It’s Tax Time!

Understanding unreimbursed business expenses. By Pat Adams.

An often overlooked deduction at tax time is unreimbursed business expenses incurred by an individual employee. The rules governing this deduction are somewhat complex.

Ideally, all business expenses are paid directly from the businesses' own funds.

However, occasionally employees, corporate shareholders, partners, and sole proprietors pay for business expenses with personal funds as a matter of necessity or convenience. In some cases, the business reimburses the individual for these expenses, but often the individual fails to seek reimbursement or the business has no provision for reimbursement. Depending on the circumstances, the unreimbursed business expenses may or may not be deductible by the individual taxpayer.

Below are three tax-planning strategies for dealing with business expenses paid with personal funds.

1. Use of an accountable plan- deduction allowed on the business return.

· Employees, shareholders, and partners should seek reimbursement for business expenses through an accountable plan or some other reimbursement system.

· If a reimbursement policy is in place, and the employee, shareholder, or partner fails to seek reimbursement, no deduction is allowed by the individual or the business.

· When a corporation or partnership reimburses an employee, shareholder, or partnership for business expenses paid by the individual, the corporation or partnership can deduct the reimbursed amount from gross income.

2. Claiming deductions on the personal return instead of the entity’s return.

· Employee reimbursements that are paid under a non-accountable plan are added to W-2 income as wages. The individual can then deduct these employee business expenses on Schedule A as a miscellaneous itemized deduction. This also applies to a corporate officer that is an employee.

· Certain corporate expenses paid by non-employee shareholders might qualify to be treated as investment expenses, deductible as miscellaneous expense on Schedule A, subject to the 2% AGI limitation.

· If a partnership includes a provision in the partnership agreement requiring partners to pay certain business expenses of the partnership, those unreimbursed expenses can be treated as trade or business expenses of the partner. Unreimbursed partnership expenses (UPE) are reported along with the partnership income on Schedule E, page 2 of the individual partner’s tax return.

3. Tax deduction on personal return not allowed or not desired.

· Taxpayers who do not itemize on their personal return will get no benefit from deductions for unreimbursed business expenses and should make use of accountable plans for reimbursement of employee business expenses.

Shareholders who are not entitled to deduct corporate business expenses on their personal return or not entitled to reimbursement can treat the payments for corporate business expenses as a capital contribution, increasing their stock basis. They may also treat the payments as a loan to the corporation as long as proper loan procedures are followed, which will also increase their stock basis.

Anyone considering taking the deduction for unreimbursed business expenses should consult their local tax professional.

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