Unreimbursed Expenses: Definition, Example, and FAQs
Unreimbursed expenses refer to work-related costs paid by an employee out of their own pocket, for which they are not compensated by their employer. These expenses are a significant aspect of personal finance and taxation, as their deductibility for federal income tax purposes has changed considerably over time. Historically, individuals could claim a tax deduction for certain unreimbursed expenses, but recent tax reforms have largely eliminated this for most employees.
History and Origin
The ability to deduct unreimbursed employee business expenses from federal income tax has a long history, evolving with various tax laws. Prior to the Tax Cuts and Jobs Act (TCJA) of 2017, employees could deduct job-related expenses that were not reimbursed by their employer as a miscellaneous itemized deduction. These deductions were subject to a 2% floor of the taxpayer's Adjusted Gross Income (AGI), meaning only the amount exceeding 2% of their AGI could be deducted. For example, if a taxpayer's AGI was $50,000, and they had $2,000 in unreimbursed expenses, they could only deduct the amount above $1,000 (2% of $50,000).
However, the landscape for unreimbursed expenses significantly shifted with the TCJA, enacted in December 2017. This comprehensive tax reform suspended miscellaneous itemized deductions subject to the 2% AGI floor for tax years 2018 through 2025. This change effectively eliminated the federal deduction for most unreimbursed employee business expenses for this period. The move was part of a broader effort to simplify the tax code, which also saw a near-doubling of the standard deduction, reducing the number of taxpayers who itemize. Many changes within the new tax law impacted various deductions, including those previously taken by individuals for work-related costs.
Key Takeaways
- Unreimbursed expenses are work-related costs paid by an employee and not compensated by their employer.
- The Tax Cuts and Jobs Act of 2017 (TCJA) largely eliminated the federal tax deduction for most unreimbursed employee expenses for tax years 2018 through 2025.
- Prior to TCJA, these expenses were deductible as miscellaneous itemized deductions, subject to a 2% AGI floor.
- The non-deductibility applies primarily to traditional employees receiving a W-2 form.
- Self-employed individuals or independent contractors can still deduct legitimate business expenses on Schedule C.
Formula and Calculation
This section is omitted as, under current federal tax law (Tax Cuts and Jobs Act of 2017), most unreimbursed employee expenses are no longer deductible for tax years 2018 through 2025. Therefore, a formula for their deductibility is not applicable in the general context for employees.
Interpreting Unreimbursed Expenses
For the majority of individuals who are traditional employees, unreimbursed expenses currently have no direct impact on their federal taxable income through a deduction. This means that if an employee incurs a job-related expense—such as professional development courses, home office costs, or tools—and their employer does not provide reimbursement, the employee simply bears the full financial burden without a corresponding tax benefit.
The interpretation of unreimbursed expenses, therefore, primarily lies in understanding the shift in tax policy. For employees, it emphasizes the importance of negotiating reimbursement policies with employers or ensuring that any necessary job-related expenses are explicitly covered. For self-employed individuals, however, unreimbursed expenses are simply legitimate business costs that reduce their gross income and thus their net income for tax purposes.
Hypothetical Example
Consider Sarah, an employed graphic designer who works from home. Her employer does not provide a stipend for her home office, nor does it reimburse her for the specialized design software she purchases annually. In 2024, Sarah spent $800 on new design software and $1,200 on upgrading her internet service, which is solely used for work. These are her unreimbursed expenses.
Under tax laws enacted by the TCJA, Sarah, as a W-2 employee, cannot deduct these $2,000 in unreimbursed expenses on her federal income tax return, even though they are directly related to her job. If, however, Sarah were an independent contractor running her own design business, she would be able to deduct these costs as ordinary and necessary business expenses on her Schedule C, reducing her self-employment income.
Practical Applications
While the federal deductibility for most employees has been suspended, understanding unreimbursed expenses remains crucial in several contexts:
- Employer Policies: Companies often implement specific reimbursement policies to cover employee expenses, which can range from travel and entertainment to professional development and office supplies. These policies are vital for employees to avoid incurring significant out-of-pocket costs that are no longer tax-deductible.
