Deductible Expenses for Employees

For the most part, employees can deduct all "ordinary and necessary" business expenses, using the same definition that is used by a business owner. An "ordinary" expense is one that is common and accepted in your line of work. A "necessary" expense is one that is appropriate or helpful for the work you do, even if it's not absolutely indispensable to your business.

For employees, expenses may be considered "unnecessary" if you could have been reimbursed for them, but you neglected to ask the employer for reimbursement.

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A 1996 National Education Association study found that the average kindergarten through grade 12 educator spent about $400 per year out of their personal funds for unreimbursed classroom supplies. For a limited time, there is a tax break that rewards our educators for such generosity.

For tax years 2002 through 2005, eligible educators are entitled to an above-the-line deduction of up to $250 per year for unreimbursed expenses incurred in connection with books, supplies (other than nonathletic supplies for courses of instruction in health or physical education), computer equipment (including related software and services) and other equipment, and supplementary materials used in the classroom.

To be deductible, the expenses must be more than the following amounts claimed for the tax year:

interest from U.S. Savings Bonds used to pay higher education expenses that was excluded from income
distributions and earnings from qualified tuition programs that were excluded from income, or
tax-free withdrawals from Coverdell education savings accounts

An eligible educator is an individual who, for at least 900 hours during the school year, is a kindergarten through grade 12 teacher, instructor, counselor, principal or aide. For purposes of the deduction, a school is any school that provides elementary or secondary education as determined under state law.

The above-the-line deduction for eligible educator expenses is claimed on the educator's Form 1040 or Form 1040A individual income tax return. The deduction will no longer apply to expenses incurred after December 31, 2005.

As a general principle, amounts that you spend for personal or family reasons are not deductible. While it's sometimes difficult to tell the difference, the IRS has specific rules in a number of areas (such as car expenses, travel, meals and entertainment, and education) to help you determine what portion of an expense is truly business-related. If you pay for property or have some other expense for both business and personal purposes, you must allocate the expense between the two types of usage. The allocation must be made on a reasonable and consistent basis, depending on the nature of the expense.

Tip

If a car is used partly for business and partly for personal purposes, the allocation is based on the number of miles driven during the year for business, compared to the miles driven for personal use. If you use a room in your home as a home office, the allocation is based on the number of square feet in the office as compared with the square footage of the entire home.

Certain expenses, while they may be ordinary and necessary, must be treated as capital expenditures.

Generally speaking, the cost of equipment or business real estate that will be used for more than one year must be treated as a capital expenditure and depreciated. Employees may claim a depreciation deduction for equipment they need in their job (such as a cellular phone, or a laptop computer) and would use a separate Form 4562, Depreciation and Amortization, to compute the proper amount. The result from Form 4562 would be carried over to Line 4 of the Form 2106 or 2106-EZ. See our detailed explanation of capital assets, including depreciation and sales of business assets.

Finally, certain types of expenses are not deductible even if they meet the "ordinary and necessary" tests, and are not personal or capital expenses. This category includes illegal payments (e.g., bribes or kickbacks) and payments of fines or penalties (such as parking or traffic tickets).

For more detailed information, check out the following: