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Dear Tax Experts,

In 2011 and the beginning of 2012 I was in a legal fight with a company I held a minority interest in. The result was a settlement that involved the sale of my interest back to the company. Without getting into the details, it was obvious from the beginning that the sale would occur - the only issue really in dispute was valuation.

In 2011 I deducted my legal expenses under schedule A after speaking with a CPA. Now in 2012 I'm stumped. The settlement closed early in 2012 and I had reached a flat-fee agreement with my lawyer and paid those in advance in 2011, leaving only some court reporter and copying costs in 2012. My legal expenses for 2012 were relatively minor (<$1,000). With a 12 year holding period, the amount realized from the sale should be treated as a long-term capital gain.

Now I know I can treat this as a Schedule A item again. That will effectively leave it unreported because those expenses won't exceed 2% of my income. But it leaves me with a question that might not be worth asking a CPA because the resulting tax savings would only be around $125.

The question is, Can I deduct my remaining 2012 legal expenses as part of the "Selling Expenses" I incurred for this transaction?

I said this is only worth around $125 because at most I could use it to reduce my long-term capital gain. Also I'm pretty sure this doesn't matter, but as additional background the settlement proceeds were paid to my lawyer and he paid me from his escrow account.

BTW, IRS publications appear to be intentionally vague on what is "Selling Expenses". It seems to allow legal expenses, including attorney's fees; but it doesn't spell out what that might be in great detail other than for the sale of real property - and that's not really helpful to me here because you could argue that there are strong similarities in my case, even though this is the sale of privately held common stock.

Thoughts? Opinions? If I spend money on a CPA's opinion, I might wind up out the cost of his time and receive no benefit - other than avoiding interest and penalties, assuming I get audited and my mistake is caught. I'm also pretty skeptical about the IRS giving me any help on the matter. I called them last year about if and where I could deduct such an expenses and the two staffers I spoke with both said it was outside their training.

So rather than pursue the matter with a CPA first, I thought I would ask for some free advice here instead. If you guys say it's a matter for a Schedule A, then I'll just leave my gain as-is. If you think I'm on the right track, I'll consider asking a CPA.

Finally I've thought of one additional question, Should the company have sent me any type of tax form (such as a 1099) reporting the sale? I've not received anything and I'm betting I won't.

Thanks in advance,
- Joel
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Fools,

While I wasn't really expecting an answer in my favor ... or expert advice one way or another, I was hoping someone might be willing to express some kind of opinion - even if it's to just call me crazy for asking.

At this point I'm assuming I can't deduct these legal expenses from the sale price - even though that would be logical. After all, you often can't apply logic to the IRS.

What is frustrating here is that when in doubt (and the amount isn't too significant), the default action seems to be to just pay up. I was hoping someone would either confirm that they thought paying it was the right thing to do ... or that I might be on the right track with treating it as a selling expense and should talk to a CPA again.

- Joel
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Can I deduct my remaining 2012 legal expenses as part of the "Selling Expenses" I incurred for this transaction?

Let me put my answer this way. I don't know if you can, but in your shoes, I would. The expenses just strike me as being incurred as an integral part of the sale.

Should the company have sent me any type of tax form (such as a 1099) reporting the sale?

Whether they should or not is their problem, not yours. If I were advising them, I'd advise them to file a 1099B.

But whether one is issued or not, your concern is reporting the sale on your return. The 1099 doesn't matter to you or change your tax obligation in any way.

--Peter
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Peter,

Thank you for taking the time to respond.

You wrote, Let me put my answer this way. I don't know if you can, but in your shoes, I would. The expenses just strike me as being incurred as an integral part of the sale.

Yes, it strikes me as an integral part of the sale as well. Had I not filed suit against them, I would not have realized nearly as much of a gain - much of which went to the lawyer. Also, the stock itself was being held in escrow and the escrow agent was a majority shareholder in the company, so there was no real action they needed on my part to make the transaction go through - I had to sue to prevent it or get them to change the terms to something more equitable.

The problem I have here is that the suit was initiated in early 2011 and most of my expenses were incurred in 2011, while the settlement was in 2012. Also since all of my taxes in the past has been on a cash basis, I felt it was necessary to find some way to expense most of my legal expenses in 2011 - thus the Schedule A filing.

So my concern is that I will be switching from claiming these expenses on my schedule A in 2011 to claiming them directly as part of the income on Schedule D in 2012. That would seem to be a red flag. Of course if no one reported the sale, I'm not sure what the IRS would have to go on for an audit other than the fact that I'm claiming a substantial capital gain for 2012. Because of this unusual income, I'm guessing my return will have a good chance of triggering a manual review...

I'll take your advice and mull it over. More and more, I don't think it's enough money to bother paying for a CPA's opinion no matter what. Now if I claim the expense on Schedule D and the IRS eventually says I'm wrong (and without a CPA's opinion to back it up), I'm risking penalties and interest. So to make my decision I have to wonder exactly how much in penalties and interest I might be risking if I file that way and I'm wrong.

Finally, If I were advising them, I'd advise them to file a 1099B.

The instructions say this form was only required of brokers and barter exchanges. This transaction involved no intermediary other than our lawyers and their accounting firm. I'm curious you would advise filing a 1099B in this situation?

And yes, I do realize that this isn't my problem. That doesn't mean I don't want to understand it.

- Joel
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So my concern is that I will be switching from claiming these expenses on my schedule A in 2011 to claiming them directly as part of the income on Schedule D in 2012.

You're assigning way too much thought process to the IRS here. I don't think they do all that much automated comparing of one year to the next. If that happens, it's auditors that will do the comparing after a return has been selected for an audit. And even then, it mainly to assist them in deciding what to look at in the audit.

I'm curious you would advise filing a 1099B in this situation?

Well, a corporation that regularly redeems its own stock is considered to be a broker (see the 1099-B instructions). Rather than get into an argument with the IRS over whether the corporation regularly redeems its own stock, I'd just suggest filing the 1099-B. It's way less time and cost than dealing with any question the IRS might have.

--Peter
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