The passage of the Tax Cuts and Jobs Act of 2017 (“TC&JA”) has increased the planning importance of so-called “unreimbursed partner expenses” for members of partnerships and LLCs treated as partnership. The Conference Agreement relative to the TC&JA suspended (until tax years beginning after Dec. 31, 2025) the Schedule A deduction for “Miscellaneous Itemized Deductions Subject to the Two-Percent Floor” provided under Sections 62, 67 and 212 of the Internal Revenue Code of 1986 as amended. Those rules had been relied on by many taxpayers, including partners and LLC members, who incurred significant expenses in connection with the production or collection of income, tax preparation or the trade or business of being an employee.
However, the TC&JA did not affect the above-the-line deductibility of “unreimbursed partner expenses” under a comparatively less used alternative available to members of partnerships and LLCs treated as partnerships in certain circumstances.
Generally, a partner (or member of an LLC treated as a partnership) may not directly deduct the expenses of the partnership on such person’s individual federal income tax return, even if the expenses were incurred by the partner or member in furtherance partnership or LLC business.
But, a long-standing exception applies when there is an agreement among the partners (or members), or a routine practice equal to an agreement, that requires a partner or member to use that member’s own funds to pay a partnership or LLC expense. See, Klein v. Commissioner, 25 T.C. 1045 (1956). Careful planning is required to take advantage of this exception, including drafting (or amending) the applicable partnership or operating agreement with some specificity to provided that the partner or member is required to non-reimbursed automobile, telecom, client entertainment, professional association or other items. And, of course, adequate records must be kept substantiating the expenses consistent with the documentation requirements of the tax code.
For more information, please contact William E. Elwood in the Washington, D.C. office at 202-659-6972.