Are Legal Fees Tax-Deductible? + FAQs

Some legal fees are indeed tax deductible, but it all depends on the nature of the expense and how it relates to income or business activities.

According to a 2024 American Bar Association survey, over 60% of taxpayers and small business owners are unsure which legal fees are tax-deductible, risking audits and overpaying thousands in taxes.

• 💼 Business vs. Personal Legal Costs: Discover which attorney fees businesses can write off versus personal legal expenses that won’t get you a tax break.

• ⚖️ IRS Rules Demystified: Learn the key IRS terms (like ordinary and necessary, miscellaneous itemized deduction, and above-the-line) and what they mean for your legal bills.

• 🛡️ Avoid Audit Red Flags: Find out what not to do when claiming legal fee deductions (and how to stay on the IRS’s good side).

• 📊 Real Examples & Tables: See side-by-side examples of deductible vs. non-deductible scenarios and a handy table of pros and cons for different deduction strategies.

• 🤔 FAQs Answered: Get quick answers to the most common questions (from Reddit and beyond) about deducting attorney fees—in plain English.

Are Legal Fees Tax Deductible? (Short Answer)

Yes — some legal fees are tax-deductible under U.S. law, but it depends on the context. If the expense is directly related to earning taxable income or running a business, it’s likely deductible. If it’s a purely personal expense (like a divorce or personal injury lawsuit unrelated to taxable income), then it’s not deductible.

In tax terms, legal fees must be considered an “ordinary and necessary” expense of a trade, business, or income-producing activity to qualify as a write-off. Business-related attorney fees and costs tied to producing taxable income can often be deducted. Personal legal fees—no matter how important to you—usually come out of your own pocket with no tax relief.

The IRS lets you deduct legal fees that are closely tied to making money, but not those stemming from personal life matters. Below, we break down exactly which legal expenses qualify and how to claim them properly.

Common Deductible Legal Fees for Individuals

Not all lawyer bills are created equal. As an individual (not a business), you can only deduct legal fees in specific circumstances. Here are common deductible attorney fees for individuals:

• Employment-Related Claims: Legal fees for suing an employer for unlawful discrimination, whistleblower awards, or civil rights violations are deductible. Congress allows an above-the-line deduction (an adjustment to gross income) for these cases, so you’re taxed only on your net winnings, not on the portion paid to your lawyer.

  • (For example, if you win a $100,000 workplace harassment settlement and pay $40,000 to your attorney, you can deduct that $40,000 so you’re not taxed on it.)

• Tax Advice & Representation: If you hire an attorney or tax professional for tax planning, to help with an IRS audit, or to contest a tax bill, those fees are considered part of determining your taxes. They have historically been deductible as a miscellaneous itemized deduction.

  • Important: Due to recent tax law changes (2018 through 2025), these personal tax-related legal fees aren’t deductible on federal returns. However, some states still allow them (more on state differences later).

• Income or Investment-Related Fees: Legal expenses incurred to produce or collect taxable income can be deductible. This might include attorney fees to collect taxable alimony (for divorce agreements before 2019 when alimony was taxable), to sue for back wages or royalties, or to fight for an investment-related claim where any award would be taxable. These fall under expenses for the “production of income”

  • (IRS Section 212 expenses). Currently, they’d be miscellaneous itemized deductions on Schedule A (subject to limits) — which, again, are suspended federally until 2026. Even so, keep track of these expenses in case laws change or for state tax purposes.

• Rental or Royalty Property Legal Fees: If you own rental property or earn royalties (say from intellectual property) as an individual, any legal fees related to that income are deductible against that income. For instance, hiring a lawyer to evict a non-paying tenant, or to draft contracts for licensing your artwork, would be deductible on Schedule E (as they are part of managing income-producing property). These are not personal expenses but part of your profit-seeking activity.

• Adoption Legal Fees: Uniquely, legal fees and court costs for adopting a child can qualify for the federal adoption tax credit. While this is a credit (not a deduction) up to a certain limit, it effectively gives you a tax benefit for adoption-related expenses including attorney fees. If your adoption expenses exceed the credit limit, those excess fees aren’t deductible — but the credit covers a significant portion (over $14,000 per child in recent years).

