Unreimbursed Partner Expenses

[Possi]

Well, this is a new one for me.

I didn't know until recently, that partners in a partnership can deduct their business expenses on the K1. This is huge because it directly reduces the self employment tax as well as ordinary income tax.

I read that "The unreimbursed expenses have to be required under the partnership agreement. For example, the partnership agreement should state that each partner is required to pay his own automobile or cellphone costs in pursuit of the partnership’s business. Accordingly, the partner would record standard mileage or actual auto expenses plus business cellphone use, and claim that as UPE. If the partner is subject to self-employment tax on the net earnings of the partnership, then he could reduce the income subject to tax by the UPE."

My doctor is new in this partnership. Before this, he was paid on a regular W2.

Is there any limit to his business deductions on the K1, meaning can we deduct all of his business (work) expenses as they relate to him, and not necessarily to the partnership? ex. CE, Legal, professional dues, supplies, etc.?

 

[BHoffman]

The UPE is deducted on his Schedule E page 2 on his form 1040 and appears nowhere on the partnership tax return or his K1 from the partnership.   The UPE must be shown as a separate line item on the Schedule E page 2.   I'm not sure what limits the amount of UPE other than perhaps the usual issues:  partner's basis, amount at risk, etc. in the event that the whole transaction (K1 income - UPE expenses) results in a loss.

 

 

[Possi]

Thanks! That's what I thought. All the typical business expenses that would normally be reflected on a 2106 should be deductible there, as it relates to this particular income.

First, I need to check his partnership agreement and make sure it is addressed there. I believe if it is an "accepted practice," it doesn't have to be spelled out in the agreement though. Need to look that up again before I go back to this return.

I don't know why in all my years, I never was aware of this deduction. I don't do partnership returns or corporate returns. I have a lot of K1's, and need to look back at the partnership ones. I don't think I have but one partnership with active income. But what a surprise this was. I wonder how many others are missing this deduction.

Maybe just this one... me...

[Lion EA]

Read the partnership agreement.

[Possi]

30 minutes ago, Lion EA said:

Read the partnership agreement.

I will, to see if it's stipulated. But I have never read one before. Always something new.

[Lion EA]

Ask all your clients who receive K-1s from a partnership to give you a copy of their partnership agreement.  You can learn some interesting things!  (I had some guys who called themselves partners, but it was a C-corp!)

[SaraEA]

Many partnership agreements are verbal, and that is okay with IRS  If this one is, get something from the partnership stating that all partners are responsible for their own mileage, cell or whatever.  Be careful if this physician also works elsewhere.  You'll have to pro-rate expenses like license renewals, malpractice insurance, board memberships, medical journals, etc.  I usually do it by income at each work site.

[Possi]

18 hours ago, Lion EA said:

Ask all your clients who receive K-1s from a partnership to give you a copy of their partnership agreement.  You can learn some interesting things!  (I had some guys who called themselves partners, but it was a C-corp!)

Wouldn't that have come to light on K1?

[Possi]

14 hours ago, SaraEA said:

Many partnership agreements are verbal, and that is okay with IRS  If this one is, get something from the partnership stating that all partners are responsible for their own mileage, cell or whatever.  Be careful if this physician also works elsewhere.  You'll have to pro-rate expenses like license renewals, malpractice insurance, board memberships, medical journals, etc.  I usually do it by income at each work site.

The first year, 2015, he worked on a W2 from another firm, so that year needs to be prorated. But now, it's all the partnership. Thanks for chiming in!

[Lion EA]

I usually work with clients when they bring in all their tax information EXCEPT those pesky K-1s that might not arrive until after 15 September.  It was good to get a handle on the entity they worked for sooner rather than later, especially that time since it turned out they work for a C-corporation.  That way I knew to ask for W-2s, told them what they would receive/not receive from that company, let them know the low value of unreimbursed employee expenses ($0 in their case of high AGIs), and talk to them about fringe benefits.  By the way, they still call themselves partners; some things you can't change.

[Edsel]

Can the science of "Partner's Unreimbursed Expenses" apply to Subchapter S corporations as well?

Don't know why it couldn't, except it would now be "Shareholders' Unreimbursed Expenses".  If set out early in the articles of corporation, looks like it would work.  Do any of y'all know?

[Edsel]

21 hours ago, Lion EA said:

Read the partnership agreement.

Right, Lion.  Of course there is always a partnership agreement, right?

I keep referring to the two guys that show up in your office and say "Duh...we're sorta partners..."  Fat chance of getting them to execute a partnership agreement.  Due to transient nature of a situation like this, we might be well advised to simply never do a partnership return until we've seen the agreement.  No agreement - no 1065.  Two schedule Cs instead.

 

[jklcpa]

38 minutes ago, Edsel said:

Can the science of "Partner's Unreimbursed Expenses" apply to Subchapter S corporations as well?

Don't know why it couldn't, except it would now be "Shareholders' Unreimbursed Expenses".  If set out early in the articles of corporation, looks like it would work.  Do any of y'all know?

 

Unreimb'd expenses paid by an S corp shareholder/employee would be reported on Sch A as employee business expenses.  If this is the case, it is better to suggest that the S corp set up an accountable plan to reimburse for those out-of-pocket expenses, and those expenses need to meet the "ordinary and necessary" criteria.

[Lion EA]

Sometimes it is just a joint venture between two Schedule Cs.  And, sometimes if potential clients don't know what business entity they are and don't know where there finances stand and have no plan at all, it might be a hobby!

With realtors, it's location, location, location.  With tax preparers, it's question, question, question.  Keep asking questions.

[SaraEA]

Joint ventures are usually for a single purpose--e.g., let's get together and develop a website app vs. let's go into business together developing website apps.  Spouses get different treatment.  Read the IRS definitions.  And talk about shareholders calling themselves partners....we had a partner in a fairly big business who waltzed in the late afternoon of Sept 14 with her records she'd been promising to bring in for months.  I told her there was no guarantee it would be done in time and explained the penalties per partner for filing late.  She told me she wasn't a partnership but an LLC.  The gal has been in business for 20 years and doesn't even know what entity she operates under????  Have to wonder how she's so successful.

[Edsel]

On 9/21/2017 at 12:07 PM, jklcpa said:

 

Unreimb'd expenses paid by an S corp shareholder/employee would be reported on Sch A as employee business expenses.  If this is the case, it is better to suggest that the S corp set up an accountable plan to reimburse for those out-of-pocket expenses, and those expenses need to meet the "ordinary and necessary" criteria.

The most prolific example I can think of was a subchapter S where the major shareholder was required to pay the interest on the building note.  Interest would be ordinary and necessary, and not be affected by an accountable plan.  Interpreting what I read from the above, the interest would be deducted on schedule A, in the area subject to the 2%, and NOT in the section devoted to interest, and NOT as "Investment" interest.  Not knowing better, I deducted it as PUE even though it was a Sub S corp.  Drake let me do it.

It gets worse.  If you think this through, you've probably wondered why a building (real estate) would be owned by a corporation to begin with.  I did not allow this to happen without protest - I argued until I was blue in the face.  Some lawyer told him to put the building under corporate ownership, believe it or not.  no..no..no..no..no......

So much easier to rent the building to the corporation, then ALL such ordinary/necessary expenses are deductible right off the top.