J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

19.18 Contingent Fees Paid Out of Taxable Awards

Contingent attorney fees paid to recover taxable damages have been held by the Supreme Court to be includible in the litigant’s income (11.7). An offsetting deduction for the fees may be available. An above-the-line deduction (directly from gross income) is allowed for attorneys’ fees and court costs in employment discrimination suits, certain other unlawful discrimination actions, and Federal False Claims Act cases. The deduction, claimed on Line 36 of Form 1040 (12.2), is limited to the amount of the judgment or settlement reported as taxable income for the year.

If the above-the-line deduction does not apply, fees for recovering taxable personal damages or job-related damages (19.17) are allowed only as a miscellaneous itemized deduction subject to the 2% AGI floor (19.1). If the alternative minimum tax (AMT) applies, fees claimed as a miscellaneous itemized deduction for regular tax purposes must be added back to income in calculating AMT (23.2), so the benefit of the deduction is lost.

Fees incurred in recovering lost business income (19.17) are deductible on Schedule C.