Form 1040's Schedule A is where itemizers claim deductions for, among other outlays, miscellaneous expenses. The major miscellaneous categories are unreimbursed employee business expenses, investment expenses, and payments for return preparation and advice on tax planning.
The key restriction on write-offs is that most miscellaneous expenses are allowable only to the extent that they, in the aggregate, exceed 2 percent of adjusted gross income—something that many of your clients may not realize. You have to explain that if a client's AGI is, say, $50,000, the 2-percent floor wipes out any deduction for the first $1,000 of expenses.
But that doesn't completely box you in. You have ways to help your clients. Your goal should be to speed up or postpone payments into a year when you anticipate that they surpass the 2-percent floor, just as you maneuver payments for medical expenses to overcome their nondeductible floor. It's difficult to overcome the 2-percent hurdle. But if your clients are close to, or already surpass, the barrier, it makes sense to maneuver, for example, into 2014 what would otherwise be 2015 payments for write-offs like tax advice.
Prepaid expenses. However, you have to play the payment game according to the IRS rules. Forget about boosting your 2014 deductions for miscellaneous expenses by December prepayments of expenses that span several years. Some examples of improper write-offs: Dues for union or professional associations; rentals of safe deposit boxes that hold securities; and purchases or renewals of multiple-year subscriptions to business or investment publications.
IRS revenue agents will limit your 2014 deduction to the cost applicable to 2015. The cost attributable to, say, 2016 isn't deductible until 2015 and allowable only if it surpasses the 2-percent hurdle. Another no-no for 2014 is to prepay for services that won't be performed until 2015—preparation of a return for 2014, for instance.
Exemption for "statutory employees." There's an exemption from the 2-percent floor for business expenses of employees who come within the definition of "statutory employees." Because this part of the tax law treats these individuals as though they were self-employed, they do not have to list their business expenses on Schedule A and deduct just the part above 2 percent of their AGI. Instead, they get to deduct their expenses in full on Schedule C (Profit or Loss From Business).
Which employees qualify for this break? There are four groups: (1) full-time life insurance agents; (2) full-time sales representatives seeking orders from retailers, wholesalers, contractors; or operators of hotels, restaurants, or other businesses dealing with food or lodging, for goods they resell or use in their own businesses; (3) agent or commission drivers who deliver laundry, dry cleaning, food or beverage items, other than milk; and (4) individuals paid to do work at home under guidelines set by the person for whom the work is done, with materials that person furnishes and to whom the products are returned.
Exception for fees for Schedule C, E, or F preparation or tax advice. Revenue Ruling 92-39 authorizes relief from the 2-percent floor. It allows fee splitting for the portion of return-preparation fees that are allocable to Schedule C, Schedule E (rental income from stores, vacation homes or other properties; royalties; partnerships, and S corporations) or Schedule F (Profit or Loss From Farming). Claim such fees as "above-the-line" deductions (right on the Schedule C, E, or F) that fully offset business, rental, or farming income. Claim the remainder of the fees as miscellaneous deductions subject to the 2-percent floor. Also fully deductible are fees for advice on tax planning or to fight audits of Schedule C, E, or F activities.
To illustrate how the rules work, suppose you don't have sufficient miscellaneous expenses to surpass the 2-percent floor. The charge for filling out your return is $1,000, of which $500 is attributable to Schedule C. If you're in a 35-percent federal and state bracket, that means a savings of $175.
An additional deduction on Schedule C for preparation fees doesn't just reduce the amount shown as net profit, thereby reducing the amount of income subject to income taxes. It also reduces the amount of business income subject to self-employment taxes (Social Security taxes for the self-employed). Calculate those taxes on Schedule SE (Self-Employment Tax).
Alternative Minimum Tax. Those who suspect they're subject to the alternative minimum tax might want to defer payments until next year. The AMT disallows miscellaneous deductions, except for those that aren't subject to the nondeductible two percent floor, such as gambling losses.
About the author:
Julian Block writes and practices law in Larchmont, New York, and was formerly with the IRS as a special agent (criminal investigator) and an attorney. More on this topic is available from "Julian Block's Year Round Tax Strategies", available at julianblocktaxexpert.com.
About Julian Block
Attorney and author Julian Block is frequently quoted in the New York Times, Wall Street Journal, and the Washington Post. He has been cited as “a leading tax professional” (New York Times), an “accomplished writer on taxes” (Wall Street Journal), and “an authority on tax planning” (Financial Planning magazine). More information about his books can be found at julianblocktaxexpert.com.