A legal expense is generally deductible if the dispute or issue arose in the course of your business or employment or involves income-producing property. Legal expenses for personal lawsuits are not deductible unless you recover taxable damages. Legal fees incurred in obtaining an award of tax-free damages, such as for physical injuries (11.7), are not deductible.
If you are self-employed, your deduction for legal fees arising from a business-related dispute is claimed on Schedule C. Legal expenses related to your job as an employee or to investment activities are claimed as miscellaneous itemized deductions subject to the 2% AGI floor, except for fees relating to employment discrimination claims, which may qualify for an above-the-line deduction (19.18). The IRS may disallow the deduction on the ground that the legal dispute does not directly arise from the business or income activity. Thus, for example, the cost of contesting the suspension of a driver’s license for drunken driving is not deductible despite a business need for the license; the suspension arose out of a personal rather than a business-related activity. A deduction may also be disallowed where the dispute involves title to property.