What to Know About Estate Planning Attorney Fees
Understanding Attorney Fees for Estate Planning
Similar to Medicare premiums and other health care expenses, attorney fees paid for estate planning are not deductible. If you are in a higher income tax bracket, the 3.8 percent NIIT (net investment income tax) could further increase the estate planning costs . In general, fees paid for estate planning preparation and consultation are for the creation and/or performing of a will, revocable trust, various life insurance trusts, and the like.
The services usually performed by an estate planning attorney include preparing estate planning documents, conferences with clients, corresponding with financial institutions, providing deeds, and other documents, and planning of asset disposition at death.
Estate Planning Legal Fee Deductibility
The general rule is that attorney’s fees for estate planning on behalf of a decedent or a trust are not tax deductible on the income tax returns of the taxpayer. A taxpayer cannot deduct legal fees incurred to create an estate plan because legal fees paid to create, acquire, or to preserve a capital asset are a capital expenditure, or to protect, produce, or improve income producing property may be capitalizable if they relate to a non current asset. See Reg. § 1.212-1(k); Reg. § 1.263(a)-2.
If the legal fees are incurred after death they are deductible on the income tax return of the personal representative (federal Form 1041) as administrative expenses. The only deduction that is permissible with respect to administration of an estate for income tax purposes is the deduction for administrative expenses in obtaining and receiving the property of the decedent. This deduction includes probate and other estate administration expenses. See § 2053(a).
Legal expenses paid or incurred after the decedent’s death that are incurred solely for the production or collection of income or the management, conservation, or maintenance of property held for the production of income are allowable deductions. Furthermore, where a decedent claims a deduction because estate administrative expenses were required to distribute the estate under local law, 20.1 Private Letter Ruling 9539058 (July 10, 1995).
Legal fees incurred with respect to the defense of a claim against a decedent or trust would not be income tax deductible.
Because legal fees are not incurred to produce income and the creation of an estate is not income producing property, legal fees incurred in the drafting of a Will are not income tax deductible. If the attorney is consulted or has prepared a Will after the decedent’s death then the attorney’s fees are part of the cost of administration and are an income tax deduction on Form 1041 by the estate or trust or an ancillary estate.
New IRS regulations provide clarification on deductions for legal expenses. The regulations adopt an exclusive list of deduction rules under §162 and §212. Treas. Reg. §1.274-2(b)(1)(i). The regulations allow taxpayers to deduct expenses paid for the exclusive benefit of another party or on behalf of another party under §162 that do not interfere with or detract from the performance of service. Treas. Reg. §1.274-2(b)(3)(i), but this does not apply to estate planning legal fees.
IRS Regulations for Deducting Estate Planning Attorney Fees
The IRS allows taxpayers to claim a miscellaneous deduction for certain types of expenses, including expenses relating to the management of property held for production of income. However, to qualify for the deduction, the direct and proximate connection between the expenditures and the income-producing property must be established.
Under the general rule, miscellaneous deductions are subject to the 2% floor. A taxpayer’s miscellaneous deductions must exceed 2% of the taxpayer’s adjusted gross income (AGI) before the deductions can be allowable. Further, expenses paid or incurred in connection with the determination, collection, or refund of any tax are deductible. Miscellaneous deductions, however, are disallowed if they are deemed a non-business item.
While there is an exception that allows a taxpayer to deduct professional fees among the miscellaneous deductions, it does not apply to estate planning fees. Legal fees commonly paid in connection with preparing a will are not deductible, as are fees paid for estate tax planning.
The American Jobs Creation Act of 2004, P.L. 108-357, amended Internal Revenue Code (IRC) § 67 and suspended the overall limitation on itemized deductions for taxable years beginning after December 31, 2008, and before January 1, 2011. Thus, the "miscellaneous deduction" for fees paid for an estate plan may be deducted without regard to the 2% limitation.
Prior to the enactment of the American Jobs Creation Act, law firms were divided by whether, and to what extent, they would deduct the fees paid for estate planning. In PLR 8935003, a law firm argued that estate planning fees were deductible up to 10% of the gross income of the law firm, but the IRS issued a favorable ruling to the law firm that treated the fees as miscellaneous deductions.
Essentially the same argument was made in PLR 9308012; however, this time the IRS disallowed the miscellaneous deduction. In Rev. Rul. 81-353,1981-2 C.B. 191, the IRS ruled that the amount charged by an attorney was not deductible, unless related to taxable income of the client. Because the fees were not incurred in connection with a taxable event, the judge/counsel fees were not deductible as miscellaneous deductions under IRC § 212.
