By Alan S. Kufeld, CPA, Partner
Key Takeaways
- Partners in professional firms may be able to deduct unreimbursed business expenses on their individual tax returns if specific Internal Revenue Service (IRS) criteria are met.
These expenses must be ordinary, necessary and directly related to the partnership’s business, and the partnership agreement must explicitly state that such expenses are not reimbursable.
- Deductibility depends on the language of the partnership agreement and proper documentation of expenses.
Expenses eligible for reimbursement or not addressed in the agreement are not deductible, so firms should maintain clear written policies and partners should retain receipts and records to support their claims.
- Home office deductions are subject to additional IRS requirements and vary based on individual circumstances.
Partners considering this deduction should consult a qualified professional to help ensure compliance with applicable rules.
For professional firm partners, covering unreimbursed personal and business development expenses is often a requirement. Whether working for an architectural, engineering, law or other professional services firm, partners frequently incur costs related to travel and transportation, professional and licensing fees, supplies and office costs.
Partners may, for example, maintain memberships in industry associations, participate in continuing education or certification courses, use personal vehicles to attend client meetings, maintain home offices, travel to pursue new business, entertain prospects at restaurants or clubs and more. Fortunately, such expenses can be deductible and, when managed properly, can help mitigate tax liability and reduce taxable income.
Partner Business Expense Deduction Basics
The Internal Revenue Service (IRS) calls such expenses unreimbursed partnership expenses (UPEs). These are out-of-pocket expenditures incurred by a partner in connection with the partnership’s trade or business that are not reimbursed by the partnership. In many cases, partners may be eligible to deduct these expenses on their individual tax returns.
To do so, however, the IRS requires that specific conditions be met. To help ensure deductibility at the partner level proper identification, substantiation and reporting of these expenses – as well as alignment with the language of the firm’s partnership agreement is required.
Specifically, to qualify for deduction, partners must demonstrate that the:
- Expenses are ordinary, necessary and directly connected to partnership activities.
- Partnership agreement does not require reimbursement in either written or implied form.
- Expenses were not reimbursed by the partnership.
In addition, under IRS guidance, specifically Rev. Rul. 70-16, a partner may deduct UPEs when both:
- The partnership agreement does not provide for reimbursement.
- The partner is required to pay the expenses out of personal funds in furtherance of the partnership’s trade or business.
Finally, should the IRS conduct an audit, it’s imperative that any claimed expenditures can be substantiated with receipts, personal logs and other documentation.
How it Works
Assume that you are a partner in a law firm. Further, assume that according to your firm’s partnership agreement, partners are expected to bear all costs associated with generating new clients, from meals to air travel and hotels. The firm also expects you to cover your own professional fees and licensing costs. As long as these out-of-pocket, business-related expenses are not reimbursed, you should be able to deduct them as unreimbursed business expenses on your individual tax return in the year paid.
Partners cannot deduct expenses if the costs were eligible for reimbursement by the firm, referred to as “voluntary” out-of-pocket expenses. In the example above, the firm’s partnership agreement would clearly state that such expenses are the partner’s sole responsibility. If the partnership agreement indicated that the expense could be reimbursed or if it contained no reimbursement language altogether, the expense would not be deductible. It’s critical for firms to establish a clearly written policy stating what will and will not be reimbursed to avoid any confusion regarding the tax treatment of unreimbursed partnership expenses. This helps ensure that partners can deduct their unreimbursed business expenses.
Important Home Office Guidance
Partners who incur the cost of maintaining a qualified home office and intend to claim a deduction must comply with the IRS’ complex qualification requirements. These rules are nuanced and may vary based on each partner’s specific facts and circumstances. A qualified professional who understands these rules can offer valuable advice.
Contact Us
For specific inquiries regarding deductibility of unreimbursed partnership expenses, please reach out to your PKF O’Connor Davies client service team. Our professionals are available to assist you with tailored guidance.
Alan S. Kufeld, CPA
Partner
akufeld@pkfod.com | 646.449.6319