How to Write-off Business Expenses You Pay For
by BarbaraWeltman, Guest Blogger
- Created: March 20, 2014, 8:38 am
As an owner, your company may not pay for every expense you incur on its behalf. Your out-of-pocket costs may be legitimate business expenses that you’ll want to deduct. How you do this depends on your business’ entity type … and more.
Deducting your out-of-pocket costs
The legal entity for your business dictates how you deduct the expenses not covered by your company.
- Sole proprietors. Independent contractors and other sole proprietors and their businesses are one and the same; in effect there are no unreimbursed expenses. All deductible items are reported on Schedule C. Limited liability companies (LLCs) with a single owner (member) are treated the same as sole proprietors; they too report business expenses on Schedule C (unless they make a special election to be treated differently for tax purposes, which most don’t).
- Corporations. Shareholders can only deduct their out-of-pocket expenses as unreimbursed employee business expenses on Schedule A. This means only amounts in excess of 2% of adjusted gross income become deductible and, if they are high-income taxpayers, a portion of the deductible amount is lost. What’s more, if they are subject to the alternative minimum tax, then none of the unreimbursed expenses are deductible. The same treatment applies to shareholders in C and S corporations.
- Partners and LLC members. Out-of-pocket business expenses that an owner is required to pay on behalf of the entity are an offset to business income; they are subtracted on Schedule E (the deduction is labeled “UPE” for unreimbursed partnership expense). There are no separate limitations on these deductions as there are on business deductions claimed by shareholders on Schedule A. However, as the Tax Court has pointed out, no deduction is allowed for the owners if the entity would have paid the expense under the terms of the partnership agreement or past business practices but the owners failed to ask for reimbursement.
You can sidestep the need for personal deductions if your business agrees to cover all of the expenses you incur on its behalf. It’s advisable to put this arrangement in writing, specifying what you need to do to receive reimbursement.
Corporations can set up accountable plans to reimburse employee business expenses. The plans create tax savings for both the corporations and owners because reimbursements are not treated as taxable compensation; there are no employment taxes on the reimbursed amounts. To be treated as an accountable plan, all of the following three conditions must be satisfied:
- Expenses reimbursed under the plan must have a business connection (a condition that is usually easily satisfied).
- Employees must adequately account to the company for expenses within a reasonable time (generally within 60 days after the expenses were paid or incurred). Accounting means providing the company with proper documentation of expenses (e.g., an expense account form or other statement—on paper, electronically or via mobile).
- Employees must return to the company any excess reimbursement or allowance within a reasonable time (generally 120 days after the expense was paid or incurred). Advances usually can’t be made more than 30 days before the time of the expenses.
While most employee benefit plans have nondiscrimination rules, such rules don’t apply to accountable plans. There is nothing in the conditions of accountable plans that would bar a corporation from limiting reimbursements to owner-employees (i.e., not reimbursing other employees) if it makes business sense to do this.
Technically accountable plans cannot be used for the expenses of self-employed owners (such plans are limited to reimbursement of employee business expenses). However, partnerships can have a reimbursement arrangement for owners. Partnership agreements should specify their reimbursement policy, which may include or exclude certain reimbursements. For example, if partners want to deduct unreimbursed expenses, there should be a reimbursement policy stating that partners are required to cover such costs and that the partnership will not pay for them. Unreimbursed costs can include indirect partnership expenses, such as partners’ cell phones and local travel (e.g., between the office and clients and customers).
Keep good records
It’s easy to lose track of items you pay for on behalf of your business unless you have a recordkeeping system. You may want to use a separate credit card on which you charge only business-related items. Take advantage of apps that let you track business expenses and capture receipts on the go.
Questions? Be sure to ask your tax advisor about the best way to handle business expenses so you’ll maximize your business deductions for legitimate business costs.
About the Author
Barbara Weltman is an attorney, prolific author with such titles as J.K. Lasser's Small Business Taxes, J.K. Lasser's Guide to Self-Employment, and Smooth Failing as well as a trusted professional advocate for small businesses and entrepreneurs. She is also the publisher of Idea of the Day® and monthly e-newsletter Big Ideas for Small Business® and host of Build Your Business Radio. She has been included in the List of 100 Small Business Influencers for three years in a row. Follow her on Twitter: @BarbaraWeltman.
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