Whether attorney's fees and other costs in business litigation can be currently deducted has always been a thorny issue. The IRS recently ruled 1 that costs incurred by a taxpayer to protect against patent infringement by a competitor could be deducted currently (i.e., as the costs are paid or accrued).
The tax treatment of litigation costs are analyzed under the so-called "origin of the claim" test to determine the tax treatment, as opposed to the potential consequences to the taxpayer of the resolution of the lawsuit or the purpose in participating in the lawsuit. Under this analysis, the costs of claims relating to capital transactions (e.g., acquisitions of property) are capitalized and costs of claims related to ordinary business functions are currently deductible.
The taxpayer in the IRS ruling had licensed a patent from a related entity. Under the license agreement, the taxpayer had a contractual obligation to protect the patent from any infringement. The taxpayer brought a patent infringement claim against a competitor who countered that they had not infringed and that the patent had not been validly issued.
The IRS held that the litigation costs were deductible since the origin of the claim related to the business use of the patent. Cases and rulings have generally permitted taxpayers to deduct the costs to protect against infringement of a patent. It was noted in the ruling that if the lawsuit had related to whether the taxpayer had title or ownership of the patent, the costs would have been required to be capitalized.2 The competitor had contended that the patent was not validly issued and not that the taxpayer was not the true owner of the patent.
1 PLR 201536006 (June 1, 2015)
2 See Treas. Reg. sec. 1.263(a)-4(d)(9)
If you have questions, contact your Berdon advisor. Berdon LLP, New York Accountant