Legal fees for business expenses are surely deductible. However, personal legal expenses are typically excluded. There are multiple exceptions and clauses that need clarification on which legal fees are deductible and which remain a burden on your pocket!
This blog will explain every write-off and legal tax deduction that you can claim. Keeping your tax bills lower than your expectations!
Business & Income-Related Fees (The Good News)
Business and income-related fees are deductible as far as they are ordinary and necessary. The IRS allows you to deduct legal expenses, but they must be for your trade or business. The cost should be related to managing income and profit-making assets.
What Ordinary and Necessary Means:
- Ordinary: The expense is common and accepted in your particular business or industry.
- Necessary: The expense is helpful and appropriate for your business. (It does not have to be indispensable.)
Examples of Fully Deductible Legal Fees:
Typically, these are ongoing expense that a business have during a tax year:
- Business Operations: Legal advice on contracts, employee handbooks, licensing or compliance matters.
- Business Litigation: Defending or filing a lawsuit directly related to your business activities. It can be a contract breach, infringement of intellectual property or debt collection.
- Employment Issues: Fees related to handling wrongful termination disputes and drafting employment agreements.
- Rental Property: Specifically for rental businesses. Including legal expenses related to eviction, drafting a lease and defending a liability claim.
- Tax Matters: Fees for solving tax issues, advice and tax preparation services for businesses.
Startups and Organizational Costs:
Startups can deduct the cost of establishing a business. Typically, registering a business involves forming an LLC, C-Corp, or Partnership. It includes drafting organizational documents.
- The Deduction Rule: You can deduct a total of $10,000 in business expenses and organization. $5,000 for each in the first year of business formation.
- The Balance: Any remaining startup or organizational costs must be amortized (deducted) equally over the following 180 months.
Quick Note: Legal fees to defend the name and ownership of business property must be added to the property’s cost. You can’t deduct it immediately!
The Golden Rule for Maximizing Your Business Deduction:
The IRS places the burden of proof on the taxpayer. The single most important action you can take to secure your deduction is requesting an itemized invoice. Ask your tax attorney to provide an invoice separately for business matters. A single, vague “Legal Services” line item makes it difficult to defend the deduction.
Deducting Costs for Tax Help and IRS Disputes
Here is another piece of good news! You can get a tax deduction for tax advice, preparation of tax returns or representations in case of audits. However, you will need Schedule C if it’s a business expense. On the other hand, for personal tax services, it will go as a miscellaneous itemized deduction.
Heads Up! Miscellaneous itemized deductions for tax help are suspended until 2026.
Divorce, Child Custody, and Other Non-Deductible Personal Expenses
The legal fees are generally considered personal expenses by the IRS. These include fees for:
- Filing Divorce
- Child Custody
- Personal Property Dispute
Prior to the TCJA (Tax Cuts and Jobs Act) 2018-2025, there were exceptions. For instance, collecting alimony or personal tax advice during a divorce, but these are suspended now.
Special Cases: Lawsuits and Life Planning
The tax treatment of legal fees depends heavily on the type of case. Particularly, whether the settlement money you receive is considered taxable income. Here are multiple scenarios and how the IRS sees them:
Personal Injury:
The general rule for personal injury cases is straightforward. According to federal tax laws, IRC Section 104, compensatory damages received for personal physical injuries or physical sickness are generally excluded from your gross income and are therefore not taxable.
As you do not pay income tax on the personal injury settlement itself. There is no need to deduct the legal fees. The fees paid to your attorney are not tax-deductible in this scenario.
Taxable Settlements (The Exception):
The rules are drastically different for settlements that are considered taxable income. These include settlements for:
- Employment Discrimination
- Wrongful Termination
- Certain Whistleblower Claims
Estate Planning:
Fees for typical personal legal services are generally not tax-deductible. Estate planning falls into this category. It generally includes:
- Wills
- Revocable Living Trusts
- Powers of Attorney
- Healthcare directives
However, there are some exceptions to this rule, which make some estate planning tax-deductible.
- Legal Fees for Tax Advice: It must be clearly separated and billed by your attorney.
- Legal Fees for Estate Planning: Must be directly related to the management of income-producing property or a business interest. For example, business succession planning.
Wrap Up & Actionable Advice
In short, you can expect to deduct business expenses while personal expenses are non-deductible. Read the guide carefully to see if you fall under any exceptions, reducing your tax bill.
Here is a pro tip! Ask for an itemized invoice from your attorney. It will allow you to maximize your legal deduction lawfully. Furthermore, consult with a tax professional for your specific situation. At Tax King, we have expert tax accountants you can lean on. We won’t just help you with deductions but find credit for your personal and business taxes. Ensuring you pay the least taxes possible!
