As a self-employed individual or small business owner, you may incur various professional fees over the course of a tax year. Determining what qualifies as a tax-deductible professional fee can be confusing. This comprehensive guide will explain what professional fees you can claim as tax deductions.
Overview of Tax Deductions for Professional Fees
If you pay for professional services to help you carry out your business, the fees are typically tax deductible. Deductible professional fees include amounts paid for legal, accounting, consulting, and other professional advice services. However, personal professional fees are not deductible.
To qualify as a tax deduction, a professional fee must be both ordinary and necessary for your business. This means the service is commonly used in your trade or business and is appropriate for your business operations. Essentially, deductible professional fees should directly relate to producing business income.
You can deduct professional fees paid for both in-house employees and external consultants and service providers. However, professional fees categorized as capital expenses may need to be deducted differently. Additionally, some limits apply to the amounts you can deduct.
Legal Fees
Most legal fees that relate to your business operations are deductible professional fees. This includes amounts paid for:
- Business formations fees when establishing a business entity
- Legal services for drafting partnership agreements, buying or selling a business, reviewing business contracts, etc.
- Patent, copyright, and trademark registration fees
- Legal defense against business issues (e.g. tax disputes)
- Legal advice related to employee issues
You can also deduct legal fees paid for tax advice related to your business and representation during an IRS audit. However, personal legal fees for issues like custody disputes, traffic violations, criminal charges, etc. are not deductible.
Example of Deductible Legal Fees
James hired a law firm to provide legal services for incorporating his new business. He paid $5,000 in legal fees for this service. Since the fees were directly related to establishing his business entity, the $5,000 are deductible professional fees.
Accounting and Tax Preparation Fees
Accounting fees for regular business accounting services are fully deductible. This includes amounts paid for:
- Bookkeeping
- Preparing financial statements
- Business tax preparation
- Payroll services
If you hire an accounting firm to handle your business bookkeeping, financial reporting, and tax preparation, these fees are deductible. You can also deduct amounts paid for tax preparation software and tools used solely for your business.
Example of Deductible Accounting Fees
Oscar runs a small retail shop. He paid an accounting firm $3,000 over the course of the tax year for bookkeeping services, preparing quarterly financial statements, and preparing his annual business tax returns. The $3,000 paid for these accounting services are deductible professional fees.
Consulting Fees
Consulting fees paid to improve your business processes, operations, or strategy are generally deductible. For example, you can deduct fees paid to consultants for:
- Business strategy and development consulting
- IT consulting and security assessments
- Operations management consulting
- Financial management consulting
Deductible consulting fees also include amounts paid to specialists like engineers, architects, and scientists for professional advisory services relevant to your business. However, you cannot deduct personal consulting fees like marriage counseling.
Example of Deductible Consulting Fees
Julia owns a small chain of pizza restaurants. She hired a restaurant consultant for $4,000 to assess her business operations and provide advice on improving profit margins. The $4,000 paid for these consulting services are deductible professional fees.
Payroll Fees for In-House Employees
When you hire employees to work in your business, any fees related to payroll and HR services are deductible. These include amounts paid for:
- Processing payroll
- Payroll tax filings
- New employee background checks
- Benefits administration
- HR and labor compliance services
You can deduct fees paid to external payroll service providers. Amounts paid as salaries and wages directly to your employees are deductible as well. Payroll fees unrelated to your business are not deductible, however.
Example of Deductible Payroll Fees
Jake hires two full-time employees for his business. He paid a payroll services company $2,000 over the year to process payroll, submit payroll taxes, and provide HR support. These $2,000 in fees related to his employees are deductible payroll fees.
Commissions and Fees
Commissions and fees paid to non-employees for services provided for your business are deductible. For instance, you can deduct amounts paid for:
- Sales commissions to an independent contractor who secures sales for your business
- Commissions paid to affiliate marketers who refer customers
- Payment processing fees charged by online payment services
- Fees paid to freelance designers, writers, etc.
To prove the commissions or fees are tax deductible, you should have a written independent contractor agreement and record of services provided. You must also issue Form 1099-NEC to any individual non-employee paid over $600.
Example of Deductible Commission Fees
Julia sells her handmade jewelry online. She paid a 10% sales commission of $5,000 over the year to an online influencer who promoted her jewelry. This $5,000 commission fee is deductible as a professional fee.
