Posted by Elliot Kravitz, ATP

Unreimbursed Partnership Expenses: What are they?

Unreimbursed Partnership Expenses: What are they?

When it comes to tax treatment, there is a difference between unreimbursed business expenses for partners and S corporation shareholders. Also known as ordinary and necessary expenses, unreimbursed business expenses are incurred by a partner or shareholder which are not reimbursed. Unreimbursed employee expenses can be deducted by individual partners and shareholders if they are:

  • Ordinary and necessary,
  • Paid or incurred within the tax year, and
  • are for carrying on a trade or business of being an employee.

Here’s a quick definition of the types of expenses related to this topic:

  • Ordinary expenses - your field of trade, business or profession, consider this as common and is accepted.
  • Necessary expenses - it is incurred to help your business function and is also appropriate.

To be considered necessary, an expense doesn’t have to be required. Here are a few examples of unreimbursed expenses:

  • business liability insurance premiums;
  • dues to professional societies;
  • Education expenses that are work-related
  • legal fees related to your job;
  • Insurance premiums on malpractices
  • tools and supplies; union dues and expenses;
  • work clothes and uniforms;
  • travel, transportation,
  • meals & entertainment,
  • gifts and
  • lodging related to work.

Expenses Incurred on Partnerships

If the partnership would have reimbursed the partner for those expenses, a partner cannot deduct expenses incurred on behalf of the partnership. A partner must pay certain partnership expenses out of his or her own pocket according to the IRS rules for partnership agreement or practice. The partner can then deduct such expenses on the individual tax return. The incurred expenses are claimed on Schedule E when it’s deductible. If a partner was required to pay these expenses under the partnership agreement, unreimbursed ordinary and necessary partnership expenses paid on behalf of the partnership may be deducted on Schedule E as instructed on Form 1040. On a separate line o Schedule E, Part II, enter deductible unreimbursed partnership expenses from activities and put a description “UPE”. The passive activity loss limitations are likely to apply if the unreimbursed business expenses are from a passive activity. At the partner level, the deduction may not be allowed if the partnership agreement specifically states that the partnership has a non-reimbursement policy when expenses incurred outside of the partnership or that certain expenses aren't required to be paid specifically by partners. If there is no direction stated in agreement of the partnership, the routine practice of the partnership will be considered.

The partner’s earned income from the partnership is being reduced by the deductible unreimbursed business expenses. This generally results in a reduction of the partner’s earned income for the purpose of self-employment taxes.

Expenses Incurred on S Corporation Shareholders

Unreimbursed business expenses generally cannot be deducted by S corporation shareholders on Schedule E because when performing services for the corporation, the shareholders are categorized as employees. If not subject to reimbursement from the corporation, these expenses are considered as unreimbursed employee business expenses and are subject to the 2% of the adjusted gross income (AGI floor since it’s treated as miscellaneous itemized deductions. According to the IRS rulings, unreimbursed business expenses incurred by a corporate officer or controlling shareholder can only be deducted by the corporation when they relate to corporate business and not of the officer or shareholder.

In order to support the business expenses eligible for the deduction, you must keep adequate records or have enough evidence that will support your own statement and tax returns regardless if you are a partner or an S corporation shareholder. To support the adequate records requirements, there must be a maintained written records, such as an account book, diary, log, statement of expense, trip sheet or similar record. It’s also important to save documentary evidence, such as receipts and canceled checks, that, together with records or logs as they will support each element of an expense. A hotel receipt containing the name and location of the hotel, the dates you stayed there and separate amounts for charges such as lodging, meals and telephone calls for your business travel, for example, is enough to support expenses. The cost is ordinarily established by a canceled check along with a bill from the payee. A canceled check by itself is not enough to prove business expenses. It’s necessary to include a writtens statement of the business purpose of an expense.

Elliot Kravitz, ATP
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