Suspension of 2% Miscellaneous Deductions on Schedule A: How to Claim Unreimbursed Employee Expenses
The Tax Cuts and Jobs Act (TCJA), passed in November of 2017, made a number of changes to itemized deductions. One that may have drastic impact on you is the elimination of all miscellaneous itemized deductions subject to 2% of the adjusted gross income. This includes unreimbursed employee expenses, non-business tax preparation fees, and other expenses such as legal fees, broker fees, and safe deposit boxes. Previously, if an employee was not reimbursed for ordinary and necessary business expenses, they could be claimed on Schedule A. For some taxpayers, the out-of-pocket expenses spent as an employee can be significant and this change will cause a substantial increase in the taxpayer’s tax bill if steps are not taken.
It should be noted that certain business expenses of reservists, performing artists, and fee-basis government officials that are claimed on line 24 of 1040 are not affected by this change.
There are now three ways to either have the company pay for expenses or to claim the expenses other than on Schedule A.
The first option is for employers to pay directly or reimburse for the business expenses. The goal of the TCJA was to push employers into adopting accountable and nonaccountable plans. An accountable plan would be when an employee incurs expenses and submits receipts to the employer who then reimburses the employee. These reimbursements are non-taxable and the expenses are not then claimed as deductions by the employee. A plan is nonaccountable when an employer provides an allowance or advance to the employee to use for business expenses. Any unused allowance should be returned to the employer otherwise it is considered taxable income to the employee on a W-2. Accountable plans are not required of employers. The second option is to switch to an independent contractor and be issued a 1099 instead of being treated as a W-2 employee. The income would then be treated as self-employment income and reported on a Schedule C. This would allow for the expenses to be claimed against the income. This is not an ideal solution as many overhead costs that are incurred by an employer would now fall completely on the taxpayer’s shoulders. This option is not automatic and comes with IRS scrutiny. Carefully consider this with your tax preparer.
The third option for certain types of employees is to be classified as a statutory employee. A statutory employee is defined by the IRS as an independent contractor under common law rules who may be treated as employee by statute for certain employment tax purposes. Their status is indicated on a W-2 by marking the statutory employee box. There is no harm to employers to mark this box; therefore, if an employee should be considered statutory and is incurring expenses that are not reimbursed, they should request a W-2 from their employer with this designation.
A statutory employee falls into four categories:
- A driver who distributes beverages (other than milk) or meat, vegetable, fruit, or bakery products; or who picks up and delivers laundry or dry cleaning, if the driver is your agent or is paid on commission
- A full-time life insurance sales agent whose principal business activity is selling life insurance or annuity contracts, or both, primarily for one life insurance company
- An individual who works at home on materials or goods that you supply and that must be returned to you or to a person you name, if you also furnish specifications for the work to be done
- A full-time traveling or city salesperson who works on your behalf and turns in orders to you from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments. The goods sold must be merchandise for resale or supplies for use in the buyer’s business operation. The work performed for you must be the salesperson’s principal business activity.
Additionally, they must be able to show that most or all of the duties performed are done personally by the employee, that they do not have a substantial investment in the equipment or property used in performing their duties, and that the duties and services are performed on a continuing basis for the employer.
Being classified as a statutory employee means the employee can carry the W-2 income to Schedule C. Now the disallowed 2% miscellaneous unreimbursed employee expenses can be claimed. This is especially advantageous because the employee still gets the benefit of having half of Social Security and Medicare taxes paid by the employer as well as accessing any benefits the employer provides including liability protection. Additionally, the expenses are no longer subject to the 2% floor of AGI and can be claimed at 100%.
However, the taxpayer needs to be aware that federal income tax is not withheld on the W-2 once statutory employee is noted so you should work with your tax preparer to ensure that timely estimated payments are made or risk penalties being assessed.
While on the face this seemed like a small change, you can quickly see how this might impact you and your tax situation. If you have further questions, don’t hesitate to contact your KTLLP tax professional.