PORTFOLIO

Deductibility of Legal and Other Professional Fees (Portfolio 523)

Tax Management Portfolio, No. 523-3rd, Deductibility of Legal and Other Professional Fees provides a detailed discussion of the circumstances under which a taxpayer may deduct legal and other professional fees.

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DESCRIPTION

Tax Management Portfolio, No. 523-3rd, Deductibility of Legal and Other Professional Fees provides a detailed discussion of the circumstances under which a taxpayer may deduct legal and other professional fees.
Legal and other professional fees are not specifically mentioned in the Code as deductible items. Therefore, a taxpayer is able to deduct these types of fees only if they qualify as “ordinary and necessary” expenses under §162 (business expenses) or §212 (expenses related to the production of income). Expenses that do not qualify as deductible under either §162 or §212 are either nondeductible personal expenses or capitalized expenditures.
There are several requirements that must be met in order for a taxpayer to deduct legal or other professional fees as trade or business expenses or as expenses related to the production of income. Each of these requirements is discussed in detail in Section I of this Portfolio. The determination as to whether these types of fees are deductible is based on an analysis of all of the relevant facts and circumstances. In the context of expenses related to legal proceedings, the “origin of the claim” test is used to determine whether a particular expense is deductible. This test is discussed in detail in I, D, 3.
Section II of this Portfolio provides a discussion of how legal and other professional fees are allocated when only a portion of those fees are deductible. Section III of this Portfolio provides a discussion of the deductibility of specific types of legal and other professional fees including accounting fees, fees for investment and management, and fees related to corporations and other entities.


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AUTHORS

LISA MARIE STARCZEWSKI
Lisa Marie Starczewski, Smith College, B.A. (magna cum laude, 1985); Villanova University, J.D. (summa cum laude, 1988); Editor-in-Chief, Villanova Law Review (1987–88); member of adjunct faculty, Villanova University School of Law; former associate, Morgan, Lewis & Bockius; Schnader, Harrison, Segal & Lewis; member, Philadelphia Bar Association Section of Taxation; author, 714 T.M., Partnerships — Allocation of Liabilities; Basis Rules, 752 T.M., Corporate Alternative Minimum Tax, 587T.M., Noncorporate Alternative Minimum Tax, and 565 T.M., Installment Sales; co-author, 517 T.M., Scholarships and Educational Expenses, 503 T.M., Deductions: Overview and Conceptual Aspects, and 504 T.M., Deduction Limitations: General; author and co-author of numerous book chapters; contributor to various tax publications.

TABLE OF CONTENTS

Detailed Analysis

I. Legal and Accounting Fees - General Requirements for Deducting

A. Introduction

B. Trade or Business Legal and Professional Fees

1. Fees Must Be Incurred in Carrying on a Trade or Business

2. Fees Must Be Ordinary and Necessary

3. Fees Must Be Reasonable in Amount

4. Fees Must Be Paid or Incurred During Taxable Year

5. Fees Must Be Paid by Person to Whom Services Are Rendered

C. Deductible Non–Business Legal and Other Professional Expenses

1. Introduction

2. Fees Paid or Incurred in Connection with the Production or Collection of Income

a. Production or Collection

b. Distinction Between Disposition of Property and Collection of Income

c. Distinctions Between Acquisition, Perfection of an Undefined Income Interest, and Collection of Income

d. Expenses Incurred In Involuntary Dispositions

e. Treatment of Expenses Where Sale Not Consummated

3. Fees Paid in Connection with the Management, Conservation, or Maintenance of Property for the Production of Income

4. Fees Paid in Connection with the Determination, Collection, or Refund of Any Tax

D. Legal and Other Professional Fees Constituting Personal Expenses or Capital Expenditures

1. Personal Expenses

2. Capital Expenditures

3. Origin of the Claim Test

a. Origin of the Claim Test as Applied in the Context of Nondeductible Personal Expenses

b. Origin of the Claim Test as Applied in the Context of Nondeductible Capital Expenditures

(1) Perfecting and Defending Title to Property

(2) Acquisition and Disposition of Property

E. Allocation of Legal and Other Professional Fees Which Are Partly Personal Expenses or Capital Expenditures

II. Legal and Other Professional Fees

A. Categories of Fees

1. Legal Fees and Related Expenses

a. Court Costs

b. Legal Fees Related to Settlements

2. Accounting Fees

3. Professional Fees for Investment and Management

a. Fees for Investment Advice

b. Management Fees

B. Employment Agreements

C. Fees Related to Activities of Corporations and Other Entities

1. In-House Counsel and Accountants

2. Corporate Reorganization Expenses

a. Expenses of Corporations in Acquisitive Reorganizations

(1) Expenses of the Acquiring Corporation

(a) Taxable Acquisitions

(i) Amounts Paid to Facilitate

(ii) Exceptions

(iii) Treatment of Amounts Required to be Capitalized

(b) Tax-Free Reorganizations

(2) Expenses of the Acquired Corporation

b. Expenses of Corporations in Divisive Reorganizations

(1) The General Requirement of Capitalization

(2) Exceptions to the Capitalization Requirement

c. Expenses of Corporations in a Type E Recapitalization or Type F Reorganization

