Posted by Fred Lake

Are Legal Expenses Deductible on Your Taxes?

Are Legal Expenses Deductible on Your Taxes?

Legal fees are deductible if business expenses are incurred. The deduction can be claimed on corporation returns (for example, in a partnership form 1065) or directly on Schedule C of personal income tax returns.

The IRS allows individuals and businesses to claim money paid for certain professional services, including legal fees. However, to qualify for deductions, legal fees must be directly related to business transactions or be part of acquisition costs, including legal fees for starting or purchasing a business.

Can you waive the legal fees?

Legal fees that are routine and necessary expenses of running your business can generally be deductible business expenses. To assess whether the legal fees can be waived, the legal fees' nature must be taken into account.

Personal Legal Fee

The general rule is that business-related legal fees are tax-deductible. Legal fees related to personal matters are generally not deductible. There are a few exceptions, including legal fees incurred for your business or trade.

Corporate Legal Fees

According to the IRS, a taxpayer's legal fees in connection with a business or trade are generally deductible if they are ordinary and necessary business expenses.

Some cases in which it is possible to claim tax deductions for business expenses are:

  • Lawyers' fees charged to defend and report damages in a business are deductible.

  • Lawyers' fees, court costs, and similar costs if these costs are incurred in producing or collecting taxable income.

  • Legal fees incurred in defending against criminal charges relating to the taxpayer's business or trades are deductible. However, legal fees to defend criminal charges against an individual are not tax-deductible.

  • Legal fees related to business bankruptcy are tax-deductible.

  • Legal fees related to the administration, protection, or maintenance of income-generating properties are generally tax-deductible.

The deduction of legal fees for the year depends on the accounting method used. For example, suppose you are using the cash method of accounting. In that case, you charge the legal fees as a business expense in the year you pay the expenses while you are on an accrual basis; you can claim the expense when the lawyer provides the service or pays for it.

While some legal fees can be deducted during working hours and offer the greatest benefit, others must be deducted as a series of different deductions, the total of which is subject to 2% of the minimum deduction of AGI.

Can you waive LLC fees?

A limited liability company (LLC) owners can deduct a certain amount for the business's organization and start-up costs. This is independent of how the LLC is referred to in terms of the tax structure.

To claim this tax deduction, an LLC must bear the initial costs before formally commencing operations. These upfront costs include finding or purchasing an LLC, marketing costs, travel expenses, etc.

Once the business is officially opened, ongoing costs can be reduced under the category of business operating costs.

Can you waive the tax preparation fees?

The Internal Revenue Service allows business owners to deduct tax preparation fees as a business expense.

This is limited not only to the costs of hiring a tax professional to prepare your tax return but also the costs of purchasing tax software and books, legal fees for representation in tax audits, planning advice, tax, tax collection, and criminal investigations.

Can you waive the license fees?

As with many deductions, you can waive fees and license fees if they are considered business expenses. For example, a lawyer must pay an annual fee to keep the license in the state. This fee can be written off.

Deductible legal fees

In general, legal fees related to your business, including rental properties, can be deducted. This is true even if you did not win the case.

For example, according to the IRS, you can deduct:

  • Common and necessary expenses directly related to your business's activities (must be entered on Form 1040, Schedule C).

  • Rents or royalties for income properties (must be included on Form 1040, Schedule E)

  • Taxes on farm income and expenses (must be included in Form 1040, Schedule F).

  • Taxes related to allegations of unlawful discrimination (must be included in Form 1040).

  • The cost of resolving tax issues, consulting or preparing tax forms related to your business (must be included in Form 1040, Schedule C).

  • Whistleblower complaint fees (must be included in Form 1040).

The following legal fees are also tax-deductible, even if they are not related to work:

  • Adoption costs for children, if they are eligible for the federal adoption tax credit (listed on Form 8839).

Non deductible legal fees

Legal fees related to personal matters cannot be included in itemized deductions. According to the IRS, these fees include:

  • Costs related to non-business tax matters or tax advice.

  • Defense costs of civil or criminal charges resulting from your participation in a political campaign

  • Fees paid in connection with the establishment, collection, or reimbursement of any tax.

  • Personal legal costs, including child care, purchase of real estate, breach of promise of marriage, civil or criminal charges related to personal relationships, personal injuries, title preparation, real estate planning, such as preparing wills, property claims or agreements, and divorce.

What does itemizing your deductions mean?

When filing taxes, you can usually choose to take the standard deduction or itemize the deductions. Both options generally lower your taxable income, which means you'll pay less tax. In the case of a statutory tax deduction, you should itemize the deductions instead of the tax year's standard deduction.

From 2018, the new tax law limits the types of itemized deductions that a taxpayer can claim and, at the same time, increases the standard deduction. In other words, some of the itemized deductions you may have made in previous years are no longer applicable.

The 2% rule

When you itemize taxes before 2018, remember that you have heard of the "2% rule". This rule meant that taxpayers who could not pay certain expenses related to their work could deduct a portion of various itemized expenses that exceeded 2% of adjusted gross income (AGI).

Since 2018, the deductions linked to this 2% rule have been suspended. However, some legal fees may be deducted if they are related to your work.

Awards from legal proceedings and settlement

If you received money from a settlement or a lawsuit, the reward amount is likely taxable and should be included in your gross income reported to the IRS. Usually, the only exception is if the money was returned to you due to an injury or illness claim. But even then, some other rules and exemptions may apply, as described by the IRS. In most cases, the legal fees in these cases cannot be deducted from taxes.

Tips for record-keeping to reduce taxes

Make sure your lawyer's accounts identify the nature of the services provided. If the invoice provided by your lawyer does not specify the type of legal opinion or advice, ask your lawyer to modify it to include all the necessary information. This way, you can precisely justify the statutory taxes deducted from the taxes. You can also make the process much easier by ordering separate accounts that list deductible and non-deductible service charges.

Final Word

It can be tough to keep track of which deductions you are entitled to, especially if there are rules such as those that involve legal fees. A tax professional like FRED LAKE will find all the deductions and credits you're eligible for by asking simple questions to help you get the most from your tax refunds.



Fred Lake
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