Legal Fee Tax Write Offs Made Simple

• Publication year: 2022
• Author: Written by Robert W. Wood

LEGAL FEE TAX WRITE OFFS MADE SIMPLE

Written by Robert W. Wood

If you hope to write off your legal fees, there is some good news from the IRS. But before you rejoice, the bad news is that the complex and confusing rules governing when legal fees are deductible have not gotten any easier. There are still plenty of cases in which deducting legal fees is difficult or when the rules seem to say that you should not be deducting them at all. Even so, there is some good news, because the mechanics for deducting employment, whistleblower, and civil rights legal fees have been improved, at long last.

I have seen plenty of mechanical glitches with these deductions since 2004. I have seen some plaintiffs not properly claim the deductions they deserve and some plaintiffs and their return preparers not claim them at all—sometimes purely or largely because they cannot seem to manage the mechanics. In that sense, easier mechanics is a big win. The issue is hardly new.

Indeed, the tax code was amended back in 2004 to allow legal fee deductions "above the line" in some cases, which is almost like not having the income in the first place. But the deduction has been quirky to claim ever since. Many taxpayers have trouble— so do accountants and some types of tax return preparation software. That is barely surprising. Since 2004 it has been a kind of write-in deduction, sort of like writing in a political candidate who is not on the ballot.

Because the previous versions of Form 1040 did not have a separate line to write in "other" above-the-line deductions, above-the-line deductions in cases involving employment, whistleblower, and civil rights cases had to be written onto the dotted leader line next to the box where the total of the above-the-line deductions was to be calculated. This reporting not infrequently created confusion with the computer systems of state taxing agencies, because their algorithms often did not recognize the legal fee deduction reported on the leader line, and outside of any box of the form.

State agencies, like California's FTB, would regularly send notices to taxpayers who followed the IRS's instructions asserting that the taxpayers' tax returns must contain a calculation error: The total of the above-the-line deductions reported in the boxes of the Form 1040 as calculated by the states' computers simply did not match the taxpayer's self-reported total on the tax form. Of course, in these cases, the supposed calculation error was simply that the taxpayer's calculated total correctly included the legal fee deduction written onto the leader line, where the state's calculation did not. Even though these state notices are relatively easy to address, it was obviously frustrating to taxpayers to default into a state income tax examination over a poorly drafted tax form.

Not only was there no proper line for legal fee deductions on the IRS forms, but you had to include a particular code next to your write-in. If your case was an employment case, the code to enter was "UDC" for unlawful discrimination claim. The instructions said: "Write 'UDC' and the

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amount of the attorney's fees next to line 36 of Form 1040. For example, if you paid $100,000 in attorney fees, write 'UDC $100,000' next to line 36."

If your case was a whistleblower case, you put in "WBF" for whistleblower. (I'm not sure what...