Legal fees aren’t cheap, and they add up quickly. But many legal fees are either fully deductible or partially deductible, so at least you can get some of that money back. Forbes recently published an article describing the various types of fees. Here’s what you need to know.
The best kind of fees are business fees. If you file business taxes yearly, your business legal fees count as an expense.
Personal injury legal fees are also fully deductible. But punitive damages and interest are taxable, so be sure to verify what’s deductible and what’s not.
If you have business legal fees but don’t file business taxes every year, you may be required to treat them as itemized deductions, which have numerous limitations. Legal fees up to 2% of your adjusted gross income aren’t deductible, deductions are phased out at higher incomes, and you get no deduction with the AMT.
Personal legal fees are not deductible — fees for divorce cases, family cases, anything other than personal injury cases.
A Few More Rules
There are a few additional rules you need to know when it comes to legal fees:
- Contingent Fees: If you recover $1 million in a lawsuit and your contingent fee lawyer keeps 40%, you actually are considered to have $1 million of income even if you only net $600,000. You’ll need to pay taxes on $600,000 and then deduct the $400,000 of fees.
- Capitalizing Fees: Some business and investment legal expenses must be “capitalized.” If you’re selling your business and spend $50,000 in legal fees, you’re required to add it to your basis.
- Tax Advice: Legal fees for tax advice are deductible, and any tax qualifies: income, estate, gift, property, excise or sales and use tax.
- Beware Combined Cases: If you receive tax-free and taxable damages (like punitive damages or interest), you’ll need to apportion your attorney fees. For example, if you’re seriously injured in your car and recover $500,000 in compensatory damages and $500,000 in punitive damages from the other driver, and your lawyer gets 40%, half of your lawyer’s fees are taxable income income, since punitive damages are taxable income, and you can only deduct them as a miscellaneous itemized deduction.