The Tax Cuts and Jobs Act of 2017 (TCJA) brought many changes to the tax code. Among many other changes, it redefined the deductibility of business expenses and disallowed the deduction of out-of-pocket expenses paid by employees on their personal tax return. Unreimbursed corporate expenses paid by shareholders are treated as unreimbursed “employee” business expenses. The remedy is to establish an accountable plan.
S corporation owners should establish an accountable plan to have the company reimburse home office expenses.
Generally, accountable plans work on the concept that if reimbursement payments to business owners and their employees are properly claimed and documented, they are not taxable to the recipient. However, if reimbursements are not legitimate business expenses or are not properly documented, they are taxable income to employees.
An employer must comply with three standards to offer an accountable plan:
- The expenses must have a business connection,
- The expenses must be substantiated within a reasonable period, and
- The employee must return any money not spent to the employer, also within a reasonable period.
The reimbursement arrangement is treated as a nonaccountable plan when the above conditions are not satisfied. The reimbursements become taxable compensation to the employee and subject to employment taxes.
The regulations provides some flexibility in the types of documentation necessary to prove an expense. Section 274 expenses of less than $75 do not require a specific receipt, with the express exception that lodging expenses, regardless of the amount, must be documented.
An accountable plan does not have to necessarily be in writing. However, a written document provides a structure to ensure that the three required elements are covered.
A written expense reimbursement policy should clarify:
- The time period for employees to submit expenses,
- The process for requesting reimbursement, including what documents are required to prove the request,
- The process for returning excess reimbursements or allowances,
- The types of expenses that are reimbursable,
- The maximum allowable amount for certain expenses, and
- Preferred suppliers for reduced expenses.
When the owner is reimbursing himself or herself as an employee, the owner should make sure that separate checks are written in response to specific reimbursement items. If an employer reimburses entertainment expenses, the reimbursement must be treated as wages because entertainment expenses are no longer deductible under the TCJA.
Partners home office expenses deduction must be stipulated in the partnership agreement.
The owners of partnership interests can deduct home office expenses on their individual tax Form 1040 when the expense is one that the partner is expected to pay without reimbursement. The partner can deduct the expense on Schedule E, Supplemental Income and Loss, as “unreimbursed partner expense” (UPE). UPE should be reported on a separate line of the section reporting partnership loss, along with the name of the partnership, a description of the amount, and the notation “UPE.”
The partnership expenses are not deductible on an individual return unless the partnership agreement expressly states that the partner is required to pay the expense personally. (see McLauchlan v. Commissioner, 558 Fed. Appx. 374 (5th Cir. 2014); see also Technical Advice Memos 9316003 and 9330004).
The partnership agreement should include language that each partner or member is required to pay for home office and other partnership expenses without reimbursement. The taxpayer should also have adequate substantiation of the expenses.
IRC Section 62(c). IRC Section 274(a)(1). Treasury Regulation Section 1.62. Treasury Regulation Section 1.274-5(c)(2)(iii)(A)(1). McLauchlan v. Commissioner, 558 Fed. Appx. 374 (5th Cir. 2014). Technical Advice Memos 9316003 and 9330004.
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