Are Legal Costs Deductible? Guidance for Publishers Suing Over AI Training (Hachette & Cengage vs. Google)

Quick answer for busy publishers and tax advisors

Yes — many legal costs incurred by publishers suing over AI training data can be deducted as ordinary business expenses, but some costs must be capitalized or treated differently depending on the claim, the taxpayer's accounting method, and how a settlement or court award is characterized. The 2026 wave of copyright suits (including Hachette & Cengage’s bid to join litigation against Google) makes this an urgent planning issue: how you treat costs now affects tax liabilities when—and if—you receive damages, a fee award, or a settlement.

Why this matters in 2026

Late 2025 and early 2026 saw a surge in high‑stakes IP litigation around AI training datasets. Publishers, visual artists, authors, and music labels have been suing large tech companies for alleged unauthorized use of copyrighted works to train generative AI models. These suits commonly involve:

• Fee‑shifting claims under the Copyright Act (17 U.S.C. §505),
• Large statutory and actual damages, and
• Requests for injunctive relief and accounting of profits.

From a tax perspective, those three outcomes have different consequences. Whether you’re a C‑corp publisher, an S‑corp, an LLC, or an author filing Schedule C, you need a plan for deduction vs capitalization, for reporting recoveries, and for preserving tax positions through settlement negotiations.

Top takeaways (what to do now)

1. Document every legal expense separately by matter and claim—trial prep, discovery, expert fees, and settlement negotiation costs need distinct trails.
2. Identify whether litigation relates to ordinary business operations (generally deductible under Section 162) or to the acquisition/defense of a capital asset (generally capitalized under Section 263).
3. Negotiate settlement allocations (damages vs. punitive vs. injunctive relief vs. attorney fees). Allocations drive tax character of the proceeds.
4. Coordinate timing: cash‑basis taxpayers deduct when paid; accrual taxpayers deduct when all events have occurred and amount can be determined.
5. Run all settlement language and fee allocation plans by tax counsel—Supreme Court precedent (Commissioner v. Banks, 2005) and IRS positions make the gross inclusion and deduction sequence important.

Federal tax rules that matter

1) Ordinary business expenses: IRC §162

Costs that are ordinary and necessary expenses paid or incurred in carrying on a trade or business are generally deductible under Section 162. For publishers, litigation to protect ongoing publishing operations (recovering lost sales, stopping ongoing infringement) usually qualifies as deductible business expense. Examples:

• Legal fees to stop ongoing copying of current inventory or digital products.
• Attorney and expert costs to recover lost revenues tied to everyday business activity.

2) Capital expenditures: IRC §263 and basis adjustments

Costs that create, acquire or materially improve a capital asset generally must be capitalized under Section 263(a). For IP holders, costs to acquire a copyright or to obtain or defend a title to a capital asset are often capital expenditures. Practical examples:

• Legal fees to acquire rights or to defend ownership of a copyright as part of a purchase or sale—these add to basis of the intangible.
• Costs to perfect or defend title to an existing copyright that increase its economic life—IRS treatment often requires capitalization and possible amortization when the asset is sold or otherwise disposed.

When litigation results primarily in strengthening or protecting a capital asset (for instance, securing a monetary recovery that restores the value of a specific copyrighted textbook that has resale value), capitalization rules and basis adjustments may apply.

3) Amortization of acquired intangibles: IRC §197

If a publisher acquires a copyright (or a portfolio) in a transaction, the purchased intangible is generally amortizable under Section 197 over 15 years. Litigation costs tied to that acquisition may be capitalized and included in the amortizable basis. For suits defending an asset you already own (not acquired), §197 does not create a current deduction; instead, capitalized costs typically increase basis.

4) Cash vs accrual accounting

Accounting method matters. Cash‑basis taxpayers generally deduct litigation costs when paid. Accrual taxpayers generally deduct when the liability is fixed and amounts can be determined. This can create timing differences that affect taxable income in years of heavy litigation.

