Morgan has accepted a new sales job that requires travel and some entertainment expenses. She will work out of her apartment and be reimbursed for some travel expenses. Some of Morgan's expenses may be deductible, including transportation between client sites, home office expenses if the office space is exclusively used for work, and moving expenses if she meets certain tests. However, commuting costs and some education or entertainment expenses would not be deductible.

1. Chapter 9
Deductions: Employee and
Self-Employed-Related
Expenses
Individual Income Taxes
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 1

2. The Big Picture (slide 1 of 2)
• Morgan, a recent college graduate who majored in
finance, has accepted a job with Kite Corporation.
– The job is in sales and will require travel and some
entertainment (i.e., business lunches).
• She will be based in a major metropolitan area in
another state.
– Kite has no available space in the locale, so she will have
to maintain her own work facility.
– In addition to her salary, Morgan will receive a travel
allowance.
• However, Kite has made it clear that the allowance will not cover
all of her travel expenses.
2

3. The Big Picture (slide 2 of 2)
• Morgan is delighted with the new job since it
will enable her to maintain a flexible work
schedule.
– Furthermore, working out of her own apartment
avoids a time-consuming and costly commute.
• What are some of the income tax problems
presented by this situation?
– Read the chapter and formulate your response.
3

4. Employee vs. Self-Employed
(slide 1 of 2)
• Business expenses for self-employed persons
are deductible for AGI
– Reported on Schedule C
• Unreimbursed business expenses for
employees are generally deductible from AGI
subject to 2% of AGI floor
– Reported on Form 2106 (Employee Business
Expenses) and Schedule A (Itemized Deductions)
4

5. Employee vs. Self-Employed
(slide 2 of 2)
• Person is classified as an employee if:
– Subject to will and control of another with respect
to what shall be done and how it shall be done
– Another furnishes tools or the place of work
– Income based on time spent rather than task
performed
5

6. Employee Expenses
• Fall into one of the following categories:
– Transportation
– Travel
– Moving
– Education
– Entertainment
– Other
6

7. Transportation Expenses
(slide 1 of 2)
• Transportation expense defined
– Very limited, only from job site to job site and
commuting to/from temporary work place
– Commuting from home to work and back is
nondeductible
• Exceptions:
– Additional costs incurred to transport heavy tools
– Employees with more than one job
7

8. Transportation Expenses
(slide 2 of 2)
• Amount deductible
– Actual expenses
• Must keep adequate records of all expenses and
depreciation is limited, or
– Automatic mileage method
• 55.5 cents per mile for business miles for 2012
– Adjustment to basis of auto is required for depreciation
considered allowed
• Plus parking, tolls, etc.
• Adequate documentation of mileage required
8

9. The Big Picture - Example 9
Commuting Expense
• Return to the facts of The Big Picture on p. 9-1.
• Because Morgan will have an office in her
home, the apartment will be her principal place
of business.
– Thus, any transportation from her home to
business sites will not be disallowed as a
commuting expense
9

10. The Big Picture - Example 11
Automatic Mileage Method
• Return to the facts of The Big Picture on p. 9-1.
• During Morgan’s senior year in college, her parents
gave her one of the family cars—a 2009 Chevrolet
Impala.
– Morgan has no idea as to the car’s original cost or the
odometer reading at the time the car was registered in her
name.
– She has, however, kept track of the miles driven for
business since she accepted her new job.
• Morgan should use the automatic mileage method in
claiming business use of the car.
10

11. Travel Expenses
(slide 1 of 2)
• Travel expense defined
– Expenses while “away from tax home” overnight
on business
– Includes transportation, lodging, 50% meals, and
miscellaneous expenses
11

12. Travel Expenses
(slide 2 of 2)
• “Away from home” requirement
– Need not be a 24-hour period but must be longer
than ordinary work day and taxpayer will need to
rest during release time
– Being “away” should be a temporary situation (not
in excess of 1 year)
– “Tax Home” generally means business location,
post, or station of the taxpayer
12

13. Restrictions on Travel Expenses
(slide 1 of 2)
• Convention travel expenses
– No deduction for travel unless directly related to
taxpayer’s trade or business
• Example: Doctor attending out-of-town seminar on
estate planning would not have deductible travel
expenses
– Restrictions apply to the deductibility of travel
expenses of the taxpayer’s spouse or dependent
• Generally, accompaniment by the spouse or dependent
must serve a bona fide business purpose, and
• The expenses must be otherwise deductible
13

