Christopher S. Mulvaney,

Attorney and Counselor-at-Law

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THIS WEBSITE INCLUDES GENERAL INFORMATION & THE OPINIONS OF CHRISTOPHER S. MULVANEY. IT IS INTENDED TO STIMULATE A BASIS FOR QUESTIONS RELATED TO YOUR PARTICULAR FACTUAL CIRCUMSTANCES — BEFORE YOU ACT.  THIS WEBSITE DOES NOT CONSTITUTE LEGAL ADVICE. IF YOU WANT LEGAL ADVICE, PLEASE MAKE A ZOOM APPOINTMENT TO SPEAK WITH ME.

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Gonzaga University School of Law – Spokane, Washington – Class of 2002 – Cum Laude The Latin phrase “Deo patriae, scientiis, artibus” translates to “For God and country through sciences and arts”.  The initials A.M.D.G. on the seal of Gonzaga Law School stand for Ad Majorem Dei Gloriam, which is Latin for “For the Greater Glory of God” the Motto of the Society of Jesus (Jesuits): a Catholic religious order founded by St. Ignatius of Loyola.

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Lawyers should explain the distinction between business and personal expenses, the limitations on certain deductions, the importance of record-keeping, and the tax implications of legal settlements. 

Business vs. personal expenses

• Definition: Deductible expenses must be “ordinary and necessary” for the client’s business or income-producing activity. An “ordinary” expense is common in the industry, and a “necessary” expense is appropriate and helpful for the business.

• Separating finances: Clients, especially small business owners and sole proprietors, must keep their business and personal finances separate. This makes it easier to accurately track deductible expenses and avoids issues in case of an IRS audit.

• Personal expenses: Legal fees and other costs for personal matters, like divorce, child custody disputes, or will preparation, are generally not tax-deductible. 

Key tax deduction limitations

• Legal fees: While legal fees for business-related issues are deductible, the rules for personal legal fees changed significantly under the Tax Cuts and Jobs Act (TCJA). Most personal legal expenses, including fees for resolving tax issues, are no longer deductible as miscellaneous itemized deductions.

• Home office: For clients claiming the home office deduction, the space must be used “exclusively and regularly” for business. The deduction is based on the percentage of the home used for business and is claimed on Schedule C for sole proprietors.

• State and local taxes (SALT): The total deduction for state and local income, sales, and property taxes is limited to $10,000 per tax unit ($5,000 if married filing separately) for tax years 2018 through 2025.

• Travel and meals: Transportation and lodging costs for business travel are generally 100% deductible. In most cases, business meals are only 50% deductible, with the exception of certain meals which may be fully deductible. 

Settlements and judgments

• Origin of the claim: The taxability of a legal settlement or judgment depends on the “origin of the claim” that led to the recovery. For instance, a recovery for lost business profits is taxed as ordinary income, while damages for physical injuries are typically tax-free.
• Damage allocations: When negotiating settlements, it is often advantageous to allocate damages across different categories. This can influence whether the recovery is treated as ordinary income, capital gain, or a non-taxable amount. The parties should agree on these allocations and include them in the settlement agreement.
• Taxability of awards: Punitive damages and interest included in a settlement or judgment are always taxable, even if the underlying claim was for tax-free physical injuries. 

Record-keeping and professional advice

When to consult a tax professional: Lawyers should clarify that they are not tax advisors and encourage clients to consult with a qualified accountant or tax professional, especially for complex tax planning, bookkeeping, or when dealing with audits. 

Importance of records: Accurate and detailed records are critical for substantiating all claimed deductions. Clients should be advised to keep receipts, invoices, mileage logs, and other documentation in case of an IRS audit.

Use of forms: Depending on the business structure, clients will need to file specific forms. For example, sole proprietors report business deductions on Schedule C, while depreciation is often reported on Form 4562.

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