Are Legal Fees Tax Deductible?

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It's no secret legal representation in an auto accident case can be expensive, and many people look for ways to minimize the hit to their bank accounts. One common question that comes up is whether legal fees paid to litigate a lawsuit are tax deductible. The good news is that you may be able to write off some of your expenses, but only in specific situations. Here's more information about this issue to help you save as much money as possible.

Only Business-Related Legal Fees Are Deductible

If your accident case is a personal one, you will not be able to deduct any of the legal fees you incur. However, if the case involves your business, you can write off some of the expenses generated by the lawsuit. For example, your employee collides with another vehicle while making deliveries in the company van. The costs of litigating the case could be written off your company's taxes.

This is because expenses associated with starting and managing a business are typically deductible. As long as the legal expense has to do with your company—and not you personally—you'll be allowed to write the amount off your business taxes. It may seem fairly straightforward, but things can get confusing very quickly depending on the circumstances of the accident and how your business is structured.

For instance, you have a home-based real estate business where you use your car for company and personal reasons. If you get into an accident while ferrying a client to an open house, you could write off the legal expenses you paid to pursue or defend against a lawsuit. On the other hand, if you were doing something of a personal nature (i.e. going to get lunch), the incident would not be considered business related. Thus, the legal expenses would not be tax deductible.

Be aware that attorney's fees would be listed under the miscellaneous section of your itemized deductions. Because of this, the total amount of all your miscellaneous deductions must exceed 2 percent of your adjusted gross income before you can write it off. So if your adjusted gross income is $50,000, for example, the deductions must be over $1,000 to qualify.

Only Non-Contingency Fees are Deductible

The second issue is only non-contingency fees can be written off your taxes. Most attorneys who take auto accident cases charge their fees on a contingency basis, meaning they only get paid when clients win their lawsuits. Fees charged this way are not eligible for the tax deduction. In fact, you will likely have to pay taxes on those fees.

This is because the IRS views your court award or settlement as income, and the entire amount must be reported on your taxes, including the contingency fee paid to the attorney. In the case Commission vs. Banks, the judges determined that contingency fees functioned more like the attorney's share of an income producing property rather than a payment the client makes from his or her normal source of income.

The reasoning behind this is the attorney would only get paid after the case resolved and there was a risk of the attorney not getting any money at all. Thus the time and effort the attorney spends on the case and viewed more as an investment rather than a service arrangement suggested by hourly fees.

Unfortunately for clients, this means they must pay taxes on all the non-exempt portions of the award. Luckily, a good portion of court awards (e.g. money for medical bills) are non-taxable, so this issues tends to cancel out the fact that you can't write off your legal fees.

For more information about this issue or help with an auto accident case, contact a lawyer from a place like Speers Reuland & Cibulskis, P.C.

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1 September 2017