How the New Tax Law Could Affect Your 2017 Returns

SMITH BRAIN TRUST – While the newly adopted tax code didn’t go into effect until 2018, it might actually create a soft spot in the 2017 tax returns Americans are filing now.

And that’s because of the things that the new law strips from the tax code, says Samuel Handwerger, lecturer in the Accounting & Information Assurance Department at the University of Maryland’s Robert H. Smith School of Business.

“In the bowels of the new tax law,” he says, “is the gut-wrenching nix of many deductions typically found under the category of ‘Miscellaneous Itemized’ deductions.”

They are also known as the 2-percent miscellaneous itemized deductions, because the deductible portion is limited to amounts above 2 percent of a filer’s adjusted gross income (AGI).

The congressional committee report that was released along with the recent tax act helpfully listed almost all of the 2-percent itemized deductions that can no longer be claimed in 2018. And, Handwerger says, “the list is an admirable, thoroughly comprehensive road map – almost acting as a checklist – so we wouldn’t forget any for 2017, the last year these apply.”

The deductions aim to take the pain out of expenses that workers face that relate to their ability to earn an income. Perhaps the biggest category, says Handwerger, is unreimbursed employee expenses. Those are expenses incurred by wage earners for things that help them do a job but that aren’t specifically being paid for or reimbursed by an employer. 

Examples include tools, technology or supplies for work as an employee, clothes worn for work that aren’t suitable for daily use, job-related travel that goes beyond a commute, work-related meals and entertainment expenses, work-related education to improve skills, a home office required for work, union dues, association dues and subscriptions, cell phone service, internet fees, legal fees related to employment, and licenses.

Another broad category of deductions are investment expenses, such as clerical help to keep track and manage investments, advisory fees to brokers or money managers and their firms, depreciation on a home computer that’s used to help with investing activities, and subscriptions to publications that relate to investing.

Hold on to your hat because there are still more miscellaneous deductions, such as: tax preparation fees, research costs for college professors, safety deposit boxes, IRA fees, job search expenses, tax and estate planning legal costs, certain other legal costs and certain business bad debts. “The list can go on and on to the extent of one’s creativity,” says Handwerger.

“What makes this soon-to-be-forgotten category of expenses interesting for 2017 is the associated IRS tax audit risk,” he says.

Filers should always follow the letter of the law, Handwerger says. Nonetheless, he predicts that 2017 might be the one tax year when the IRS will audit those 2-percent deductions “with less alacrity” and with more forgiveness in the event of lack of best evidence of deductibility.

Here’s why: Returns filed with this tax season’s due date of April 17, will be subject to IRS scrutiny for three years under the general statute of limitations rule, he says.

“With the IRS already busy with the new law and underfunded, 2017 as an audit year probably doesn’t start until sometime in the middle or late 2019,” he says.

An IRS audit aims both to correct current errors and encourage future compliance, Handwerger explains. But IRS audit adjustments to this category for 2017 tax return audits would “only light one end of that candle since these deductions are not applicable in the future,” he says.

Taking the longer view, Handwerger says that as IRS audit trends do try to hit multiple years, the audits of 2017 returns on this particular category that start in 2019 presumably don’t start seeing a pattern of noncompliance until end of 2019 or early 2020. And that might leave 2016 as the only other open year to enforce.

The IRS could not go forward and add 2018 to the audit, he says – “the deductions don’t apply. Thus, the IRS incentive to audit this area for 2017 most likely gets diminished in terms of priority and audit procedures.”

Regarding the changes for 2018, where none of these apply, Handwerger says taxpayers would be well advised to work with their employers to “establish accountable” plans. Instead of the employee spending their own money for employee expenses that are no longer deductible, they should ask their employers to reimburse them for those expenses. The deduction would be available to the employer.

"And as for those investment advisory fees charged by the financial advisors/brokers heretofore," adds Handwerger, "it will be interesting to see where the industry goes with this." Losing that deduction for their clients may increase the pressure to reduce fees or to come up with another balm. For example, he says, brokerage fees attached to buy and sell transactions do reduce tax by reducing the gain on sale of the investment, but that involves waiting for that event to happen.