So what does this mean for you as the employee?
Because the deduction is eliminated for tax years through 2025, employees will not receive any compensation to offset unreimbursed work-related expenses unless their employer intervenes. There are a few options that allow you, as the employee, to receive reimbursement for the work-related expenses incurred. We recommend that you discuss these options with your employer and work with your employer to select an option and set it in motion.
1. Accountable Plan: According to the IRS, to be an accountable plan, your employer's reimbursement or allowance arrangement must include all of the following rules:
- Your expenses must have a business connection—that is, you must have paid or incurred deductible expenses while performing services as an employee of your employer.
- You must substantiate these expenses within 60 days after the expense was paid or incurred by providing details of the expenses along with receipts to your employer.
- You must return any excess reimbursement or allowance within 120 days after the expense was paid or incurred. (An excess reimbursement or allowance is any amount you are paid that is more than the business-related expenses that you adequately accounted for to your employer.)
If you meet the three rules for accountable plans, your employer will be able to deduct these reimbursements as business expenses but shouldn’t include any reimbursements in your income in box 1 of your Form W-2.This means that the reimbursements you receive will be tax-free.
2. Nonaccountable Plan: If a reimbursement or allowance arrangement doesn’t meet one or more of the three rules listed above, then it’s a nonaccountable plan. Even if your employer has an accountable plan, if you fail to return excess reimbursement or allowance, then the excess will be treated as being under a nonaccountable plan.
If it is a nonaccountable plan, your employer will still be able to deduct these reimbursements but should include any reimbursements in your income in box 1 of your Form W-2. This means that the reimbursements you receive under a nonaccountable plan will be taxable.
3. The third option is to request a pay increase that will adequately cover the expenses that you incur. A pay raise will be taxed normally as wages, therefore you must factor in the payroll and income taxes you will incur on the wage increase to determine the total amount that is appropriate to fully cover your anticipated previously unreimbursed work-related expenses.
What does this mean for employers?
At first glance, you may assume this change only hurts individuals. Some employers may consider implementing one of the three options above to offset the out of pocket costs that their employees can no longer deduct on their individual tax returns, however, some employers may assume that they pay a higher wage already which is intended to help pay for any additional expenses they require of their employees. If the latter is the case, you may want to consider whether a change in pay structure that reduces taxable wages, while implementing a corresponding accountable plan, may benefit both the employee and the employer through reduced income and payroll taxes while keeping the cash flow between the employee and the employer the same as it is currently.
What does this mean for partners of a partnership?
Partners of a partnership deduct unreimbursed partnership expenses directly on Schedule E of their individual tax returns because partners are not considered employees. The partners are still only permitted to deduct these expenses on their personal return if an agreement is in place among the partners that requires partners to use their own funds to pay certain partnership expenses (i.e. home office use, travel expenses, etc.). This deduction has not been changed by the Tax Cuts and Jobs Act.
What does this mean for shareholders of an S corporation?
If shareholders of an S corporation have unreimbursed work-related expenses, those are treated as unreimbursed employee expenses. Shareholders are treated as employees for this purpose and therefore should discuss the three options listed above with their fellow shareholders and possibly implement one of the three options.