A frequently asked question in our law office is whether a client can deduct certain legal expenses. The answer is more complicated than you might think. In most cases, the answer boils down to whether the expenses can be considered personal, or emanate from a trade or business.
If legal expenses are paid in a business and are ordinary and necessary, they are generally deductible by the business as “business expenses”. This is generally preferable to expenses deducted as “investment expenses” because investment expenses can only be deducted to the extent they exceed 2% of a taxpayer’s adjusted gross income. It should be noted that fees for tax advice are almost always considered investment expenses.
For other legal expenses, deductibility hinges on whether the expenses are personal or business in nature. In United States v. Gilmore, the Supreme Court ruled that expenses for attorneys in the course of a divorce were personal in nature, despite the fact that an adverse ruling in the divorce action would certainly destroy the taxpayer’s business. The origin of the claim was in divorce, not in the taxpayer’s business, therefore the expenses were not deductible.
The nexus between the trade or business and the expenses must be strong for the deduction to be upheld, as in Commissioner v. Tellier. In this case, the taxpayer was allowed to deduct expenses related to a defense to the charge that he violated the 1933 Securities Act. Because the taxpayer was in the business of buying and selling securities, the nexus between the expenses and the business was strong enough to sustain the deduction.
As mentioned above, the fact that a taxpayer’s business would be ruined by a criminal conviction or even barred from practicing his or her profession, the deduction will only be allowed where the expenses stem from the trade or business itself.
If you have any questions about a deduction for legal expenses (or any other business or tax question) please do not hesitate to contact the Hood Law Group at 816-561-5000 or send us a message through the form below.
*This post was originally published on December 13, 2014
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