I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox ๐ Also on YouTube at PlugAccountingandTax!
Unreimbursed Partnership Expenses - a Little-known Loophole
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If you've followed me for long, you'll know I'm a big advocate for partnerships as a tax entity structure. S-Corps and C-Corps have their roles, but I see them misused more than you'd imagine. They trap appreciation of assets ๐ชค with sometimes next to no benefit in return. But there's another less-known reason to use a partnership for tax purposes - the ability to deduct unreimbursable expenses. ๐ "Unreimburseable Expenses" Usually, things like travel, meals, or other out of pocket ๐ costs are what are picked up with this option. These are expenses which are incurred with a business purpose and deductible under ยง162 (ordinary and necessary). For example, if my partner does not want to incur the expense for a training program that is directly related to my role in the firm, I can still deduct that cost on my personal return as an Unreimbused Partnership Expense (UPE). ๐ค Before 2017 tax reform, employees also had this option as an Unreimbursed Employee Expense that was subject to a 2% of AGI limitation (basically as an Itemized Deduction on your 1040). Post 2017 reform, this went away for employees - but not for partners. ๐คฉ How is it Reported? The total amount of UPE is "tagged" to a partnership K1 and recorded as an other reduction on Schedule E on the partner's 1040. No detailed information is provided to the IRS with this reporting, which is good ๐ and bad ๐. Because there is lack of transparency into it without a full-blown IRS audit, it can be a number that gets abused. To that end, just like any expense incurred in relation to a trade or business, taxpayers should keep good accounting records and support for the deduction. If you've listened to my Aboui v. Commissioner episode on the Today in Tax Court podcast, you'll know about the Cohan rule. But that's not always the best strategy when it can be avoided with planning up front. Is it that Easy? No. Of course not. The caveat is that the Partnership Operating Agreement (OA) must speak to what is reimbursable and what is not. So this is something you (and your attorney) should consider when drafting up your OA. That said, if you don't have that OA language you're not necessarily cooked. A tax court case in the 1940s set a helpful precedent in allowing unreimbursed partnership expenses for a partner that actually didn't have that language in the OA. But because the manner in which the partner worked for the partnership in that case, the court considered that "such an arrangement was tantamount to an agreement." See Klein v. Commissioner (1946) Again - you don't want to rely on this if you don't have to. So put it in your OA if these kinds of expenses are foreseeable. If you want to learn more about UPE, or about how Trump used this to deduct $27 million you should check out this thread I ran a few years ago. TLDR - Trump deducted these expenses over like 6 years. And when audited, the IRS basically threw up their hands and said "we're not going through all those partnership agreements to determine if they were allowed or not" and allowed them all.
๐ซก ๐ Reminder that I offer one-off consultations. $500 for up to an hour, or $1,500 for a full review of Operating Agreements and tax returns. Reply to this email to set up a call. ๐
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The Plug [Newsletter]
I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox ๐ Also on YouTube at PlugAccountingandTax!
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