Example 5: E incurred legal fees to try to recover damages from a carpet cleaning company that damaged carpets in her personal residence. The origin of the claim is the maintenance of E`s personal residence, so the expenses are not deductible. Several provisions of the Code are relevant to the tax treatment of attorneys` fees incurred by an individual. Section 162 authorizes ordinary and necessary expenses incurred in the course of a trade. Section 212 provides a similar rule, but for ordinary and necessary expenses incurred for the production or collection of income or for the management, maintenance or maintenance of assets held for the generation of income. In contrast, section 262 rejects deductions for personal, living or family expenses. 17 Chaplin, TC Memorandum 2007-58. The Court applied the common law rules to establish that the taxpayer was an employee and not an independent contractor. Thus, IAG`s legal fees were deductible and not AGI`s fees. The existence of less favourable categories of deductions has led taxpayers to claim that their legal fees fall into the favourable categories or to describe the costs in such a way as to directly reduce the associated income, making the deduction rules irrelevant. Due to taxpayers` efforts to obtain favourable tax treatment, complicated factual models, and the lack of clarity in the law, there have been numerous court decisions on the treatment of attorneys` fees incurred by individuals. This article explains the possible tax treatment of legal fees and how to determine the correct treatment.
Several court decisions are cited as examples and recent developments in this area are explained. An analysis of the performance of the current rules with regard to certain tax principles is also included. Possible favorable treatments for the attorney`s fee deduction include either offline deductions or adjustments to the base or sale price in a real estate transaction. However, attorneys` fees incurred by individuals may also fall into less favorable categories: personal expenses, non-deductible expenses, or various individual deductions limited by the 2% adjusted gross income limit (AGI) for regular and unauthorized taxes for other minimum tax (LMO) purposes. As intellectual property becomes increasingly important and valuable to businesses of all types and sizes, business owners need to pay attention to how and when legal fees (and other expenses) incurred to create or defend intellectual property rights are treated for federal income tax purposes – currently deductible as ordinary business expenses or capitalized on the The life of the asset. If a company incurs attorneys` fees in a patent infringement lawsuit, attorneys` fees should only be capitalized if the company successfully defends (i.e. wins) its patent. If the company defends itself unsuccessfully, it assumes the legal costs of the accumulated period. Example 3: T`s rental property has been condemned by the State.
T incurred legal costs to challenge the value set by the State and to obtain interest on the proceeds of the delay. T eventually received a higher payment for the property plus interest income. T must capitalize all legal costs. None of the costs can offset interest income; The origin of the trial was the conviction, and T`s lawyer devoted his time to it. There would have been no interest income if there had been no conviction.9 Example 4: R&P incurred legal fees to dispute the amount their insurance company offered them when their personal residence was destroyed by fire. They managed to get the highest damages (for replacement value) they claimed and profited from the destruction. R&P cannot deduct lawyer`s fees under section 212 for the purpose of generating income. The argument that replacement value insurance was a separate financial arrangement from homeownership will fail because home and home insurance are linked (without the house, there would be no insurance). The origin of the claim is the house. Costs related to the acquisition or disposal of an asset should be capitalized. The legal fees incurred to increase the insurance premium are §263 investments and result in a lower gain on the sale.10 Offit Kurman, one of the fastest-growing full-service law firms in the United States, serves dynamic businesses, individuals, and families. With 18 offices and more than 250 lawyers advising clients in more than 30 practice areas, Offit Kurman helps maximize and protect business value and personal wealth by providing innovative and entrepreneurial advice focused on clients` business goals, interests and objectives.
