Miscellaneous Itemized Deductions – On the Brink of Extinction or Just in a Seven-Year Ice Age? by Jeffrey M. Mutnik, CPA/PFS
Posted on March 07, 2019 by Jeffrey Mutnik
Individual taxpayers have long relied on miscellaneous itemized deductions as a catch-all for a variety of business- and investment-related expenses that the tax code did not already allow as specified itemized deductions, such as those for medical expenses or contributions to charitable organizations. However, with the passage of the new tax law, these miscellaneous itemized deductions are no longer available for taxpayers to claim on their tax returns beginning in 2018.
Many taxpayers will not even notice the removal of these deductions, which were previously subject to being phased-out based on the taxpayer’s adjusted gross income (AGI). The only way taxpayers could yield the benefits of these deductions was if the total amount exceeded 2 percent of AGI. The peculiarity of the U.S. tax system was that the more income a taxpayer earned (creating a higher AGI), the greater the likelihood that the taxpayer would have more miscellaneous itemized deductions, but continue to lose the tax benefits since the higher income also increased the 2 percent limitation of these deductions. Additionally, the higher a taxpayer’s income, the more likely they would be subject to the alternative minimum tax (AMT), which essentially eliminating all tax benefits of the miscellaneous itemized deductions.
From a public policy point of view, eliminating these deductions will raise revenue and save the IRS time and money by not having to review, audit or litigate such matters. However, the impact on taxpayers can be significant, especially when they do not engage in advance planning to account of the loss of the deduction and improve their tax positions.
For example, while the new law prohibits individual taxpayers from deducting the costs they incur for hiring professionals to prepare their tax returns, taxpayers whose returns include a business reported on Schedule C have an opportunity for that business to fully deduct the associated fees on the Schedule C. This is similar to how an incorporated business would deduct professional fees on its corporate tax return. Since fees for the preparation of an individual tax return is not always segregated into its component parts, taxpayers should request their professional accountants provide them with an appropriate allocation of these fees.
In addition, without the benefit of deductions for unreimbursed business expenses (reportable on IRS Form 2016) beginning in 2018, taxpayers should consider requesting that their employers reimburse them directly for these expenditures. The employer’s reimbursement should become a business expense deduction for the employer without becoming taxable income to the employee. The employer’s policies and procedures should be reviewed and updated appropriately.
Additionally, without the availability of the miscellaneous expense deduction in 2018, taxpayers should weigh the benefits of paying their IRA fees individually with after-tax dollars versus having their IRAs pay those fees with pre-tax dollars. Under prior law, taxpayers often chose to pay IRA fees directly from their own funds to allow their IRAs to continue to compound growth without reducing their account balances for such fees. Along the same lines, the new law’s elimination of deductions for investment fees may compel high net worth taxpayers to potentially create new organizational structures that allow them to treat these expenses as operating deductions rather than investment costs. The family that created Lender’s Bagels may be considered a pioneer of this strategy, creating a roadmap through litigation with the IRS in the Tax Court (TC Memo. 2017-246, Lender Management, LLC). Other families will find the facts and circumstances of their unique situation do not align with this case, and they will seek out alternate strategies. No matter what route taxpayers choose to take, their decision should always be made with the benefit of advice from informed tax professionals.
About the Author: Jeffrey M. Mutnik, CPA/PFS, is a director with the Taxation and Financial Services practice of Berkowitz Pollack Brant Advisors and Accountants, where he provides tax and estate-planning counsel to high-net-worth families, closely held businesses and professional services firms. He can be reached in the CPA firm’s Ft. Lauderdale office at (954) 712-7000 or via email at email@example.com.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.