Legal Fees - Disability

[MariaMc]

My client received a lump sum payout from an employer provided disability insurance payer (not SS). She is being taxed on the gross amount although the attorney which fought for the claim took their percentage before the net proceeds were paid to the taxpayer.

Can I deduct these legal fees as an adjustment to gross income? If so, which code section should I reference ? Should I attach a copy of the attorney's document referencing the percentage they retained before paying the net proceeds to the taxpayer ?

Thanks !

[mwarney]

My client received a lump sum payout from an employer provided disability insurance payer (not SS). She is being taxed on the gross amount although the attorney which fought for the claim took their percentage before the net proceeds were paid to the taxpayer.

Can I deduct these legal fees as an adjustment to gross income? If so, which code section should I reference ? Should I attach a copy of the attorney's document referencing the percentage they retained before paying the net proceeds to the taxpayer ?

Thanks !

Legal fees incurred to collect wages or a disability settlement are deducted on Schedule A miscellaneous, and are subject to the 2% floor. I'll see if I can find the pub that references this.

[BP.]

Can I deduct these legal fees as an adjustment to gross income?

Legal fees as adjustment to income- see TTB 3-6 & 4-26. Don't think your case fits the requirements for adjustment treatment.

[mwarney]

From Pub 915, Social security and RR Retirement benefits.

"Legal expenses - You can usually deduct legal expenses that you pay or incur to produce or collect taxable income or in connection with the determination, collection, or refund of any tax. Legal expenses for collecting the taxable part of your benefits are deductible as a miscellaneous itemized deduction on Schedule A (Form 1040), line 23."

and again from Pub 17 under "Miscellaneous Itemized Deductions"
"Legal Expenses - You can usually deduct legal expenses that you incur in attempting to produce or collect taxable income or that you pay in connection with the determination, collection, or refund of any tax."

The key here is to what extent the legal fees are in connection to taxable income. Legal fees are deductable only to the extent that they are for the collection of taxable income. If the benefits are taxable, then the legal fees are deductable as a miscellaneous itemized deduction. If only a portion of the benefits are taxable, then you may need to prorate.

[RitaB]

Agree

If 56% of the SS is taxable, deduct 56% of the legal fees on Sch A, line 23.

[MariaMc]

not SS disability

This is not SS disability income, it was paid directly from a private insurance company so it is all taxable on a W-2 (3rd party sick pay) with no taxes withheld. I know that the whole legal fees taken off the top before the taxpayer received the net would be deductible however, I hate to be subject to the 2% limit but am not finding any basis for it to deducted on the front page to AGI.

[Burke]

You are correct. It must go on Sche A subj to 2%. Since all is taxable income for lost wages, all legal expense is reported on Sche A. Maybe, if it is enough, the TP can itemize other expenses he might not normally be able to.

[mwarney]

This is not SS disability income, it was paid directly from a private insurance company so it is all taxable on a W-2 (3rd party sick pay) with no taxes withheld. I know that the whole legal fees taken off the top before the taxpayer received the net would be deductible however, I hate to be subject to the 2% limit but am not finding any basis for it to deducted on the front page to AGI.

Doesn't matter who pays it. Same rules apply. I went through this once before and we had to look for other 2% deductions that we would have otherwise not bothered with. I think the best you can do is try and build up closer to the 2% floor with other deductable items. (safe deposit box, tax prep fees, investment expenses, (money magazine?)

[RitaB]

Well, my face is red

This is not SS disability income, it was paid directly from a private insurance company so it is all taxable on a W-2 (3rd party sick pay) with no taxes withheld. I know that the whole legal fees taken off the top before the taxpayer received the net would be deductible however, I hate to be subject to the 2% limit but am not finding any basis for it to deducted on the front page to AGI.

Sorry, you said that it was NOT SS in the original post. Apparently, I'm losin it.

TTB 4-26 lists three types of claims where you can take the legal fees as an adjustment to income.

I hate that 2% whack. And, I hate the 7.5% haircut even more.