733 / What are miscellaneous itemized deductions? What limits apply?

“Miscellaneous itemized deductions” are deductions from adjusted gross income (“itemized deductions”) other than the deductions for (1) interest, (2) taxes, (3) non-business casualty losses and gambling losses, (4) charitable contributions, (5) medical and dental expenses,
(6) impairment-related work expenses for handicapped employees, (7) estate taxes on income in respect of a decedent, (8) certain short sale expenses (see Q 7529, Q 7530), (9) certain adjustments under the IRC claim of right provisions, (10) unrecovered investment in an annuity contract, (11) amortizable bond premium (see Q 7654, Q 7664), and (12) certain expenses of cooperative housing corporations.¹

“Miscellaneous itemized deductions” were allowed only to the extent that the aggregate of all such deductions for the taxable year exceeded 2 percent of adjusted gross income.² For tax years other than 2010 through 2012 (and 2018-2025 under the 2017 Tax Act), miscellaneous itemized deductions were also subject to the phaseout for certain upper income taxpayers (see Q 732).

Miscellaneous itemized deductions generally include unreimbursed employee business expenses, such as professional society dues or job hunting expenses, and expenses for the production of income, such as investment advisory fees or the cost for storage of taxable securities in a safe deposit box.³

Expenses that relate to both a trade or business activity and a production of income or tax preparation activity (see Q 8048, Q 8050) must be allocated between the activities on a reasonable basis.⁴

Certain legal expenses from employment-related litigation may be deductible.⁵ In Biehl v. Comm.,⁶ the Ninth Circuit Court of Appeals affirmed the Tax Court’s holding that attorneys’ fees paid in connection with employment related litigation must be treated as a miscellaneous itemized deduction, and not as an above-the-line deduction. The Ninth Circuit stated that simply because a lawsuit arises out of the taxpayer’s former employment, that determination is not sufficient to qualify the taxpayer’s attorneys’ fees for an above-the-line deduction under IRC Section 62(a)(2)(A). Concurring in the Tax Court’s analysis, the Ninth Circuit reiterated that the proper inquiry in deciding whether an expense has a “business connection” is what the expenditure was “in connection with” and not simply whether the expenditure arose from, or had its origins in, the taxpayer’s trade or business. According to the appeals court, whereas IRC Section 62(a)(1) only requires that the expense be attributable to a trade or business, the language in IRC Section 62(a)(2)(A) is much more definite. The court concluded that for a reimbursable expense to qualify for an above-the-line deduction not only must it be attributable to a trade or business, it must also have been incurred during the course of “performance of services as an employee.”⁷

The IRC prohibits the indirect deduction, through pass-through entities, of amounts (i.e., miscellaneous itemized deductions) that would not be directly deductible by individuals.⁸ However, publicly offered mutual funds are not subject to this rule, and “pass-through entity,” for this purpose, does not include estates, trusts (except for grantor trusts and certain common trust funds), cooperatives, or real estate investment trusts (REITs).⁹ Affected pass-through entities (including partnerships, S corporations, nonpublicly offered mutual funds, and REMICs) must generally allocate to each investor his respective share of such expenses; the investor must then take the items into account for purposes of determining his taxable income and deductible expenses, if any.¹⁰ See Q 7694, Q 7937, Q 7954, Q 7728, and Q 7776 regarding REMICs, mutual funds, exchange-traded funds, publicly traded limited partnerships, and S corporations, respectively.