Note: Prior to 2018, many of the above individual legal expenses were deductible if you itemized and they exceeded 2% of your income (the so-called 2% AGI rule for miscellaneous deductions). The Tax Cuts and Jobs Act suspended these deductions for 2018–2025.

This means until at least 2026, you generally cannot deduct things like tax advice fees or investment lawsuit costs on your federal return. The only exceptions for individuals right now are the above-the-line deductions for certain employment-related cases (which are taken on Form 1040 without itemizing). Always double-check current law, as these rules can change.

Non-Deductible Personal Legal Fees (Individuals)

Now for the bad news: most personal legal fees are not tax deductible. The IRS explicitly forbids deducting the costs of personal matters. Here are common examples of non-deductible legal fees for individuals:

• Divorce and Family Matters: Attorney fees for divorce, child custody, child support, or separation are personal expenses — not deductible. It doesn’t matter how necessary the legal help was; the IRS treats it as a personal/family cost.

  • The only sliver of a divorce bill that could be deductible is any portion that is clearly billed for tax advice (for example, an attorney or accountant giving advice on the tax implications of alimony). If your lawyer’s invoice breaks out a fee for tax planning related to the divorce, that part might be deductible as a tax preparation fee (miscellaneous itemized deduction, subject to the limitations discussed).

• Personal Injury Lawsuits: Legal fees for personal injury cases (like car accidents, medical malpractice, slip-and-fall cases) are typically not deductible. If your lawsuit winnings are tax-free (which most physical injury settlements are under law), you get no deduction for the attorney costs.

  • Even if you have to pay tax on part of a settlement (say, punitive damages or interest, which are taxable), the associated legal fees aren’t deductible under current federal law for personal cases. Essentially, if the underlying case is personal in nature (injury, defamation, emotional distress not related to employment, etc.), the legal fees come out of your pocket after-tax.

• Wills and Estate Planning: Fees for drafting a personal will, setting up a living trust for your family, or general estate planning are considered personal expenses. You cannot deduct the cost of preparing wills or trusts. As with divorce, one exception is if part of the estate planning involves tax advice (for example, discussing estate tax planning strategies). If the attorney clearly itemizes the time spent on tax advice, that portion could qualify as a deductible tax planning expense (again, subject to misc. deduction rules and currently suspended on federal returns).

• Real Estate Closing Costs (Personal Residence): Hiring a lawyer for purchasing or selling your personal home? Those legal fees are not deductible. They are considered part of the cost of acquiring the property. Instead of a deduction, you may capitalize them — meaning add to your home’s basis (the purchase price for tax purposes) which could reduce taxable gain when you sell. But you get no immediate tax break for attorney fees in a personal home purchase or sale.

• Civil or Criminal Defense (Personal): If you incur legal fees to defend yourself in a criminal case or civil lawsuit that is personal (not stemming from your job or business), you cannot deduct those costs. For example, legal fees to fight a traffic ticket, a DUI charge, a lawsuit over a personal dispute, or any litigation arising from your hobbies or personal life are non-deductible. Even political or reputational cases — say you had to hire a lawyer in a personal defamation case — are not tax write-offs. They’re personal in nature, even if the issue is important to you.

Remember: Trying to write off personal legal fees as though they were business expenses is a huge red flag. The IRS applies the “origin of the claim” test: if the origin of the legal issue is personal (a marital dispute, a personal injury, etc.), then the legal fees are personal, no matter the consequences.

There was a famous Supreme Court case, United States v. Gilmore (1963), that established this principle. In that case, a husband’s legal fees to protect his business assets during a divorce were ruled non-deductible, because the dispute originated from the personal relationship (the divorce), not from the business itself. The bottom line: Don’t try to classify personal legal bills as tax deductions — it won’t fly and could invite IRS scrutiny.

Legal Fees for Businesses: What’s Deductible?

If you run a business (or even a side hustle), the tax rules are far more favorable. The IRS allows businesses to deduct ordinary and necessary expenses paid in carrying on the trade or business — and that includes most legal fees. Here’s how it breaks down for businesses:

• Ordinary & Necessary Business Expenses: Legal fees that arise from operating your business are generally deductible business expenses. “Ordinary” means common and accepted in your industry, and “necessary” means helpful and appropriate for the business. For example, paying an attorney to draft contracts, review leases, handle employment agreements, or defend the business in a lawsuit are typically deductible.

