One common question from disabled claimants, especially around tax time, is whether the attorney fees and expenses incurred to recover their denied disability benefits are deductible. In short, attorney fees and expenses incurred to are generally not deductible under the Tax Cuts and Jobs Act of 2017. However, there are exceptions for “above-the-line” deductions, which include legal costs related to disability income benefit claims. If your benefits are taxable and you have incurred legal fees to secure them, these expenses may still be deductible.
Detailed Discussion:
Understanding the Background: Many workers file for long-term disability insurance benefits due to injury or illness, often through employer-sponsored plans. Unfortunately, claims are frequently denied, leading to the need for legal assistance. Most of these claims fall under the Employee Retirement Income Securities Act (ERISA), a complex law that often necessitates the expertise of an experienced ERISA attorney. Whether through appeals or lawsuits, claimants may incur significant attorney fees and expenses in the process.
Taxability of Disability Benefits: The taxability of disability income benefits depends on several factors, including how the premiums were paid and who paid them. If the claimant paid the premiums with after-tax dollars, the benefits are generally tax-free. However, if the premiums were paid by the employer or with pre-tax dollars, the benefits are likely taxable.
Deductibility of Attorney Fees and Expenses: Under the 2017 Trump Tax Cut, miscellaneous itemized deductions, including legal fees, are no longer deductible for federal income tax purposes. This change is in effect until December 31, 2025. However, there’s an exception for legal fees and expenses related to disability income payments. These may still be deductible or, if awarded by the court, not included in income at all.
Above-the-Line Deductions: Attorney fees based on claims that qualify for “above-the-line” deductions are still deductible. These deductions are taken from the taxpayer’s gross income to arrive at a lower Adjusted Gross Income (AGI). Disability income benefit claims fall under this category, as per IRC Section 62(a)(20) and (21), which allow deductions for costs and attorney fees involving claims of unlawful discrimination, including those related to disability income benefits.
Caveat and Warning: It’s important to note that above-the-line deductions for attorney fees cannot exceed the income received from the litigation in the same tax year. Additionally, many seasonal tax preparers may not be familiar with how to apply this deduction. It’s advisable to seek assistance from a qualified CPA or tax attorney for accurate filing.
For specific advice tailored to your situation, please contact us at 800-562-9830 or consult with a qualified CPA.
Appendix:
26 U.S. Code § 62 – Adjusted gross income defined
(a)General rule For purposes of this subtitle, the term “adjusted gross income” means, in the case of an individual, gross income minus the following deductions:
(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)) or a claim of a violation of subchapter III of chapter 37 of title 31,United States Code [2] or a claim made under section 1862(b)(3)(A) of the Social Security Act (42 U.S.C. 1395y(b)(3)(A)). The preceding sentence shall not apply to any deduction in excess of the amount includible in the taxpayer’s gross income for the taxable year on account of a judgment or settlement (whether by suit or agreement and whether as lump sum or periodic payments) resulting from such claim.
(e)Unlawful discrimination defined
For purposes of subsection (a)(20), the term “unlawful discrimination” means an act that is unlawful under any of the following:
(7) Section 510 of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1140).
(18) Any provision of Federal, State, or local law, or common law claims permitted under Federal, State, or local law—
(i) providing for the enforcement of civil rights, or
(ii) 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.