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Are Litigation Fees Tax-Deductible?

May 4, 2021

Many companies think of litigation as simply a cost of doing business. Does this mean that litigation fees can be deducted as a business expense? The IRS and Maylan Inc. recently went to court over Mylan’s 2014-2021 filing wherein they deducted patent litigation fees. 1 The mixed outcome is one with implications for businesses and their legal teams, particularly for patent litigation.  

The specific area in which disagreements arose between the IRS and Mylan Inc., was the preparation of Paragraph-IV Notice Letters. These letters are a necessary part of any new Abbreviated New Drug Application.2 The purpose of this letter is to begin the FDA approval process and confirm that any patents in question are not infringed by the generic version of the product.  

The IRS raised issues with the legal expenses being claimed for patent infringement litigation. These fees represented $130 million in deductions, all of which were being disputed by the IRS.3 The court found that the fees required to simply meet statutory requirements related to Paragraph-IV are not deductible. This is because Mylan was exposed to these expenses as a result of the need for regulatory approval. This approval generated benefits for the taxpayer, which must be capitalized.4 

The decision that is perhaps most interesting is that the defense of lawsuits aimed at challenging patent validity were in fact tax deductible. Being that Mylan’s intention was to protect the branded version of drugs that it wanted to produce in generic form, the associated costs can be legally deemed as necessary business expenses. The Tax Court stated that the reason for this decision is that Mylan’s defense against litigation is not a required step within the process of FDA approval.5  

While there is still a chance that the IRS appeals this case, the current implications are clear: Any companies that find themselves in the midst of regular IP litigation may be able to deduct legal fees associated with patent infringement lawsuits from their tax filings. Many view this as a taxpayer-favorable ruling, assuming it isn’t overturned on appeal. 

Meanwhile, generic drug manufacturers, and in fact many companies outlaying significant funds for patent litigation, and their legal teams should strongly consider how this ruling impacts previous tax years. There is the potential to claim a refund, however consent from the IRS will be required. Considering the fiscal benefit that this ruling presents for companies around the world, businesses may want to audit their legal expenses in order to pinpoint potential deductions in the face of this new ruling.   

This ruling may also open the door to claiming other types of litigation fees as business expenses . . . perhaps even fees for expert witness work? Stay tuned as these questions will likely be playing out in court in the coming years.  

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