Law firms incur many different types of expenses on behalf of clients, and many costs can be reimbursed in the course of client billing.
It is important to understand what these costs are, distinguish between hard and soft costs, and make sure that fee agreements between you and your clients delineate these costs upfront so that clients aren’t faced with a surprise.
Reimbursable costs are typically known as advanced client costs and fall into two different categories, hard costs (or direct expenses) and soft costs (or support-type services). These categories differ in terms of how they are treated under tax law.
Hard costs, or direct ligation expenses. These are an expense directly relating to the case. They can include:
- Court filing fees
- Court reporting fees
- Deposition expenses
- Mediation fees
- Travel expenses
- Hearing transcript fees
- Expert witness fees
- Medical record expenses
Hard costs also include any other direct fees a law firm pays to external parties in the course of litigation.
These costs are typically considered an upfront loan to your client. They are not deductible as a business expense because the liability is passed along to the client when you bill, and they are not considered income because they are the repayment of an outstanding debt. In the event that a client does not reimburse for the costs, the firm can then deduct the amount paid as a loss.
Soft costs. or support services. Soft costs are support-type services and may require the work of somebody associated with the billing firm. Soft costs can also be considered overhead expenses, but some firms choose to bill for these expenses if the cost can be directly attributed to a specific client’s needs.
Soft costs can include:
- Faxing costs
- Postage fees
- Delivery services/messengers
- Clerical services
- Online research
- App costs
- Legal research costs
- Word processing
For example, if a firm needs to send a fax for a client, the soft cost includes the labor of sending the fax, as well as the cost of the ink, paper, and fax machine maintenance.
If these costs are billed to the client, the proceeds are considered part of the firm’s income (rather than repayment of a loan) and are therefore taxable.
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3. What is the difference between a hard cost and a soft cost for a law firm?