  • You would deduct these on your business tax form (Schedule C for sole proprietors, Form 1065 for partnerships, Form 1120 for C-corps, etc.). In practice, a small business owner or freelancer would include such legal costs on Schedule C as professional services, reducing their business income.

• Legal Fees for Business Income or Taxes: Fees paid for advice on business taxes, or for representing the business in an IRS audit, or for suing to recover business income, are deductible. If you own rental properties through a business or LLC, legal fees for evictions or lawsuits related to the rental are deductible on Schedule E. If you’re a farmer, attorney fees related to farm income go on Schedule F. The idea: if it’s part of making or protecting your business income, it’s a write-off.

• Costs to Acquire or Improve Assets (Capital Expenses): One big caveat: if the legal fees are related to acquiring a capital asset for your business, those fees are not immediately deductible as expenses. Instead, they get added to the cost basis of the asset. For instance, say your company pays $10,000 to a lawyer to help purchase a piece of commercial real estate or to negotiate a business acquisition.

  • That $10,000 isn’t taken as a deduction in the year paid; instead, it becomes part of the asset’s cost for tax purposes (which you might recover through depreciation, amortization, or when you sell the asset). Similarly, legal fees to defend or perfect title to property are treated as part of the asset’s cost. This is a well-established rule from cases like Woodward v. Commissioner (1970) — the courts said fees paid to defend or quiet title are capital expenditures, not expenses.

• Start-Up Expenses and Organization Costs: If you’re starting a new business, the legal fees to set up your business entity (e.g. forming an LLC or corporation, drafting partnership agreements) are treated as startup or organizational costs. The IRS lets you deduct up to $5,000 of startup/organization costs in the first year, but only if your total startup costs are $50,000 or less (above that, the immediate deduction phases out). Any remaining amount beyond the $5,000 must be amortized (spread out) over 15 years. So yes, you can deduct those incorporation attorney fees — just not all at once if they’re large.

• Business vs. Personal Split Bills: Sometimes legal services cover both business and personal matters. For example, you consult a lawyer who handles both your business contract and a personal real estate deal. In such cases, only the portion related to your business is deductible. It’s crucial to have the law firm invoice or documentation break out the fees by task. If not, you should ask for an allocation. The IRS will only allow the business-related portion. Good recordkeeping here is key; mixing personal and business legal costs in one bill without clear separation is a recipe for trouble if audited.

When Business Legal Fees Are Not Deductible

While most legal expenses for businesses are deductible, be aware of a few exceptions and gray areas:

• Personal Expenses Paid by the Business: If your business pays a legal bill that is actually personal (e.g. the company pays for the owner’s divorce attorney), the IRS will not allow the business to deduct that. It would likely be treated as an improper deduction (and possibly as personal income to the owner). Always keep personal legal costs separate from business finances.

• Legal Fees Related to Tax-Exempt Income: If a legal fee relates to producing income that isn’t taxable, you cannot deduct it. For instance, if your partnership incurs legal fees to generate tax-exempt municipal bond income, those fees aren’t deductible against taxable income.

• Fines and Penalties (and Related Legal Fees): While paying a lawyer to defend your business against a lawsuit or charges is deductible, any actual fines or penalties your business pays (to a government for violating a law) are not deductible. The legal fees to dispute a fine are generally deductible, but if, say, you had to pay a penalty to a regulator, that penalty expense cannot be written off. This is codified in the tax law for public policy reasons.

• Illegal Activities: If your business is engaged in illegal operations (hopefully not!), some otherwise ordinary expenses might not be deductible. There are specific rules (for example, no deduction for drug trafficking expenses beyond cost of goods). However, legal fees for defending a business owner or employee charged with a crime related to the business are usually deductible.

  • A classic example is Commissioner v. Tellier (1966), where the Supreme Court allowed a securities dealer to deduct legal fees for his criminal defense in a fraud case related to his business. The conviction didn’t stop the deduction because the fees were part of his business activities. The only time “public policy” stops a legal fee deduction is in extreme scenarios (the tax code disallows things like legal fees for defending civil rights violations under certain circumstances, but such cases are rare for businesses).

