1. for the production or collection of income;
2. for the management, conservation, or maintenance of property held for the production of income; or
3. in connection with the determination, collection, or refund of any tax.
Section 212 is limited by the two percent (2%) floor under § 67 of the Code. Section 67 provides an individual’s “miscellaneous itemized deductions” may only be deducted to the extent that the aggregate of the deductions exceed two (2%) percent of adjusted gross income. IRC §67(a). Because of the itemized deductions floor, most clients will not benefit from a deduction for legal expenses incurred in estate planning.
The Tax Court has considered numerous cases to determine whether legal fees incurred in estate planning are deductible. One of the first cases to allow a deduction for estate planning fees, Bagley v. Commissioner, found that the law firm provided deductible legal services under §212(2). The law firm consulted the clients with regard to tax-favorable investments, loans to the corporation owned by the client family, and the review and creation of estate plans for the family members.
In Merians v. Commissioner, the court allowed a §212(3) deduction for legal fees allocated to tax advice. The court narrowly construed their decision to a deduction for only the portion of services which it considered tax advice. The attorney did not maintain accurate time entry or billing records reflecting the amount of time spent on tax-related aspects of his representation.
The Tax Court has disallowed deductions for legal fees paid for estate planning and general business guidance when the taxpayer does not have any evidence of how the fees relate to the §212 categories. The mere preparation of a will or testamentary trust will not be deductible. However, an argument can be made that the creation of a revocable living trust is a tax-motivated transaction for the management and conservation of property. Similarly, the taxpayer could argue the fees were incurred in connection with the determination (minimization) of the taxpayer’s future tax liability. Therefore, the fees should be deductible under §§212(2) and 212(3).