Miscellaneous Itemized Deductions- Employee Expenses

Meals and Entertainment

To be deductible, entertainment costs must be either “directly related” to business or “associated with” business.

The cost of “quiet entertainment” expenses (where no business is discussed between the taxpayer and a client) is not deductible. If a taxpayer purchases tickets to an event and attends with the client, the expense is meals and entertainment (M&E), subject to the 50% rule; if the client does not attend, the ticket cost may be treated as either M&E or as a gift.

Any allowable entertainment costs are subject to a 50% disallowance rule; only one-half of such costs are deductible. The disallowance applies to the party ultimately paying the expense; thus, if an employer reimburses a meal expense of an employee, the 50% limit applies to the employee.

Costs associated with maintaining taxpayer-owned entertainment facilities (such as company yachts or hunting lodges) or club memberships are not deductible. Additionally, the annual costs of country club memberships are not deductible, regardless of the percentage of time the club is used for business purposes. However, direct entertainment costs incurred at the facility, such as business meals at a country club, are deductible if otherwise qualified M&E.

Strict substantiation rules apply to entertainment costs; the taxpayer must document the “who, what, where, when, why, and how much” particulars of an expenditure.

The Code limits the deduction for business gifts to $25 per donee per year. Such gifts must otherwise be deductible as business expenses (i.e., advertising, entertainment, etc.). Exceptions are made for certain advertising with the name imprinted on the item that costs $4 or less, such as pens, and employee awards based on length of service or safety (a $400 limit per gift).

Transportation, Commuting, and Auto Expenses

Legitimate transportation costs are deductible, such as going from office to client, or between two jobs. However, the costs of commuting from home to office are not deductible. If a taxpayer travels from home to office and then to a client’s office, the costs of commuting to the client’s office will be deductible. But the cost of commuting back to home from the client’s office would not be deductible.

 Any incremental costs incurred in transporting heavy tools or equipment from home to office are deductible; however, the incremental cost must be separately stated. The two methods allowed for claiming expenses for the business use of a vehicle driven by an employee are the actual costs of operating it or the standard mileage rate. Both methods require totals for the miles the car was driven during the year and the miles it was driven for business purposes alone.

Under the actual cost method, actual costs of operating a car include gasoline, oil, repairs and maintenance, insurance, cleaning and washing, registration, and depreciation on the vehicle cost (if owned) or the lease payments (if leased). These costs must be prorated between business and personal use.

Instead of deducting actual expenses, taxpayers can claim a standard mileage allowance (an amount published annually) for each business mile traveled. The standard mileage rate is intended to include most costs of operating vehicle, such as depreciation of original cost, gasoline, oil, cleaning, repairs and maintenance, and insurance. The standard mileage allowance may not be used on leased vehicles, cars held for hire (like taxicabs), fleet vehicles (when two or more vehicles are used simultaneously, although not alternately), or if the car was previously depreciated using any method other than straight line. An employer may adopt a Fixed and Variable Rate (FAVR) method of reimbursement (fixed and variable payments) that is deemed substantiated.

 Taxpayers who use an actual expense method and accelerated depreciation are prevented from switching to the standard mileage allowance in later years, and if they switch from standard to actual, straight-line depreciation must be used.

Travel Expenses of an Employee

Travel expense incurred for a business reason is deductible, under the theory that such travel represents a duplication of living expenses caused by the business. Travel must be related to business; travel expenses related to an income-producing activity such as rentals (a “no money down” seminar, for example) are not deductible.

The term “travel” is broader in scope than transportation and includes all transportation, meals (subject tothe 50% disallowance), lodging, and incidental costs while “away from home” on a trip that normally would involve overnight stay. In other words, the employee has to be away from his or her “tax home” substantially longer than one would be on a normal workday with no travel. 

 In order to be in travel status, a taxpayer must be away from home. For these purposes, a taxpayer’s tax home is where he or she works (his or her “post of duty,” or regular place of business), and not necessarily where he or she actually lives. If a taxpayer has more than one place of business, then the “main business” location is the tax home, as measured by time, activity, and total income. If a taxpayer does not have a main place of business, then his or her personal residence may be his or her tax home if part of the business is in the area of the taxpayer’s residence and that residence has not been abandoned.

 Travel status also indicates that a duplication of living expenses is being incurred because of the job. It is possible that a taxpayer does not have a tax home if he or she has done nothing to establish a residence.  Travel expenses are deductible for temporary out-of-town work assignments; however, if the assignment is expected to last longer than one year, no travel expenses are deductible. In effect, the taxpayer’s home has shifted to the temporary location. Also, if the assignment is indefinite, the tax home is the temporary location.

Employee Reimbursement Plans and Expense Documentation

Any reimbursement received by an employee reduces the allowable deduction. If meals and entertainment expenses are reimbursed, the 50% limit applies to the employer and not the employee; the employee may be able to omit the expense and reimbursement from the return altogether under the accountable plan rules discussed below.

 If only a portion of the expenses are reimbursed, the unreimbursed portion must be reported as a miscellaneous itemized deduction, subject to the 2% of AGI floor. Employees first report any unreimbursed expenses on Form 2106, Employee Business Expenses, and net totals are transferred to Schedule A, Itemized Deductions.

 If reimbursements exceed income, the excess must be reported as gross income on the return.  Generally, an employee must be able to document fully all the particulars regarding an expense. These include five basic elements: (1) amount, (2) time, (3) place or description, (4) business purpose, and (5) business relationship. If an employee reports all expenses to an employer under an “accountable plan,” then generally the expense and the reimbursement may be omitted from the tax return by the employee.

This is beneficial, since the reimbursement would otherwise be included in gross income and the expense would be subject to the 2% of AGI floor. An accountable plan is one where the employee incurs legitimate business expenses, is required to document all expenses to the employer, and must return any unused amounts from the reimbursement within a reasonable time. If these conditions are not met, then the reimbursement is included in gross income and the expense would be a miscellaneous itemized deduction subject to the 2% of AGI floor.

Education Expenses

An employee may be able to deduct education expenses if the expenditure (1) improves skills required on the employee’s present job (e.g., a course on the new tax law taken by a practicing enrolled agent), or (2) meets the minimum express requirements of the employer to retain the present job (e.g., a requirement that all secondary school teachers take three hours of education courses each year).

Two types of education expenditures are not deductible: (1) those expenditures that meet the minimum requirements for a job (a bachelor’s degree, for example, or a law review course), and (2) those that qualify taxpayer for a new job (e.g., law degree). Travel expenses seldom qualify as education expenses; for example, a French teacher traveling to France to study the language would not qualify. Travel may qualify if the uniqueness of the location is paramount for the study (e.g., a particular laboratory).

Any employer reimbursements reduce the deduction, and no deduction is allowed for expenses reimbursed by an educational assistance plan furnished by the employer. Legitimate education expenses may include transportation, books, tuition, and fees. The cost of a purely recreational course will not qualify for deduction.

Miscellaneous Employee Expenses

Any ordinary and necessary business expenses incurred in carrying on the trade or business of being an employee are deductible as miscellaneous itemized deductions, subject to the 2% of AGI floor.

Job-hunting expenses are deductible if the taxpayer is already “carrying on” the particular trade or business that is being pursued; if a different trade or business is involved, the expenditures are not deductible.

Unreimbursed union dues, professional fees, and professional subscriptions may be deducted by employees as miscellaneous itemized deductions. Special purpose work clothing that is not adaptable to ordinary wear, and tools and equipment required for the job, are deductible expenditures. Home office deductions, and deductions for home computers, are seldom available for employees.