One of my clients was recently audited by the IRS for deducting unreimbursed employee business expenses on his tax return. These expenses are deductible as an itemized deduction on Schedule A of Form 1040. Those expenses make their way to the Schedule A (Itemized Deductions) by way of Form 2106 (Employee Business Expenses). To get the “big picture”, if you are an employee and receive a W-2 for your wages, Form 2106 is designed to allow you to deduct business expenses that your employer requires you to pay as a condition of employment, but they do not reimburse you for incurring these expenses. Even though any job may have unreimbursed business expenses, the most common situation where this arises is “outside salesmen” such as insurance agents. Any job can require employees to pay business expenses that are not reimbursed. For instance, we had a high school teacher who was also the football coach. He not only had additional business miles to go to practices and games, but he also was running junior high programs for 3 elementary schools that were “feeder schools” for the high school. Be aware of your situation; you may have unreimbursed business expenses also.
Common unreimbursed business expenses are business use of your personal auto for business purposes. (Even though, you can track and deduct actual expenses, most people chose to deduct standard mileage rate. The amount the IRS allows per mile is currently 53.5 cents per mile. This is not bad considering that the average car costs less than 15 cents per mile in gasoline.) Another common unreimbursed business expense, is the cost of using a portion of your home as an office or as a storage place for supplies used on your job. As an example of how this works is as follows: If you use 200 square feet of your 1000 square foot apartment as a home office, you can deduct 20% of your rent, utilities, repairs, etc. The same can be true of your cell phone. In addition, meals and entertainment may be deductible if needed in your business but not reimbursed by your employer.
This seems too good to be true. Right? Read on.
The reason for this brief article is to prepare you what records the IRS expects if you are audited.
First, the IRS requires a letter from your employer on the employer’s letterhead stating the company’s reimbursement policy. The IRS is not only checking to see how much your employer reimburses for employee business expense, but they are checking to see what expenses you are required or expected to incur. If your employee provides an office in which you can do your job, the IRS will not allow you to take a deduction for another office at home. Also, if they don’t require you to have a cell phone, there goes another deduction. As you can see the Company’s employee business expense reimbursement letter is much more important than it appears. Many small companies may need assistance in writing this letter. Your employer may not think to tell you that a cell phone, laptop computer and client meals and entertainment are required, but what would sales be without them. Also, if you share a desk with 5 other people, I don’t consider that being office space provided by employer. The letter should state that an office at home is required even if they don’t strictly enforce that requirement. The letter must also say you are required to make sales calls sales calls and they do not reimburse for the use of your vehicle to make these sales calls. They should outline your territory (if any) and list expected contact frequency. The same is true for expenses like meals and entertainment that are necessary while making sales calls. Without these requirements, the IRS could challenge these deductions even if everything else concerning these expenses are properly documented.
Now, a few words concerning required documentation required to deduct employee business expenses.
If you need to use your personal vehicle to perform your job duties, what should you document. You need to show proof of both the total miles and business miles. The best way to prove total miles put on your vehicle during a year is to get an oil change close to the end or beginning of the year each year. The reason is that the documentation from an oil change receipt shows the odometer reading. You will need one that is dated near the beginning of the year and one that is near the end of the year. If you traded cars during the year, you will need odometer reading document at trade in to prove the ending odometer reading. You will also need the odometer reading document from the purchase of the new car to support its beginning odometer reading and an oil change receipt at the end of the year to support the ending odometer reading for the new car. After documenting total miles, now you need to support business miles. A detailed log of each trip is not required, but you need a schedule showing your typical route over a period of time such as a week or a month. List the business mile to run this route. Or you mileage may be best represented by appointments on a calendar or day planner. Using that assign the business miles required each day.
Keep in mind if your employer does not require that you work from your home, the miles from your home to your first sales call will be considered “commuting” (IRS talk for not deductible). The same is true of the miles from your last sales call back to your house. As you can see, that letter from your employer and the wording included in that letter is extremely important.
Finally, you think if you have your credit card statement, the IRS will consider it to be documentation of business expenses such as meals and entertainment. You will need more than just a credit card statement to support the business purpose of the expenditure. You need notations telling the name of the customer, or potential customer, and the business purpose of the meeting. Of course, the credit card statement will have the other information needed such as the date of the meeting.
Hopefully, this article gives you an opportunity to get an insight into how the IRS thinks. Be a good boy scout. “Be prepared” if you plan to claim unreimbursed employee business expenses.
Steve Gentry, CPA