Unreimbursed partnership expenses revisited

The Tax Cuts and Jobs Act triggers changes to the tax treatment of unreimbursed partnership expenses for 2018. Partnerships should revisit their policies to ensure that partners and employees maximize tax savings under the new law.

Under former law a partner could deduct the expenses of the partnership on his or her individual income tax return when there is an agreement among partners, or a routine practice equal to an agreement, that requires a partner to use his or her own funds to pay a partnership expense1. This was typically used for a lawyer’s home office, for example, or a sales person’s travel expenses. However, for 2018 that deduction on an individual tax return no longer exists under the new tax law.

The most logical response is for the partnership to establish an accountable reimbursement plan. An accountable plan is based on the simple concept of Section 162 of the Internal Revenue Code that a business is entitled to deduct ordinary and necessary business expenses in computing net taxable income. The tax savings are amplified by an accountable plan because the separately recognized expenses are not subject to wage-related income taxes, Medicare or social security premiums, self-employment tax, or worker’s compensation premium expenses.

If the partnership does not wish to incur additional expenses then this accountable plan may be paired with a voluntary reduction in partnership draw. The total tax savings achieved by accountable plans can be significant; typically several thousand dollars per employee per year.

My Freedom Benefits practice is able to establish and administer these supplemental employee benefit plans.

1 The general tax rule remains that a partner may not deduct the expenses of the partnership on an individual income tax return in the absence of an agreement, even if the expenses incurred by the partner were in the normal course of business of the partnership. In McLauchlan v. Commissioner, No. 12-60657 (March 6, 2014), the Fifth Circuit Court of Appeals noted that when a partner has been required to pay certain partnership expenses out of his or her own funds under an agreement then the partner is entitled to deduct that amount from his or her individual gross income. Law regarding non-partner employees does not change. Existing law regarding limitations to members and non-members employees in an LLC taxed as a partnership does not change. This blog post only refers to the situation where an agreement does exist and the partner is no longer able to deduct expenses on Schedule A of an individual tax return. For example, a lawyer who conducts some business at home may wish to reconsider that practice. For more information I suggest the earlier ruling in Peter A. McLaughlan, TC Memo 2011-289  and the related third-party commentary in recent years. (Note the original link to the case decision in the California court system is apparently no longer available so a third party web site with a copy of the decision is substituted. I did not read and am not endorsing the third party comments on this page).


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