Are legal fees deductible in the United States/Canada?
When it comes to deductibles on your tax returns, you always want to milk it for all it’s worth. Every single thing that can be deducted or written off should be done so. However, this often leads to grey areas, in which you’re unsure whether or not, if some-thing is deductible.
Worst of all, when it comes to legal fees, there is a large variety of them and it can get very complicated as to whether or not all or only some legal fees are deductible.
First it must be known that, I am not a chartered account or professional legal advisor in any capacity. The surest and best practice when filing taxes or questioning deductibles is to speak with a professional. With that said, let’s take a closer examination into some of these legal fee deductibles.
Starting with Canadian tax laws, there are only a few situations in which you can claim legal expenses to the CRA (Canada Revenue Agency).
Deductible Tax help
You are able to deduct legal fees that you have obtained in regards to assistance or advice in response to the CRA, when it does a review on your deductions, credits and income. You may also deduct any legal fees, if the CRA were to perform an audit on your tax returns from any previous year.
This also extends to any legal fees you obtain when objecting or appealing a decision or assessment by the CRA under the employment insurance act as well as the unemployment insurance act.
The deductible legal fees in this situation also extends to the Canadian pension plan (CPP), the income tax act, and the Quebec pension plan (QPP).
Retirement & Pension
The legal fees incurred by confirming or collecting the right to pension benefits or a re-tiring stipend are both deducible, but only to a specific yearly limit. Each individual will have a different yearly limit. To calculate your limit, you take your retiring stipend or pension income collected in the year, then subtract any portion from these amounts that were sent to a RRSP or RPP, the amount left is your limit. Any legal costs you don’t claim in that year, can actually be carried over to the next year, for a term of seven years.
It’s possible that the limit may change from time to time, so it’s best to confirm whether or not the limit has changed before making any deductions.
Legal fees paid while making non-taxable child support compensations are able to be deducted. On the other side, legal fees paid, when trying to collect support compensation owed by either a current or former spouse are deductible. In some cases, these rules will also apply to the biological parent and some common law relationships.
Any legal fees paid, to obtain a divorce, separation or to settle visitation or custody rights are not deductible. You also cannot deduct any legal fees in obtaining, negotiating or contesting child support payments.
Wage & Salary
Any legal fees you might of paid to establish or collect a legal salary or wages, related to employment earnings paid directly from your employer. Whether the amount owed to you is collected or not, does not matter, so long as it is a true attempt on your behalf to obtain what you think you are overdue. The total you are owed must be unmistakably for wages or salary you are owed.
If you obtain legal fees, during the operation of your business, the total sum of the fees are deductible as a business expense.
The above situations are the main talking points when speaking about deductibles with the CRA. There may be some other nuances or loopholes, that one could take ad-vantage of or that you’ll need to double check so that your return is legitimate.
The IRS, is a bit more of complex situation, when it comes to deductible legal fees. When it comes to tax law, no where explicitly does it say that legal fees are deductible items.
A lot of legal deductions rely on the context of how they are incurred. This has caused some debate among CPAs, lawyers and the IRS. Fees paid for legal services can sometimes be deductible depending on the actual circumstances and that the taxpayer meets all the legal requirements for a deduction.
For the most part, personal legal fees are not deductible. If you are getting a divorce, you’ll have to pay all your legal fees, with the exception of legal fees incurred attempting to obtain alimony. General Criminal Defense Lawyer fees are not deductible, unless the fees arise out of your job performance or deal with keeping your job, such as potentially deducting Criminal Defense Lawyer fees for insider trading if you are a stockbroker. However, you probably could not deduct drunk driving defense fees, according to Colusa County DUI Lawyer Michael Rehm. However, trade or business legal expenses are deductible, assuming you meet the legal requirements, which are:
1. Incurred in carrying on a trade or business.
This is tricky since, there is no specific definition of what “trade or business” actually entails. This specific point has been interpreted in many ways, some being contradictory to others.
2. Ordinary and necessary.
There’s also no specific rules that defines what is considered “ordinary and necessary” and it treated more as just a statement of fact. It is rarely interpreted or generalized and a fairly simple requirement to meet.
3. Reasonable in amount.
A reasonable amount is fairly straight forward.
4. Paid or incurred during the taxable year in which the taxpayer seeks to deduct them.
The deduction is dependent on when the fee is paid or incurred in the year, that the deduction is sought.
5. Paid by the person to whom the services are rendered.
This is another fairly straight forward clause. You must be trying obtain the deductions for yourself and not for someone else.
In addition to trade and business, there are a few legal expenses that fall outside of those two conditions, but also don’t exactly fall into personal legal expenses, and are deductible as long as they fulfill the following:
1. Paid or incurred for the production or collection of income,
Much like the CRA counterpart, legal fees incurred, while trying to collect or obtain in-come from a wage or salary can be deductible.
2. Paid or incurred for the management, conservation, or maintenance of property held for the production of income
Expenses incurred or paid for the management of a property can be deductible, regard-less if the property being held is being productive or not.
3. Paid or incurred in connection with the determination, collection, or refund of any tax.
Again, like the CRA counterpart, legal fees obtained in connection to the collection, refund or determination of any tax.
4. Ordinary and necessary
5. Reasonable in amount
As you can see, the IRS has several more legal requirements, than the CRA. If you’re unsure what category your legal fees might be falling under, it is best to consult with a professional.