Where to Deduct Legal Expenses For Damages
Discover where to properly deduct eligible legal expenses for damages on your federal taxes. IRS rules can change from year to year, so doing your research is crucial. The following information will help:
Related to Individuals
Depends upon when the expenses are incurred:
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2018 through 2025 Tier 2 Treatment: As part of the TCJA, Tier 2 miscellaneous deductions are suspended for years 2018 through 2025. Therefore, any expenses incurred in obtaining a personal taxable award or settlement, including legal fees, will not be deductible for years 2018 through 2025 and the taxpayer will be liable for the tax on the entire taxable amount., On the bright side, the miscellaneous deduction often triggered the AMT – no longer the case now.,
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Pre-2018 Tier 2 Treatment: Generally, for years prior to 2018, legal expenses related to non-business awards or settlements are deducted on Schedule A as Tier 2 miscellaneous itemized deductions., The entire amount of the legal fees included in a taxable damages award or settlement must be included in the taxpayer’s income, even if the taxpayer receives the award net of the attorney fees. This issue has been hashed out in court numerous times, all with the same unfavorable result for the taxpayer. The following are some citations:
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When an attorney is paid under a contingent fee arrangement, the client must include in gross income the amount paid to the attorney as a contingent fee. (Campbell v. Commissioner, affirmed CA-11, 2011-2)
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Under the assignment-of-income doctrine, a taxpayer may not avoid taxation by assigning income to another party. The amount paid to the attorney is includible in gross income regardless of whether the attorney-client contract or state law gives the attorney any special rights, such as a lien. (Commissioner v. Banks, 2005-1 USTC)
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Related to Business
If related to the taxpayer’s: (1) self-employed business, deduct expenses on Schedule C, or Schedule F if a farm sole proprietorship; (2) real estate rental, deduct on Schedule E.
Related to Capital Items
If the expenses must be added to basis, sale of the related property would be reported on Form 8949 (Schedule D) or Form 4797.
Above-The-Line Deduction for Some Discrimination Awards
An above-the-line deduction is allowed for attorneys' fees and costs paid by, or on behalf of, a taxpayer in connection with a claim of unlawful discrimination, certain claims against the federal government, or a private cause of action under the Medicare Secondary Payer statute. This provision applies to judgments or settlements occurring after October 22, 2004, and is unchanged by the TCJA. (Code Sec 62(a)(20))