In summary, a business can write off most legal expenses as long as they’re properly categorized. When in doubt, consult with a tax professional to ensure you capitalize what needs to be capitalized and expense what can be expensed.

What to Avoid When Claiming Legal Fee Deductions

Claiming legal fees on your tax return can get tricky. Here are some pitfalls to avoid and tips to stay out of trouble:

• 🚫 Don’t Mix Personal & Business: Never lump personal legal expenses under business deductions. If you incorporated your personal legal bills into your business accounting to try for a write-off, back up! The IRS is keen on disallowing such maneuvers, and it could trigger an audit. Keep a clear line: personal is personal, business is business.

• 🔍 Mislabeling Expenses: Be careful how you label legal fees on your tax forms. For instance, don’t call a personal lawsuit settlement fee a “consulting expense.” The IRS examines large or unusual legal expenses. Misclassification can be seen as negligence or fraud. Instead, use the proper categories (legal and professional fees on Schedule C, for example).

• 💡 Not Documenting the Purpose: If audited, you’ll need to prove why a legal fee was deductible. Always keep engagement letters, invoices, and payment records that describe the legal work. Ideally, your attorney’s bill should detail the matter (e.g. “Review of lease for Store #5” or “Advice on tax audit for 2022”). Vague invoices (like “Legal services – $10,000”) make it harder to defend a deduction. Ask your lawyer to be specific in billing.

• ❌ Overstating Deductible Portion: In cases where fees are partly deductible and partly not (like a combined personal/business case), don’t try to deduct the full amount. Reasonably allocate and only deduct the portion that qualifies. If the split isn’t clear, err on the side of caution or get a tax advisor’s input. Over-aggressive deductions (taking 100% of a fee that’s only 50% business-related) can lead to penalties.

• ⏱️ Timing Issues: Deduct expenses in the right year. Legal fees are typically deductible in the year paid (cash basis taxpayers). If your case spans multiple years and you’re billed later, you generally deduct when you actually pay. Don’t try to deduct future expected legal costs that you haven’t paid yet. Also, if you prepaid a lawyer, that might need to be allocated over the service period if it spans years.

By avoiding these mistakes, you reduce the risk of an IRS audit or deduction disallowance. When in doubt, consult a CPA or tax attorney. Pro tip: If your situation is unusual (say, a big legal settlement), getting professional advice on how to handle the legal fees on your return can save you from headaches down the line.

IRS Tax Code Terms Explained (Legal Fee Deductions)

Taxes come with a lot of jargon. Let’s break down some key terms and concepts relevant to legal fees:

• “Ordinary and Necessary” – This is the basic standard from IRC § 162 for business expenses. Ordinary means common and accepted in your field; necessary means appropriate and helpful for the business. Both criteria must be met for a business expense (like legal fees) to be deductible. It doesn’t mean absolutely essential, just helpful for the business. A court case might be “necessary” to defend your business’s interests even if, in hindsight, you might have survived without litigating.

• Miscellaneous Itemized Deductions – These are certain personal expenses (under IRC § 212) that can be written off on Schedule A if you itemize. They include things like unreimbursed employee expenses, investment expenses, and personal tax advice or legal fees related to producing taxable income.

  • They were subject to the 2% of AGI floor (meaning you could only deduct the amount beyond 2% of your income) and also disallowed entirely under the AMT (Alternative Minimum Tax). Importantly, from 2018 through 2025, miscellaneous itemized deductions are suspended on federal returns. So, while the concept still exists in theory, right now you generally can’t benefit from these on your federal 1040. Keep this term in mind though, as it may return in 2026 if laws aren’t changed.

• Above-the-Line Deduction – A deduction “above the line” means it’s taken before calculating your Adjusted Gross Income. These are also called adjustments to income or deductions for AGI. They are generally more valuable because they reduce your AGI (which can affect many other tax calculations and limitations) and you don’t have to itemize to take them.

