Are legal fees deductible on my taxes?

by | May 9, 2025 | Deductions, Individual Taxes

Here’s what HIVE AI had to say about “Are legal fees deductible on my taxes?”:

Legal Fees Deductibility on Taxes

Whether legal fees are deductible on your taxes depends on the purpose of the fees and how they relate to your income-producing activities. The deductibility of legal fees follows the “origin of the claim” test established by the Supreme Court.

The Origin of the Claim Test

The deductibility of legal fees depends on the origin and character of the claim for which the expenses were incurred and whether the claim bears a sufficient nexus to the taxpayer’s business or income-producing activities. This principle was established in United States v. Gilmore, 372 U.S. 39 (1963). Dawson U.S. Tax Court Opinions: Ames D. Ray Dawson U.S. Tax Court Opinions: Ames D. Ray

The Supreme Court has stated that “the origin and character of the claim with respect to which an expense was incurred, rather than its potential consequences upon the fortunes of the taxpayer, is the controlling basic test.” If the claim arose “in connection with the taxpayer’s profit-seeking activities,” the fees are deductible. If not, then they are not deductible, regardless of “the consequences that might result to a taxpayer’s income-producing property” from losing the case. Ascertainment of a claim’s origin and character is a factual determination made on the basis of the facts and circumstances of the litigation. Dawson U.S. Tax Court Opinions: William French Anderson & Kathryn D. Anderson

Business-Related Legal Fees

In general, legal fees are deductible under section 162 only if the fees paid originated in the taxpayer’s trade or business and only if the claim is sufficiently connected with that trade or business. Dawson U.S. Tax Court Opinions: Kenneth Delano Humphrey Dawson U.S. Tax Court Opinions: Kenneth Delano Humphrey

Amounts paid for legal expenses in connection with litigation are allowed as business expenses where such litigation is directly connected to, or proximately results from, the conduct of a taxpayer’s business. For example, in Kornhauser v. United States, 276 U.S. 145 (1928), the court held that a taxpayer may currently deduct amounts paid in defense of a suit against it by its former law partner. Similarly, in Howard v. Commissioner, 22 B.T.A. 375 (1931), the court decided that legal fees incurred by a taxpayer to settle a shareholder’s claim of misrepresentation in the conduct of business are deductible as business expenses. PLR-118469-05

Personal Legal Fees

Expenses paid or incurred by a taxpayer for family, living or other personal reasons are only deductible as specifically provided in the Internal Revenue Code. With respect to a deduction for legal fees, we look to the origin of the claim giving rise to those legal fees. If the legal fees relate to a taxpayer’s trade or business, or other types of activities that specifically allow for deductions, then the legal fees might be deductible. If the legal fees relate to a family or a personal matter, then the fees are not deductible. Dawson U.S. Tax Court Opinions: John M. Majcher

Divorce-Related Legal Fees

Legal fees incident to a divorce generally are not deductible, because they are personal. However, divorce-related legal fees that are allocable to tax advice or collection of taxable alimony or incurred in a dispute regarding entitlement to business profits may be deductible under section 212. Dawson U.S. Tax Court Opinions: James A. Hill, Jr.

Amounts paid as damages for breach of promise to marry, and attorney’s fees and other costs of suit to recover such damages, are not deductible. Generally, attorney’s fees and other costs paid in connection with a divorce, separation, or decree for support are not deductible by either the husband or the wife. However, the part of an attorney’s fee and the part of the other costs paid in connection with a divorce, legal separation, written separation agreement, or a decree for support, which are properly attributable to the production or collection of amounts includible in gross income under section 71 are deductible by the wife under section 212. Tresuary Reg. 1.262-1

Tax-Related Legal Fees

Expenses paid or incurred by an individual in connection with the determination, collection, or refund of any tax, whether the taxing authority be Federal, State, or municipal, and whether the tax be income, estate, gift, property, or any other tax, are deductible. Thus, expenses paid or incurred by a taxpayer for tax counsel or expenses paid or incurred in connection with the preparation of his tax returns or in connection with any proceedings involved in determining the extent of his tax liability or in contesting his tax liability are deductible. Tresuary Reg. 1.212-1

Legal Fees Related to Rental Property

You can deduct, as a rental expense, legal and other professional expenses on Schedule E, Part I. For example, on your 2024 Schedule E, you can deduct fees paid in 2024 to prepare Part I of your 2023 Schedule E. You can also deduct, as a rental expense, any expense (other than federal taxes and penalties) you paid to resolve a tax underpayment related to your rental activities. IRS – Publication 527: Residential Rental Property (Including Rental of Vacation Homes)

Legal Fees as Part of Property Basis

The following settlement fees and closing costs for buying property are part of your basis in the property:

Legal Fees Related to Investment Income

Investment fees and expenses, and legal fees related to producing or collecting taxable income or getting tax advice, were previously deductible as miscellaneous itemized deductions. IRS – Publication 529: Miscellaneous Deductions

However, it’s important to note that for tax years 2018 through 2025, miscellaneous itemized deductions subject to the 2% of AGI floor have been suspended under the Tax Cuts and Jobs Act.

Special Cases for Legal Fee Deductions

Whistleblower Awards

Any deduction allowable for attorney fees and court costs paid by, or on behalf of, the taxpayer in connection with any award under section 7623(b), or in the case of taxable years beginning after December 31, 2017, any action brought under section 21F of the Securities Exchange Act of 1934, a State false claims act, including a State false claims act with qui tam provisions, or section 23 of the Commodity Exchange Act, is allowed as an adjustment to gross income. IRC § 62(a)

Criminal Defense Costs

Public policy does not prohibit the deduction of legal fees relating to criminal activity so long as the legal fees are an ordinary and necessary expense of a trade or business. Dawson U.S. Tax Court Opinions: William French Anderson & Kathryn D. Anderson

Documentation Requirements

To deduct legal fees, you must maintain adequate records to substantiate the deduction. Dawson U.S. Tax Court Opinions: Kenneth Delano Humphrey

Conclusion

The deductibility of legal fees depends primarily on the origin and nature of the claim or activity that generated the legal expense. Here’s a summary of when legal fees may be deductible:

  • Business-related legal fees: Deductible as ordinary and necessary business expenses if they originate from your trade or business activities.
  • Investment-related legal fees: Previously deductible as miscellaneous itemized deductions subject to the 2% AGI floor, but currently suspended through 2025.
  • Tax-related legal fees: Deductible when related to determining, collecting, or contesting any type of tax.
  • Rental property legal fees: Deductible as rental expenses on Schedule E.
  • Property acquisition legal fees: Added to the basis of the property rather than deducted.
  • Personal legal fees: Generally not deductible, including divorce costs (with limited exceptions).
  • Whistleblower claims: Deductible as an adjustment to gross income.

Given the complexity of these rules and the impact of the Tax Cuts and Jobs Act, it’s advisable to consult with a tax professional to determine the proper treatment of your specific legal expenses.

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