5) Recovery treatment — what you get back

How a settlement or judgment is characterized determines how it is taxed:

• Compensatory damages that restore lost business income are treated as ordinary income.
• Damages that are a return of capital reduce the recipient’s basis in the asset and are not ordinary income to the extent they restore basis.
• Punitive damages and interest are generally taxable as ordinary income.
• Attorney’s fees awarded under the Copyright Act (17 U.S.C. §505) are typically includible in the plaintiff’s gross income, but the plaintiff can generally deduct the legal expense under §162 or capitalize it under §263 depending on facts.

Remember: the Supreme Court in Commissioner v. Banks (2005) confirmed that plaintiffs must include the full amount of a settlement in gross income even if the attorney receives a contingent portion directly. The ability to deduct attorney fees follows established Code rules—it does not eliminate the initial gross inclusion.

Applications to publisher lawsuits against AI trainers (Hachette & Cengage context)

When major publishers like Hachette and Cengage enter suits against Google for alleged copying of books and textbooks used for AI training, several specific questions arise:

Which legal costs are likely deductible right away?

• Defense and enforcement costs tied to ongoing publishing operations — e.g., costs to stop current unauthorized distribution or to recover lost licensing revenue — are typically deductible under §162 for corporate publishers and on Schedule C for self‑employed authors.
• Costs to pursue statutory damages for infringement that compensate for lost sales are usually ordinary and deductible when they directly relate to the business activity.

Which costs may need to be capitalized?

• Costs to acquire or establish ownership of copyright interests (for example, litigation that results in securing ownership to previously contested copyrights) may require capitalization under §263 and result in addition to basis.
• Costs that produce or defend an enduring intangible that will be amortized or sold later may be capitalized.

How should settlement awards be handled?

Settlement language matters. If you obtain a lump sum, the allocation in the agreement (and supporting list of how the sum was computed) will control tax treatment if it reflects economic reality. Typical allocation buckets to negotiate and document:

• Compensatory damages for lost sales (ordinary income),
• Statutory damages (often treated as ordinary income),
• Attorney's fees paid by defendant (usually included in plaintiff’s gross income and then deductible where allowed), and
• Injunctive relief or licensing settlement terms (non‑taxable exchange in some circumstances but often taxable if it includes monetary consideration).

Practical tip: request a detailed allocation from the defendant and include express tax allocation language in the settlement (while acknowledging the IRS can recharacterize). This step is especially important in large AI‑era copyright matters where multiple types of relief are part of a single resolution.

Practical examples and numerical walkthrough

Hypothetical: A publisher spends $5 million on legal fees (contingent + hourly) and obtains a $30 million settlement with a $6 million separate attorney‑fee award paid to the publisher's counsel (defendant paid counsel directly). How to think about tax outcomes:

• Full settlement $30M is includible in the publisher’s gross income.
• Attorney’s fee award of $6M is still included in the publisher’s gross income under Commissioner v. Banks if it is paid on their behalf, but the publisher may deduct the attorney fee under §162 to the extent it is an ordinary and necessary business expense.
• If $10M of the $30M is allocated to restoration of capital (e.g., return of basis in a sold copyright), that portion reduces basis rather than being ordinary income — but the allocation must be strong and defendable.
• Net taxable ordinary income could be roughly $30M − $6M deduction = $24M, adjusting for any capital recovery components and capitalization requirements.

That simplified sketch highlights why the gross-inclusion then deduction sequence, plus allocation, materially affects tax paid in the year of resolution.

