Can you deduct legal fees you have incurred when filing taxes? The answer is complicated, the guidance is provided by the Internal Revenue Service Publication 529. In short, it depends on what the legal fees were in regard to. The general rule, as stated by the IRS, is that: “You can usually deduct legal expenses that you incur in attempting to produce or collect taxable income or that you pay in connection with the determination, collection, or refund of any tax.”
Therefore, if the legal fees related to obtaining a tax refund or filing the taxes in general, they appear to be deductible. If the legal fees are based on the attempt to collect taxable income, those fees would also be covered. Deducting legal expenses is also governed by the 2% rule, as discussed below.
What type of Legal Fees Are Deductible?
As stated above, legal fees incurred due to filing/receiving taxes or obtaining taxable income are deductible. Below are more examples of where legal fees are potentially deductible.
• Family Law – you are allowed to deduct attorney fees that relate to collecting taxable income, as discussed above. Therefore, legal bills incurred attempting to obtain alimony (which does constitute taxable income) would also be included.
• Criminal Law – legal fees incurred defending yourself in a criminal case that is related to or arising out of your job are deductible. This deduction is probably heavily scrutinized. According to DUI Attorney Michael Rehm, legal fees defending a DUI charge would not be deductible, unless there was some evidence that the arrest arises out of a work related event, and even then it would be stretch. The rule applies more to incidence of white-collar crime such as insider trading where the activity is related to the profession.
• Business Attorney– this is obvious considering the role business attorneys play in helping business ensure survival, thus collecting taxable income.
2% Percent Rule
The 2% rule means that you are only allowed to deduct the total of certain expense that exceed 2% of your Adjusted Gross Income. Certain expense are a part of the 2% rule. When deducting your expenses, you add up all of the expenses that fall under the 2% rule category, and if they exceed 2% of your adjusted gross income, then you deduct the amount that is in excess.
Legal fees are fees covered by the 2% rule, so when adding up all of the expenses, legal fees fall under this category.
Non-deductible legal expenses
Family law legal fees that are spent to collect alimony are deductible, but family law legal fees defending an alimony lawsuit are not. Family law fees spent to collect child support are also not deductible, since child support is not taxable income. When determining whether legal fees are deductible, the best steps to take is to determine whether the fees were incurred in relation to taxes in and of themselves, or your job, or obtaining taxable income. Always consult with a professional, whether it is a tax attorney or CPA to determine which legal fees are deductible. Don’t forget to write down the advice and save the receipt for a future deduction.