Expert: John Kirk, CPA Date: 7/26/2008 Subject: S- corp and legal fees
Question QUESTION: I own an S- corporation. I sued on behalf of myself and the S-corporation to collect income that would have been taxable (to the S-corp) if I had won the suit. I lost the suit. Does that count as “attempting to produce or collect taxable income”? I claimed it as a misc deduction as I paid the fees from my personal account since the S-corporation is inactive. If the misc deduction is disallowed since I lost the suit and no taxable income was received could I now file an S-corp return and generate a loss. This would be the only activity of the S-corp.
Thanks
ANSWER: The answer depends on if there was a valid sale. Your question seems to indicate that the court found that it was not income.
If so, what is it?
Since the income was not valid, no income should have been recorded, so a reversal of the income is required and the legal expense associated with the collection is a valid legal expense to the corporation.
We would need to see the court's opinion to further anaylse the transaction.
John Kirk, CPA
www.johnkirkcpa.com
---------- FOLLOW-UP ----------
QUESTION: New York State is taking the position that that the line on page 193 of Pub. 17 In the section Other Expenses (Line 23)
1. To produce or collect income that must be included in your gross income.
superceded the line in The Federal Income Tax publication 17 on page 194 regarding Legal Expenses says you can “deduct legal expenses that you incur in attempting to produce or collect taxable income”
and that if you did not actually produce and collect the income but merely sued in an attempt to produce and collect the income it is not deductible.
They claim that any miscellaneous expense such as that for managing conserving or maintaining property held for producing income, investment fees and expenses etc. are not deductible unless they produce income that is reported on your return.
Thus, if you paid a bank to be the custodian of your Google shares and/or paid an investment advisor to manage an account that held only shares such as Google that did not produce any income that year, the fees to the bank and advisor would not be deductible.
There was no sale involved, rather a jury found that the contract was breached, but found estopple. However, that is not the issue, under NY States interpretation even if I won the case but was unable to collect any money because the other party declared bankruptcy, the legal fees would still not be deductible because no taxable income was "reported"
Answer So according to the court you are paying damages for breach of contract. Since the damages are not deductible, legal expenses associated with that are not deductible as well.
If you had won the case, you would have received taxable income and the expenses would have been deducted.
