One of the first things that the Trump Administration did to fulfill campaign promises was to work with the Republican majority in Congress to enact tax reform. Although the issue was one that both parties agreed on, they each had different priorities and the final legislation had things that both sides weren’t totally happy with.
The new law almost doubled the standard exemption—from $12,700 to $24,000 for a married couple filing jointly— and it took away used personal and dependent exemptions used by many taxpayers who itemized on their returns. This included limiting deductions for state and local taxes to $10,000 annually and eliminating unreimbursed employee business expenses entirely.
For some inexplicable reason, the authors of the reform came to the conclusion that only the rich were in a position to write off work related expenses and if they didn’t put a stop to it, this would continue to be “loopholes for the rich.” That position totally ignores the teacher who buys the classroom supplies the district doesn’t provide or the police officers who go out and buy equipment that their department doesn’t provide or won’t replace. The same can be said for firefighters, nurses, sales people, and so on. For those people, being able to deduct those expenses isn’t a loophole, it’s what’s fair.
Many officers work side gigs in their spare time, often doing off-duty security or private protection details. It is not uncommon that the person hiring for services will want to treat the off-duty officer as an independent contractor and not take out any taxes from the pay and give a Form 1099 – MISC at the end of the year.
Some officers don’t care for this arrangement because they feel that unless taxes are deducted from their pay, they will suffer at the end of the year. But, in my professional experience, this typically is not the case. Most times, the off-duty work only amounts to a few thousand dollars over the course of the year, but you may be able to deduct expenses for uniforms and safety equipment, books and publications, seminars and continuing education against that income.
While unreimbursed employee business expenses that were previously deductible on schedule A – Itemized Deductions, have been eliminated, those expenses are still deductible on schedule C – Profit or Loss from Business. Schedule C is where Form 1099 – MISC income is reported. You are allowed deductions for those ordinary and necessary business expenses incurred in the course and scope of one’s trade or business under Internal Revenue Code Section 162. So, if enough expenses can be deduced against the income reported on schedule C, there likely will be little or no profit on which to pay tax when all is said and done. But one must be prudent and judicious about the amount of deductions claimed on Schedule C. You don’t want to claim so many deductions that will result in a loss. In other words, reporting more deductions than you receive in income.
If you claim a loss, a Schedule C loss is the kiss of death. It is not uncommon for the IRS to extensively audit Schedule C losses. So the objective is to claim just a sufficient amount of deductions to offset the Schedule C income without throwing the Schedule C into a loss. A small profit is preferable.
You may not be able to write off all your expenses against Schedule C income, but getting to write off something is better than nothing. Remember, to be able to claim deductions on the Schedule C, you have to have received a Form 1099-MISC and NOT a Form W-2. The 1099 is issued to independent contractors and a W-2 is issued to employees. And, what you can’t deduct on schedule C, you still might be able to get some benefit on your state return by deducting the remainder as an itemized deduction on the state tax return. For example, the state of California has not adopted all provisions of the new tax law for California state purposes. So you might get some benefit on your state return. But remember, unreimbursed employee business expenses have been eliminated from the federal return on Schedule A – Itemized Deductions. Also keep in mind that the IRS can audit your tax return and disagree with the deductions that you claim.
In the face of IRS adversity, prevailing in a challenge during audit will depend on establishing that the deductions you claimed were an ordinary and necessary business expenses with respect to the business. If audited, you should always seek competent representation. Not doing so would be like going into an internal affairs investigation without a rep.
Seeking competent professional advice and preparation is the best way to minimize your tax burden and optimize your refund. If you are nearing retirement and realize that your department pension won’t completely replace your paycheck and you’re worried about market volatility that can shrink and erode your 401k/deferred comp, speak to a trusted professional about programs that will bridge the income gap between lifestyle, paycheck and pension payment..
Niels Winther, CPA, CFS, is President of Winthco Wealth Management in Simi Valley, California.