Legal expenses were discussed in our last blog which were more related to the person opposed to the business. In this blog, we will discuss legal expenses associated with business and the production of taxable income, the tax benefits, and present examples of legal expenses and how they may be deducted.
- Examples of Legal Expenses and Their Deductibility
- The Tax Benefit of Legal Fee Deductions
A frequent question that arises is whether legal expenses are deductible. We explained that the answer to that question can be both yes and no. It can also be complicated depending upon the nature of the legal expense.
Bankruptcy – Legal fees connected with a business bankruptcy are deductible. If personal bankruptcy is primarily caused by the failure of a business activity, the legal expenses related to the bankruptcy proceedings are partially deductible as a business expense. The courts have used a proration of the fees based on the ratio of business creditor claims to total creditor claims.
Conduct of a Business – Legal expenses incurred by a taxpayer in the course of a trade or business are generally deductible. This is provided if the fees are ordinary and necessary expenses of the business.
Managing, Conserving, or Maintaining Income-Producing Property – Legal fees related to managing, conserving, or maintaining income-producing property are generally deductible. However, just because a taxpayer may have to sell income-producing property to satisfy a possible adverse judgment does not mean he/she can deduct the cost of defending the suit under this provision.
Related to Title of Property – Although legal fees to acquire, perfect, defend, or clear title to property currently cannot be deducted as business or investment expenses. They are capital expenditures whose cost may be recovered through depreciation, depletion, or cost recovery. Incurred legal expenses related to title of personal property, such as a principal residence, are not deductible but can be added to the basis of the property.
Damage Suits – Legal expenses for defending and filing damage suits in a taxpayer’s business are deductible. This is true for or in employment. Examples include expenses paid for defending a suit for wrongfully taking property, Settling a damage suit against a business could help to avoid adverse publicity and controversy. Also, getting a judgment for damages to rental real estate.. And finally, a teacher’s action of sex discrimination against a university.
Criminal Cases – Legal fees to defend against criminal charges related to a taxpayer’s trade or business are deductible. This is true even if the taxpayer is convicted of the crime. However, legal defense expenses incurred by an individual charged with a crime are personal and generally not deductible.
Tax Issues – Legal expenses associated with getting tax advice, having tax returns prepared, and defending a taxpayer who is audited are all specifically included as deductible legal expenses.
If legal expenses are deductible, will a person receive any tax benefit from the deduction?
Just because legal fees are deductible does not necessarily mean you will receive any tax benefit from the deduction. Some legal fees can be deducted on business schedules and provide the maximum benefit. Others have to be deducted as a miscellaneous itemized deductions, the total of which is subject to a 2% of AGI deduction floor. In addition, miscellaneous itemized deductions are not deductible for alternative minimum tax (AMT) purposes.
As you can see, determining which legal expenses are deductible is complicated. Even if allowed, a deduction may not provide any tax benefit. As every circumstance is unique, you are encouraged to Alex Franch, BS EA at 781-849-7200 to determine if you will derive any tax benefit from your legal expenses.