The Tax Court in [Chang v. Commissioner, T.C. Summ. Op. 2024-18 (Sept. 16, 2024)] allowed a taxpayer to deduct legal and professional expenses incurred in the defense of a criminal case involving business activities. The taxpayers were a husband and wife who were members of a church. The husband was in charge of the church’s finances. The husband set up two entities: a tax-exempt non-profit and a for-profit LLC. Both entities were engaged in real estate activities. In 2016, the husband was indicted on multiple criminal charges, including wire fraud and money laundering, related to transactions involving the church, the two entities he formed, and his personal accounts.
In 2019, the husband was convicted of wire fraud and money laundering. The Husband paid $365,735 in legal expenses to defend against the criminal charges, which were reported on Schedule C of the LLC he formed. The IRS issued a notice of deficiency and disallowed the deduction of legal fees. The Tax Court held that taxpayers were entitled to deduct the legal and professional expenses because the origin of the legal fees stemmed from the husband’s profit-seeking business activities as a director of the entities, even though those activities were fraudulent.
The taxpayers were successful in deducting their legal fees because the criminal case was related to a for profit entity even though those activities were fraudulent. In other words, if the origin of the claim is business related, the legal fees may be tax deductible. Legal fees to defend a personal criminal charge would not be deductible.