If your employees pay for some business expenses, they’re going to be in for a big surprise when they file their 2018 returns in 2019. They won’t be able to deduct anything. The reason: The Tax Cuts and Jobs Act suspended for 2018 through 2025 miscellaneous itemized deductions subject to the 2%-of-adjusted-gross-income floor. So, for example, if they drive their personal vehicle on company business, they’re out of luck taxwise.
But as an employer, you may be able to help employees by covering certain costs or taking other actions. Here are two options to consider:
Use an accountable plan
You can reimburse employees for company-related expenses in a way that avoids any taxable compensation for them and any employment taxes for you. This is done through an accountable plan. I’ve previously explained what accountable plans are and why they’re important. It’s worth discussing this option now with your CPA or other tax advisor. Some key points:
- You can adopt the plan any time during the year (there’s no deadline as there is for retirement plans and other employee benefit plans).
- The business gets to deduct the expenses covered by the reimbursement arrangement (to the extent otherwise permissible).
- You need to educate employees about their responsibilities under the plan (e.g., timely substantiating costs to you; returning excess advances).
Treat workers as statutory employees
Certain employees aren’t affected by the suspension of miscellaneous itemized deductions because they’re permitted to take write-offs on Schedule C. These are “statutory employees,” and there are 4 categories of such workers:
- 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.
For statutory employees, their compensation is subject to employment taxes (i.e., income tax withholding; FICA taxes), but their business expenses are deductible on Schedule C as if they were independent contractors. Form W-2 has a box that can be checked to indicate statutory employee status.
You may not think that any of your employees fall within these categories, but think again. A recent Tax Court decision decided that a semi-retired aerospace engineer who worked part-time from his home as a consultant for a company fit within category 3 (a home worker). He was essentially an independent contractor not under the control of the company but still a statutory employee under the language of category 3.
I’m not suggesting that you can shoehorn all of your home-based workers into the same category to enable them to write off their business expenses. They must be independent contractors who just happen to also be required to be treated as statutory employees. But the court case makes it clear that category 3 isn’t limited to piece workers stitching garments in their home. Who knows where this will go?
The Tax Cuts and Jobs Act have called some traditional business practices into question. Which costs should companies bear? Which should employees pay for? Take another look now.