The Tax Cuts and Jobs Act of 2017 (the “2017 Tax Act”) reduces the income tax rates of most individuals, businesses, and other entities in the United States while simultaneously eliminating deductions in many areas. Some commentators have said this is an effort to simplify the Internal Revenue Code while others say the effect of the lower tax brackets is offset by the unavailability of deductions that were previously allowed under the old tax law.
The 2017 Tax Act begins on January 1, 2018, and ends on December 31, 2025. One of its most significant provisions is that it eliminates many itemized deductions. Under the old tax law, an individual taxpayer who took itemized deductions on his or her personal income tax return rather than the standard deduction was able to deduct legal fees that exceeded 2% of his or her adjusted gross income. As a result of the 2017 Tax Act, taxpayers can no longer deduct most types of legal fees as an itemized deduction.
This change could adversely impact clients and attorneys alike. For example, if a plaintiff settles a case for $1.5 million but incurs $500,000 worth of attorney’s fees, the plaintiff could now be taxed on the full $1.5 million recovery without any offsetting $500,000 deduction for the attorney’s fees. However, there are many common situations where the clients may deduct the legal fees.
Section 62(a)(20) of the Tax Code allows plaintiffs to deduct fees and expenses incurred in pursuing those claims involving “unlawful discrimination.”
The term, “unlawful discrimination,” is defined as: “any provision of Federal, State, or local law, or common law claims permitted under Federal, State, or local law… regulating any aspect of the employment relationship, including claims for wages, compensation, or benefits, or prohibiting the discharge of an employee, the discrimination against an employee, or any other form of retaliation or reprisal against an employee for asserting rights or taking other actions permitted by law.” The deductibility of legal fees and expenses of pursuing such claims remains unchanged with the 2017 Tax Act.
Plaintiffs in cases involving unlawful discrimination (i.e., most employment claims) may still deduct attorney’s fees and costs. However, plaintiffs with claims other than those related to unlawful discrimination or whistleblower claims may not be able to deduct fees and costs. Individuals should know whether legal fees will be deductible before pursuing any claims on agreeing to any settlements, as what they will receive after taxes could affect their decision to pursue the claim or the amount for which they would settle it.
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