- Self-Employment and Business Ownership: For individuals operating as independent contractors or owning a business, unreimbursed expenses are fundamental. They are classified as legitimate business expenses and are fully deductible on Schedule C (Form 1040) against their business income, significantly impacting their overall tax liability.
- Tax Planning: Even without direct deductions, awareness of these costs influences financial planning. Employees might factor them into salary negotiations or evaluate whether a particular job's benefits outweigh the burden of non-reimbursed costs.
- Limited Exceptions: While most unreimbursed employee expenses are nondeductible, certain categories of employment may still be eligible to deduct some expenses. For example, some categories of state or local government officials, qualified performing artists, and fee-basis government officials might still be able to claim them. Taxpayers should consult the IRS website for specific guidance on these limited exceptions.
Limitations and Criticisms
The primary limitation of unreimbursed expenses for most employees stems directly from the Tax Cuts and Jobs Act (TCJA) of 2017, which eliminated their deductibility for federal income tax purposes from 2018 through 2025. This change removed a previously available federal tax deduction for many workers, including those with substantial job-related costs.
Critics argue that this change disproportionately affects certain professions that inherently require employees to incur significant out-of-pocket costs, such as traveling salespeople, educators, or performing artists, if their employers do not offer full reimbursement plans. While the increased standard deduction under TCJA benefited many taxpayers by simplifying their filing and potentially lowering their taxable income, it eliminated the specific relief previously offered for these job-related expenses. The practical consequence for many employees is that these necessary work costs become a direct reduction of their net income without any offsetting tax deductions.
Unreimbursed Expenses vs. Business Expenses
While often confused, "unreimbursed expenses" and "business expenses" refer to distinct categories, particularly in the context of tax law. The key differentiator lies in the taxpayer's employment status and the purpose of the expenditure.
Unreimbursed Expenses specifically apply to employees who incur costs related to their job that are not compensated by their employer. These are personal outlays for work-related activities. As discussed, for most employees, these are generally not federally deductible post-TCJA.
Business Expenses, on the other hand, are the ordinary and necessary costs incurred by self-employed individuals or businesses in the course of operating their trade or profession. These expenses are fully deductible from gross income to arrive at net income for tax purposes. Examples include office rent, advertising costs, or professional fees paid by a freelance consultant. The distinction is critical because an independent contractor can deduct many costs that a traditional employee cannot, even if the nature of the expense (e.g., travel, supplies) is similar.
FAQs
Q: Can I deduct unreimbursed expenses if I'm self-employed?
A: Yes, if you are a self-employed individual or an independent contractor, you can generally deduct ordinary and necessary business expenses incurred in your trade or business on Schedule C of your tax return. This is distinct from unreimbursed employee expenses.
Q: What happened to the deduction for unreimbursed employee expenses?
A: The Tax Cuts and Jobs Act (TCJA) of 2017 suspended the deduction for most unreimbursed employee business expenses for tax years 2018 through 2025. These expenses were previously categorized as miscellaneous itemized deductions subject to a 2% AGI floor.
Q: Are there any exceptions for deducting unreimbursed employee expenses?
A: Yes, a few specific categories of employees, such as certain state or local government officials, qualified performing artists, and fee-basis government officials, may still be able to deduct unreimbursed expenses. It is best to consult IRS publications for the most current and specific guidance.
Q: Does my employer have to reimburse me for job-related expenses?
A: Federal law generally does not require employers to reimburse employees for business expenses, though some state laws might have such requirements. However, many employers do offer reimbursement as a matter of policy or industry practice.
Q: How do unreimbursed expenses affect my taxable income now?
A: For most employees, unreimbursed expenses no longer reduce their federal taxable income as a tax deduction from 2018 through 2025 due to changes from the TCJA. This means you bear the full cost without tax relief.