Deducting Legal Fees

Tax

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.

Canada
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.

Child support
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.

Self-employed
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.

USA

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.

IRS

History of the IRS

Internal Revenue Service – The History of the IRS

The beginnings of the Internal Revenue Service (IRS), originate back during the American Civil War. Now, it wasn’t because they were greedy men, it was because war is expensive, and the President and Congress needed some way to help pay for it.

The original conceit for raising money was to force an import tariff, property tax and an income tax on every person living in the United States. President Abraham Lincoln and Congress passed the Revenue Act of 1861, and thus created the first Federal income tax.

The Revenue Act of 1861, imposed a flat 3% tax on those who made over $800, but the main problem was, there wasn’t a proper mechanism of enforcement. The goal of the Revenue Act of 1861, was to raise about $50 million in revenue, but it failed to do so, because the enforcement of the Revenue Act was so poor.

The Civil War raged on and it still needed to be funded. The income tax portion of the 1861 bill was repealed, before any citizen actually participated. President Lincoln and the Congress of 1862, brought into existence a new bill called, The Revenue Act of 1862 and the bill was passed and signed into law on the 1st of July, 1862.

The Revenue Act of 1862, had several new provisions to try and rectify the problems encountered with the original 1861 bill. There were three key portions that would play an important role in doing so.

The first was, the establishment of the office of the Commissioner of Internal Revenue. The Commissioner was selected by the President and was in charge of all the formalities in the assessment and collection of taxes. These formalities included such things as, preparing instructions, forms, regulations, licenses and the distribution of such materials. It would be the Commissioners imperative to make certain that taxes were collected. This would be the basis, in which, the modern incarnation of the IRS is founded on.

The second was, the burdening of excise taxes on the majority of every day goods and services. Many luxury items like tobacco, liquor, jewelry, and pianos were all taxed. More common items also received the same treatment, such as, newspapers, patented medicines and a variety of services. In addition to taxing common day items and peoples, corporations, banks, insurance companies and other such institutions were required to report their earnings and receipts, to ensure they were all taxed appropriately.

The third, adjustment to the income tax provision created in the Revenue Act of 1861. While the original bill, had only a flat 3% tax on incomes over $800, the new Revenue Act of 1862, ushered in a new progressive income tax system. Residents who reported an annual income of less than $600 paid no taxes. Residents reporting an income within $600 – $10,000, paid a 3% tax and those earning more than $10,000, paid a 5% tax.

Perhaps the most important portion on the Revenue Act of 1862, was section 92, which stated, the taxes on incomes imposed will be paid on or before the 13th day of June, 1863, and every year after that until the year 1866. This essentially means that the taxes put on the residents on America, were only supposed to last for 4 years.

Even though section 92 existed in the Revenue Act of 1862, the bill continued to be active until 1972, as much of the public and Congress agreed, transitioning into peace and reconstruction would require public funding.

In 1894, Congress approved a new flat rate income tax, but it was struck down as unconstitutional by the Supreme Court. The Supreme Courts reasoning was that, the direct tax violated a provision in which direct taxes must be apportioned between the states on basis of population.

In 1906, President Theodore Roosevelt began a movement for tax reform. President William Taft continued it and pushed for a constitutional amendment for tax reform and it wasn’t until President Woodrow Wilson was elected, that the movement gained critical mass.

In 1913, due to political pressure to form a more powerful Federal government, the Constitution’s Sixteenth Amendment was ratified so that, Congress would have the power to impose and collect taxes on incomes, no matter what kind of sources they came from and without apportionment among the states and without having to do or operate around censuses or enumerations. This new amendment would supersede the Supreme Courts earlier ruling.

It would be in 1913, that the first 1040 forms were introduced and the permanent formation of the Bureau of Internal Revenue was established.

Just as the Revenue Act of 1861 and 1862, was enacted to help with the Civil War effort, the Revenue Act of 1918 was passed to help with World War I efforts.

In 1919, after the United States ratified the 18th Amendment, prohibiting alcohol, Congress also passed the Volstead Act. This would give the Commissioner of Internal Revenue the additional duty of enforcing Prohibition until 1933, when Prohibition was repealed.

In 1931, President Theodore Roosevelt, passed what he would call, “the greatest tax bill in American history.” It introduced such things as medical deductions, but also raised taxes for some Americans.

Up until 1952, the Bureau of Internal Revenue operated on a patronage appointment system. President Harry Truman created what he called his Reorganization Plan No. 1, that would remove the old patronage system and in its place put in a civil service system.

In 1953 President Eisenhower would put Truman’s plan into effect and change the name of the Bureau of Internal Revenue to what it is now known as today, the Internal Revenue Service. The only appointed positions still at the IRS currently are, the Commissioner and the Chief Counsel, whom are both selected the by the President and also confirmed by the Senate.

Since the 1950s to current day, there has been several more minor and some more significant reforms, in both in the operating structure of the organization and regulatory reform for the taxpayers. Perhaps the largest being the Tax Reform Act of 1986, which had over 300 provisions.