Are Estate Planning Fees Tax Deductible in Arizona?

Introduction

Like most legal questions, the answer to this question begins with “it depends.”

Tax Deductible Legal Expenses

IRS Publication 529 dictates which expenses can be itemized as miscellaneous deductions for the purpose of tax returns. According to the IRS, legal fees for estate tax planning services may be tax deductible if they are incurred for one of the following purposes:

  • The production or collection of income
  • The maintenance, conservation, or management of income-producing property
  • Tax advice or planning, especially regarding the determination, collection or refund of any taxes

That means if your estate plan includes advice regarding the construction of income-generating instruments (such as a trust), the legal fees related to that service are tax deductible. Another example would be advice regarding estate taxes, whether it involves forming a general strategy to minimize potential taxes, or transferring assets to avoid an inheritance tax.

Outside of estate planning, there are a few other legal fees that qualify as miscellaneous deductions. These include legal fees related to:

  • Performing or maintaining your job
  • Tax advice or planning for a divorce
  • Collection of taxable alimony
  • Resolving tax issues stemming from business profits or losses
  • Rent or royalties from property
  • Farm income or expenses

Non-Deductible Legal Expenses

Publication 529 also explains which legal expenses are not tax deductible. These are considered personal legal expenses because they do not directly pertain to taxes. The list includes:

  • Preparation of a will, power of attorney, or medical directive
  • Breach of a promise to marry suit
  • Property claims or settlements from a divorce
  • Custody of children
  • Civil or criminal charges pertaining to a personal relationship
  • Preparation or defense of a title
  • Damages for personal injury

Understanding the Difference Between Income Taxes and Estate Taxes

While everyone is required to file a tax return with the IRS each year, only about 0.1% to 0.2% of estates are valued high enough to be subject to an inheritance tax when an individual passes away. As of 2017, individual estates with less than $5.49 million are exempt from estate taxes. Joint estates are allowed up to $11 million in assets before they are subject to the tax. The estate tax may be as high as 40%, but the average percentage is usually closer to 17%.

How to Deduct Qualified Legal Expenses From Your Income Taxes

Your attorney will provide an array of services in the course of constructing and managing your estate. As stated previously, some of these services are tax-deductible, and some are not. To itemize qualified legal expenses as miscellaneous deductions, your attorney will need to distinguish in the invoice what portion of their services are tax-related. For example, your attorney could state that 25% of their fees were for your will (non-deductible), and the remaining 75% were for income and estate tax planning. The actual percentage of your bill that is ultimately tax-deductible will vary from case to case, but it’s common for 60% to 75% of estate planning legal fees to be deductible.

Keep in mind that qualified deductions are subject to the 2% miscellaneous deduction rule. Once the total deduction is calculated, the IRS will subtract 2% of your adjusted gross income (AGI) from the final figure. For example, if your miscellaneous deductions amount to 5% of your adjusted gross income, the IRS will deduct 2%, and allow you to deduct the remaining 3% from your taxable income.

Questions to Ask Your Estate Planning Attorney

Many estate planning attorneys already bill separately for tax-deductible services, but it’s still a good idea to address the topic with your attorney early in the process. The best time to discuss it would be in your initial consultation, while you are evaluating the potential fit with this particular attorney. In addition to addressing the billing practices, consider asking the attorney some of the following questions to get a feel for their process.

How Much of Your Practice Deals with Estate Planning?

There’s a difference between estate planning attorneys and attorneys who do estate planning. If your estate is simple and you aren’t at risk for estate taxes, then this distinction is less important. If your estate plan involves any complexities, or is large enough to put you at risk for estate taxes, then you’ll want to work with an attorney who specializes in estate planning. Look for someone who spends at least 50% of their time on estate planning, and who has complimentary experience in probate, taxes, and elder law.

Do You Charge a Fixed Rate, or By the Hour?

Many clients prefer a fixed rate over hourly billing so there is no surprise when the final invoice comes in the mail. Your attorney should be able to provide you with an estimate based on the work expected for your case. Keep in mind, however, that this is only an estimate. If any unexpected complications arise in the process, the attorney may charge additional fees to cover the extra work, so be sure to ask what the rate would be if that happens.

How Often Do You Hold Account Reviews?

The legislative landscape is liable to change over time, and chances are your situation and goals will change over the years, too. If your estate plan is simple and your personal situation doesn’t merit changes, then you should reassess your planning documents every 3 – 5 years. However, a good attorney should check in with you annually—even if it’s just by phone or email—to review your plan and address the need for any adjustments.

If Applicable, Will You Be Able to Assist Me With Transferring My Assets Into a Trust?

Depending on your situation, your attorney may advise you to establish a trust as part of your estate plan. Many estate planning attorneys have an assistant or small department to assist you in transferring assets to the trust, but not all attorneys do. At a minimum, they should be able to provide you with detailed, written instructions on how to transfer assets to the trust. The process can be complex and overwhelming, though, so it’s best if they can actually help you through the process.

Call Our Arizona Estate Team at (480) 467-4325 to discuss your case today.

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