The 2% rule for itemized deductions is a concept that used to apply to certain types of miscellaneous expenses in excess of 2% of your adjusted gross income (AGI).
In 2018, this rule changed, but some people still qualify to deduct certain unreimbursed employee business expenses. In today’s post, I’ll explain this rule and help you decide whether or not you qualify for these types of deductions.
What is the 2% rule?
Prior to January 1, 2018, taxpayers could deduct various expenses that exceeded 2% of their AGI when calculating itemized miscellaneous deductions on their federal individual income tax return. This included deductions for costs like tax preparation fees, job search expenses, home office expenses, and other expenses related to employment.
So, how did the 2% rule work? Let’s say you are a freelance writer who works from home. You incur expenses for a home office, internet service, and a new computer. These expenses total $2,500 for the year. However, your AGI is $60,000, which means that you would need to have expenses totaling more than $1,200 (2% of $60,000) in order to be able to deduct them.
In this scenario, you would be able to deduct $300 ($2,500 – $1,200) on line 23 of Schedule A. This is because only the amount of expenses that exceed 2% of your AGI could be deducted. The remaining $1,900 would not be deductible.
It’s also worth noting that there are some expenses that were not subject to the 2% rule, and these expenses can still be deducted if you itemize your deductions on Schedule A of your Form 1040. These include things like medical and dental expenses, certain casualty and theft losses, and gambling losses. These expenses can be deducted in full as long as they meet certain criteria.
Is the 2% rule currently in effect?
No. The Tax Cuts and Jobs Act (TCJA) passed in 2017 suspended the 2% rule from 2018 through 2025. However, there are some exceptions (keep reading!).
Who can deduct unreimbursed employee business expenses?
If you are a business owner or self-employed, you can deduct qualifying business expenses on your Schedule C of your Form 1040.
If you aren’t a business owner, you may be able to deduct certain unreimbursed employee business expenses that may have previously been subject to the 2% rule if you fall into one of these 5 categories:
- You are an Armed Forces reservist claiming travel expenses.
- You are a qualified performing artist claiming expenses related to performing that job.
- You are a fee-basis state or local government official claiming expenses related to performing that job.
- You are an individual with a disability who is claiming impairment-related work expenses.
- You are a K-12 teacher, counselor, principal, or aide who worked at least 900 hours during the school year claiming expenses related to materials used in the classroom or professional development.
You can deduct your qualifying unreimbursed employee business expenses as adjustments to your gross income by completing Form 2106. However, if you are deducting qualified educator expenses, you are not required to complete Form 2106 but will instead report your adjustment to your gross income on your Schedule 1 of your Form 1040.
What types of employee business expenses can I deduct?
If you fall into one of the categories above, you can deduct unreimbursed employee expenses that are deemed “ordinary and necessary” for carrying out your business or trade. This means that the expense is common, accepted, appropriate, and helpful to you when doing your job. An important note is that an expense can be necessary even if it isn’t required.
Obviously, the types of expenses you can deduct will depend upon your career field. For instance, actors can deduct the cost of theatrical clothing that can’t be used as “everyday wear” whereas teachers cannot deduct the clothing they wear to work.
For a more complete list of what may and may not be deductible as unreimbursed employee expenses, you’ll want to review the information on IRS Publication 529.
What are itemized deductions?
Itemized tax deductions are expenses that are allowed to be deducted from your taxable income. These expenses are reported on Schedule A of your tax return and include things like medical and dental expenses, state and local taxes, mortgage interest, charitable contributions, and certain work-related expenses.
The reason you would want to itemize deductions instead of taking the standard deduction is that it can lower your taxable income and potentially lower the amount of tax you owe. However, since Congress greatly increased the standard deduction with the passing of TCJA in 2017, the large majority of people simply take the standard deduction rather than itemizing.
Remember that even if it makes sense for you to itemize your deductions, not all expenses can be deducted, and even those that can may be subject to certain limitations.
Why did the 2% rule exist?
The purpose of the 2% rule was to limit the amount of deductions that taxpayers can claim for certain types of expenses. It was intended to prevent people from claiming deductions for minor expenses that do not significantly impact their overall tax liability.
If you’re interested in learning more about tax deductions, check out my related posts:
- Tax Deductions vs. Tax Credits – and How to Use Both to Pay Less in Taxes
- Home Office Deduction
- The Tax Deductions Limit for Gifts