14. Restrictions on Travel Expenses
(slide 2 of 2)
• Education travel expenses
– Travel as a form of education is not deductible
• Example: Spanish language professor traveling to Spain
to work on the language would not have deductible
travel expenses
• Example: Spanish history professor traveling to Spain
to study historical documents available only in Spanish
museums would have deductible travel expenses
14

15. Combined Business/Pleasure Travel
(slide 1 of 4)
• Only actual expenses for business are
deductible
– Meals, lodging and other expenses must be
allocated between business and personal days
• Deductibility of transportation costs depends
on whether the trip is domestic or foreign
15

16. Combined Business/Pleasure Travel
(slide 2 of 4)
• For domestic travel
– If primary purpose of trip is business,
transportation is deductible in full
– If primary purpose is pleasure, no deduction for
transportation allowed, but other expenses (e.g.,
lodging) associated with business days are
deductible
16

17. Combined Business/Pleasure Travel
(slide 3 of 4)
• For foreign travel
– Transportation expenses must be allocated between
business and personal unless:
• Trip is 7 days or less,
• Less than 25% of time was for personal purposes, or
• Taxpayer had no substantial control over arrangements
for the trip
17

18. Combined Business/Pleasure Travel
(slide 4 of 4)
• Travel days are considered business days
• Weekends, legal holidays and intervening days
are business days if both the preceding and
succeeding days are business days
• If trip is primarily for pleasure, no
transportation expenses are deductible
18

19. Moving Expenses
• Deductible for moves in connection with the
commencement of work at a new principal
place of work
• Two tests must be met for moving expenses to
be deductible
– Distance test
– Time test
19

20. Moving Expenses - Distance Test
• Distance from old home to new job must be at
least 50 miles farther than from old home to
old job
• New home location not relevant for decision
20

21. Example of Distance Test
• Gail lived 20 miles
from her old job 20 mi. Old
Old
• Gail’s new job is 75 Job
Job
miles from her old Old
Old
home Residence
Residence
• Gail meets the
distance test 75 mi.
New
New
Job
Job
21

22. Moving Expenses - Time Test
(slide 1 of 2)
• Taxpayer must be full-time employee for 39
weeks in the 12-month period following the
move, or
• Self-employed must work in new location for
78 weeks during the next two years following
the move
– 39 of the weeks must be in the first 12 months
• Test waived if die, disabled, discharged, or
transferred
22

23. Moving Expenses - Time Test
(slide 2 of 2)
• If time test not met during taxable year, two
alternatives:
– Take the deduction in year moved. If test is not
met in following year, either:
• Include the amount deducted in gross income in the
following year, or
• File amended return for year of move
– Alternatively, wait until time test is met and then
file amended return for year of move
23

24. Deductible Moving Expenses
• ‘‘Qualified’’ moving expenses include
reasonable expenses of:
– Moving household goods and personal effects to
new location
– Expenses of travel for taxpayer and family to new
location
• Lodging
• Actual auto costs (not depreciation) or mileage rate of
$.23 per mile for each car in 2012
– Meals are not deductible as moving expense
24

25. Tax Treatment of
Moving Expenses
• Unreimbursed moving expenses are deductible
for AGI
• Reimbursement or payment by employer:
– For qualified moving expenses, amount is
excluded from gross income, but no deduction for
related expenses
– For nonqualified moving expenses, amount is
included in gross income and no deduction is
allowed
25

26. The Big Picture - Example 28
Moving Expenses
• Return to the facts of The Big Picture on p. 9-1.
• Even though this is her first job, Morgan will
be entitled to a moving expense deduction.
– This presumes that she is not reimbursed by Kite
Corporation for these expenses.
– The mileage on her car also is allowed.
• Her deduction is for AGI and can be claimed
even if she chooses the standard deduction
option.
26

27. Education Expenses
(slide 1 of 3)
• Education expenses of an employee are
deductible if they are incurred:
– To maintain or improve existing skills, or
– To meet express requirements of the employer or
requirements imposed by law to retain
employment status
27

