By Lori Elmenhurst, CPA

A recent tax court decision provides a reminder that missing the details can be costly.  It is not unusual for partners to incur entertainment, auto, professional publications, education and home office expenses while performing partnership duties.  However, a partner generally can’t deduct these on Form 1040 unless the partnership agreement or established partnership practice obligates the partner to cover the partnership expenses on behalf of the partnership. 

Here’s the story:  The McLauchlan case involved a lawyer who paid various business expenses in connection with his law practice.  He contended that he paid over $100,000 of the firm’s expenses in each of the two years at issue for which he was not reimbursed; deducting these expenses on his Form 1040. The firm had a written reimbursement policy which provided that travel, lease and rental automobile expenses, business meals and entertainment, education expenses and other indirect expenses were reimbursable.

The IRS disallowed these expenses on the grounds that if the business has a written expense policy that provides for reimbursement, the taxpayer must seek reimbursement from the partnership.  The Tax Court agreed and imposed the 20% accuracy-related penalty to boot!

If the taxpayer had at least requested and been denied reimbursement, he would have had a much better chance of sustaining the deductions.  Our advice is to spend some time and effort drafting the reimbursement policy in contemplation of the Partners incurring business expenses and not being reimbursed in specific circumstances.  Several tax cases support this approach and it would have likely saved the day in this case.

The IRS has used this same approach to deny deductions to S-corporation shareholders as well.  This is clearly a cheap shot by the IRS but one that is consistently enforced by the Courts.  Don’t be a victim-- let us assist your legal adviser in drafting a solid reimbursement policy to protect your business.