Legal Costs

[Taxman]

I have a client who entered into a lease for a warehouse with an option to purchase it. The landlord of the property decided to sell the property to another party after he signed a lease with my client. Now my client is suing the landlord to enforce the lease. Would the attorney fees be a deductible expense as they are incurred or must they be capitalized and amortized over the life of the lease if judgement is in favor of my client or expensed in the year the judgement goes against my client?

[Brad Imsdahl]

TTB, page 8-8 says: “The cost of getting a lease is amortized over the term of the lease…”

TTB, page 4-26 says: “legal fees related to producing or collecting taxable income or getting tax advice is deductible.”

The question then; Is the legal fees a cost of getting a lease, or a cost of producing taxable income?

I would think that having to sue a landlord is not a normal cost of getting a lease. If the legal fees were incurred to look over the lease agreement, or do background checks on the property, etc., then those types of legal fees would be related to the cost of getting a lease.

In your situation, however, the legal fees are not incurred to get a lease, but to enforce an already signed lease. The legal fees are necessary to carry out the business of collecting taxable income as the warehouse may be essential to the carrying on of the taxpayer’s trade or business.

I haven’t done any searches to see if there are any court cases on this. Maybe someone else has some citations that will help.

[Taxman]

Thanks

for your input Brad. I'm going to do a little more research and see what I can come up with. Thanks again

[Snaggletooth]

Fully Deductible as Paid

I'm going to switch hats from IRS and taxes to AICPA and Accounting Theory.

In situations where tax code and regulations are not defined, there is an implied
application that GAAP will be upheld. Many differences exist, but I don't think
this situation falls into anything addressed in tax law.

Absent that, I usually follow GAAP. The legal costs as you have discussed are
neither an acquisition cost, nor a cost that can be reasonably expected to add
value to anything of already-established cost. This means that the legal expense
is a pure "period expense" (as referred to by CPAs), meaning it is chargeable
to current earnings.

The expense is deductible in full in the year paid. "Paid" would also include
"accrued" if the taxpayer was on accrual basis and satisfied the debt by the
due date of the tax return.

[jainen]

Never deductible

Never deductible. If you lose the case, that proves it wasn't a legitimate business expense. If you win, the defendant will reimburse you for the legal costs.

[Snaggletooth]

Are You Nuts?

Jainen, you've got to be kidding. I'm assuming the original post was a serious question, and I tried to give a serious answer.

In most locales, the winner is almost NEVER reimbursed for legal fees, a factor which reduces dockets and frivolous lawsuits. There are exceptions when the loser has been particularly using time-advantage and other nefarious tactics.

And for losers? The IRS has not habitually disallowed business deductions for inefficient and poor business decisions, only extravagant and non-business types and other flagrant categories. No one who goes to the expense of hiring a lawyer thinks they have no case.

I wouldn't swear my answer is 100% correct, and Brad also admits his response is not conclusive. But NEVER deductible? Good Grief Charlie Brown...

[jainen]

look at new ideas

>>Are You Nuts?<<

Well, gee, Snaggletooth. You might say I can be helpful when I want to but I answer questions with riddles.

Sure, it was a serious post, but since it's not my client I have no control over the accuracy or completeness of the information provided. By the way, neither do you. All I can do is try to put some perspective on it by exploring the kind of issues that might be buried here. Sometimes I'm right; sometimes I'm wrong. Sometimes I'm technically right but in a way that doesn't work in practice. Sometimes I know I'm wrong but I'm going to do it anyway.

Lighten up, Snag! It's just an Internet forum. You can't learn anything new here if you aren't willing to look at new ideas.

[Snaggletooth]

Veterans

Jainen, you and I are grizzled veterans on this board, and have agreed/disagreed many times. I was looking out for the guy who started this post and asked a serious question and did my best to answer him without misleading him.

That's why I'm really appalled that with your vast knowledge, you chose to give him such an answer. I'm known to "lighten up" most of the time, but I can't imagine giving this question such a misleading response -- it's not really "light" anymore and not a joke when it can be more damaging than funny. Maybe "Taxman" was astute enough to understand your answer was off-the-wall, and maybe not.

To tell you the truth, I have often read your posts totally in awe of your knowledge and keen wit, and have considered your grasp of taxes far beyond mine. Your knowledge is at the very top along with the editors and a few other very smart people. The rest of us may not be among this elite, but we know you can give very helpful and authoritative answers and are disappointed with anything less, I suppose.

[jainen]

let's take a look

>>did my best to answer him without misleading him<<

Well, then let's take a look at your answer. You said, "In situations where tax code and regulations are not defined, there is an implied application that GAAP will be upheld." Now, that is simply not true. I mean, it's a nice, creative idea that has a lot of uses, but it can't be generally supported by tax authorities. In particular, the treatment of fixed assets (like a warehouse) differs greatly between tax accounting and GAAP.

You might make an argument about ordinary business care and so on, except there is absolutely NOTHING in the original post to indicate that the taxpayer's circumstances involved a business. You are making a completely unfounded assumption when you say, "the legal expense... is chargeable to current earnings." So let's not get too worked up about what might be misleading.

[Joe Btfsplk]

[QUOTE=jainen]>>absolutely NOTHING in the original post to indicate that the taxpayer's circumstances involved a business. QUOTE]

People don't usually rent warehouses for non-business purposes. Of course, you might rent a warehouse to store your private collection of valuable art work or some other non business items.

[Taxman]

For business use

Yes the warehouse is 100% business use. The client currently owns a warehouse in Florida and is trying to expand his business by leasing another warehouse out of state in Kentucky. The client does international shipping and has a large client in Kentucky who would use my client and that warehouse.

[Brad Imsdahl]

Well, then let's take a look at your answer. You said, "In situations where tax code and regulations are not defined, there is an implied application that GAAP will be upheld." Now, that is simply not true. I mean, it's a nice, creative idea that has a lot of uses, but it can't be generally supported by tax authorities. In particular, the treatment of fixed assets (like a warehouse) differs greatly between tax accounting and GAAP.

Yes, the treatment of fixed assets does differ greatly between tax and GAAP, but that is because the code and GAAP have specific written rules defining those differences. Snag was talking about those issues that do not have specific written rules to define what is what.

Snag’s theory does have some bases of support in the code and regs. For example, Reg. Sec. 1.312-6(a) indicates that net income calculated for book purposes is an important factor in determining the E&P of a C Corporation. E&P is an important concept in calculating the taxable dividend distributions of a C Corporation.

We also have Code Section 162(a), which is a blanket statement that all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business are tax deductible. That opens up a huge door of opportunity in taking the position that if the code and regs are silent on a specific issue, GAAP rules might help in determining what is ordinary and necessary.

Remember that the basic principal of GAAP, or any other kind of acceptable accounting method, is that a current expense is something that depletes the ability to distribute profits without depleting contributed capital. Other than specific rules mentioned in the IRC and Regs, these same rules generally work for tax accounting purposes as well.

[jainen]

a good response

This is a good response and I appreciate it. I was feeling a little guilty about being so hard on Snaggletooth. To be fair, I made the same assumption about business use. It was a reasonable assumption and we now have additional information that it was correct. Still, we need to recognize when something IS an assumption.

We haven't talked much about accounting principles on this forum, and Snaggletooth did us a great service in bringing it up. It's an important perspective and we should keep it in mind.

[Snaggletooth]

Goat to Hero?

Amazing. I've somehow gone from goat to hero in 24 short hours. Only on TTB message board! Thanks guys.

If you can meet with triumph and disaster, and treat those two imposters just the same - Kipling