Record Keeping Basics
Tools for record keeping
Audit proof your business - Internal records
Summary of required documents
Exception for partnerships
If you run your business with a partner then chances are you run your business as a partnership. As a partner in a partnership, you are not considered an employee. The accountable plan discussed in the previous post is an employee reimbursement agreement. Since partners are not considered employees, the accountable plan does not apply to partners. Partners do not receive W-2s, rather they received a Schedule K-1 (Form 1065) where their share of partnership income is reported. Amounts received in exchanged for services are classified as guaranteed payments subject to self-employment tax.
Partners in partnerships can deduct un-reimbursed partnership expenses by using one of the following methods:
Partnership Agreement Clause
As a partnership, you should have a partnership agreement (operating agreement if LLC). Treatment of the un-reimbursed partner expenses is specified in the partnership agreement. In the partnership agreement, they should be a clause that allows the expenses paid for by the owner to be fully deductible without limitations. The amount is deducted on the partners personal form 1040, Schedule E on page 2, part II.
Partner’s un-reimbursed expenses can be treated as capital contribution. Capital contribution increases the partner’s basis in the partnership.
The un-reimbursed expense can be treated as a loan to the partnership. The following procedures must be followed to document the expense as a loan:
- Both the partner and the partnership must intend for this to be a loan
- The partnership is obligated to pay the partner
- There is a written agreement and interest is paid on a periodic basis
- Form 1099-INT is issued to the partner
A loan that derives from un-reimbursed expenses is generally treated as recourse loan. A recourse loan increases both the partners basis and at risk basis.
If your partnership does not have a partnership or operating agreement, you cannot deduct your un-reimbursed expenses on your schedule E. The partnership or operating agreement must state what is charged on the business account and what the partners are responsible for. Partners have to be careful to maintain documentation of their un-reimbursed expenses. The un-reimbursed expenses are deducted on Schedule E and reduces the partner’s taxable income.