Legal Settlements

[chess999]

I have a question regarding legal settlements. Are the fees you paid to the lawyer tax-deductible?

[taxref]

It depends upon the nature of the settlement. If the settlement is non-taxable to you, the legal fees are not deductible.

If the settlement is taxable to you, you might be able to deduct the legal fees. You would have to itemize deductions, and the legal fees are a 2% miscellaneous itemized deduction. They are first combined with any other 2% deductions you may have. Only the part of the total which exceeds 2% of your AGI is deductible.

[commentator]

If the settlement is a federal discrimination case, then the attorney fees are fully deductible whether you itemize or not. You would probably be surprised how small a percentage of all legal settlements meet that exception.

[mwcpa]

As noted by the other two responders... it depends...

To support the ref's statement from IRS publication 525

Taxable income includes "Attorney fees and costs (including contingent fees) where the underlying recovery is included in gross income."

but

"Legal expenses. You may be able to deduct attorney fees and court costs paid in connection with the civil action. Depending on the facts and circumstances, these expenses are either claimed on Schedule A (Form 1040) or Form 1040NR (Schedule A), or deducted in figuring the income you report on Form 1040, line 21, or Form 1040NR, line 21. If the qualified settlement income was received in connection with your trade or business (other than as an employee), you can reduce the taxable amount of qualified settlement income by these expenses. In all other situations, you can only claim these expenses as a miscellaneous itemized deduction subject to the 2%-of-adjusted-
gross-income limit on Schedule A (Form 1040), line 23, or Form 1040NR (Schedule A), line 11. For example, an employee or the surviving spouse or beneficiary of a deceased plaintiff would claim the expenses as a miscellaneous itemized deduction subject to the 2% limit."

And to back up commentators statement, from the same IRS publication (525)

"Deduction for costs involved in unlawful discrimination suits. You may be able to deduct attorney fees and court costs paid to recover a judgment or settlement for a claim of unlawful discrimination under various provisions of federal, state, and local law listed in Internal Revenue Code section 62(e), a claim against the United States government, or a claim under section 1862(b)(3)(A) of the Social Security Act. You can claim this deduction as an adjustment to income on Form 1040, line 36. The following rules apply.
The attorney fees and court costs may be paid by you or on your behalf in connection with the claim for unlawful discrimination, the claim against the United States government, or the claim under section 1862(b)(3)(A) of the Social Security Act.

The deduction you are claiming cannot be more than the amount of the judgment or settlement you are including in income for the tax year.

The judgment or settlement to which your attorney fees and court costs apply must occur after October 22, 2004."

[chess999]

thank you for the replies. Do people normally receive a 1099 or otherwise after receiving a legal settlement?

[mwcpa]

that depends on who paid it....

but a 1099 is not the governing documents as to what is or is not taxable.... IRC 61 states that income includes everything unless specifically exempted, it does not say income is only reported on a 1099 or w-2....(but I wish it did... my tax cost would be cut in half then....)