Find Out From An Expert What Legal Fees Are Tax Deductible.

Should you know what kind of legal fees are tax deductible?

Not all legal fees are tax deductible. After you read this article, you will know when and where your legal fees are deductible.

I’ll break down the different ways you can deduct legal fees you pay in the coming article.  We’ll go over several scenarios and explain the proper method of deducting your attorney fees and how the deduction will affect your tax liability.

Deducting legal fees isn’t as straight forward as it appears.  Taxes, as I’ve stated for much of my career, are not born out of logic.  Tax law and how they come to be are a political process.  This process is a political tool that means we need to understand the different ways these legal fees can be treated. They will not always make sense.

One more big issue. At this time, most personal legal fee deductions are suspended.  This info will be viable for your state, and certain legal fees not affected by the TCJA.

Here goes!

The deductibility of legal and attorney fees as an individual are generally only allowed if they were for one of two topics.  Taxes and income protection.  An inconsistency of this rule is legal fees paid for estate planning are typically NOT tax deductible.  In my mind, estate planning covers both taxes and income protection.

See.  Political.  Not logical in many ways.  And this makes it more complex and confusing than it need be.

  • Just Your Regular Old Legal Fees

For the most part, legal fees paid for things like estate planning, divorce, child custody or accidents are not tax deductible. Sometimes there is a way to get a partial deduction and I’ll explain this when appropriate.

  • Dedectible Personal Legal Fees

Do You Have a Rental Property?

The IRS looks are real estate rentals as a passive activity.  I know.  Cleaning up after messy tenants or repairing plugged toilets isn’t exactly passive.

If you incurred legal expenses due to tenant issues, or any contractual issue relating to the rental property, this would be 100% deductible as a business expense.  You’d deduct these legal fees on Schedule E.

Include legal fees paid for renovation or building planning process in the basis of the improvement or property and amortized.

Do You Have Your Own Business or Side Hustle?

Legal fees paid with regard to a business or side hustle (I know.  They’re technically the same thing.  My distinction is between a full-time gig and a part time thing).

Regardless, money spent on legal fees for a business or side hustle are generally fully deductible.  There must be a direct connection between the business and the why of the legal fee.

Suing someone who owes the business money would be 100% deductible.

As an example, you use your car 50% for work and 50% personally.  An elephant from the local circus damaged your car.

You sue the circus and they pay to fix your car.  Since the car was used personally 50% of the time, 50% of your legal fees would be deductible as a business deduction.

Take a legal fees deduction on your personal tax return under the TCJA as follows:

  • Deduct legal fees paid for your rental property on Schedule E.  Schedule E discloses your activity on a specific rental unit or site.
  • Deduct legal fees paid in relation to your business or side hustle on Schedule C. Schedule C discloses your activity on you business or side hustle..
  • Allocate legal fees which had a personal element to them. If a personal element exists, you can only deduct the amount which pertained to the business or rental property.
  • I suggest you ask your attorney for two invoices.  One to your business, one to you personally.
  • For legal fees deducted before 2018 and after 2026 you were limited by a 2% “haircut” The amount was 2% of your adjusted gross income.
  • You can’t deduct legal fees on Schedule A until 2026.
  • If your lawsuit was due to your being discriminated against, the legal fees are NOT deductible on Schedule A.  These fees are an Above The Line deduction and should be reported on Schedule 3.  This is really important!
  • What if you were discriminated against?

This little hitch in the tax code is a real benefit.

Tax deductible legal fees as an itemized deduction isn’t a 100% deduction.  Items deducted as Miscellaneous Itemized Deductions get a 2% haircut.

This means you lose part of the deduction equaling 2% of your Adjusted Gross Income.