  • The special deductions for legal fees in employment discrimination or whistleblower cases are above-the-line. Practically, you’d list them on Schedule 1 of Form 1040 (which feeds into the AGI calculation). Starting with tax year 2021, the IRS even added a specific line for “Attorney fees” for these cases, making it easier to claim. Above-the-line = you get the deduction no matter what, and it’s not limited by the 2% rule or AMT.

• Below-the-Line Deduction – This refers to a deduction taken from AGI (i.e., part of itemized deductions on Schedule A). If legal fees are only deductible as a miscellaneous itemized deduction, they’re below-the-line. You’d only get a benefit if you itemize and if those fees (plus other misc. deductions) exceed 2% of AGI (in normal times when allowed). And they wouldn’t reduce your AGI. Bottom line: below-the-line deductions are less beneficial and more limited. Unfortunately, most personal legal fees fell into this category (and currently into the “suspended” category).

• Adjusted Gross Income (AGI) – This is your gross income minus above-the-line deductions. It’s an important subtotal on your tax return. Many deductions, credits, and phaseouts are based on AGI. Why it matters here: keeping an attorney fee deduction “above the line” lowers your AGI, which can in turn help you qualify for other breaks (and avoid things like high-income surtaxes).

  • Conversely, deductions that are below the line don’t help your AGI, and some might not reduce your taxable income at all if you take the standard deduction or fall under AMT. That’s why Congress making certain legal fees above-the-line was a big deal for taxpayers with large settlements.

• Capitalizing vs. Expensing – If you expense a cost, you deduct it in the current year, reducing current income. If you capitalize a cost, you treat it as part of an asset and generally deduct it over time (through depreciation or when you sell the asset).

  • Many legal fees for businesses can be expensed (immediately deducted), but if they relate to acquiring a capital asset or benefit future years, they may need to be capitalized. The classic example is legal fees to buy a piece of property or to establish a long-term benefit. Capitalizing spreads the deduction over multiple years, which is less of an immediate benefit than expensing.

• Origin of the Claim – This is a doctrine from tax court cases (again, notably Gilmore as mentioned earlier). It means to determine deductibility, you look at what gave rise to the legal dispute. If the origin is personal (a divorce, a fight between neighbors, etc.), the legal fees are personal. If the origin is linked to profit or business (a contract dispute with a client, defending your professional license, etc.), then the fees might be business or income-producing expenses. Sometimes a lawsuit’s origin can be mixed, but the tax law tries to characterize it based on the primary root cause.

• Unlawful Discrimination Claims – This term, defined in the tax code, covers a range of lawsuits (like claims under the Civil Rights Act, Americans with Disabilities Act, Title VII employment discrimination, whistleblower laws, etc.).

  • If your legal fees are from a case that falls under these laws and you win a settlement or award, the fees can be deducted above-the-line (up to the amount of the award included in income). It was Congress’s way of preventing double taxation on plaintiffs. Always check if your case type is listed in IRC § 62(e) – it’s a long list of statutes that count as “unlawful discrimination” for this purpose.

• Alternative Minimum Tax (AMT) – A parallel tax system that disallows certain deductions and has its own tax rates. Why mention it? Because before the above-the-line fix, even if you deducted legal fees as a miscellaneous itemized deduction, you might lose the benefit under AMT. Many high-income taxpayers who had large attorney fee deductions (like from winning a lawsuit) got hit by AMT and ended up paying tax on money that went to their lawyers.

  • The above-the-line law fixed this for covered cases, because above-the-line deductions are allowed in computing AMT as well. Just be aware that if you ever are in AMT territory, miscellaneous deductions won’t help you there.

Understanding these terms helps you navigate the conversation around legal fees and taxes with more confidence. They often show up in IRS instructions and court opinions about deductions.

Federal vs. State Law: Deducting Legal Fees at Different Levels

Taxes in the U.S. come at two levels: federal and state. You might assume the rules are the same, but state tax laws sometimes diverge from federal rules on deductions. Here’s what to keep in mind regarding legal fees:

• Federal Law Reigns for Federal Taxes: Everything we’ve discussed so far is about your federal income tax return (the IRS rules). States often use your federal Adjusted Gross Income or taxable income as a starting point, but then they have their own adjustments.

