There are some legal fees that qualify for a tax deduction but It all depends on the type of legal services you require as many legal fees are considered personal expenses. As a general rule, legal fees for estate planning are not tax-deductible. However, there are exceptions which we will explain in more detail.
Non-Deductible Legal Service Fees
Examples of non-deductible services relating to estate planning, for the purposes of tax returns, include:
- The creation of a will
- Medical directive
- Power of attorney
- Custody of children
- Personal injury claims
- Civil or criminal charges (related to a personal relationship)
- Property claims or settlements after a divorce
- Family members disputes
Estate Planning Services That Are Tax-Deductible
Note that for the services to qualify for a deduction, they must be used for:
- Producing or collecting income; or
- Maintaining or managing income-producing properties; or
- Tax advice and planning (especially on tax returns).
An example of this is seeking estate planning advice about constructing a trust that will generate income. The legal costs of such advice qualify as tax-deductible. The same goes for advice on estate taxes, for example, to form a strategy for minimizing taxes, i.e. by transferring assets to avoid the inheritance tax.
Other Miscellaneous Services
Other legal services that fall in the miscellaneous deductions category include:
- Farm income or expenses
- Tax advice related to divorce
- Performing or maintaining your job
- Property rent or royalties
- Collection of taxable alimony
- Business profits/losses tax issues
Nevertheless, with the introduction of the Tax Cuts and Jobs Act (TCJA), miscellaneous deductions are suspended until 2026. Some estate planning fees may still be tax-deductible if they fall into specific categories.
Categories of legal expenses that qualify for a deduction:
- Tax return preparation fees for an estate or a trust
- Legal fees relating to defense against an undue influence claim
- Trustee fees - the annual cost of professional trust management services
- Management and maintenance of property expenses
- Investment advisory fees
- Fees paid to a personal representative or fiduciary for administering an estate
Deduction Limits For Beneficiaries
The beneficiaries of a trust or an estate have limitations upon the tax deductions they can claim in their tax returns. The conditions of ending an estate or a trust, for the purposes of tax deduction, are still under review by the IRS.
However, here are a few facts we know so far:
- A beneficiary may request a tax deduction from any financial or capital losses.
- Charity contributions exceeding the gross income may not qualify for a deduction because they are considered miscellaneous deductions.
- A trustee, executor, or personal representative can claim estate administration fees relating to an estate in Colorado (these are taxable ordinary income, even though they are deductible by the estate or trust).
Estate Tax & Estate Income Tax
There is a distinction between estate tax and estate income tax. The first one is a tax imposed on cumulative assets after someone’s death, currently, and always subject to change. The estate tax exemption is high, currently for 2021 at $11.7 million per person or double that ($23.4 million) for a married couple. This amount is due to change in the coming years and could possibly be lowered.
On the other hand, estate income tax applies to interest, dividends or other types of income gained by the estate after the decedent has died. It is not an inheritance tax, but a tax on the profits or income the estate receives from a property or investments.
If the decedent had established a trust, their representatives may make an IRC section 645 election for the trust and estate tax return to be done as one federal tax return instead of separately.
How to Claim your Tax Deductions for Legal Fees
To claim deductions of legal fees on your tax return, you need your attorney’s invoices clearly stating the tax-deductible services. You may receive several invoices, depending on the length of time your case takes. Your attorney must specify what portion of the services they provided are deductible.
Some attorneys issue separate invoices for the deductible and non-deductible legal fees. Commonly, about 40% to 60% of estate planning legal fees may be deductible, although the percentage varies for each individual case. We encourage you to discuss this with your attorney early on in the process.
Keep in mind that the IRS has a 2% rule on miscellaneous deductions. This means that they subtract 2% from your adjusted gross income (AGI) and allow you to apply a deduction on the remaining percentage of your taxable income, which can further limit the deduction allowed.
It is always useful to keep accurate records of your financial affairs to support potential tax deduction claims. You should seek the expert advice of a tax attorney to make sure you claim all deductions to which you are entitled.