Are employment-related legal fees still deductible in California?

[Stockmoose16]

I had an employment-related lawsuit that ended in a settlement.  I understand that the misc. deduction for legal fees was removed in 2018, but because my case was employment-related, I took an above-the-line deduction on my Federal taxes.  I'm wondering if this same deduction applies to my CA taxes?  

Also, did CA eliminate the misc. legal fee deduction, or is that just a Federal statute?

[maglib]

You can deduct legal expenses that are related to doing or keeping your job, such as those you paid to defend yourself against criminal charges arising out of your trade or business.

 - Employment cases. You may be able to deduct legal fees related to certain employment cases, such as a claim of unlawful discrimination, a claim against the U.S. government, or a claim made under the Social Security Act, as an adjustment to income. These fees are  NOT limited to 2% of your AGI or subject to phase-out for AMT purposes .

• In your open Federal return, choose the tab for Wages & Income
• Scroll down to Less Common Income and Show more
• Start/Revisit Miscellaneous Income and choose Other reportable income 
• Say Yes to continue to the screen "Other Taxable Income". Enter the description "Qualifying Legal Fees" and the amount as a negative number. 

A corresponding subtraction will be entered on Line 21 of your return.

1. Clients can still deduct attorney’s fees based on claims that qualify for “above the line” deductions.

“Above the line” deductions are set forth in Internal Revenue Code (“IRC”) Section 62 and are deducted against the taxpayer’s gross income to reach a lower Adjusted Gross Income (“AGI”). “Below the line” deductions are set forth in IRC Section 63 and are deducted against AGI to reach a lower taxable income. The “line” is set by the Adjusted Gross Income.

The standard deduction or itemized deductions are “below the line” deductions. Because legal fees based on claims that qualify for above the line deductions are deducted before taxpayers apply itemized deductions, the repeal of the miscellaneous itemized deduction has no impact on their deductibility.

2. Which claims qualify for above the line deductions?

a. Discrimination suits (especially employment claims) and attorney’s fees relating to awards to whistleblowers.

IRC Section 62(a)(20) and (21) allow a taxpayer to deduct costs involving discrimination suits and attorney’s fees relating to whistleblower awards. Specifically, under IRC Section 62(e)(18), unlawful discrimination is defined to include: “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.”

3. Clients do not need to include attorney’s fees (i.e., money damages that were awarded to pay for attorney’s fees) in their income.

Excludable fees include: (i) compensatory damages awarded under a pure physical injury case with no interest and no punitive damages; (ii) court awarded fees; and (iii) statutory attorney’s fees.

4. Reporting

a. Discrimination suits or whistleblower awards

Taxpayers filing Form 1040 for 2018 wishing to take an “above the line” deduction for their attorney’s fees related to discrimination suits or whistleblower awards must attach Schedule 1. The deduction will be considered a “write-in” adjustment. The type and amount of the deduction must be reported on the dotted line of Schedule 1, Line 36, since no other line has been allocated to it (please consult with your tax specialist about how to properly identify the deduction as specific acronyms exist for different deductions). All deductions from Schedule 1 will then flow to Line 6 of the taxpayers’ Form 1040.

b. Trade or business expenses

Taxpayers who do business as a sole-proprietorship for federal tax purposes wishing to deduct attorney’s fees as part of the business must attach Schedule C to their Form 1040 for 2018. Attorney’s fees incurred as an “ordinary and necessary” expense of the business can be deducted in Schedule C, Line 17.

c. State conformity to the 2017 Act

States generally rely on taxpayers’ federal taxable income to calculate how much will be owed by them at the state level (with some adjustments).   It is recommended that taxpayers consult with an attorney or accountant before taking a position on what deductions are available to them in a state.

[philscharber]

Seems that for the 2019 tax year the schedule 1 no longer has a line 36.  So, where would we enter the "qualifying legal fees" for an above the line adjustment to income?

[MaryK4]

In TurboTax, you would enter under Federal Taxes--> Wages & Income--> Less Common Income--> Miscellaneous Income

Other Reportable Income

On the tax forms, it would be on Schedule ! Line 8 as a negative number.

@philscharber

[Stockmoose16]

This appears to be for the Federal deduction. I understand you can still take an above the line federal deduction for certain discrimination cases, but what happens when you get to the CA return. Do you take that same deduction as above the line? Or do you take it as misc deduction for the state return? 

