Free Advice the IRS Loves: Writing Off Legal & Accounting Fees
Is it business or is it personal? That is the question when it comes to whether professional fees are deductible.
So let’s start with the obvious. The IRS has a special place in its heart for “tax preparation fees” because they lead to revenue, and the IRS encourages you to get your taxes right every chance it gets. Most of your tax preparation fees are fully deductible. That question you asked your Tax Attorney about that tricky business expense – deductible! Those Quickbooks adjustments your accountant did for you – deductible! And, that audit, or dispute over taxes owed for your business that you paid Fazzio Law Offices to defend for you – deductible! Legal fees related to determining your business taxes are fully deductible on your Sch. C while expenses related to your personal taxes can only be deducted on Sch. A, if you itemize, which won’t give you the same bang for your buck. More on how the TCJA effects this perennial favorite below.
There are even those rare cases where the IRS has to pay your legal fees. Yes, you got that right. Under Sec. 7430 of the Internal Revenue Code (“IRC”), if you have to take the IRS to court over a dispute on your taxes, and you win, you may be entitled to “reasonable litigation costs.” We are not talking about a deduction folks – we are talking about a check. What should you do with this information? Just tuck it away and remember that not only can you deduct professional fees for getting tax advice or for professional fees necessary for the production of income, but you also can be reimbursed for the costs you have to incur if the IRS takes a truly unreasonable position and forces you to fight it out.
It’s complicated. It’s justified. And it’s smart.
Tax preparation is the bread and butter of the IRS collection function. And the IRS will give you a deduction for the full cost of tax preparation. However, under the TCJA these are no longer available as miscellaneous itemized deductions for the average taxpayer! A tax lawyer or accountant can help you to take these deductions on Schedule C and preserve these tax savings. In fact, the TCJA incentivizes shifting many employees with significant income to sole proprietors with their own pass-through entities. The 20% individual income tax deduction for income from pass-through entities – a small business incentive – incentivizes middle income non-professionals to shift their tax structure because they can lower their tax rate by becoming a sole proprietor from what it would be as an employee.
Estate planning, sales tax planning, and corporate tax planning are all fully deductible. Just as we will get into why legal fees for “personal” matters are not deductible, the reason that tax preparation and planning advice connected to business activities is deductible is – its complicated. Having professional advisers assist you with these thorny issues both increases the likelihood that your business will confidently undertake profit-seeking activities and simultaneously guarantees that you will properly account for the government’s share of the profits. Because its complicated, getting a tax deduction for the cost of the advice to get it right is justified. And since these costs can be offset against business profits, it’s smart to spend money on legal and accounting fees related to moving your business forward.
When it comes down to it, you can deduct COGS, labor, and marketing costs you incur to make you money. Why wouldn’t you be able to deduct the professional fees incurred to get sound advice? It just makes sense that you should.
Don’t Take it Personally
Where does the business vs. personal rule come from? Under Section 212 you can take a deduction for business expenses that fall into any one of three (3) buckets:
- For earning income;
- For managing income-producing assets; or
- For expenses related to determining your taxes.
What Section 212 gives, Section 262 takes away. There is no deduction for “personal, living or family expenses.”
Tax wonks refer to this business vs. personal dichotomy as the “origin-of-the-claim-rule.” This rule comes from the Supreme Court case of U.S. v. Gilmore, 372 U.S. 39, 44 (1963). In Gilmore, a husband in the midst of a divorce could not deduct legal fees incurred to protect income-producing business assets from claims by his wife because the nature of the legal claims at issue was primarily personal – originating from a desire to divorce and equitably divide marital assets – not from a profit-seeking motive. The Court adopted the “origin-of-the-claim-rule” and found that the motivations of the divorce proceedings at issue was primarily personal and not primarily business-related.
The Gilmore rule is flexible and looks at the facts and circumstances and what particular professional fees are primarily for. For instance, a divorcing wife can deduct legal fees for claiming taxable alimony.
Here’s a Quick Summary
- Representation Before the IRS Legal Fees: Legal and accounting fees for defending yourself against the IRS are tax deductible and specifically accounted for under I.R.M. 18.104.22.168. The fees must be reasonable and necessary.
- Tax Advice Top 10 - Legal Fees: Legal and accounting advice is fully deductible. Business tax, income tax, estate tax, sales & use tax. All Tax Deductible. All of the following are tax deductible: (1) legal/accounting fees for analyzing how to set up a business entity in a tax efficient manner; (2) legal/accounting fees for determining how to make an investment in a tax efficient manner; (3) legal/accounting fees for determining how to deal with a tax bill; (4) legal/accounting fees for business succession or estate planning; (5) legal/accounting fees for setting up your online business in a tax efficient manner to minimize sales tax online; (6) legal/accounting fees for litigating a tax assessment; (7) legal/accounting fees for best tax option for a business acquisition or merger; (8) legal/accounting fees for the best tax option for selling a business or shares; (9) legal/accounting fees for tax efficient partnership divorce; or (10) legal/accounting fees for negotiating an employment contract or independent contractor arrangement.
- Taxable Alimony Legal Fees: The portion of legal fees and court costs attributable to securing alimony are deductible by the recipient spouse who is fighting in court for the highest possible alimony figure. This is just one more incentive for a dueling spouse to stick to their guns and dig in their heels and hold out for a fair settlement on this issue.
- Damages for Personal Injury or Chronic Illness & Associated Legal Fees: The portion of legal fees, accounting fees and expert expenses are deductible if they are related to making you whole and compensating you for out-of-pocket costs for medical treatments, pain and suffering, emotional distress, loss of enjoyment or loss of consortium, or quality of life damages. Lost wages, lost earning capacity, and other economic losses related to your injury are not tax deductible because these items would have been subject to income tax had you received them in the ordinary course. The legal, accounting, and expert fees associated with them are likewise not deductible.
- Prosecuting a Business Insurance Claim Legal Fees: If you suffer a current business loss and have to pursue a claim against your insurance connected to the activities you engage in to produce income, you can deduct these legal and accounting fees.
- Collecting Delinquent Payables Legal Fees: Accounting, legal and recovery costs associated with collecting delinquent accounts receivable are deductible.
- Business Bankruptcy Legal Fees: Legal and accounting fees associated with bankruptcy and creditor protection to keep your business safe from aggressive creditor action are tax deductible.
If you have questions about deducting legal and professional fees or expenses for the production of income or your treatment under the new Tax Cut & Jobs Act, give us a call at (201) 529-8024 or e-mail me at [email protected]
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