The simple answer is that lawyer fees for personal legal matters are not tax deductible. Legal fees can only be deducted if they were incurred to produce or collect taxable income, according to IRS publication 529. If the attorney fees help to produce or collect taxable income they are thought of as job-related and may be considered a business expense. As a business expense, they are fully deductible.
In simple terms, the deduction can be taken if help is needed from a lawyer to make money that is taxed, or if a lawyer helped with a tax matter. If the lawyer fees are connected in some way to taxes or taxable income, then a deduction can be taken.
Common examples of situations in which legal fees arise out of trying to produce or collect taxable income include: the legal fees paid to sue someone for back rent, the legal costs of defending a business from a lawsuit, and legal fees paid fighting for a tax refund.
Legal expenses cannot be deducted for advice or help on personal matters. For example, lawyer fees cannot be deducted for filing and winning a personal injury lawsuit or wrongful death case.
Fortunately, damages in personal physical injury cases are tax-free. So if a contingent fee lawyer is working on an auto accident case or other personal physical injury case, much of the recovery is tax-free.
No legal fee deduction will be allowed for legal fees allocable to non-taxable awards or settlements, say Internal Revenue Code Section 265(a) and Treasury Regulation 1.265-1(a)).
There are several exceptions to this rule.
IRS publication 529 states that a person “cannot deduct personal legal expenses such as those for… damages for personal injury (except for certain unlawful discrimination and whistleblower claims).”
Unlawful discrimination is typically defined as violating one of a number of laws that mostly pertain to civil rights, labor and employment rights, housing rights, disability rights, and whistleblower rights. (Internal Revenue Code Section 62(e)).
IRC § 62(a)(20) establishes an above-the-line deduction for attorney fees and court costs paid in connection with discrimination and certain other suits. IRC § 62(a)(21) establishes above the line-deduction for attorney fees and court costs associated with suits involving whistleblower claims.
Legal fees related to either doing or keeping a job, such as the fees paid by an individual to defend him- or herself against criminal charges arising out of their trade or business, can be deducted as specified on IRS Publication 17.