Attorney’s Fees: When They Are or Are Not Deductible

Attorney’s fees you pay to help you right a wrong can be very costly. Whether the fees are charged hourly or a flat amount, you may or may not be able to deduct them. Here’s a roundup of the situations you may encounter and what to do about legal fees for personal matters. Be sure to note the changes in some rules for 2017 versus 2018 as a result of the Tax Cuts and Jobs Act of 2017.

Personal injuries

Typically you pay a contingency fee where the attorney recovers a percentage of any settlement or award. If the award is for physical personal injuries or sickness, then attorney’s fees are not deductible because they relate to a tax-free recovery. However, the fees related to taxable damages, such as punitive damages or any amounts related to nonphysical personal injuries (e.g., defamation) can be deductible for years before 2018.

For 2017, the deduction is a miscellaneous itemized deduction subject to the 2%-of-AGI floor; only the amount exceeding the 2% floor is deductible as an itemized deduction. However, if you are subject to alternative minimum tax (AMT), you will lose the benefit of the deduction because miscellaneous deductions are not allowed at all for AMT purposes. Starting in 2018, miscellaneous itemized deductions subject to the 2%-of-AGI floor are eliminated, so no deduction for these attorney’s fees can be claimed.

Discrimination actions. There’s special tax treatment for attorney’s fees if you bring a discrimination case. Instead of deducting the fees as a miscellaneous itemized deduction subject to the 2%-of-AGI floor, they may be deducted from gross income; no itemizing is required. They continue to be deductible after 2017.

Home purchases and sales

Attorney’s fees for buying or selling a home are not deductible.

• Fees for buying a home become part of the cost basis of the residence.
• Fees for selling a home are treated as selling expenses, which reduce the amount of gain.

Divorce

Generally, fees in the course of a marital dissolution are not deductible.  However, fees that relate to obtaining taxable alimony may be deductible on 2017 returns as a miscellaneous itemized deduction subject to the 2%-of-AGI floor. Fees to protect one’s business or other assets during a property settlement are not deductible, even though they relate to business or the production of income.

Estate planning

Generally, fees to prepare a will or handle other estate-planning matters are not deductible. However, if an attorney can specify the portion of the fees that relate to estate tax planning, then that portion may be deductible as a miscellaneous itemized deduction (subject to the 2%-of-AGI floor) on 2017 returns.

Tax matters

If you use an attorney to prepare your return or represent you in an audit or litigation, the fees are tax deductible. However, they are miscellaneous itemized deductions subject to the 2%-of-AGI floor so they are not deductible after 2017.

Conclusion

Attorney’s fees may be necessary for certain matters. To the extent you can claim a current tax deduction, the pain of the cost of attorney’s fees can be eased somewhat. However, new law changes impact deductibility of certain personal legal fees. Attorney’s fees that have been deductible (for 2017 and earlier years) as a miscellaneous itemized deduction subject to the 2%-of-AGI floor will no longer be deductible at all starting in 2018.