[MaryK4]

California uses the federal adjusted gross income as the base of its tax calculation then makes additions or subtractions for specific items. The above the line deduction would be included in the AGI, and since California does not have it as an addition to put it back into taxable income, you would not have to make any adjustments in the California state section.

@Stockmoose16

[LaJolla]

Are legal fees to obtain employment related benefits (i.e. long-term disability benefits governed by ERISA) considered an above the line deduction regardless of the stage of the appeal (i.e. administrative appeal vs litigation)? 

It is my understanding that the proper characterization of legal fees simply depends on the origin of the claim, and it doesn't matter if the contingency fees arose during the administrative appeal process or through litigation; however, I cannot find anything which supports that point of view.

My legal expenses are directly connected with recovery of employment-related benefits, and this appear to be an above the line deduction as per AJCA, Section 703 of H.R. 4520 and 26 USC 62(e)(18), butI am just uncertain if this tax code only pertains to litigation or also is applicable to legal fees incurred during the administrative appeals.   Does anyone know and have a reference for this tax treatment of legal fees?

[DawnC]

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 are miscellaneous itemized deductions and are no longer deductible.

.You can deduct legal expenses that are related to doing or keeping your job, such as those you paid to defend yourself against criminal charges arising out of your trade or business.

.

You can deduct expenses of resolving tax issues relating to profit or loss from business reported on Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship), from rentals or royalties reported on Schedule E (Form 1040), Supplemental Income and Loss, or from farm income and expenses reported on Schedule F (Form 1040), Profit or Loss From Farming, on that schedule.   Expenses for resolving nonbusiness tax issues are miscellaneous itemized deductions and are no longer deductible.

Reference - IRS Publication 529.    @LaJolla

Can I Deduct Legal Fees on My Taxes?

[LaJolla]

I am uncertain why you said these legal fees would be classified as an "expense to collect taxable income".

The origin of the contingency fees was to overturn an unjustified denial of a long-term disability claim governed by ERISA and this falls under 26 USC 62(e)(18) (IRS private ruling Number [removed]).  However, this tax code is a vague, and its unclear if the above the line deduction is only applicable during litigation or if it also cover the administrative appeal process which is required by ERISA regulation prior to proceeding to litigation.

IRC Section 62 (20) Costs involving discrimination suits, etc.  

Any deduction allowable under this chapter for attorney fees and court costs paid by, or on behalf of, the taxpayer in connection with any action involving a claim of  unlawful discrimination (as defined in subsection (e)) ----   IRC Section 62(e)(18), unlawful discrimination is defined to include: “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. 

The above tax code specifically says "suites, etc." and "any action", and it does not state the tax code is only applicable during the litigation, and for all employer benefits governed by ERISA the employee MUST go through the internal administrative appeal, prior to submitting a lawsuit). Therefore, I wanted to know if anyone is familiar with this particular tax code

[maglib]

@LaJolla  you are posting on a 2019 post and that is old tax law.    If you are interested in 2019 laws as the disability monies would not be taxable income the the legal fees would not be deductible is basically what it ultimately comes down too.  In connection with employment and benefits is taxable income. You are now looking at disability claims. Legal fees for SSD benefit claims are not deductible which could in your argument always be stretched to go back to someone's employment income.  You can always argue your case of course and you can always take your deduction, the question is will you succeed?  All the best.  I do like your case law try though.  Itemized deduction have been severely limited with the large increase in the standard deduction.  

[LaJolla]

The tax code pertaining to deductibility of most legal fees as a misc expense changed in 2018 due to passage of TCJA.

The Tax regs (AJCA, Section 703 of H.R. 4520, (Sec. 703)) pertaining to the above the line deduction for certain legal fees including "discrimination" cases/employment related benefits, civil rights, whistleblower etc. were passed in 2004 and no changes with TCJA.

Therefore, there really isn't any difference between the tax code in 2019 and now.

In my case my employer paid for my long term disability benefits so its 100% taxable to me.

IRS private ruling (number [removed]) agreed that legal fees incurred to obtain taxable employer sponsored benefits governed by ERISA (IRA, disability benefits and others) are deductible as an above the line deduction in accord with IRC Section 62(e)(18). My only question is whether the legal fees that are incurred outside of litigation, i.e. during the administrative appeal process, would also be considered aan above the line deduction.