Did you know that in 1982, the IRS issued a ruling (Private Letter Ruling 8246013) that a law firm “may not deduct as an ordinary and necessary business expense the various litigation costs advanced for a client on a contingent-fee basis”?
According to the IRS, case costs are actually advanced as loans to the client and should be booked as an asset, on the firm’s Balance Sheet. It is not recommended that these costs be booked as an expense reported on the Profit & Loss Statement.
The issue with this method is that when collected, the expenses are reported as income. The IRS objective is to match expenses to the income generated by those expenses. Since case costs related to contingency fee cases are typically paid well in advance of income receipt, recording case costs as an expense results in the firm likely deducting expenses prior to reporting the revenue associated with those expenses.
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