Are work related expenses deductible?

By Thomas R. Tartaglia, CPA (Jan, 2011)

Let's face it, in these tough economic times we are constantly looking for ways to end the day with a few extra bucks in our pocket. Consequently the question of whether work related expenses are deductible or not comes up quite often and the answer is a definitive "it depends".

Most ordinary and necessary business expenses you incur as an employee of a business are deductible by either you or your employer. Some common types of qualified business expenses include vehicle expenses (travel), business gifts, home office expenses, trade and professional publications and meals and entertainment which are only 50% deductible. Depending on the type of reimbursement plan your employer has will determine where and how you deduct those expenses. Most employers' plans fall under one of two types of employer expense reimbursement arrangements; they are either an "accountable plan" or "non-accountable plan".

An accountable plan is an expense or reimbursement arrangement that meets two conditions:

  1. The plan must require proof of a business connection (a business purpose) and the employee must substantiate his/her expenses to the employer. 
  2. The plan must require the employee to return any amounts received that exceed the expenses actually incurred. Excess reimbursements must be returned to the employer within a reasonable amount of time, normally within 120 days. Any excess reimbursements not returned by the employee are reportable as income and included on the employees W-2. 

Employers who have accountable plans do not report expense reimbursements as income to employees; no action is required by the employee unless the employee's actual business expenses exceed employer reimbursements. In this case, expenses and reimbursements (which are not included in income) are reported on Form 2106, and carried to Schedule A as a miscellaneous itemized deduction subject to the 2% of AGI limitation.

A nonaccountable plan is one where an employee is not required to account to the employer in order to be reimbursed for his business expenses. Employers who operate nonaccountable plans must report reimbursements as income to employees (subject to FICA and income tax withholding). A monthly expense allowance is an example of such a plan. Payments under a nonaccountable plan are 100% deductible by the employer as additional compensation to the employee. As wages, the payments are subject to withholding and FICA taxes and are included with other salaries and wages on the employee's W-2 Form. The employee can deduct the employee business expenses as miscellaneous itemized deductions on his or her individual income tax return.

Special Rules for Travel and Mileage Reimbursement Plans:
Special rules allow employers to treat per diem or mileage reimbursement plans as accountable plans. If the employer's reimbursement rates do not exceed IRS rates, the employer will not report any income to an employee who substantiates time, place, business purpose, and mileage amounts (for mileage reimbursements). The amount of expenses actually incurred need not be substantiated, and the employee is not required to return reimbursements that exceed his actual expenses. Conversely if the employer's reimbursement rates exceed the federal allowances, the employer will report only the excess as income to the employee. If for example the employee receives a flat auto allowance, he must document the time, place, and business purpose for the auto usage and the amount of auto expenses incurred in order to provide the employer with substantiation. Also, the employee must return excess (unsubstantiated) amounts to the employer. The IRS generally disallows any deduction unless the taxpayer can substantiate by adequate record or sufficient evidence the (1) amount of an expenditure (or mileage for vehicles), (2) time and place of use, (3) business purpose, and (4) business relationship. Substantiation includes using an account book, diary, or similar record; trip sheets; expense reports; or other corroborative evidence. Also documentation including receipts, paid bills, and similar information should be included with your "log". 

The type of detail required to document business use of a vehicle varies depending on specific facts and circumstances. For example, an individual who regularly drives an established route can satisfy the adequate record requirement by recording the length of the trip once. Subsequent trips can be substantiated by a notation of the date of each trip including any receipts. In some cases, a log maintained for part of a year may suffice to establish the taxpayer's pattern of business use if it can be demonstrated that the period for which the record was maintained is representative of the vehicle's business use for the entire tax year. Absent these fact patterns a daily log must be kept. 

Traveling expenses, including meals and lodging, on overnight business are qualified business expenses if the taxpayer is traveling "away from home." Determining the location of an individual's tax home is critical to the deductibility of travel expenses. An individual's tax home is normally (1) his/her regular or principal place of business, or (2) if he/she has no regular or principal place of business, regular place of abode. "Commuting" expenses (the cost of transportation from the residence to the principal place of business) are never deductible. 

Another area that gets extra scrutiny by the IRS is expenses for meals and entertainment. These expenses are only deductible if the expenses are (1) directly related to the active conduct of business or (2) associated with the active conduct of business and directly precede or follow substantial business discussions, the taxpayer must engage in business during the meal and/or entertainment. The taxpayer must have more than a general expectation of deriving income or expect some other specific business benefit to occur.

The rules are somewhat different for partners in a partnership or S-Corporation shareholders: 

A partner in a partnership cannot deduct expenses incurred on behalf of the partnership if the partnership would have reimbursed the partner's expense. However, if under the partnership agreement or practice, a partner must pay certain partnership expenses out of his or her own funds, he or she can deduct such expenses on their individual tax return. These expenses are claimed on Schedule E and will reduce the partner's earned income.

S-Corporation shareholders generally cannot deduct unreimbursed business expenses on Schedule E because they are categorized as employees when performing services for the corporation. These expenses, if not subject to reimbursement from the corporation, are unreimbursed employee business expenses treated as miscellaneous itemized deductions subject to the 2% of AGI floor.

Failing to Seek Reimbursement: Reimbursable business expenses for which an employee, partner or shareholder does not seek reimbursement are not deductible by the individual because they are considered ordinary and necessary expenses of the employer, not the employee, partner or shareholder. Failing to seek reimbursement does not convert an employer's expenses into an employee expense. 

Please feel free to contact the tax professionals at Dermody, Burke & Brown to assist you in achieving your goal to live well.

 

The information reflected in this article was current at the time of publication. This information will not be modified or updated for any subsequent tax law changes, if any.

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