Actionable tax planning checklist for publishers suing over AI training

1. Create a litigation tax plan at engagement: Before litigation ramps up, agree with counsel how fees will be tracked and how settlement allocations should be negotiated.
2. Segregate costs by claim: Maintain a cost ledger that separates defensive costs, injunctive relief costs, and costs to obtain or defend title to copyrights.
3. Decide accounting method treatments: Confirm your client’s accounting method and when expenses become deductible (paid vs. incurred).
4. Negotiate settlement allocations and record rationale: Get the defendant to sign a clear allocation reflecting compensatory vs. capital recovery vs. punitive elements.
5. Prepare for Form reporting: Expect 1099s for certain settlement payments and collect invoices and payment records for attorney fee deductions. Coordinate with counsel on gross inclusion issues (Commissioner v. Banks).
6. Assess entity structure: Evaluate whether litigation within existing corporate structures is optimal. For example, C‑corporations deduct legal fees but may face double tax issues on distributions; S‑corps and partnerships pass through results to owners where different rules for individual taxpayers (e.g., §212 rental/royalty or Schedule C) apply.
7. Plan for audit risk: Document the business purpose and connect costs to revenue streams. Litigation in the AI space will attract IRS scrutiny because of large sums and new factual contexts.

Common pitfalls to avoid

• Failing to document the business nexus for disputed costs — failing documentation invites capitalization or disallowance.
• Relying solely on settlement labels — the IRS can recharacterize allocations that lack economic substance or evidentiary support.
• Ignoring accounting method timing — claiming deductions in the wrong year spikes audits and penalties.
• Not coordinating with counsel on contingent fee arrangements and fee awards — remember how Commissioner v. Banks shapes reporting.

2026 trends & what to watch next

Expect increased IRS interest in large AI‑era IP settlements during 2026 as courts clarify awards and fee‑shifting becomes more common. Watch for these developments:

• More detailed allocation language in settlements as parties realize how tax payoff depends on characterization.
• Possible IRS guidance or private letter rulings focused on attorney fee awards in class or representative AI litigation.
• Higher frequency of fee awards under the Copyright Act (17 U.S.C. §505) as courts seek to deter large‑scale dataset scraping.

Case study (hypothetical publisher)

Acme Publishing spends $2M defending a suit and receives a $12M settlement, allocated as $8M compensatory for lost royalties and $4M for injunctive license terms. Counsel receives a $3M fee award paid by defendant and $1M in disbursements reimbursed to Acme. Tax treatment for Acme:

• Include the full $12M in gross income under Banks jurisprudence.
• Deduct the $3M attorney fee as an ordinary business expense to the extent it relates to protecting the business under §162.
• Deduct reimbursed disbursements only if they are included in gross income (documentation needed).
• If any portion of the $12M restores capital (say, $2M restores basis in a copyrighted work sold later), that portion reduces basis and is not ordinary income.

Net effect: substantial but manageable tax liability—if Acme had instead capitalized the $2M legal defense, the year‑one deductions would have been lower and amortization spread over future years.

When to call a specialist

If your dispute involves any of the following, consult an experienced tax litigator or tax partner immediately:

• Large anticipated settlements or judgments (multi‑million dollars),
• Attorney fee awards paid by the defendant directly,
• Claims that include both injunctive relief and monetary payment, and
• Complex acquisition or assignment of copyrights as part of the settlement.

Final checklist before you settle

1. Obtain a proposed tax allocation and the economic rationale from opposing counsel.
2. Run allocation scenarios with your tax team—estimate taxable income under several characterizations.
3. Draft settlement language preserving audit defenses and reflecting mutually agreed allocations.
4. Confirm how fee awards will be handled and who will receive Form 1099s.
5. Document all receipts and payments diligently for the tax year of recognition.

Closing — your next steps (clear call to action)

The Hachette and Cengage developments in early 2026 show that AI‑related copyright litigation will drive large settlements and complex tax issues. If your publishing house or author collective is involved (or considering joining litigation), take three immediate steps:

1. Get your accounting team and outside tax counsel in a short strategy session with plaintiffs' counsel to agree on cost‑tracking protocols;
2. Insist on settlement allocation language and preserve evidentiary support tying categories of recovery to their economic bases; and
3. Book a consultation with an IP tax specialist to model taxable outcomes under multiple settlement scenarios.

Need help modeling outcomes or negotiating tax‑sensitive settlement language? Our tax attorneys and CPAs have experience with multi‑million dollar IP litigation and will run impact scenarios tailored to your entity type and accounting method. Contact us for a targeted consultation before you sign anything — in 2026, the tax treatment of AI copyright recoveries will often be as consequential as the dollar amount on the headline.

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