The Bodyguard – A cautionary tale for unreimbursed employee expenses (and other 2018 tax advice)
Unreimbursed employee expenses and the dos and dont's for claiming work-related deductions under Sec. 162 and Sec. 212 of the Tax Code confuse a lot of people... but, there are some basic principles to follow, and it is important to document the business use for all your expenses.
The BodyguardIn Rick Colbert v. Comm*r of Internal Revenue, Tax. Ct. 2018-7, a retired Long Beach policeman who was working for Screen International Security Service, Ltd. (*SISS*) in Beverly Hills found out that getting reimbursed for the Bodyguard lifestyle is not as easy as he thought. He was hired by celebrities to perform a wide range of tasks including: chauffering them to appointments, deflecting paparazzi, monitoring construction at their homes, installing and monitoring security devices, patrolling their estates, providing access control for events, and responding to emergency and distress calls. He had a concealed weapon and carried a pistol most of the time during work. SSIS had a reimbursement policy for *vehicle costs, parking, necessary purchases, and client requests.* Rick never requested reimbursement. Rick reported wages of $25,546 from SISS and claimed deductions for unreimbursed employee expenses of $23,965 on Schedule A of his Form 1040. The IRS disallowed most of these deductions for lack of substantiation. After the court reviewed the matter, this is how things panned out.
The Expenses That Passed MusterRick was able to convince the court that the following expenses were *ordinary and necessary* expenses that were *not reimbursed* that were needed to perform his job:
* Replacement of duty pistol and target practice ($1,154);
* Earbuds so he could drive without listening to annoying celebrity chatter ($86);
* Flashlight for evening patrols on celebrity estates ($26); and
* Sanitary handwipes for frequent handshakes/pat downs ($92).
The Expenses the Court DisallowedRick could not convince the court that the following expenses were *ordinary and necessary* expenses that were *not reimbursed* that were needed to perform his job, because they found they were items for personal consumption.
* The cost of clothing and shoes and dry cleaning the work attire * khakis and polo shirts could be used for personal use, and it was not shown these were exclusively for business ($1,711);
* Expenses for newspapers and magazines, a gym membership, weight loss pills and satellite radio * there was a personal benefit for these, and it was not shown even though Rick claimed it was a *job requirement* to keep up with celebrity gossip or stay fit or that he was required to have satellite radio ($1,609);
* Home office expenses, iPad and printer * because the room (and devices) claimed by the taxpayer as a home office use weren*t used exclusively for business * it was used as a weight room and spare bedroom and devices used for personal use * under IRC Sec. 280 the IRS requires *exclusive* or *dedicated* business use of a portion of the home ($4,486) * $133 of office supplies allowed!; and
* Communication expenses (e.g., Verizon service and an iPhone and cover) * again, he could not prove what *business uses* these items were dedicated for and how he used them on the job ($5,003).
Lessons from the BodyguardUnder prior law, unreimbursed employee business expenses could be deducted, along with other miscellaneous expenses, subject to a deduction threshold of 2% of adjusted gross income (AGI). But for 2018-2025, the Tax Cuts and Jobs Act (TCJA) eliminates most miscellaneous expense deductions (including the one for unreimbursed employee business expenses).
Word of warning: A lot of people like to try to make themselves an *independent contractor* when they are really an employee. For instance, take a lawyer who claims an *of counsel* relationship, but gets all of their legal work from their employer and doesn*t have their own client list. Unless you have a substantial client list of your own (in many cases defined as a minimum of 5 other significant contracts per year), the IRS may reclassify you as an employee. Thus, all of your deductions on your Schedule C will potentially be disallowed, along with your home office, transportation, etc. This is a common mistake in my industry and people who try this approach are often surprised when most of their expenses are disallowed when the IRS eventually audits their Schedule C.
So, what does all of this mean? What do you do under the new tax law? It means that you need to go into business for yourself!!! Don*t worry, I*m not suggesting you quit your day job. In fact, that would probably be a bad idea. Instead, when your side-business grows into a real-business, you can start paying yourself a salary there as well. Now, you will have 2 salaries and profits from your own gig! Not bad. But, firs you have to start.
Having a separate business or moonlighting as an *independent contractor* in addition to any wage-based employment will help you get the full benefits of the new tax code. But, this should be a *separate business.* Mixing the two is a big mistake and where people get hung up. If you work your day job as a Marketing Professional on large contracts for multinationals, then your side-business should not be in the vein of *extra services* in conjunction for that job, that market and that employer. You should have *separate* clients (i.e., small businesses needing help with advertising or individuals looking to create a web presence) who you provide a service, even for a modest price, that is akin to a paid *passion project.* It should be something you like to do that fits in with your same skill set, but which could be scaled up.
This message is for employees. If you are already an entrepreneur with your own clients and employees, you can keep doing what you are already doing, but make sure to formalize your arrangements to take advantage of tax savings. For employees though, its critical to get a side-business set up if you want to get the maximum bang for your buck under the new tax code. And it needs to be set up as a pass-through entity (i.e., LLC or S-Corp.).
Then this side-business can garner deductions for you on Schedule C of your tax return. There will be overlap between your main employment and your side-business. For instance, contacts you meet in the one will provide you clients for the other.
Lessons from the Bodyguard2But, you do not claim *unreimbursed* employee expenses like Rick for these. For example, if there is a lunch with an *employment-contact* that is carrying over to your side-business and you are there to talk about employment-related items, that shouldn*t be in your mind as deductible. But, if you prepare a proposal for this person for your side-business the associated costs would be deductible.
When it comes to a home office, this is something you should have, but starting an entity or d/b/a and doing your marketing, billing or other specified tasks from a dedicated space an *logging that time* will give you the proof you need if the expense is challenged. Unlike Rick, you will be able to back-up what you use the space for, how it is dedicated to that use, and how much time you spend on those activities (together with the supplies, digital assets, devices and other resources associated with those tasks).
Likewise, if you have a cell phone or electronic device or other business asset, you need to track in some fashion how you use it for your business, and there are a lot of great apps that will help you to do that. Mile IQ is good for tracking mileage. Your phone bill is the best and easiest way and all you need is a highlighter and spreadsheet to keep track of the overall weekly/monthly time spent on personal vs. business calls. Better yet, get a separate business cell phone used exclusively for business purposes and keep everything totally separate. Some apps like Uber allow you to use different credit cards for different trips and you can split the personal vs. business travel up by having a business and a personal credit card and splitting the costs across the two.
There are a whole list of benefits and tax strategies to take advantage of including the new QBI deduction which we will get into and expound on in later articles on this topic.