Attorney Fees



The general rule for being entitled to deduct attorney fees is pretty straight-forward.  You can deduct attorney's fees you pay for:
  • Trying to produce or collect taxable income, or
  • To help in determining, collecting or getting a refund of any tax

In simple terms, you can take a deduction if you need an attorney's help to make money you have to pay taxes on, or if an attorney helped you with a tax matter, such as representing you in an IRS or State tax audit. If the legal fees are connected to taxes or taxable income, you can take a deduction.

Attorney fees that pertain to property division (such as in a divorce) are not deductible.

Whether or not certain legal fees paid are deductible can become a complicated issue.  The IRS's position is that you can usually deduct legal fees that you incur in attempting to produce, protect or collect taxable income.  However, if the income you are trying to collect is tax exempt, then none of the legal fees are deductible.  If the income is partially taxable, then a portion of the attorney fees may be deductible.

Any fees that are not deductible can perhaps be used to increase your basis in the subject property or investment, and either reduce your capital gain, or increase your capital loss upon disposition of the asset or investment.

Here are some examples of attorney fees that generally will be deductible
  • Tax advice you may get during a divorce case, such as how you and your ex-spouse will take deductions for home mortgage interest or child care, or whether alimony is tax deductible by the payor spouse or taxable income to the recipient spouse 

  • Trying to get your ex-spouse to pay past-due alimonyDefending a lawsuit filed against you on work-related matter, such as an unlawful discrimination claim filed by a former employee that you fired

  • Receiving your share of a class action settlement in a lawsuit against your employer or former employer. For example, your former employer settles a class action claiming that it didn't pay overtime wages. You get a $1,500 check for your share of the settlement, but $2,000 is reported to the IRS as income because you're charged $500 as your share of attorney's fees. Because the income is work-related, you can take a tax deduction for the $500 in fees

Generally, you cannot deduct fees paid for advice or help on personal matters or for things that don't produce taxable income. For example, you can't deduct fees for:

  • Filing and winning a personal injury lawsuit or wrongful death action - the money you win isn't included in your gross income and so it's not taxable

  • Settling a will or probate matter between your family members

  • Help in closing the purchase of your home (however, the fees may be part of the basis/cost of the home in determining future gain on sale)

  • Defending you in a civil lawsuit or criminal case that's not work-related, such as defending you on a drunk driving charge or against a neighbor's claim that your dog bit and injured her child

Contingent Attorney Fees

One area to be careful about is the proper handling of contingent attorney fees.  In a successful lawsuit that seeks compensation or damages that are taxable with a contingent fee agreement with the attorney, the arrangement may be that the attorney gets his or her portion of the award paid to him or her directly, with the balance to the plaintiff.  The plaintiff may be under the impression that he or she needs to only report that part of the award received, and that the portion that the attorney receives does not have to be reported.

Most of the circuits have ruled that the full amount of the award (we'll assume it is all taxable for this example) must be reported in income, and the part of the award that was paid directly to the attorney is a miscellaneous deduction, subject to the 2% AGI limitation.  In very large award situation, the deduction for the attorney's fee may be totally lost (because of the 2% AGI limitation).   It is very important that if you receive a judgment or award and incurred attorney fees - whether or not it was a contingent arrangement - you need to seek professional advice on its treatment for tax purposes.

Here is a site to a case in the 2nd Circuit that addresses this very issue:

RAYMOND v. U.S., Cite as 93 AFTR 2d 2004-416, 01/13/2004 , Code Sec(s) 61

 The Second Circuit, reversing a Vermont district court, held that an individual who settled a wrongful termination suit cannot exclude from income the portion of the settlement paid directly to his attorneys under a contingent fee arrangement. Instead, these amounts had to be included in income and deducted as miscellaneous itemized deductions subject to the 2%-of-adjusted-gross income floor.

FTB Initiates Audits on Contingent Attorney Fees

Here is an article from the FTB news that appeared in August 2006:

In the Attorney Fees Study, auditors are investigating noncompliance associated with attorney contingency fees resulting from lawsuits. Damage awards or settlements are often taxable, and cannot be excluded from the taxpayer's gross income. When taxable, attorney fees associated with the settlement must be taken as a miscellaneous deduction, subject to a two percent limitation.

When damage awards are excludible from gross income, the attorney fees associated with the settlement cannot be deducted.

Using creative sources like legal periodicals and newspapers, FTB auditors contact taxpayers to determine whether they correctly followed the law.

The study's early results show a high ratio of non-compliance. Based on these results, we expect to conduct more of this type of audit.


In 2011, the Tax Court issued a Memorandum Decision addressing the issue of legal fees paid by a principal of a corporation pertaining to corporate business operations who deducted the fees on his personal income tax return.  The Court cites several positions supporting their denial of the deduction:

Code Section 162—Business deductions—legal fees—business vs. personal expenses—ordinary and necessary expenses—proof.

Attorney/business owner-operator wasn't entitled to Code Sec. 162 deduction for legal expenses allegedly relating to his business operations: taxpayer didn't show to what business operations legal fees/lawsuits related, why he was making payments for same out of account that he used for personal expenses vs. out of corp. accounts, or why corps. themselves weren't claiming deductions. He also failed to show business relation of multiple other claimed expenses, including expenses for law license for year during which he didn't practice law, payment to express shipping service for shipments to ex-wife, and bank overdraft charges, so deductions for those items were also denied. (Martin G. Plotkin v. Commissioner, (2011) TC Memo 2011-260)

Updated 11/14/2011