• States That Allow More Deductions: A few states did not conform to the federal suspension of miscellaneous itemized deductions. For example, California, New York, Alabama, Arkansas, Hawaii, Minnesota, and Pennsylvania have allowed deductions for unreimbursed employee expenses or other misc. deductions in some form during the period 2018-2025.

  • This means if you’re in one of those states, you might still deduct things like tax prep fees or certain legal expenses on your state return even though you can’t on the federal return. Each state has its own nuances: e.g., California allows miscellaneous deductions essentially as they existed pre-2018 (with the 2% floor), while Pennsylvania has its own rules (PA typically only allows very limited itemized deductions like work expenses for certain professions).

• States That Follow Federal Fully: Many states, however, piggyback exactly on federal itemized deductions. If it’s not deductible on the federal Schedule A, it’s not deductible on the state return either. For instance, if you live in a state with income tax that conforms to federal law (like Illinois or Texas — well Texas has no income tax, but say Virginia, etc.), you won’t get a state deduction for those personal legal fees either.

• Different Definitions or Credits: Some states have unique tax breaks. For example, a state might offer a credit similar to the adoption credit or allow deductions for certain legal fees as part of a state-specific program. Always check your state’s tax instructions or consult a state tax expert for any special provisions.

• State Tax Court Awards: If you win a lawsuit and a portion is attorney fees, states also generally follow the federal lead on taxing the gross versus net. But there can be differences. There have been instances where, say, a state court allowed a deduction on a state return for legal fees in a civil rights case even when the federal treatment was muddled.

  • Massachusetts, for example, had some nuances on attorney fee deductions in discrimination cases before the federal law was clarified. The key is: report things consistently, but be alert to state-specific deduction lines.

• Business Entities and State Taxes: For business legal fees, typically if it’s deductible for federal, it’s deductible for state, since states use your federal business income as a starting point (with some adjustments). One exception is if a state disallows certain write-offs (some states, for example, might not allow certain federal deductions, but legal fees usually aren’t targeted for add-back).

• Local Taxes: A quick note – if you have local city income taxes (like New York City, for instance), they may also follow state or federal rules. Usually, they keep it simple and stick closely to state definitions of income.

In short, always do a two-layer check: deductibility under federal law, and then deductibility under your own state’s law. They’re often the same, but those differences can matter. If you use tax software or a professional, they will usually handle this automatically by knowing your state’s conformity (or lack thereof) to federal rules.

Deductible or Not? Real-World Scenarios

Nothing beats examples to illustrate when legal fees are deductible. Let’s look at a few common scenarios, comparing a deductible situation to a non-deductible one:

Scenario 1: Business Lawsuit vs. Personal Lawsuit

Suppose you incur $20,000 in legal fees in a given year. Here’s how the deductibility shakes out depending on the situation:

In essence, business context = tax break, personal context = no tax break.

Scenario 2: Employment Settlement vs. Personal Injury Settlement

You receive a settlement and pay your lawyer a contingency fee. How the tax works:

This scenario shows that getting taxed on an award opens the door to a deduction for fees (in specific cases like employment law), whereas a tax-free award yields no deduction.

Scenario 3: Starting a Business vs. Personal Legal Help

Let’s compare legal fees to start a venture versus a purely personal service:

The contrast: Business launch costs have tax provisions to ease the burden; purely personal planning does not.

These examples highlight a common theme: tie the fee to taxable income or business, and you often get a deduction; if it ties to personal or tax-exempt matters, you don’t.

Pros and Cons of Different Deduction Strategies

When dealing with legal fees, you might have choices in how to handle them for tax purposes. Here’s a quick comparison of strategies and their pros/cons:

Each strategy fits different scenarios. For instance, a business owner will aim for the immediate expense; an individual plaintiff will use the above-the-line if possible; and capitalizing is more for one-time big transactions. The main takeaway is to use the most advantageous method you legally can, and plan ahead with your attorney and CPA if possible.

How Court Cases Shaped Legal Fee Deductions

Tax law isn’t just statutes and IRS rules – many key principles come from court decisions. Here are a few landmark cases and rulings that have influenced how legal fees are treated:

• United States v. Gilmore (1963): Established that the origin of the claim dictates deductibility. Gilmore couldn’t deduct divorce-related legal fees to protect his business assets because the origin was personal. This case is why personal motives can’t be converted into business expenses for taxes.

