Legal Expense Tax Deduction
Legal fees are limited as tax deductions. A legal expense tax deduction is only granted to fees for disputes arising form business or income producing affairs. Personal legal fees are not deductible.
When a legal dispute occurs as a result of business activity or as a result of some matter that is related to the producing of income, the legal fees may be taken as a legal expense tax deduction. This is itemized as a miscellaneous tax deduction and is subject to the 2% Adjusted Gross Income floor. Personal legal fees are not tax deductible.
To understand this distinction, the legal fees involved in the dissolution of a marriage provide a good example. The legal fees paid to a lawyer to handle divorce proceedings would be considered purely personal legal fees and would not be tax deductible. However, if the divorce involved the collection of alimony and the alimony was going to be considered as taxable income, the portion of the legal fees paid for this purpose would be deductible. It would be necessary for the lawyer to make a statement detailing what portion of his fee was attributable to the alimony collection.
Another example would involve personal injury suits. If the reward for the personal injury suit was considered taxable income, the legal fees would be deductible. Some personal injury suits do not involve taxable income and, in this case, the legal fees would not be taxable. This would be the same with legal fees regarding a Will dispute. Since any inheritance would not be income that would be reported and taxed on your income tax return, the legal fees would not be deductible.
The principle involved here is actually that the legal fees are considered much the same as a business expense. In a business model, you are only taxed on the profit that you make. If you buy a product for $10, sell it for $15, and pay your salesman $2, you have made a profit of $3. It is the $3 that is subject to tax, not the entire $15 you received for the sale. In the same manner, if you need a lawyer and pay legal fees in order to realize any income subject to tax, the profit is what you receive after you have paid the lawyer.
When you keep that simple rule in mind, it should clear up any confusion on the use of legal fees as a tax deduction. Obviously, the money paid to a lawyer to defend you for a traffic ticket violation is not going to be tax deductible. If you keep in mind the profit model from business, you should be able to easily tell which legal fees may be taken as an itemized deduction.