Proving employee business expense deductions

Editor: Mark G. Cook, CPA, CGMA

Prior to the passage of the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, taxpayers were allowed to deduct unreimbursed employee business expenses as miscellaneous itemized deductions, subject to Sec. 67’s 2% floor on miscellaneous itemized deductions and Sec. 68’s overall limitation on itemized deductions, on Schedule A, Itemized Deductions, of Form 1040, U.S. Individual Income Tax Return. The deduction was disallowed for the years 2018 to 2025 by the enactment in the TCJA of Sec. 67(g), which suspends the allowance of miscellaneous itemized deductions. Nonetheless, because unreimbursed employee business expenses will be deductible again in 2026, and court cases involving disputes between the IRS and taxpayers over their deduction on tax returns for years before 2018 continue to make their way through the courts, knowledge of the details of the unreimbursed employee business expense deduction remains important.

Employee business expense deduction

To get started, what is a deductible unreimbursed employee business expense? Per Sec. 162(a), there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business. Performing services as an employee constitutes a trade or business (see, e.g., Primuth, 54 T.C. 374 (1970)). Thus, with respect to employee business expenses, a deduction under Sec. 162(a) will be allowed for an unreimbursed expense that is:

• Paid or incurred during an employee’s tax year;
• For carrying on his or her trade or business of being an employee; and
• Ordinary and necessary.

An expense is ordinary if it is common and accepted in the taxpayer’s trade, business, or profession. An expense is necessary if it is appropriate and helpful to the taxpayer’s business; it does not have to be required to be considered necessary.

Employer reimbursements

To prevent a taxpayer from obtaining a double benefit, only unreimbursed business expenses are deductible. Also, business expenses are not “necessary” if reimbursement is possible (Podems, 24 T.C. 21 (1955)). Thus, if an employee incurs an expense that he or she has a right to reimbursement for under an expense reimbursement plan of his or her employer, but the employee fails to obtain reimbursement for the expense, the employee cannot take a Sec. 162(a) deduction for the expense.

This is true regardless of why an employee does not seek reimbursement for a business expense incurred on behalf of his or her employer. The Ninth Circuit held in Orvis, 788 F.2d 1406 (9th Cir. 1986), that a taxpayer’s lack of knowledge that his employer had a policy of reimbursing such expenses was not relevant to whether he could take a deduction for the expenses on his personal return.

The burden of proof

Should the tax return be audited or a notice of deficiency be received, the taxpayer generally has the burden of proof. However, the burden of proof switches to the IRS if an individual taxpayer produces credible evidence in support of an expense, has complied with the substantiation requirements for the expense, has maintained all required records for the expense, and has cooperated with reasonable requests by the IRS for witnesses, information, documents, meetings, and interviews regarding the expense.

Credible evidence is evidence that, after critical analysis, the court would find sufficient upon which to base a decision on the issue if no contrary evidence were submitted (without regard to the judicial presumption of IRS correctness). The burden is not shifted if the taxpayer presents incredible or implausible evidence, even if that evidence is not controverted.

Substantiation requirements

An employee must be able to substantiate a deduction for an unreimbursed business expense by keeping (and producing for the IRS, if requested) adequate records. In general, the Code does not require the records to be in a specific form. However, under Sec. 274(d), specific proof is necessary to substantiate deductions for away-from-home travel and business gift expenses, and deductions related to listed property. A taxpayer must substantiate these expenses by adequate records or by sufficient evidence corroborating the taxpayer’s own statement showing:

(A) the amount of such expense or other item, (B) the time and place of the travel or the date and description of the gift, (C) the business purpose of the expense or other item, and (D) the business relationship to the taxpayer of the person receiving the benefit.

Temp. Regs. Sec. 1.274-5T(c)(2) in general defines “adequate records” as an account book, diary, log, statement of expense, trip sheets, or similar record, and documentary evidence that, in combination, are sufficient to establish each of the required elements of an expense.

Temp. Regs. Sec. 1.274-5T(c)(3) defines “sufficient evidence corroborating the taxpayer’s own statement” as the taxpayer’s own statement, whether written or oral, containing specific information in detail about the required element of an expense and other corroborative evidence sufficient to establish that element. However, the Tax Court has routinely held that it is not required to accept a taxpayer’s self-serving testimony without objective, corroborating evidence.

The taxpayer must substantiate the required elements for every Sec. 274(d) expense. Because Sec. 274(d) overrides the Cohan rule (Cohan, 39 F.2d 540 (1930)), courts cannot estimate the amount of the taxpayer’s expenses.

Temp. Regs. Sec. 1.274-5T(c)(5) offers an exception to the adequate-records rule if the loss of records is due to circumstances beyond the taxpayer’s control (e.g., a natural disaster). In this circumstance, the taxpayer has the right to substantiate his or her deductions through reasonable reconstruction of expenses.

Takeaway

If, as scheduled, unreimbursed employee business expenses again become deductible, employees should understand their employer’s policy about business expense reimbursements to avoid denial for business expense deductions. If the employer’s policy is unclear, the taxpayer should attempt to receive a reimbursement and document the results as evidence. It is important for taxpayers to keep a good record of the business expenses and make sure it is detailed enough to show that the expenses were incurred or paid during the tax year. For deductions for travel expenses, gifts, and deductions related to listed properties, taxpayers must ensure that they can substantiate the deductions under the strict standards in Sec. 274(d).

EditorNotes

Mark G. Cook, CPA, CGMA, MBA, is the lead tax partner with SingerLewak LLP in Irvine, Calif.

For additional information about these items, contact Mr. Cook at 949-623-0478 or mcook@singerlewak.com.

Contributors are members of SingerLewak LLP.