Dallas Mavericks team owner Mark Cuban had a big victory here in Dallas Wednesday.  He was cleared of all charges of insider trading. The Dallas Morning News called it a “slam-dunk victory.”  This article by Natalie Posgate and Mark Curriden is a well written summary of the matter.

Cuban had been involved in a nine-year battle with the SEC involving his sale of 600,000 shares of Mamma.com.  The article notes that Cuban’s legal fees for fighting the SEC could be more than $8 million, which is four times the amount of potential fines he faced.

The part of the article I liked the best was Cuban’s comments about the case:

Cuban was cool, calm and collected on the witness stand. Outside the courthouse, he was blunt in his criticism of the SEC.

“Their lawyers came up to me after the trial and said it was just business and not personal,” he said. “They’re wrong. It is personal. They lied about me, and they lied about Charlie [McKinney, Cuban’s stockbroker], and that’s not right.”

“The SEC tried to pull a fraud on America, and thankfully I live in a country where juries can decide these kinds of cases,” he said.

It is clear from his statement that he was fighting this case on principle.  Unlike the SEC attorneys – this was personal for him. So what about the $8 million in attorney’s fees?  Can he deduct them?  Or does the IRS get to further financially abuse him by denying any deduction for attorney’s fees? My short answer is that the IRS will likely get to abuse him as well.

There are several options when it comes to deducting legal fees:

Are the fees “ordinary and necessary” business expenses?

I doubt that these fees could be considered business expenses.  Generally in order for the legal fees to be deductible as business expenses Mr. Cuban would have to be in the business of trading or dealing in  securities.  An example of this would someone who is a day trader.  I really don’t think he dedicates enough time to securities trading/dealing to reach this level.  After all, doesn’t he mostly run the Mavericks?  As a side note – he does this pretty well and is a great asset to the City of Dallas.

But there might be some interesting arguments that could be made to qualify as the legal fees as deductible as business expenses.  Perhaps he is trying to protect his business reputation?

Are the fees investment-related expenses?

I think Mr. Cuban’s legal  expenses are most likely going to be considered “Expenses for Production of Income” under Internal Revenue Code Section 212.  This code section generally makes these expenses deductible.  But like a lot of deductions and credits, the law is such that it can be of no benefit.

The reason Mr. Cuban may not benefit is because Section 212 expenses are only be deductible if they exceed 2% of adjusted gross income.

For example, let’s say he is worth $2.5 billion and he gets a reasonable return of 5% on that money.  That would mean he has $125 million in income each year.  The 2% floor would only allow him to deduct expenses that exceed $2.5 million dollars ($125 million x 0.02 = $2.5 million).

He won’t get to bundle up his $8 million in expenses in one year.  Rather he can only deduct expenses in the year paid.   So if in 2013 he only paid $2 million in legal fees he wouldn’t get to deduct a penny.  If Mr. Cuban paid $3 million he could only deduct $500,000.

Or are the expenses personal in nature?

Cuban may have put his “foot in his mouth” however when he made his comments after the trial.

Mark Cuban putting his foot in his mouth? … Come on, that’s never happened before.. or has it?

Mr. Cuban is on record as saying this lawsuit was personal.  The IRS may jump on these statements and argue that the expenses were not even investment related – they were just personal.  It is clear that personal expenses are not tax deductible (see U.S. v. Gilmore).

Whether he put his foot in his mouth or not – I really doubt Mr. Cuban cares.  He slayed the dragon.