include an employee's expenditures for subscriptions to professional journals or continuing education courses, union or professional dues, costs of professional uniforms, costs of looking for new employment, and expenses allowable for business use of the employee's home. Ordinary and necessary employee business expenses generally are deductible.

Employee business expenses generally can be claimed only as itemized deductions. However, under prior law four types of employee business expenses were deductible above-the-line in calculating adjusted gross income, and thus were directly available to nonitemizers: (1) certain expenses paid by an employee and reimbursed under an arrangement with the employer; (2) employee travel expenses incurred while away from home; (3) employee transportation expenses incurred while on business; and (4) business expenses of employees who are outside salespersons (sec. 62(2)).48 In addition, the section 217 moving expense deduction was allowable above-the-line to employees or self-employed individuals.

Certain deductions for employee business expenses also are subject to specific limitations or restrictions. For example, a taxpayer's business use of his or her home (whether or not the taxpayer is in the business of being an employee) does not give rise to a deduction for the business portion of expenses related to operating the home (e.g., depreciation and repairs) unless the taxpayer uses a part of the home regularly and exclusively as the principal place of business or as a place of business used by patients, clients, or customers (sec. 280A).49 Educational expenses are deductible only if the education (1) is required by the employer, by law, or by regulations, or (2) maintains or improves skills required to perform the taxpayer's present occupation.50 Costs of looking for new employment are deductible only if they relate to employment in the taxpayer's present occupation. Also, special substantiation requirements must be met in order to deduct certain employee expenses, such as traveling expenses (sec. 274(d)).

Investment expenses

In general, expenses of producing income other than rental or royalty income are treated as itemized deductions if the related activity does not constitute a trade or business. (Trade or business expenses and expenses of producing rental or royalty income are deductible above-the-line.) Among the types of investment expenses that may be eligible, in particular circumstances, for deduction are investment counsel and trust administration fees, subscriptions to investment advisory publications, and attorneys' fees incurred in collecting income.

48 For this purpose, the term outside salesperson meant an individual who solicits business as a full-time salesperson for his or her employer away from the employer's place of business. The term outside salesperson did not include a taxpayer whose principal activities consist of service and delivery, such as a bread driver-salesperson. However, an outside salesperson could perform incidental inside activities at the employer's place of business, such as writing up and transmitting orders and spending short periods at the employer's place of business to make and receive telephone calls (Treas. Reg. sec. 1.62-1(h)).

49 See secs. 143(b) and 143(c) of the Act, amending the rules relating to home office deduc

50 See sec. 142 of the Act, disallowing deductions for travel as a form of education.

Other miscellaneous itemized deductions

Tax counsel and assistance fees, as well as appraisal fees paid to determine the amount of a casualty loss or a charitable contribution of property, may be claimed as itemized deductions (sec. 212(3)).

Expenses incurred with respect to a hobby-i.e., an activity that may generate some gross income but that the taxpayer conducts for personal recreational reasons, rather than with the goal of earning a profit-are deductible as itemized deductions to the extent such expenses would be deductible regardless of profit motivation (e.g., certain interest and taxes) or to the extent of income from the hobby.51 Gambling losses are deductible as itemized deductions to the extent of gambling gains.

Reasons for Change

The Congress concluded that the prior-law treatment of employee business expenses, investment expenses, and other miscellaneous itemized deductions fostered significant complexity, and that some of these expenses have characteristics of voluntary personal expenditures. For taxpayers who anticipated claiming such itemized deductions, prior law effectively required extensive recordkeeping with regard to what commonly are small expenditures. Moreover, the fact that small amounts typically were involved presented significant administrative and enforcement problems for the Internal Revenue Service. These problems were exacerbated by the fact that taxpayers frequently made errors of law regarding what types of expenditures were properly allowable under prior law as miscellaneous itemized deductions. 52

Since many taxpayers incur some expenses that are allowable as miscellaneous itemized deductions, but these expenses commonly are small in amount, the Congress concluded that the complexity created by prior law was undesirable. At the same time, the Congress concluded that taxpayers with unusually large employee business or investment expenses should be permitted an itemized deduction reflecting that fact. Similarly, in the case of medical expenses and casualty losses, a floor is provided (under prior and present law) to limit those deductions to unusual expenditures that may significantly affect the individual's disposable income.

Accordingly, the Congress concluded that the imposition of a twopercent floor on miscellaneous itemized deductions constituted a desirable simplification of the tax law. This floor will relieve taxpayers of the burden of recordkeeping unless they expect to incur expenditures in excess of the floor. Also, the percentage floor will relieve the Internal Revenue Service of the burden of auditing deductions for such expenditures when not significant in aggregate amount.