28. Education Expenses
(slide 2 of 3)
• Education expenses of an employee are not
deductible if they are incurred:
– To meet minimum educational standards for
existing job, or
– To qualify taxpayer for new trade or business
28

29. Education Expenses
(slide 3 of 3)
• Education expenses include:
– Tuition
– Books
– Supplies
– Transportation
– Travel (including lodging and 50% meals)
29

30. Deduction For Qualified Tuition and
Related Expenses (slide 1 of 3)
• A deduction is allowed for AGI for qualified
tuition and related expenses involving higher
education (i.e., postsecondary)
30

31. Deduction For Qualified Tuition and
Related Expenses (slide 2 of 3)
• The maximum deduction depends on filing
status and AGI
Filing Status AGI Limit Max Deduction
Single $65,000 $4,000
Married $130,000 $4,000
Single $65,001 to $2,000
$80,000*
Married $130,001 to $2,000
$160,000*
*No deduction is allowed if MAGI exceeds this amount
31

32. Deduction For Qualified Tuition and
Related Expenses (slide 3 of 3)
• Qualified tuition and related expenses include
whatever is required for enrollment
– Usually, student activity fees, books, room and
board are not included
• Expenses need not be work related
• Deduction is not available for married persons
filing separately
32

33. The Big Picture - Example 31
Education Expenses
• Return to the facts of The Big Picture on p. 9-1.
• After starting her new job, Morgan enrolls in
the night program of a local law school.
– Although Morgan does not plan to practice law,
she feels that a law degree would advance her
career.
• Except for the tuition she pays (see the
discussion of § 222), none of her expenses
relating to the education will be deductible.
33

34. Entertainment Expenses
(slide 1 of 3)
• Deductions are very restricted due to abuse
possibilities
– Deductible amount allowed:
• 50% of meals and entertainment costs including related
taxes, tips, cover charges, parking fees, and room rental
fees
• 100% of transportation costs
– Amounts cannot be lavish or extravagant
– In certain situations, the 50% cutback for meals is
eased for certain, very limited, types of employees
34

35. Entertainment Expenses
(slide 2 of 3)
• The 50% cutback rule has a number of
exceptions, such as:
– Situations where full value of meals or
entertainment is included in income
– Meals and entertainment are provided in a
subsidized eating facility or where the de minimis
fringe benefit rule is met
– Employer-paid recreational activities for
employees
• e.g., the annual Christmas party or spring picnic
35

36. Entertainment Expenses
(slide 3 of 3)
• Entertainment expenses are classified as
either:
– Directly related to business
• Actual business meeting or discussion occurs during
meal or entertainment
– Associated with business
• Meal or entertainment that directly precedes or follows
business meeting or discussion
36

37. Restrictions on Entertainment
Expenses (slide 1 of 3)
• Club dues
– Generally not deductible
• Exception: Clubs formed for public service and
community volunteerism (e.g., Kiwanis, Rotary)
– Business entertainment expenses incurred at club
are still deductible (50%)
37

38. Restrictions on Entertainment
Expenses (slide 2 of 3)
• Ticket purchases for entertainment
– Amounts paid in excess of face value of ticket are
not deductible
– Limitation on deductibility of luxury skybox
expenditures
38

39. Restrictions on Entertainment
Expenses (slide 3 of 3)
• Business gifts
– Business gifts of tangible personalty with a value
of $25 or less per person per year are deductible
• Incidental costs (e.g., gift-wrapping) are not included in
the cost of the gift in applying the limit
– If the value is $4 or less (e.g., pen with company
name) then not subject to $25 limit
• Gifts to employers or superiors are not
deductible
39

40. Office in the Home
(slide 1 of 3)
• Deductibility is very restricted due to abuse
possibilities
– Office must be used exclusively and on a regular
basis as:
• The principal place of business, or
• A place of business used by clients, patients, or
customers
– For employees, office must also be for the
convenience of the employer
40

41. Office in the Home
(slide 2 of 3)
• What constitutes “principal place of
business”?
– Home office qualifies as a principal place of
business if:
• Taxpayer conducts admin. and mgmt. activities in the
home office, and
• There is no other fixed location where taxpayer
conducts these activities
41

