Unreimbursed Partner Expenses & Self Employment Tax
When you have partnership income, you will be liable not only for income tax on that income but also for self-employment tax. Since taxes for business income are calculated on your profit instead of your gross receipts or gross profit, though, you can reduce your tax liability by applying expenses. Unreimbursed partner expenses are one of the many tools you can use to reduce your income and self-employment tax liability.
Understanding Self-Employment Tax
Self-employment tax is the business owner's equivalent to the social security and medicare withholding, usually referred to as FICA (Federal Insurance Contributions Act), taken out of paychecks. You pay self-employment tax, which is roughly equivalent to both the employee and the employer's share of FICA on your income. In the 2012 tax year, your first $110,100 in self-employment earnings are taxed at 13.3 percent, and earnings over that threshold are taxed at 2.9 percent.
Schedule K-1 and Schedule E
Your partnership will file its own tax return and will give you a form called a K-1 which documents your share of the partnership's profits and breaks out some specific line items. You then carry that income over to line 28 of Part 2 of your personal tax return's Schedule E form.
Unreimbursed Partner Expenses
All of your partner's expenses should be included in their expenses and already subtracted out of your share of the partnership's profits. However, the IRS allows for the possibility that you might have some necessary expenses that you take out of pocket for the benefit of your partnership. You are allowed to expense them if you follow a number of regulations, the most important one of which is the requirement that they be specified in the partnership agreement as something that you have to take out of pocket. Other expenses could be overturned in an audit. Allowed UPE deductions reduce your taxable self-employment income, which reduces your self-employment tax liability.
The McLaughlan Decision
In a relatively recent tax court decision -- Peter A. McLaughlan, TC Memo 2011-289 -- the IRS established further guidelines for claiming UPE. In the event that you incur expenses for your partnership's benefit that are not necessarily covered in your partnership, you should submit them for reimbursement. Your partnership's refusal to reimburse the expenses will create a paper trail showing that you tried to get reimbursed and help to strengthen your claim for the expense. If you have UPE, you should talk with your accountant to figure out the best way to maximize the value of your deduction.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.