The firm is distinguished by the quality, breadth and global reach of its legal services as well as a unique operational structure that fosters a culture of collaboration. For more information, see www.offitkurman.com. Is there justice with respect to the deduction of legal fees? It depends on your point of view. Some legal fees are currently deductible, others need to be capitalized, and still others offer no tax benefit. Let`s take a closer look at the tax treatment of different types of legal fees. The deductibility of legal fees depends on the nature of the underlying claim for which the legal fees were incurred, so businesses must consider the content of the claim or transaction that gave rise to the attorney`s fees to determine whether the expenses are ordinary (and therefore currently deductible) business expenses or capital expenses. achievable over the useful life of the asset. The benchmark for classifying expenses as business or personal (as well as deductible from capitalizable expenses3) is the Supreme Court`s decision in Gilmore.4 This case examined the tax treatment of attorneys` fees to defend a divorce action and to protect the husband`s business assets from the wife`s claims. The husband argued that the expenses were deductible because they were incurred to obtain property (shares) held to generate income, something the lower court accepted. Example 1: B incurs legal fees to defend a title challenge to his rental property.
The origin of the debt that gives B legal fees is the protection of his investment property. Therefore, B must capitalize the costs under section 263.7 Section 62(e) lists 18 types of complaints of “unlawful discrimination”. These include certain violations of the Civil Rights Act of 1991, the National Labor Relations Act, the Fair Labor Standards Act of 1938, the Family and Medical Leave Act of 1993, and several others. Section 62(a)(20) applies to attorneys` fees paid after October 22, 2004 for judgments or settlements rendered after that date. The taxpayers claimed that they are not employees because they were no longer employees during the period in which the legal fees were incurred, even though the fees were related to previous employment. Taxpayers also argued that an employer`s payments were part of a recoverable plan, allowing IAG`s attorneys` fees to be deducted under section 62(a)(2)(A). This is the issue currently being challenged by the Tax Court in the Third Judicial District. In Myland, Inc. v.
Commissioner of Internal Revenue (Case No. 22-1193, 1194&1195), the IRS appealed the Tax Court`s decision that Mylan (the taxpayer) was entitled to deduct as ordinary business expenses under IRC Section 162(a) approximately $50 million in legal fees incurred to defend against patent infringement claims related to its generic drug manufacturing. The service argued that Mylan`s $50 million legal fee should be capitalized under paragraph 263(a) of the IRC because, in its view, the expenses were related to the acquisition of capital property. Example 10: H, a pilot, was arrested and charged with assault and assault while not working. H incurred legal fees to defend himself. He loses his pilot`s licence and therefore his job as a commercial pilot if he is found guilty of the charges. H cannot consider the lawyer`s fees to be related to his employment relationship, since origin is a personal matter that does not arise from his employment. The possible consequences of H`s job loss are not relevant to the categorization of legal fees.15 Some taxpayers have described the treatment of legal fees, which are classified as various individual deductions, as unfair and unfair.
The courts have disliked these arguments, holding that any appeal falls within the jurisdiction of Congress and not the jurisdiction of the courts. The courts have also found that the law is fair in these situations because it treats all taxpayers in a similar situation equally. In Alexander,30 the Court found that, despite the LMO, taxpayers were not denied the off-balance-sheet deduction for lawyers` fees. He also noted that the objective of the LMO is to ensure that taxpayers with significant economic income pay a certain amount of tax, although they use their combination of deductions, exclusions and credits. The Court also noted that just arguments cannot override the plain meaning of the law. The origin of the claim test is the approach that individuals must use to determine the nature of their legal fees and, therefore, decide how they will be treated for tax purposes. It is important to investigate the facts of the lawsuit and ask why the person hired a lawyer. Answering these questions should then allow practitioners to determine whether the fees are personal expenses that are non-deductible, business- or income-related, or capitalizable expenses related to a property interest.
The possible consequences of not seeking legal assistance are not relevant to the classification of fees. Many judgments are useful in applying the criterion of the origin of the claim. The origin of rights test meets certain fundamental principles of good tax policy. As the Court stated in Gilmore, “if the relative impact of a claim on a taxpayer`s income-generating resources were to determine deductibility, the rule would contain significant uncertainty and unfairness.” 29 The classification of lawyers` fees on the basis of the origin of a claim, rather than on the basis of the assets which must be protected, tends to lead to taxpayers being treated in a similar manner and to increase the objectivity of the law.