In Notice 2008-84, the IRS announced the temporary suspension of the overall limitation on itemized deductions for 2008 and 2009, and allows the taxpayers to take miscellaneous deductions without being subject to the 2% limit, thus reopening the door to allow estate planning fees as miscellaneous deductions to be deductible to the extent they exceed 2%, at least until the end of 2010.
There has been an urban myth circulating that the IRS will audit every filing that deducts fees paid for estate planning on Schedule A. While there may be several frivolous cases of requesting a deduction for estate planning fees, the IRS does not routinely audit every return that deducts these fees on Schedule A, and the IRS has provided support for doing so (until the end of 2010).
Qualifying Requirements to Claim a Deduction
To figure out if some or all of your attorney fees are deductible, you must first determine whether or not your planning expenses meet one of the following tests:
- Ordinary business expense. For tax years beginning before January 1, 2018, if the estate plan is directly connected to a business you own that you manage yourself, the fees may be deductible as a business expense. Proper documentation and categorization are required.
- Ordinary and necessary expense. If the planning services were ordinary and necessary for your health care, the fees may be deductible as a medical expense . Again, proper documentation and classification are required.
- Investment-related fees. Fees that would normally be paid for investment advice are deductible if the estate plan is about asset management.
- Income production expense. Planning fees are deductible as an income production expense if they are necessary for the production of income. This category includes planning for charitable giving. Proper documentation is essential.
- Tax advice. Of course, if the planning services involved tax advice they may be deductible.
Deductible Planning Fees Misunderstood
There are common misunderstandings about deductible attorney fees which may make it seem as if a greater portion of your estate planning is deductible than might be allowed. Most people know that if you pay your attorney to defend you in a lawsuit, those costs are deductible by the loser as a business or personal loss. And similarly, if you pay an attorney to collect or secure a contract you are owed, the fees you paid to secure it are deductible as either business expenses or a personal loss, depending on whether you are a business or not. But people seem to think that paying an attorney for estate planning is like securing a contract, and by hiring an attorney to create a Will or a Trust, somehow you are asking them to collect something from yourself – i.e., your estate – and that the expense is therefore sort of the same sort of loss.
But that is not true for two reasons: First, your estate does not exist when you pay your attorney to create an estate plan for you. When you hire me to write you a Will or a Trust, I don’t go and set up an estate for you. It is just like having me come write a business contract. When we complete the estate planning paperwork, there is no bucket in which the assets "live". In fact, it’s worse than that, because with a business contract, you could hire me to draft the agreement, and then go and sign it… but you cannot do that with an estate plan. With an estate plan, there are certain benefits that cannot take effect until you die. At the moment you sign your Trust, you have no assets in the Trust, and the Trust itself isn’t even considered for tax purposes to even exist yet. Therefore, because you’re paying for a plan that does not take anything from you, it doesn’t function the same as a contract for an item you already own. You cannot say, "my estate owes it to me", because as far as the world is concerned, you have no estate to speak of. Your estate does not owe you anything just because you paid your attorney for an estate plan.
Second, even if there were such a thing as having an estate that owed you money because you paid for an estate plan, the estate tax laws clearly state that "whenever any person shall be indebted to a decedent at the time of the decedent’s death, so much of the indebtedness as does not exceed the amount of the indebtedness . . . shall be included in the gross estate." 26 U.S.C. § 2044. Thus, estate debt, by statute, cannot exceed the assets of the estate. In other words, you cannot have an estate that owes you more than its worth. Thus, if you are paying your attorney $1,500 to draft a Will, your estate will be worth at least $1,500 more than it would have been had you not hired that attorney. Therefore, estate planning expenses are not actually deductible.
So, my conclusion is that attorney fees for estate planning are not deductible.
Be Prepared to Claim Tax Savings
As part of your overall estate plan, it is important to consult with a tax professional to determine any potential tax benefits from the planning you have done. Many different strategies can be used to minimize taxes. It is important to act before the end of the year to make tax saving decisions. Once you have worked with your tax professional to determine what deductions and credits are available to you , the information should be documented in the same manner and with the same level of detail as required for the specific deduction or credit. You should also keep records of your communications with your tax professional so that you have proof on the actions taken to maximize your tax benefits. By doing so, you proactively demonstrate to the IRS your diligence with regard to your taxes.