How to Deduct Legal and Professional Fees for Business
You may deduct fees paid to accountants, attorneys or other professionals who are independent contractors, for "ordinary and necessary" expenses of your business.
The IRS specifically lists accountants and attorneys under the category of legal and professional fees, but other professionals can be included.
You Can't Deduct Personal Expenses
Fees paid to professionals for personal advice, personal taxes, personal investments or retirement planning or personal legal services are not deductible business expenses. This would apply to monthly fees (for bookkeeping, for example) and for annual or one-time payments.
If you have tax preparation fees for both your business and personal taxes, you'll need to separate the cost between the two portions of your return. For example, Schedule C for business income is part of your personal tax return if you own a small business. You can deduct the cost for a tax professional to perpare your Schedule C, but not the cost of preparing the rest of your personal tax return.
Use your business checking account or business credit card to pay for the business portion and your personal account for the personal portion.
If the business and personal work are not so easily separated, you should estimate what percentage of the work is business-related, and pay only that percentage from your business account.
Legal and Professional Fees - Deducting vs. Capitalizing
Fees in Purchase of Business Assets
If you pay legal fees or other fees to professionals to help you with the purchase of a business asset (like a building or other property), you can't deduct these costs under the "legal and professional fees" category. You must include these fees in the cost of the business asset, which is then capitalized and depreciated over time.
Business Startup Fees
Business startup costs come in two types, and they are included on your business tax return in different ways.
Costs for creating or buying a business include investigating the creation of a business. You can deduct up to $5,000 of some startup costs in your first year of business; additional startup costs must be amortized.
Costs for organizing the business, including organizational meetings, state incorporation fees, and the cost of legal services for creating documents, etc.must be amortized (spread out over time) organization costs incurred with the first tax year, including fees for legal services.
Some typical professional expenses for business startup and organization include:
- Cost of hiring an accountant or consultant to set up your business accounting system and recordkeeping system
- Cost for an attorney to help you register your legal entity with your state
- Cost for an attorney to set up your corporate records and prepare your bylaws, if you are starting as a corporation
- Cost for an attorney to write your partnership agreement for a partnership or operating agreement for an LLC.
- Cost for a financial advisor to help set up your new business retirement plan.
- Cost for an IT firm to set up your business computer and software systems.
Legal and Professional Fees on Your Business Tax Return
Where you include these fees depends on whether they are deducted or capitalized.
In most cases, you will be deducting these fees as part of your normal business activities. Here's where you would include these deductions on your business tax return:
- For sole proprietors and single-member LLCs, show these expenses in the "Expenses" section of Schedule C
- For partnerships and multiple-member LLCs, show these expenses in the "Deductions" section of Form 1065
- For corporations, show these expenses in the "Deductions" section of Form 1120.
If you have to amortize startup and organizational costs, you would include them in Other Expenses on your business tax return.
If you aren't sure which line of your return to use, check with your tax professional or use an online tax software program.
Reporting Payments to Legal and Professional Advisors
You must report payments to attorneys and other professionals if you paid that person or firm $600 or more in deductible fees in a year. The report you would use is Form 1099-MISC (miscellaneous income). This form is given to people you pay but who are not employees.
You send the form to the recipient by January 31 after the end of the tax year.
You must submit this form to the iRS no later than January 31.
Confused about this form? This article has information on what you need to prepare, send and file Form 1099-MISC.
Before you complete a 1099-MISC form for an attorney or other professional, you must have this person complete a W-9 form. This form lists the recipient's tax ID number and information about the name and address.
Payments to Attorneys: A Special Case
Attorneys have their own box on Form 1099-MISC. Normally you would report payments to attorneys, including an attorney in a firm that is a corporation, in Box 7 (nonemployee compensation).
But there are some cases when you would need to report gross proceeds to attorneys in Box 14-Gross proceeds paid to an attorney. One example of this situation would be when an insurance company pays the claimant's attorney a fee to settle a claim. This situation is complicated. See the Instructions for Form 1099-Misc (pages 2-3) and get help from your tax professional on how to report these payments to an attorney.
IRS. "Publication 535 Business Expenses." Personal versus Business Expenses. Page 5. Accessed Nov. 19, 2019.
IRS. "Instructions for Schedule C." Part V. Other Expenses, Page C-15. Accessed Nov. 19, 2019.
IRS. "Publication 535 Business Expenses." Starting a Business Pages 28-30. Accessed Nov. 19, 2019.
IRS. "Instructions for Form 1099-MISC." Payments to Attorneys, Pages 2-3. Accessed Nov. 19, 2019.