d. Expenses of Corporations in Bankruptcy Reorganizations

(1) The General Requirement of Capitalization

(2) Exceptions to the Capitalization Requirement

3. Insurgent Shareholders and Corporate Takeovers

a. Proxy Fights

(1) In General

(2) Proxy-Related Expenses in Transactions Facilitating Acquisitions and Changes in Capital Structure

b. Takeover Attempts

(1) Case Law and IRS Guidance Prior to the 2004 Regulations

(2) The 2004 Regulations

(a) Costs Incurred in Defensive Measures

(b) Mutually Exclusive Costs and Break-up Fees

4. Liquidations

a. Complete Liquidations

(1) Complete Liquidations Prior to the Promulgation of the 2004 Capitalization Regulations

(2) The 2004 Capitalization Regulations

b. Partial Liquidations

(1) Partial Liquidations Prior to the Promulgation of the 2004 Capitalization Regulations

(2) The 2004 Capitalization Regulations

5. Redemptions

6. Actions Involving Corporations and Shareholders

7. Stock Issuance Expenses

8. Expenses of Stock Appraisal Proceedings

a. Case Law and Guidance Prior to the Promulgation of the 2004 Capitalization Regulations

b. The 2004 Capitalization Regulations

9. Miscellaneous Corporate Transaction Expenses

a. Costs of Asset Sales

b. Integration Costs

c. Success-Based Fees

d. Borrowing Costs

e. Standstill Agreements

D. Antitrust Violations

E. Contract Claims

F. Tort Claims

G. Criminal Charges

1. In General

2. Professional License Suspension or Revocation

H. Divorce Proceedings

1. Alimony and Child Support

2. Property Rights and Settlements

3. Prenuptial and Postnuptial Agreements

I. Transactions Relating to Trusts and Estates

1. Trusts

2. Estates

3. Effect of Section 67

J. Collection of Income

K. Determination of Tax

1. Preparation of Income Tax Return

2. Claim for Refund

3. Civil Fraud

4. Criminal Tax

L. Perfection or Defense of Title

1. Legal and Other Professional Fees Related to the Perfection or Defense of Title

2. Acquisition and Disposition of Property

a. Stock and Other Ownership Interests

b. Real Property

M. Revocation of Operating License

N. Environmental Clean-up Costs

O. Reporting Payments Made to Attorneys

III. Allocation: Partially Deductible and Partially Nondeductible Legal and Other Professional Fees

IV. Related Sections

A. Section 165

B. Section 195

C. Section 248

D. Section 709

E. Section 263A

F. Section 170

G. Section 174

H. Section 263(a)

I. Section 162(e)

J. Section 198

V. Fines, Penalties, Bribes and Kickbacks: General

VI. Deductibility of Illegal Bribes or Kickbacks to Government Officials or Employees Under Section 162(c)(1)

VII. Bribes and Kickbacks to Persons Other Than Government Employees or Officials Under Section 162(c)(2)

Introductory Material

A. The Requirement that State Statute Be “Generally Enforced”

B. Burden of Proof Under Section 162(c)(2)

C. Violation of Federal Law Under Section 162(c)(2)

VIII. Deductibility of Kickbacks, Rebates, or Bribes Under the Medicare or Medicaid System - Section 162(c)(3)

IX. Deductibility of Fines or Penalties Under Section 162(f)

X. Inclusiveness of Public Policy Doctrine in Section 162(c), (f) and (g)


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Sample 195 Elections to Amortize Start-Up Expenditures.

Worksheet 2 Sample 248 Election to Amortize Organizational Expenditures

Worksheet 3 Senate Report to 1969 Tax Reform Act (H.R. 13270), S. Rep. No. 552, 91st Cong., 1st Sess. p. 274 (1969), 1969–3 C.B. 596

Worksheet 4 Aerospace Industry Coordinated Issue Paper Deductibility of Illegal Bribes, Kickbacks and Other Payments

Worksheet 5 GCM 34848 - Deductibility of Fees for Tax Advice Incident to Divorce

Worksheet 6 GCM 34915 - Deductibility of Legal Expenses for Suit to Recover Under Fidelity Insurance Policies.

Worksheet 7 GCM 38490 - Deductibility of Legal Fees Incurred in Defending Against Patent Infringement.

Worksheet 8 GCM 39465 - Deductibility of Legal Fees Incurred by Corporation in Defending Its Employees Against Civil and Criminal Charges.

Bibliography

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Treasury Rulings:

Cases:

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