The employees of my small technology company travel to our clients' offices to work on site. I cannot provide them with company cars, but I've instructed them to deduct the expenses and mileage they incur on their tax returns. Am I giving them correct information?
—L.S., Raleigh, N.C.
Basically, yes, you are. Unreimbursed employee business expenses can be deducted on personal income tax returns, experts say. However, there are several caveats and numerous hurdles that must be met in order for your employees to get a true tax benefit from the arrangement you're suggesting.
"Expenses like these are miscellaneous itemized deductions. If an employee does not itemize [on his return], there will be no tax benefit," says Steven Kaplan, a CPA and director of taxation at Sax Macy Fromm, based in Clifton, N.J. If your employee is subject to the alternative minimum tax (AMT), which applies to increasing numbers of taxpayers these days, she also will not get a tax benefit. That's because miscellaneous itemized deductions are not allowed as deductions for AMT purposes, Kaplan says.
ROADBLOCKS TO SAVINGS. What if your employee is not subject to AMT and she does itemize expenses on her tax return, will she see a benefit? Well, not necessarily. "If an employee does itemize, his or her total miscellaneous itemized deductions must exceed 2% of adjusted gross income in order [for them to] be deductible," Kaplan explains.
But that's not all. Even if the employee's itemized deductions meet that threshold of 2% of adjusted gross income, the deductions are likely to fall into another category that requires a reduction of most itemized deductions in an amount equal to the excess of 3% of adjusted gross income over a base amount.
Confused yet? Here's another obstacle to a real tax benefit: "Even if a deduction is ultimately allowed, the tax savings will be computed at the taxpayer's highest marginal tax rate," Kaplan says.
Ultimately, you're not doing anything illegal by instructing your employees to deduct their automobile expenses. But it's probably not wise to make any promises about the benefits they're likely to receive in the long run.
Even if they do wind up with tax savings (which seems unlikely for some) they'd be in a better economic position if you reimbursed their job-related travel expenses on a dollar-for-dollar basis. You might want to take that reality into account when you're recruiting new employees and negotiating pay increases for your current staff (see BusinessWeek.com, 6/29/06, "Can You Write Off a Victorian?").