• Commissioner v. Tellier (1966): Confirmed that even legal fees to defend against criminal charges are deductible if the charges stem from the taxpayer’s business. Tellier was a securities dealer whose legal defense for fraud charges was deemed an ordinary and necessary business expense. The Supreme Court rejected the IRS’s argument that “public policy” should bar the deduction.

• Woodward v. Commissioner (1970): A Supreme Court case holding that legal fees incurred in a corporate stock valuation dispute (to buy out minority shareholders) were capital expenditures, not current expenses. This, along with related cases, cemented the rule: costs to acquire or defend title to a capital asset must be capitalized.

• Internal Revenue Code § 62(a)(20)&(21) (Enacted 2004): Not a court case, but a pivotal legal change by Congress. This law allowed above-the-line deductions for attorney fees in certain cases (civil rights, employment discrimination, whistleblower awards).

  • It was a response to situations like the Banks v. Commissioner (2005) Supreme Court decision, which held that plaintiffs have to include their full lawsuit recovery in income even if a large chunk went to attorneys. The new law aimed to prevent unfair taxation by giving those taxpayers a way to deduct the fees. It took years (until 2021) for the IRS to simplify the form for claiming it, but it’s firmly in place now.

• Ongoing Tax Court Decisions: Every year, Tax Court and appellate courts decide cases where taxpayers push the boundaries. For example, cases where someone tries to deduct personal legal fees by claiming they relate to income – courts often refer back to Gilmore’s origin test. Or cases debating if something is a business expense or needs capitalization – the courts look at facts and prior precedents.

  • One recent Tax Court memo, for instance, denied a deduction for legal fees of an employee who sued for workplace injury because the law that provided the award wasn’t on the approved list for above-the-line deduction (illustrating how specific the rules are).

• Future Developments: It’s worth noting that after 2025, if miscellaneous deductions come back, we might see new cases on what qualifies as a deduction under Section 212. Tax professionals are watching whether Congress will extend the suspension or not. If not, people may again deduct things like investment-related legal fees – and that could lead to fresh disputes and clarifications in court.

Knowing these cases isn’t just trivia; it helps understand the “why” behind the rules. They show how the line between personal and business is drawn, and how Congress and courts respond to perceived unfairness (like the double tax on legal fees). If you ever find yourself in a gray area, these precedents give an idea of how the IRS and courts might view your situation.

Key Tax Entities Involved (Who’s Who)

When dealing with taxes and legal fee deductions, several entities and authorities come into play:

• Internal Revenue Service (IRS): The IRS is the federal agency that administers tax laws. It issues regulations and guidance on deductions (like publishing lists of what’s deductible or not, e.g., in IRS Publications). The IRS examines tax returns and may audit you if a deduction looks fishy. When you deduct legal fees, the IRS might ask for substantiation in an audit. They also are the ones who accept or deny deductions on examination. Essentially, they enforce the rules.

• Congress & Tax Code: The U.S. Congress writes the Internal Revenue Code. Changes to what’s deductible (such as the 2017 law that suspended misc deductions, or the 2004 law that added above-the-line attorney fee deductions) come from legislation. So, ultimately, what’s allowed or not allowed stems from the tax code that Congress enacts (with some interpretation by IRS and courts).

• Tax Court and Other Courts: If you disagree with the IRS on a deduction and can’t resolve it administratively, you might end up in U.S. Tax Court (or pay the tax and sue for refund in District Court or Court of Federal Claims). The Tax Court is a specialized court for federal tax disputes. Many cases about legal fee deductions have been decided here.

  • The court’s job is to apply the law to the facts and it can uphold or overturn IRS’s position. Higher courts (Court of Appeals, Supreme Court) may get involved for big principles (like they did in Gilmore, Tellier, Banks, etc.).

• Tax Professionals (CPAs/Enrolled Agents): These folks prepare returns and advise taxpayers. A good CPA will ask about your legal fees and make sure you’re taking all valid deductions (and not taking invalid ones). They keep up with the latest rules and help with documentation. If an issue arises with a deduction, they can represent you or guide you on next steps. They often serve as intermediaries between the taxpayer and IRS in audits.

