Are Legal Expenses Deductible?

Let’s start with the basic premise that personal legal expenses are not deductible.  Why not?  Because Congress enacted Internal Revenue Code (IRC) Section 262 which states that “No deduction shall be allowed for personal, living, or family expenses.”  Now let’s see how legal expenses can be deductible.  In order change legal expenses from personal and non-deductible into deductible expenses we need to look at another part of the Code.

IRC Section 212 specifically allows deductions for ordinary and necessary expenses in three separate categories:

  1. For the production or collection of income,
  2. For the management, conservation, or maintenance of property held for the production of income, or
  3. In connection with the determination, collection, or refund of any tax.

Whether a legal expense is deductible generally depends on why the expense was incurred.  If the legal expense arises from an event that would be personal in nature it is not deductible.  For example, legal fees paid in connection with a divorce are not deductible.  Even when the legal fees are paid in defending one spouse’s property rights against the other.  How do you make legal fees paid to your divorce attorney deductible?  By applying Code section 212 to the legal fees, some of the legal fees can be deductible.  Code section 212 allows a deduction for any ordinary and necessary expenses “for the production of income.”  If your divorce attorney is seeking alimony in the divorce action, request that the attorney itemize their bill so that the portion of their fees allocable to the alimony claim is separately stated.  Because alimony is taxable income, the fees paid to the attorney to establish and collect alimony are deductible.  Legal fees paid in an effort to increase alimony are also deductible. Additionally, any legal fees related to tax advice during a divorce are deductible as long as the attorney’s bill specifies how much is for tax advice and it is determined in a reasonable manner.

Another common personal legal expense is the cost of preparing a will and/or trust.  Wills and trusts deal with the disposition of an individual’s assets upon their death.  The cost of preparing a will is not a deductible legal expense.  Looking back at Code section 212 we can see that legal expenses associated with tax planning (either conservation of income producing assets or in connection with the determination of any tax) are deductible.  Living trusts will usually have some part that discusses taxes.  For a married couple a living trust will contain provisions for creating an exemption trust on the death of the first spouse.  The exemption trust refers to the estate tax exemption allowed to each individual upon their demise.  There may be other trusts created as well that have specific tax planning goals.  If you have an attorney draft a living trust, request that they provide an allocation of the cost of the tax related provisions.  The costs related to the preparation of the tax provisions of a trust are deductible.

Here are some other legal expenses that are deductible:

  • Legal expenses paid that are related either to doing or keeping your job.
  • Legal expenses paid in connection with litigating a tax deficiency.
  • Legal expenses to perfect title to property are not deductible, but any portion of the fees to collect rents on that property is deductible.
  • Legal expenses paid in connection with your business, rental property, or farm are deductible on your tax return schedule that reports the income from that activity.

Examples of personal legal expenses that are not deductible:  Property settlement in a divorce, defense of breach of promise to marry, civil or criminal defense resulting from a personal relationship, custody of children, damages from personal injury, and the ever-popular defense against a speeding ticket.

If you need more information on the deductibility of your legal expenses contact one of the tax professionals at Seid & Company, CPAs.