51 See sec. 143(a) of the Act, amending the rules relating to hobby losses.

52 Common taxpayer errors have included disregarding the restrictions on home office deductions, and on the types of education expenses that are deductible; claiming a deduction for safe deposit expenses even if used only to store personal belongings; and deducting the cost of subscriptions to widely read publications outlining business information without a sufficient business or investment purpose.

The use of a deduction floor also takes into account that some miscellaneous expenses are sufficiently personal in nature that they would be incurred apart from any business or investment activities of the taxpayer. For example, membership dues paid to professional associations may serve both business purposes and also have voluntary and personal aspects; similarly, subscriptions to publications may help taxpayers in conducting a profession and also may convey personal and recreational benefits. Taxpayers presumably would rent safe deposit boxes to hold personal belongings such as jewelry even if the cost, to the extent related to investment assets such as stock certificates, were not deductible.

The Congress also concluded that the distinction under prior law between employee business expenses (other than reimbursements) that were allowable above-the-line, and such expenses that were allowable only as itemized deductions, was not supportable in most instances. The reason for allowing these expenses as deductions (i.e., the fact that they may constitute costs of earning income) and the reasons for imposing a percentage floor apply equally to both types of expenses. However, the Congress concluded that it would not be appropriate to apply the new percentage floor to the moving expense deduction (which is subject to separate dollar limitations under sec. 217) or to the new deduction for certain impairment-related work expenses of handicapped individuals (which applies only in limited circumstances).

Explanation of Provisions

Under the Act, all employee business expenses, other than reimbursed expenses described in section 62(a)(2)(A) and the new deduction for certain performing artists, are allowed only as itemized deductions. Thus, under the Act, unreimbursed employee travel expenses incurred away from home, employee transportation expenses incurred while on business, business expenses of employees who are outside salespersons, and employee moving expenses no longer are deductible above-the-line in calculating adjusted gross income. Also, the section 217 moving expense deduction is allowable to a self-employed individual only as an itemized deduction.

The Act also provides that, subject to certain exceptions, the total of all the taxpayer's miscellaneous itemized deductions, including employee business expenses that are not deductible abovethe-line, are subject under the Act to a floor of two percent of the taxpayer's adjusted gross income. Thus, for example, if an itemizer with AGI of $30,000 incurs miscellaneous itemized deductions totaling $757, the allowable amount of such deductions is $157.

However, the two-percent floor does not apply to the following miscellaneous itemized deductions, if otherwise allowable: impairment-related work expenses for handicapped employees (new Code sec. 67(d)); 53 moving expenses (sec. 217); the estate tax in the case of income in respect to a decedent (sec. 691(c)); certain adjustments where a taxpayer restores amounts held under a claim of right

53 The term "impairment-related work expenses" means expenses of a handicapped individual (as defined in sec. 190(b)(3)) for attendant care services at the individual's place of employment that are necessary for such individual to be able to work, provided such expenses are otherwise deductible under sec. 162.

(sec. 1341); amortizable bond premium (sec. 171); certain costs of cooperative housing corporations (sec. 216); deductions allowable in connection with personal property used in a short sale; certain terminated annuity payments (new Code sec. 72(b)(3)); and gambling losses to the extent of gambling winnings (sec. 165(d)). In addition, it is intended that the two-percent floor is not applicable to deductions allowable to estates or trusts under sections 642(c), 651, and 661.54

The Act did not modify the above-the-line deduction under section 62(a)(2)(A) for certain reimbursed expenses (allowable under secs. 161-196 of the Code) paid or incurred by the taxpayer, in connection with performing services as an employee, under a reimbursement or other expense allowance arrangement with his or her employer. Thus, the Act did not alter the prior-law rules55 relating to an employee who incurs expenses solely for the benefit of the employer and who is reimbursed for those expenses under an arrangement with the employer (regardless of whether the employer or a third party for whom the employee performs a benefit as an employee of the employer actually provides the reimbursement).56 These rules provide that such an employee need not report on the employee's tax return either the expenses or the reimbursement (to the extent the reimbursement does not exceed the expenses). The Congress intended that this nonreporting rule is to be continued. If the employee has a reimbursement or other expense allowance arrangement with his or her employer, but under the arrangement the full amount of such expenses is not reimbursed, the unreimbursed portion paid by the employee is allowable only to the extent (if any) otherwise allowable as an itemized deduction (e.g., after taking into account the percentage reduction rule for meals and entertainment expenses, if applicable to the expense), and subject to the two-percent floor provided by the Act.57

54 A technical correction may be necessary so that the statute reflects this intent. Such a correction was included in the version of H. Con. Res. 395 that passed the Senate in the 99th Congress.

