Losing money on out-of-pocket expenses?

By David Katzman

If you regularly incur out-of- pocket expenses associated with your job, you may be wondering if you can deduct these costs on your federal income taxes. The answer is—maybe.

The Internal Revenue Service (IRS) allows employees to deduct qualifying business expenses, but there are restrictions. Such expenses include business meals and entertainment, which are deductible at 50 percent; travel costs, including local travel but not commuting costs; various business-related supplies; and other expenses. For an employee, the deductibility of these expenses depends on your repayment arrangement with your employer and the amount of your itemized deductions.

Your arrangement with your employer

If your company uses an “accountable reimbursement plan,” then your reimbursed work expenses are not deductable on your personal tax return. An accountable reimbursement plan requires that you document your expenses and provide adequate records to demonstrate actual costs. For example, you would fill out an expense report; provide receipts documenting where, how much and with whom you spent money; and receive reimbursement for those costs.

In some work situations, you may receive an expense allowance, but the same principles apply. For example, your company might provide $500 a month for business expenses. Under an accountable reimbursement plan, you would document your actual expenses and return any excess amounts. If your documented expenses for the month totaled $400, you would return the additional $100.

Under either scenario, you would not include your reimbursements or allowances in your income—and the amount should not be reflected as income on your W-2 form.

When can you deduct business expenses on your personal income tax return?

As an employee, you can accumulate business deductions in several ways, but you must deduct these expenses as “miscellaneous itemized deductions” on your federal tax return. This category, which also includes various other deductions, has one significant drawback—a 2 percent floor. Your miscellaneous itemized deductions must be in excess of 2 percent of your adjusted gross income (AGI). If not, you lose this deduction. For example, if your AGI is $60,000, your miscellaneous itemized deductions must total more than $1,200 to receive any benefit.

If your employer does not pay, or reimburse, any business expenses, then all documented costs can be deducted. You might also incur deductible business expenses if your employer excludes some costs. If, for example, transportation costs are not reimbursed, then you can track these expenses and deduct them—but only if they exceed the 2 percent floor.

Some employees are reimbursed for business expenses under a “nonaccountable reimbursement plan.” In these instances, reimbursements are included in total wages and reported on the W-2 form as income. This is when the 2 percent floor can be particularly costly. Let’s say your salary is actually $59,000, but you were reimbursed $1,000 in business expenses. This additional money is reported on your W-2 form and your AGI becomes $60,000. Unless you have other deductions, the $1,000 falls short of the 2 percent floor and this deduction is lost.

If you are in this situation, you may want to discuss other reimbursement options with your employer. For example, your company could begin using an accountable plan or could cover business costs directly, through a company credit card or other means. A tax professional can help you determine the best approach for both you and your employer.

David A. Katzman is a certified public accountant licensed to practice in the State of Florida and the Commonwealth of Massachusetts. He is also a certified financial planner and certified senior advisor. Please consult your tax advisor for details and assistance in applying this general information to your specific situation.