42. Office in the Home
(slide 3 of 3)
• Office in the home expenses cannot cause net
loss from the business activity
– Office in home deduction limited to business gross
income in excess of other business expenses
(ordering rules apply)
– Excess is carried forward (subject to limit)
– Form 8829 is used to report office in home
expenses
42

43. The Big Picture - Example 45
Deductible Home Office Expenses
• Return to the facts of The Big Picture on p. 9-1.
• Morgan’s rent, utilities, renters’ insurance, and the
like allocable to her office will qualify for deduction.
– Because she will be working in an apartment where space
is limited, she must be careful to meet the exclusive-use
requirement for the area set aside.
• For the furnishings she acquires (e.g., desk, file
cabinet), Morgan may prefer to forgo expensing (§
179) and claim depreciation instead.
– This way the tax deduction is deferred to later, higher-
income years.
43

44. Other Employee Expenses
• A partial list of other employee expenses that
are deductible includes:
– Special clothing (uniforms)
– Union dues
– Professional expenses
– Job hunting in same profession
– Educator expenses (deductible for AGI)
• Limited to $250 per year for supplies, etc. of elementary
and secondary school teachers
44

45. The Big Picture - Example 46
Job Hunting Expenses
• Return to the facts of The Big Picture on p. 9-1.
• Recall that Morgan conducted an extensive job
search before obtaining her position with Kite
Corporation.
– Because this is her first job, the expenses she
incurred in the search are not deductible.
45

46. Contributions to Retirement Accounts
(slide 1 of 2)
• Retirement plans fall into two major
classifications depending on who is covered
– For employees – usually follow one of two income
tax approaches
• Most plans allow an exclusion from income for the
contributions the employee makes to the pension plan
• Alternatively, using the approach followed by a
traditional IRA, a contributing employee is allowed a
deduction for AGI
– Maximum deduction is $5,000 for 2012
46

47. Contributions to Retirement Accounts
(slide 2 of 2)
• Retirement plans for self-employed taxpayers
– Called Keogh (or H.R. 10) plans
• Follow the deduction approach of traditional IRAs
• Amounts contributed under a plan are deductible for
AGI
47

48. Classification of Employee Expenses
(slide 1 of 2)
• Depends on whether they are reimbursed and,
if reimbursed, under what type of plan
48

49. Classification of Employee Expenses
(slide 2 of 2)
• Employers can have three types of
reimbursement plans
– Accountable
– Nonaccountable
– No reimbursement is given
49

50. Accountable Plan
(slide 1 of 2)
• Plan must require adequate accounting to the
employer for expense reimbursed, and
• Any excess reimbursements must be returned
to the employer
50

51. Accountable Plan
(slide 2 of 2)
• Adequate accounting is
– Submitting a record, with receipts, to the
employer, or
– Using a per diem allowance that is not more than
the Federal per diem rate
• Employee reports no income and takes no
deduction to the extent of the reimbursed
expenses
51

52. Substantiation for Expenditures
(slide 1 of 2)
• No deduction allowed for an expense if the
taxpayer does not have adequate records for
the expense
– Therefore, taxpayers need to have good records for
employee or self-employed expenses
• In some cases, use of per diem allowance will be
deemed substantiation
52

53. Substantiation for Expenditures
(slide 2 of 2)
• Records should include:
– The amount of the expense
– The time and place of travel or entertainment (or
date of gift)
– The business purpose of the expense
– The business relationship of the taxpayer to the
person entertained (or receiving the gift)
53

54. Nonaccountable Plan
• Plan that does not require adequate accounting
or return of excess reimbursement or both
– Reimbursed amounts received under this plan are
included in gross income
– Expenses are deductible from AGI as
miscellaneous itemized deductions subject to the
2% of AGI limitation
54

55. Unreimbursed Employee Expenses
• Expenses are deductible from AGI as
miscellaneous itemized deductions subject to
the 2% of AGI limitation
– If employee could have received, but did not seek,
reimbursement for whatever reason, none of the
employment-related expenses are deductible
55

56. Miscellaneous Itemized
Deductions
• Miscellaneous itemized deductions subject to
the 2% of AGI limitation
– Certain miscellaneous expenses must be added
together and the amount in excess of 2% of
taxpayer’s AGI is deductible from AGI (i.e.,
itemized deduction reported on Sch. A)
56

