understanding common errors can help you avoid costly tax penalties. The IRS scrutinizes legal fee deductions closely, and mistakes can lead to audits or denied claims. Here are a few common pitfalls:

• Misclassifying Legal Fees: Many taxpayers mistakenly classify personal legal expenses as business deductions. Make sure that any legal fees you claim as deductions are directly related to your business activities or taxable income.
• Failing to Keep Proper Records: Without adequate documentation, the IRS may disallow your deductions. Maintain thorough and organized records for all legal expenses to substantiate your claims.
• Assuming All Business Legal Fees Are Deductible: While most business-related legal fees are deductible, not all qualify. Fees related to illegal activities or criminal defense costs, even if they stem from business operations, are not eligible.

Making Sense of Lawyers’ Fees and Tax Deductions

Figuring out if your legal fees are tax-deductible really comes down to how they connect to your business or income. Staying up-to-date with tax rules and getting advice from a professional is the best way to make sure you’re getting all the deductions you’re entitled to while staying on the right side of the IRS. It’s all about being proactive and informed, so you can keep more of what you earn. 

If you have legal concerns or need expert guidance, don’t hesitate call West Coast Trial Lawyers at (213) 927-3700 or use our online contact form to speak with our experienced legal team