Corporations paid over $230 billion in tax in 2019. That figure doesn’t include taxes paid by sole proprietorships and other small businesses.
Savvy business owners are always looking for ways to reduce their tax bill. The good news is that there are plenty of tax deductions you can take advantage of.
If you’ve had to engage legal services for your business, you might be asking, “Are legal expenses tax deductible?”
Keep this guide handy as you prepare for tax season. It includes general guidance, as well as a review of specific tax deductible legal expenses.
Tax Deductible Legal Expenses Explained
So, can your business deduct legal expenses from its taxes? The general wisdom is that business legal fees are tax deductible. So long as the fee is both “ordinary and necessary” in the course of business, you can deduct it.
By contrast, personal legal fees are not tax deductible.
The exception is legal fees incurred by an individual in the course of trade. This is where the lines can become a little blurry. If you’re self-employed and run your own consulting firm, is tax advice from a lawyer a business or personal expense?
Another example might be legal fees associated with income properties. Generally speaking, you can deduct these fees. In some cases, though, the fees may not be considered deductible.
Your best bet in these matters is to try to keep business and personal separate as much as possible.
One notable exception to the rule about personal fees is the fees associated with adoption of a child. These fees are deductible, even though they’re not related to a workplace. They should be deducted on your personal return, not a business return.
Common Tax-Deductible Legal Fees for Businesses
The IRS allows businesses to deduct legal fees that are ordinary and necessary expenses for running the business. These include:
- Attorney fees, court costs, and similar expenses related to the production or collection of taxable income
- Fees for defending against criminal charges related to trade or business (legal fees for criminal charges against an individual, such as the business owner, are not tax-deductible)
- Drafting contracts and reviewing contracts
- Real estate closings for commercial properties or businesses that buy and sell residential properties (including rental properties)
- Business incorporation and business planning expenses
- Business immigration expenses (if you are moving an employee to the US from abroad)
- Legal fees to file for bankruptcy (of the business, not personal bankruptcy)
- Attorney fees paid for filing lawsuits and defending the business in any lawsuits
- Business tax fees
- Fees related to whistleblower claims
- Fees related to unlawful discrimination claims
- Fees related to farm income and expenses
Can You Deduct Tax Preparation Fees?
Yes, you can write off tax preparation fees for your business. Keep in mind that you’ll need to keep your business return and your personal return separate.
The fees associated with your personal return do not count as a business expense. You therefore can’t claim them on your tax return as a deduction for the business.
This deduction covers the fees charged by a tax professional to prepare your return. It also covers buying tax software or tax-related books. It also includes any fees associated with tax-planning advice.
If you need to conduct an audit or are undergoing investigation, you can deduct the legal fees associated with representation.
Can You Deduct Business Start-up Expenses?
Some of the costs of starting a business are legal in nature. Common business start-up fees include the following:
- Attorney fees for registering your business as a legal entity in your state
- Fees for having an attorney set up corporate bylaws
- Costs of setting up corporate records
- Attorney fees for writing a partnership agreement or LLC operating agreement
Startup costs are deducted in one of two ways. The costs for creating or buying a business can be deducted, up to $5,000 in the business’s first year.
Remaining startup costs must be amortized over time. This includes the costs associated with creating legal documents or paying state incorporation fees.
If you have an LLC, you can write off some of the costs of investigating the creation of the business. You can also deduct the costs of travel or marketing if the business incurs them before it starts formal operation.
Can You Deduct Licensing Fees?
If your licensing fees and expenses qualify as a business expense, they can be written off. An example is a lawyer that must pay an annual licensing fee to continue practicing in a state.
Personal licensing fees can’t be written off.
Sole proprietorships and single-owner LLCs report licensing fees under “Expenses” on Schedule C of their tax return.
Partnerships and multi-member LLCs include them in the “Deductions” Section of Form 1065. Corporations use Form 1120.
How Much Can You Deduct?
After getting the answer to the question “are business legal expenses tax deductible?”, most people want to know how much they can deduct from their business taxes.
The answer depends a bit on the type of expense you’re writing off. Some expenses are written off as business expenses. Others have to be categorized as “miscellaneous itemized deductions.”
Miscellaneous itemized deductions are subject to the 2% rule. This rule says you can write off a portion of an expense so long as it exceeds 2% of your adjusted gross income, or AGI.
Revisions to tax rules, beginning in 2019, made changes to standard deductions, as well as which items can be considered miscellaneous deductions. Tax preparation fees, for example, are no longer categorized this way.
To summarize, some fees can be deducted in whole. Some fees, such as startup costs, have a cap on how much you can deduction. For other fees, you’ll only be able to claim part of the fee.
Sorting out how to deduct each type of fee can be an intensive task. It’s one of the many reasons businesses work with the professionals to ensure they’re taking advantage of every deduction available for them.
Fees That Are Not Tax-Deductible
As mentioned earlier, any personal legal expenses, even if tangentially related to the business, are not tax-deductible. These include things like:
- Legal fees related to child custody or divorce
- Residential real estate sales or purchases
- Creating or reviewing contracts for individuals
- Estate planning
- Personal income tax preparation
- Legal fees related to immigration of family members or others who are not employees of the business
Don’t risk an audit by trying to deduct legal fees that aren’t related to your business.
The Right Advice When You Need It
You asked, “Are legal expenses tax deductible for businesses?” and the answer is usually yes. There are plenty of rules and red tape around these deductions, though. You can make sure you’re getting the full benefit of them by working with a team of tax law experts.
Are you looking for more legal advice relating to your business? It might be time to make an appointment with a trusted legal team. Get in touch and get the legal advice to keep your business operating the right way.