Small businesses pay legal fees to attorneys and other legal professionals for services during the normal course of a client’s business. Your business can deduct all types of legal fees that are needed for normal business activities, as long as they are deemed as both “ordinary and necessary.”
In this article, you’ll learn which specific legal fees are deductible, and how and when to deduct these fees on a business tax return.
- Small businesses can deduct all types of legal fees as long as they are deemed “ordinary and necessary” to the business.
- The category for these costs on a business tax return is “Legal and Professional Fees.”
- Legal fees for attorney work on a business startup must be deducted over 15 years, through a process called amortization.
- Legal fees for personal matters are not deductible as a business expense.
When Are Legal Fees Tax-Deductible?
To be deductible on your business tax return, legal fees must be charged by an attorney and be “ordinary and necessary” expenses directly related to operating your business. Ordinary expenses are those that are common and accepted on businesses of your type (common for retail businesses, for example). Necessary expenses don’t have to be indispensable, but they should be helpful and appropriate.
Typical deductible legal services include:
- Tax-related business, such as advice, preparation of tax forms, and tax audits
- Corporate attorneys for litigation and business transactions
- Property issues, such as buying or selling a business building
- Employment issues relating to lawsuits and policies
- Intellectual property issues (help with getting a copyright, trademark, or patent)
- Security and finance lawyers for corporations that have shares of stock
- Entertainment issues, such as royalties and entertainment contracts
Non-Deductible Legal Fees
Some legal and professional fees are not deductible. You may not deduct legal fees related to doing or keeping your job, such as defending yourself against criminal charges from your business.
In addition, you can’t deduct payments to an attorney related to sexual harassment lawsuits or settlements or for payments related to sexual harassment or sexual abuse if there is a nondisclosure agreement.
Personal Legal Fees
Legal fees for personal expenses aren’t deductible. If an attorney’s bill contains both business and personal expenses, you must separate the two types of expenses. Then you can deduct the business part.
You may be able to deduct some personal legal expenses on Schedule A of your personal tax return as a miscellaneous deduction. This personal deduction might be limited; recent tax law provisions changed the ability to deduct miscellaneous expenses on personal tax returns, including personal fees for legal services.
Legal Fees for Starting a Business
You must deduct legal fees for starting a business in a different way from legal fees for an ongoing business. These legal fees may be for an attorney who helps with startup costs or organizational costs.
Examples of attorney fees for startup:
- Costs for creating contracts with key employees
- Participation in negotiations for purchase of a business
Examples of attorney fees for organizational work:
- Preparing a partnership agreement, corporate bylaws, or operating agreement (for an LLC)
- Preparing state-required applications for business formation
These fees are considered part of your business value and they must be deducted over a 15-year period through a process called amortization. Each year, the business can deduct one-fifteenth of the cost on its business tax return.
You may be able to deduct up to $5,000 of startup and $5,000 of organizational costs, including legal fees, in the first year you are in business.
How To Deduct Legal Fees
You can deduct all legal fees paid by your business on your business tax return using the category “Legal and Professional Fees.” This section can be found on your business tax form.
To deduct legal fees, along with other tax deductions for the business, you’ll need to complete the business tax return form and determine the business’s taxable income. You then report your share of the taxable income from the business on your Form 1040.
Deductions for legal fees, like other business tax deductions, are complicated and contain limitations and restrictions. In most cases, you may want to get help from a licensed tax professional or use business tax preparation software to make sure your deduction is correct. The software version for partnerships, LLCs, corporations, and S corporations may be separate from the version for Form 1040.
Documenting Legal Fee Deductions for Taxes
Keeping excellent records is important when deducting legal expenses and other expenses, and it is important that all these documents show the payments were for business purposes. Keep all records for these deductions, including both bills from law firms and payments to them.
You may also want to include supporting documentation, including:
- Canceled checks or proof of electronic payment
- Account statements or invoices from attorneys
- Credit card receipts and statements
You’ll want to keep all these documents and your tax returns after your yearly tax return is filed in case you are audited. In most cases, you should save everything for up to three years from the date you filed the return or two years after you paid the tax, whichever is later.
Other Tax-Deductible Costs and Fees
Tax Preparation Costs
No matter who prepares your business tax return—a tax attorney, accountant, enrolled agent, or tax preparation service—you can deduct your costs for this service. In any case, the preparer must be approved by the IRS by getting a preparer tax ID number (PTIN).
Licenses, Permits, and Regulatory Fees
Businesses may deduct the cost of fees to a variety of state, local, and federal agencies for licenses, filing documents, and other regulatory fees, as long as they are required for business operations. For example, a business might have to pay for a state liquor license to sell alcohol to customers.
Filing fees generally include annual report fees, annual licenses, and fees for making changes in business documents. You can also deduct fees to federal agencies for applications for patents, trademarks, and copyrights because they are being used to generate income for a business.
Frequently Asked Questions (FAQs)
What are legal and professional fees?
The title “Legal and Professional Fees” is used in federal business tax forms to include fees for accountants and attorneys for expenses necessary for business operations. To be deductible, these fees must be both usual for your business type and necessary to stay in business.
Who pays legal fees in civil cases?
Civil lawsuits have several types of costs: court costs, for use of the court, including filing fees, fees for a summons or subpoena; fees for transcriptions; and general legal fees for attorneys on each side of a case. It’s usual that the party that “wins” the suit recovers (gets back) their court costs from the “losing” party. Each party typically pays their own attorney fees, unless payment by the losing party is specified in a contract or by state law.
Why are legal fees so high?
Attorney fees may seem high, but they include factors that clients may not be aware of. An attorney bills a client for all their time spent on a legal matter, including research, investigation, and case preparation. The billing rate depends on the complexity of the case and the level of expertise of the person doing the work. Attorneys must also include overhead (the cost of maintaining an office) into their costs. To keep your attorney fees as low as possible, consider the following strategies:
- Spend time talking with the attorney before you hire them.
- Make sure you know what’s included in any fees you are being charged and more importantly, what’s not included.
- Read the agreement carefully and ask questions.