It is common knowledge that most of us don’t like paying legal fees. It is because of this that the tax rules come in handy, you can substantially reduce your legal expenses. Read along to find out how…
I. Legal Fees for Tax Advice are Deductible.
All taxes including, income, estate, gift, property, sales, use and excise tax, even if they are personal, are deductible.
II. Legal charges in Employment Cases are Fully Deductible.
Wages, in most employment lawsuit recoveries, are contained on a (form W-2) while non-wage incomes are usually on a (Form 1099). You still must include 100% in your income, even if your lawyer receives 40% of it. Before reaching adjusted gross income, the legal fees above-the-line can still be deducted. You then end up with no tax on the legal fees; no regular tax and no AMT.
III. Business Legal costs are Deductible.
In case you sustain legal fees in a trade or business, then the fees are deductible by corporations, LLCs, partnerships, and proprietorships. However, you are required to capitalize and add some fees to the basis of assets. In case you are trying to sell your business and spend $50,000 in legal fees, it is a necessity that you add it to your basis in your company.
IV. Personal Legal bills are Non-Deductible.
Legal expenses of personal nature like expenses incurred in a divorce case or if a family sues you for slander, are usually not the least deductible. However, if your business or investment is impacted by personal legal matters, then some deductions are possible.
V. Watch out for Lawyer’s Contingent Fees.
According to the U.S. Supreme Court, you are considered as having income once it is established that indeed you can afford to pay your lawyer’s contingent charges. This means that you need to consider how to deduct the costs. In case you win a lawsuit amounting to $1 million, out of which you owe your lawyer 40% in contingent payment, then you might assume you have $600,000 of income.
In cases that involve purely personal physical injuries like a motor vehicle accident, the entire recovery is tax-free. In this case, recovery considerations including your lawyer’s charges or the net do not matter. However, the difference between what is and is not tax-free is not very clear.
VI. Payment Made to a Lawyer in an Investment Are Miscellaneous Itemized Deductions.
Legal expenses that don’t relate to your business but only to investments can be deducted but usually, only as a miscellaneous itemized deduction. That means a 2% threshold, phase-outs and not so good Alternative Minimum Tax ( AMT ). Just as the business legal fees, some investment legal fees must be capitalized to the basis of the assets (such as legal fees for the purchase of investment property).
With tax deductions, the pain of high legal bills can be lessened. Sophisticated tax analysis can make you incur legal fees falling into more than one category. There are often several ways of allocating fees, so you need to plan well to reap the benefits.