  • Mary sued her employer for $1mil because they discriminated against her due to her age when giving out promotions.  She won her case.  Her attorney’s kept 40% of the total proceeds.  Mary’s adjusted gross income for the year was $1,100,000 ($100k salary + $1mil settlement).
  • Since this was a discrimination suit, the legal fees are deductible as an above the line deduction.  You don’t lose the 2% like a Misc Itemized Deduction.  This gave her a $22,000 larger legal fee deduction.
  • “If” these legal fees were for a non-discriminatory suit, the legal fees would be a state deduction subject to the 2% haircut.  Legal fees deducted would be $378k in this case.
  • The lawsuit is based on a discrimination charge so she takes the entire $400k paid to the attorney as a deduction on Schedule 3.
  • Claim the income on the return.  Nothing special about how to report this income.  You’ll probably receive a 1099-Misc form.
  • Deduct your legal fees on Schedule 3 as an Other Deduction.  Label the deduction as Unlawful Discrimination Case.

Since this is a direct deduction without any limits, you will see a better result than if it were deducted as an itemized deduction (this will be back in 2026).

The best part of this is if you aren’t typically itemizing, you’ll still get the Standard Deduction.  More tax savings.

How About If I’m a Federal Whistleblower???

Deduct legal fees associated with being a whistleblower on Schedule 3, just like you did when discriminated against.

If you were a state level whistleblower you need to check your state specific rules.  If you are a state level whistleblower who brought an employment suit, your legal fees are treated the same as any other discrimination suits fees.

Government whistleblowers will get some relief on their taxes.  Issues as specific as these usually need some specialized research.  Remember to ask questions if you find yourself in this kind of situation.

  • Contracts… 

If you’re in business, you will always have some sort of contractual agreement with someone.  It’s smart to put your agreements to paper as a protective measure.  It’s for your protection as well as the other party.

Legal fees paid to draft, review and finalize a contract are fully deductible on your Schedule C.

  • …Broken Contracts

Does someone owe you money?  Is someone refusing to comply with a signed contract?  How about someone who did work for you, but it wasn’t to your specifications or was it some really bad work?

If you take them to court, arbitration or mediation, the fees will be deductible.

Renter doesn’t pay?  Sue and deduct the legal fees.

How about a legal fight with the City about some improvements you want to make?  These expenses you would add to your basis and depreciate over time.

How about the cost of writing up a special contract between a prospective tenant and you?  Heck yeah.  Fully deductible.

Most of these legal fees will continue to be deductible on your state return.  Check and see if your state complies with the TCJA of 2017.  Your state may comply with parts of the TCJA but not all.

Any fees paid for financial advisory services and support are deductible on your state return.  These fees are lumped in with the fees paid to manage your portfolio or subscriptions to finance based newsletters and the such. 

I lump these costs in with your tax prep cost.  Allocate part of your fee to Schedule C and E. Any fee allocated to your itemized deductions will be deductible on your state return.

How I’ve read the statute as it relates to this topic, I would add the fees to basis and not deduct in the current year.

VI. Deduction Limits and Other Weird Things to Consider

Most states will allow a deduction for legal fees as an itemized deduction.  The TCJA suspended legal fee deductions made on Schedule A until 2026.

Fees paid for discrimination suits, or as a government whistleblower are handled differently than other legal fees paid.  These fees are deducted above the line and give a much better deduction.

Just because a legal fee isn’t deductible on your federal return doesn’t mean you won’t benefit from the deduction on your state return.

Conclusion

Knowing the types of legal fees that are deductible can save you a lot of money.

Generally, the Tax Cuts and Jobs Act of 2017 suspended the deduction of many legal fees on your individual (1040) return as personal deductions.

If your lawsuit was about discrimination, or you acted as a whistleblower at the federal level, the deduction is an above the line deduction.  The above-the-line deduction refers to taking a deduction directly after your Adjusted Gross Income has been calculated.

State level whistleblowers may be able to deduct legal fees.  Most states comply with federal rules, but every state is different.

Above the Line deductions are dollar for dollar deductions which will reduce taxable income by the entire legal fee expense paid.

Legal fees paid for a rental property or business dispute will be 100% deductible.