55 See Treas. Reg. secs. 1.162-17(b), 1.274-5T(f), and 1.274-5(e). For rules relating to reporting and substantiation of certain reimbursements of persons other than employees, see Reg. secs. 1.274-5T(h) and 1.274-5(g).

56 The Congress intended that the Treasury make explicit in these regulations that these reimbursements by third parties are to be treated as expenses described in sec. 62(a)(2)(A).

57 Under the Act, it is intended that the Treasury Department issue regulations or other guidance coordinating the treatment of employee business expenses and the provisions in sec 162(h), relating to travel expenses away from home of State legislators. Under the intended rules, any excess of the allowable amount as determined under sec. 162(h) over the amount actually reimbursed to the legislator electing that provision would be allocated between meals and other travel expenses in accordance with the ratio of meals and other travel expenses under the Federal per diem reimbursement rules for travel in the United States. The reimbursed amount would be deductible pursuant to sec. 62(aX2XA), and 80 percent of the amount allocated to meals would be deductible by itemizers as an employee business expense (subject to the new two-percent floor under miscellaneous itemized deductions).

As described in the text above, the two-percent floor applies after application of the percentage reduction rule and prior to any deduction limitation that is specifically expressed in dollars. For example, with regard to away-from-home expenses of Members of Congress, the two-percent floor applies prior to application of the statutory $3,000 limitation (sec. 162(a)). In addition, if a Member has expenses subject to the 83,000 limitation and other miscellaneous itemized deduc tions, the amounts disallowed by the two-percent floor are disallowed proportionately. For example, assume that a Memner with adjusted gross income of $100,000 has $5,000 of away-fromhome expenses (qualifying for the deduction, disregarding application of the $3,000 limit and the two-percent floor, but aber auction of the 80-percent rule for meal and entertainment expenses) and $5,000 of her mazes itemized deductions, for a total of $10,000 of potential deductions subject as the wet floor. Application of the two-percent floor would limit

Continued

Pursuant to Treasury regulations, the two-percent floor is to apply with respect to indirect deductions through pass-through entities (including mutual funds) other than estates, nongrantor trusts, cooperatives, and REITs (sec. 67(c)). The floor also applies with respect to indirect deductions through grantor trusts, partnerships, and S corporations by virtue of grantor trust and passthrough rules.

In the case of an estate or trust, the Act provides that adjusted gross income is to be computed in the same manner as in the case of an individual, except that the deductions for costs that are paid or incurred in connection with the administration of the estate or trust and that would not have been incurred if the property were not held in such trust or estate are treated as allowable in arriving at adjusted gross income and hence are not subject to the floor. The regulations to be prescribed by the Treasury Department relating to application of the floor with respect to indirect deductions through certain pass-through entitles are to include such reporting requirements as may be necessary to effectuate this provision.

Under the Act, an actor or other individual who performs services in the performing arts (a "performing artist") is allowed a new above-the-line deduction for his or her employee business expenses (allowable under sec. 162) during a year if the performing artist for that year (1) had more than one employer (excluding any nominal employer)58 in the performing arts, (2) incurred allowable section 162 expenses as an employee in connection with such services in the performing arts in an amount exceeding 10 percent of the individual's gross income from such services, and (3) did not have adjusted gross income, as determined before deducting such expenses, exceeding $16,000. In general, if the performing artist is married at the close of the taxable year, this deduction is available only if the taxpayer and his or her spouse file a joint return for the year, and only if the combined adjusted gross income of the taxpayer and his or her spouse (as determined before deducting such expenses) shown on the return does not exceed $16,000. (Code sec. 62(b)).

Effective Date

The provisions apply to taxable years beginning after December 31, 1986.

Revenue Effect

The provisions are estimated to increase fiscal year budget receipts by $694 million in 1987, $4,630 million in 1988, $4,716 million in 1989, $5,039 million in 1990, and $5,383 million in 1991.

these deductions to $8,000, and the amount disallowed because of the two-percent floor would be disallowed proportionately. Thus, after application of the two-percent floor, the Member could deduct $4,000 of the away-from-home expenses and $4,000 of the miscellaneous itemized deductions. The former amount (i.e., the away-from-home expenses) is further limited to $3,000 because of the special limitation on deducting Member's expenses. Thus, the Member could deduct a total of $7,000 of miscellaneous itemized deductions. See 132 Cong. Rec. H8357 (daily ed. Sept. 25, 1986) (statement of Mr. Rostenkowski).

58 The Code provides that an employer is treated as nominal if the amount received by the individual for his or her services as an employee in the performing arts for such employer during the taxable year is less than $200.