As a partner in an LLC or LLP, you’ve probably paid for business expenses out of your own pocket.

Fortunately, you are still able to deduct these. However, the IRS treats these dollars very differently than if you were an S-Corp owner or a standard employee.

These out-of-pocket costs are known as Unreimbursed Partnership Expenses (UPE). While recent tax cuts eliminated out-of-pocket write-offs for standard W-2 employees and S-Corp owners, as a partner, you can still qualify if your partnership agreement requires you to pay them.

Knowing exactly how the IRS wants you to claim these expenses can save you serious money on your individual tax return.

What Qualifies as Business Expenses and Unreimbursed Expenses?

For a partner to claim a deduction on their tax return, the business expenses must be considered ordinary and necessary.

• Ordinary expenses are common and accepted in your specific field or profession.
  
• Necessary expenses are helpful and appropriate for your partnership business.

Common types of unreimbursed expenses include business liability insurance premiums, work clothes, professional publications, and education expenses like continuing education.

Entertainment Expenses, Union Dues, and Home Office Deductions

If you’re a partner in a service partnership, like a law firm or architecture practice, you know the work it takes to bring in new clients never stops. The good news is that you can potentially deduct the business expenses you pay out of your own pocket to grow the firm.

These often include:

• Client meetings and entertainment expenses, subject to strict current IRS limits.
  
• Union dues, professional licensing, and society memberships.
  
• Business mileage, traveling overnight, and parking fees.
  
• Home office expenses, provided the home office qualifies as a principal place of business, rather than relying solely on the partnership’s official office.
  

How to Claim Partnership Expenses on Schedule E

To stay clear of the IRS, remember that you cannot deduct any partnership expenses that were eligible for reimbursement.

To qualify, you must show them that your partnership agreement, or at least the routine practice of the firm, expects you to cover these costs out of your own pocket. Without a clear firm policy or agreement in place, these unreimbursed expenses could be labeled “voluntary” and disqualified.

When eligible, you report these on your personal return:

• Unreimbursed partnership expenses must be reported on Schedule E (not Schedule C) of your personal tax return.
  
• Enter them on a separate line labeled “UPE”.
  
• UPE is often reported as a negative amount in Boxes 1 and 14 of the Schedule K-1.
  
• These deductions can reduce your earned income from the partnership, which may lower your net self employment income and self employment tax on Schedule SE.
  
• If you are a passive investor, your deduction may be limited by passive activity loss limitations rules for the tax year.
  

Proper Documentation for Expenses UPE and Related Expenses

To protect your deduction, you can’t just rely on memory, you must continue to have proper documentation to prove your expenses upe and any related expenses.

• Keep an account book, diary, or mileage log to track your passive activity or active business purpose.
  
• Save other documentation, such as hotel receipts and canceled checks.
  
• Include a written statement of the business purpose for each expense. A canceled check by itself is never enough to prove the expense.
  

Avoiding Pitfalls with Expenses Related to Your Partnership

A clear, written policy from the partnership regarding what expenses related to the business will and won’t be reimbursed is essential to avoid confusion about tax treatment. By making sure your firm has a rock solid reimbursement policy, you protect your deductible expenses from unnecessary IRS scrutiny.

Maximize Your Deductions with Confidence

Navigating complex partnership tax rules and making sure your firm’s reimbursement policies are IRS compliant shouldn’t be a guessing game.

You deserve clear, professional guidance to ensure you are maximizing your legitimate deductions without triggering an unwanted audit