It’s not unusual for a partner to incur expenses related to the partnership’s business. This is especially likely in service partnerships such as architecture or law firms. For example, service partnership partners may incur entertainment expenses when developing new client relationships. They may also incur expenses for transportation to and from client meetings, professional publications, continuing education, and home office. Let’s take a look at the tax treatments when partners pay expenses related to the business.

Reimbursable or not

As long as the expenses are the type a partner is expected to pay without reimbursement under the partnership agreement or firm policy (written or unwritten), the partner can deduct the expenses on Schedule E of Form 1040. Conversely, a partner can’t deduct expenses if the partnership would have honored a request for reimbursement.

Unreimbursed partnership business expenses should also generally be deducted when arriving at a partner’s net income from self-employment on Schedule SE.

For example, let’s say you’re a partner in a local architecture firm. Under the firm’s partnership agreement, partners are expected to bear the costs of soliciting potential new business. Exceptions include unusual cases where attracting a large potential new client is deemed to be a firm-wide goal. In attempting to attract new clients this year, you spend $4,500 of your own money on meal expenses. You receive no reimbursement from the firm. On your Schedule E, you should report a deductible item of $2,250 (50% of $4,500). You should also include the $2,250 as a deduction in calculating your net self-employment income on Schedule SE.

So far, so good, but here’s the issue: a partner can’t deduct expenses if they could have been reimbursed by the firm. In other words, no deduction is allowed for “voluntary” out-of-pocket expenses. Implement a clear written policy detailing reimbursable items to ensure clarity on tax treatment for unreimbursed partnership expenses. That way, the partners can deduct their unreimbursed firm-related business expenses without any problems from the IRS.

Office in a partner’s home

Subject to the normal deduction limits under the home office rules, a partner can deduct expenses allocable to the regular and exclusive use of a home office for partnership business. Like other unreimbursed partnership expenses, the partner’s deductible home office expenses should be reported on Schedule E.

If a partner has a deductible home office, the Schedule E home office deduction can deliver multiple tax-saving benefits. It’s effectively deducted for both federal income tax and self-employment tax purposes.

In addition, if the partner’s deductible home office qualifies as a principal place of business, commuting mileage from the home office to partnership business temporary work locations (such as client sites) and partnership permanent work locations (such as the partnership’s official office) count as business mileage.

The principal place of business test can be passed in two ways. First, the partner can conduct most of the partnership income-earning activities in the home office. Second, the partner can pass the principal place of business test if he or she:

• Uses the home office to conduct partnership administrative and management tasks and
• Doesn’t make substantial use of any other fixed location for such administrative and management tasks.

To sum up

When partners pay expenses related to the business under a partnership agreement or standard operating procedures, the partner should turn them in for reimbursement. Otherwise, the partner can’t deduct the expenses. On the partnership side of the deal, the business should set forth a written firm policy that clearly states what will be reimbursed. This includes home office expenses, if applicable. This applies equally to members of LLCs that are treated as partnerships for federal tax purposes because those members count as partners under tax law.

We can help

Contact us if you’d like assistance in dealing with these issues or any other issues that may arise in connection with your partnership.