57. Examples of Miscellaneous Itemized
Deductions Subject to 2% Floor
• Most reimbursed expenses under a nonaccountable
plan
• Unreimbursed employee expenses
• Section 212 expenses not related to rents and
royalties
• Tax return preparation fee
• Hobby expenses
• Investment expenses (except interest and taxes)
57

58. Examples of Miscellaneous Itemized
Deductions Not Subject to 2% Floor
• Impairment-related work expenses of
handicapped individuals
• Gambling losses to the extent of winnings
• Certain terminated annuity payments
58

59. Computing 2% of AGI Limitation
(slide 1 of 2)
• Example
Taxpayer, a single individual, provides the following
information for 2012:
• $30,000 AGI
• $ 6,500 deductible interest expense and taxes paid
• $ 1,500 employee business expenses, and
• $ 500 tax return preparation fee
59

60. Computing 2% of AGI Limitation
(slide 2 of 2)
• Example (cont’d)
Interest and taxes $6,500
Misc. expenses:
Employee bus. exp. $1,500
Tax return prep. 500
Total $2,000
Less 2% AGI - 600 1,400
Itemized deductions $7,900
60

61. Refocus On The Big Picture (slide 1 of 4)
• Several tax issues might arise as a result of Morgan’s
new job.
– The first tax issue relates to the dependency exemption.
• If Morgan was living at home and accepted the job late in the year,
she could qualify as a dependent of her parents.
– If so, they might also be able to claim the qualified tuition deduction
(or the lifetime learning credit).
– If, however, her employment began early in the year, it
may not be possible for her parents to claim her as a
dependent either because
• She is not a qualifying child due to the self-supporting limitation,
or
• She is not a qualifying relative due to the gross income limitation
—see Chapter 3.
61

62. Refocus On The Big Picture (slide 2 of 4)
• Other tax issues would include the following.
• Job hunting expenses - Morgan’s ‘‘extensive search’’ for employment
suggests that she may have incurred job hunting expenses
– Such expenses are not deductible in a first job setting.
• Moving Expenses - Her qualified moving expenses are not so restricted.
– Moving expenses are deductions for AGI.
• Office in the home deduction - Under the circumstances, Morgan is
justified in claiming an office in the home deduction.
– The deduction would include a portion of the rent paid for the apartment,
depreciation on office equipment, and other operating expenses (e.g., utilities).
– She must be careful not to violate the ‘‘exclusive use’’ restriction.
• Travel – Morgan is required to travel as part of her job and so will use her
car for business.
– Thus, she will need to make a choice between the automatic mileage method
and the actual cost method.
62

63. Refocus On The Big Picture (slide 3 of 4)
• Commuting expenses - Since her tax home is in her apartment,
she will have no nondeductible commuting expenses.
• Travel Allowance – Tax treatment depends on whether it is an
accountable plan
– If she renders an adequate accounting (and has to return any excess) to
Kite Corporation, then her allowance need not be reported on her
Federal income tax return.
• Nonreimbursed amounts, however, must be allocated between meals and
entertainment (subject to the 50% cutback) and other employment-related
expenses.
• The balance is an itemized deduction subject to the 2 percent-of-AGI floor.
– If she does not render an adequate accounting, the full allowance is
included in her gross income.
• All of the meals and entertainment expenses are subject to the 50%
cutback, and
• The total of all employment-related expenses is an itemized deduction
subject to the 2 percent-of-AGI floor.
63

64. Refocus On The Big Picture (slide 4 of 4)
• If Morgan started her job late in the year, it is unlikely
that she will be in a position to itemize her
deductions.
– Instead, she will claim the standard deduction effectively
eliminating her ability to deduct any employment-related
expenses.
• Morgan must maintain adequate substantiation
regarding all of these employment related
transactions.
– Detailed records are particularly important in arriving at
the office in the home deduction and the business use of an
automobile under the actual cost method.
64

65. If you have any comments or suggestions concerning this
PowerPoint Presentation for South-Western Federal
Taxation, please contact:
Dr. Donald R. Trippeer, CPA
trippedr@oneonta.edu
SUNY Oneonta
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
65