Professional Membership Dues
Professional or trade association membership dues related to your business activities are deductible. For example, deductible dues include amounts paid to:
- Industry trade groups
- Professional societies
- Chambers of commerce
- Business leagues
However, amounts paid to social, athletic, luncheon, or sporting clubs are not deductible. If membership dues cover both deductible business and nondeductible personal benefits, you can only deduct the business portion.
Example of Deductible Membership Dues
Gary owns an insurance agency and pays $500 in annual membership dues to his local chamber of commerce. Since the chamber provides networking and business development resources, the $500 in dues is deductible.
Appraisal Fees
Professional appraisal fees are deductible when paid to value business assets or property. For instance, you can deduct appraisal fees for:
- Valuing real estate or equipment before purchasing for your business
- Appraising the value of business inventory or fixed assets
- Assessing the value of a whole business for potential sale
You cannot deduct fees paid to appraise non-business personal assets like jewelry, art, or your home. The cost of appraising donated property may be factored into the charitable contribution deduction, however.
Example of Deductible Appraisal Fees
Martha owns a machine shop and paid an engineer $1,000 to assess the value of her equipment before selling the business. The $1,000 appraisal fee is deductible as a professional fee.
Limits on Professional Fee Deductions
In most cases, professional fees directly related to your business operations can be fully deducted in the year paid. However, some potential limits apply in certain situations:
- 2% limit on miscellaneous deductions (suspended through 2025) – Miscellaneous professional fees were previously subject to a 2% of AGI limit, but this limit was suspended under the TCJA through 2025.
- 50% limit on meal and entertainment deductions – Only 50% of professional fees related to meals and entertainment are deductible, such as fees paid for a business dinner.
- Capitalization of certain professional fees – Fees paid for services related to acquiring, creating, or improving a business asset may need to be capitalized and deducted over time.
It’s important to correctly categorize professional fees to ensure proper deduction treatment and avoid IRS scrutiny. Keep accurate records of all professional services paid for your business.
Carryover of Excess Professional Fees
If your total deductible professional fees and other business expenses for the tax year exceed your business income, you may have a net operating loss (NOL). Rather than letting excess deductions go to waste, you can carry forward an NOL to offset taxable income in future years.
For example, if you had $10,000 in deductible professional fees but only $7,000 in business income this year, you would have a $3,000 NOL. You could carry forward this NOL to offset $3,000 in income next year. Depending on the type of NOL, you may be able to carry it forward indefinitely until it’s fully utilized.
Accurately Tracking Professional Fee Deductions
To claim tax deductions for professional fees, you must be able to prove the services were ordinary and necessary for your business. Be sure to obtain invoices and receipts for all the professional services you pay for. Track deductions accurately in your books throughout the year.
The type of supporting documentation you should maintain depends on the nature of the professional fee:
- Legal, accounting, consulting, etc. – Invoice showing service description, date, amount paid
- Payroll – Payroll service invoices, employee pay stubs
- Commissions/fees – Independent contractor agreement, Form 1099-NEC
- Membership dues – Receipt showing business portion paid
- Appraisal fees – Written appraisal report
With proper documentation, you can feel confident claiming tax deductions for all qualifying professional fees. Consider working with an accountant to implement a thorough recordkeeping process.
Common Questions about Deducting Professional Fees
Are credit card processing fees deductible?
Yes, typical merchant account fees and payment processing fees charged by credit card companies are deductible as professional fees. This includes setup fees, monthly service fees, and per-transaction processing fees. Keep detailed statements showing all processing costs.
Can I deduct professional fees paid in cash?
Professional fees paid in cash are still deductible as long as you maintain proper documentation. Get a signed receipt showing the date, amount paid, and service provided. Without evidence to prove you paid the fees, your deduction could be challenged.
Are professional fees deductible by both employees and employers?
In general, employees cannot deduct professional fees unless they qualify as miscellaneous itemized deductions (suspended through 2025). However, an employer can deduct professional fees paid related to their business activities.
Are personal legal fees deductible?
Unfortunately, legal fees for personal matters like family disputes, criminal charges, or traffic violations are not tax deductible. The fees must relate directly to your business operations to qualify for a deduction.
Conclusion
Deducting professional fees can provide a significant tax reduction for your business. Make sure to track expenses carefully and maintain proper documentation. Seek guidance from a tax professional to identify all deductible professional fees you are eligible to claim. With the right tax preparation strategy, you can maximize write-offs for any fees paid to operate your business.