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socrateaser, Lawyer
Category: Tax
Satisfied Customers: 38910
Experience:  Retired (mostly)
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As an attorney I advance costs for my client to file lawsuits.

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As an attorney I advance costs for my client to file lawsuits. I deduct these costs as business expenses. My client will 1099 me for legal fees and reimbursed costs. Is this the proper method of reporting these expenses and income.

IRC 162 provides that ordinary and necessary costs connected to engaging in a trade or business are deductible. If you have advance costs related to your professional practice representations, then those costs are deductible in the tax year when paid.

Correspondingly, a client whose legal fees and costs are ordinary and necessary to engaging in the client's trade or business are also deductible. Personal legal fees, not connected with the acquisition or preservation of revenue/income, are not deductible, and not reportable on form 1099-Misc. If the client's expense does not correspond to the tax year in which you advanced the costs, then you would have an deduction in one tax year, and income in another. There is no way to avoid this outcome.

Hope this helps.
Customer: replied 4 years ago.
I was more specifically concerned with the rule that if an attorney advances expenses that he knows will be reimbursed by client, then he cannot deduct the expense when incurred.

I have been on Schedule C including these as expenses and income when reimbursed.
Okay, here is a pretty thorough summary from Uncle Sam (click here).

It appears that case law suggests that filing fees, in particular, are considered "loans" to clients, not expenses, and that the client is repaying the loan when providing reimbursement -- in which case, the client would not use a but that IRS auditors should consider the success rate of a lawyer who takes contingency cases, to determine whether or not the advance fees are really expenses of the attorney with a reasonable risk of loss, or whether reimbursement is routine, which argues that the payments are a loan.

Note: I never take contingency cases, and I never advance client costs, so, to be frank, this issue is not one I've given much consideration to in the past. Fortunately, the IRS seems to have done most of the background work. If you've been expensing these costs in the past, then your audit risk probably boils down to whether or not you are fairly certain of reimbursement. If yes, then you've misreported. If not, then you have a reasonable argument to expense the costs.

Hope this helps.
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Errata: The phrase, " which case, the client would not use a but that IRS auditors should consider...", should read, "in which case, the client would not use a 1099-Misc to report the payment, and IRS auditors should consider...."

No need to reply. Sorry for the inconvenience.