• Tax Attorneys and Law Firms: Tax attorneys often come into play for planning complex situations (like structuring a settlement to maximize deductibility) or in disputes (if you go to Tax Court, you’ll likely hire a tax lawyer).

  • Also, remember that the attorneys who charge the fees might give some guidance on deductibility, but their job is mainly the legal matter at hand. Some law firms specialize in the taxation of legal settlements and can help ensure you benefit from things like the above-the-line deduction by wording settlement agreements properly.

• State Tax Agencies: Each state with an income tax has its own revenue department (like the California Franchise Tax Board, New York Department of Taxation and Finance, etc.). These agencies handle state tax returns and audits. If you deduct something on a state return that’s not allowed (or vice versa), they might challenge it. State agencies also provide guidance for state-specific rules.

• The Taxpayer Advocate Service (TAS): This is an independent organization within the IRS that helps taxpayers who are having trouble resolving issues. If there were systematic problems like people being unfairly taxed on attorney fees, TAS might highlight it (the National Taxpayer Advocate did in fact push for clearer rules on attorney fees for years). They’re a resource if you hit a snag, though not directly about deducting or not, they can cut through red tape in disputes sometimes.

Each of these entities has a role in how legal fee deductions play out. For most people, you’ll primarily interact with the IRS (via forms or maybe an audit letter) and possibly a tax professional. But it’s good to know the “ecosystem” of tax authority around this topic, especially if you ever need to challenge a decision.

FAQ: Legal Fees and Tax Deductions

Q: Can I deduct my divorce lawyer’s fees on my taxes?
A: No. Divorce and family legal costs are personal expenses and not tax-deductible, except possibly any portion explicitly for tax advice, which is generally minimal.

Q: My small business paid $5,000 to an attorney – is that fully deductible?
A: Yes, if the legal work was for the business (e.g. contract review, lawsuit defense). Ordinary business legal expenses are fully deductible against business income.

Q: I sued my employer for harassment and won a settlement. Can I deduct the attorney fees?
A: Yes. Attorney fees for employment discrimination or harassment cases are deductible above-the-line, so you won’t pay tax on the portion of the award that went to your lawyer.

Q: Are personal injury lawsuit settlements taxable, and can I deduct the legal fees?
A: Physical injury settlements are generally not taxable income, and consequently, the legal fees aren’t deductible either. For any taxable portion (like interest or punitive damages), a proportional fee deduction may be allowed.

Q: If I set up an LLC for my side gig, can I write off the legal fees?
A: Yes. Legal fees for forming a business are considered startup/organizational expenses. You can usually deduct up to $5,000 in the first year (if total startup costs are $50k or less) and amortize the rest.

Q: How do I actually claim a legal fee deduction on my return?
A: Business legal fees go on the appropriate schedule (C, E, or F) as expenses. Above-the-line deductions (for certain cases) are entered on Schedule 1 of Form 1040 (there’s a line for attorney fees). Personal miscellaneous legal deductions (when allowed) would go on Schedule A.

Q: What happens if I mistakenly deduct a personal legal expense as a business expense?
A: If the IRS catches it, they’ll disallow the deduction. You could owe back taxes, interest, and possibly penalties for negligence. Always categorize correctly to avoid problems.

Q: Is an estate planning attorney fee ever deductible?
A: Generally no, it’s personal. Only if part of the fee is for specific tax advice (like planning for estate tax) and it’s separately stated might that portion be deductible (subject to itemized deduction rules).

Q: Do I need receipts or proof for legal fee deductions?
A: Yes. Keep invoices and proof of payment. The IRS may ask for documentation to substantiate the amount and purpose of the legal fees during an audit.

Q: Does it matter if I win or lose the case regarding deducting legal fees?
A: For business expenses, no – win or lose, the legal fees related to the business are deductible. For personal cases, win or lose, they’re generally not deductible (except the special above-line cases which apply if you win taxable awards, but even if you lost a qualifying discrimination case, you could still deduct the fees you paid for that case under the above-line provision).