The deduction of legal fees is not a simple subject that can be answered in a sentence. There are certain types of legal fees that can be deducted, and others that cannot. You must be aware of the rules to properly handle legal fees on your tax return.
Personal Legal Fees
Personal legal fees are not deductible on your federal taxes. This includes child custody, suits for breach of promise to marry, personal relationships resulting in civil or criminal charges, damages for personal injury (exceptions may apply if the injuries are related to your job in any way), preparation of a title, will preparation, and property claims or property settlement in a divorce. It is possible that some of these types of suits could result in the loss of property that is used to generate income, but according to IRS Publication 529, the legal expenses still do not qualify for tax deduction.
Business-Related Legal Fees
Legal fees that are ordinary and necessary expenses directly related to operating your business can be deducted as business expenses. Legal fees you pay to acquire business assets are not deductible normally. Instead, these costs are added to the basis of the property and depreciated according to the general accounting principals.
Personal legal fees mentioned previously cannot be deducted as a business expense either. When a bill has both business and personal charges, you must determine the portion of the bill that is attributable to business and use only that amount as a deduction.
Job-Related Legal Fees
One exception to legal fees that could be categorised as personal is those that are incurred to keep or perform your job. Also deductible are fees related to obtaining or collecting taxable income or obtain tax advice. This provides for an exception to legal advice relating to a divorce in which advice that is related to the tax advice for a divorce can be broken out of the whole bill and deducted.
Any type of legal fee that would be deducted on your federal Schedule A would be subject to a 2-percent limitation on the miscellaneous portion of the itemised deductions. Business-related legal fees are usually deductible on a Schedule C, Schedule C-EZ or corporate tax returns. You should consult the website of your state taxing authority to determine how your state of residence handles legal fees, because each state has its own rules.
When you must calculate the portion of a bill that is attributable to business- or tax-related issues, you should ask the issuer of the bill to itemise the amount to make your calculations simpler and to supply you with backup documentation in case of an audit. If you are unsure if any of your legal fees are deductible, be sure to seek the advice of a qualified tax preparer.