Tips for Deducting Employee Business Expenses
Some employees may incur certain work-related expenses. If their employers reimburse them for the expenses, then the employees are not out-of–pocket for the expenses and cannot deduct them on their tax returns. If the employers do not reimburse for the expenses, the employees may deduct the expenses as a miscellaneous itemized deduction on their tax returns.
Seems simple enough, right? Well, maybe not. Let’s look at all the issues associated with deducting employee work-related expenses. We shall begin by defining the employee business expenses that can either be deducted or reimbursed. To qualify, expenses must be ordinary and necessary in performance of the employee’s duties and generally include:
- Business travel away from home (does not include commuting from home to work and back).
- Business use of the employee’s vehicle.
- Business meals and entertainment (special rules apply).
- Business use of the employee’s home (difficult to qualify for as an employee).
If an employer does not reimburse the expenses, then the only solution is for the employee to itemize the unreimbursed expenses on IRS Form 2106 and then deduct the expenses on Schedule A as an itemized deduction. But here are several negative aspects associated with deducting the expenses on Schedule A:
- A taxpayer who takes the standard deduction cannot deduct the expenses because the expenses can only be deducted as a part of a taxpayer’s itemized deductions.
- Even when deducting the expenses as miscellaneous itemized deductions, taxpayers are faced with a limitation. Most miscellaneous itemized deductions, including employee business expenses, are reduced by 2% of the individual’s modified adjusted gross income (MAGI). For example, if the taxpayer’s MAGI is $100,000, he gains no benefit from the first $2,000 of miscellaneous itemized deductions. Thus, if his miscellaneous itemized deduction only consisted of work-related expenses of $3,000, he would only benefit from $1,000 of his work-related expenses ($3,000 less $2,000).
- Finally, a taxpayer subject to the alternative minimum tax (AMT) faces still another limitation. When computing the AMT, miscellaneous itemized deductions are not allowed. So to the extent of the AMT, no benefit is derived from deducting miscellaneous itemized deductions.
Because of all the limitations associated with deducting the expenses, it is always better to have the expenses reimbursed by the employer under an accountable plan. Under this type of arrangement, the employee must account for each expense and provide the employer with written documentation (expense report). The reimbursement is not taxable to the employee and not included in the employee’s Form W-2. An accountable plan must meet three requirements; the employee must:
- Have paid or incurred expenses that are deductible while performing services as an employee.
- Adequately account to the employer for these expenses within a reasonable time period.
- Return any excess reimbursement or allowance within a reasonable time period.
If the plan under which the employer reimburses the employee is non-accountable, then the payments the employee receives should be included in the wages shown on his Form W-2. The employee must report the income and itemize deductions to deduct these expenses.
Some employers may not be willing to pick up the additional expense, in which case the employee can try negotiating a pay reduction and corresponding expense reimbursement.
The employee must also keep adequate records of his work-related expenses.
And one last word of advice: if an employee is eligible to be reimbursed for a work-related expense but fails to request reimbursement from his employer, the employee may not claim the expense as a deduction on his tax return.
If you have questions related to the tax treatment of employee work-related expenses, please give this office a call.