March 22, 2018
Law firm partners must sometimes pay for certain firm-related expenses out of their own pockets. For instance, your firm’s partners may
- Have to personally absorb the costs of wining and dining prospective clients who are not on the “approved” firm-wide list of potential clients for which the firm will reimburse entertainment costs.
- Incur personal auto expenses driving to and from client meetings and to and from other locations where firm-related business is undertaken.
- Pay for some or all costs involved in continuing legal education out of their own pockets.
The list can go on and on. The good news is these unreimbursed business-related outlays can generally be deducted on the partners’ personal Form 1040 tax returns.
The ground rules: A partner can write off unreimbursed business-related expenses on his or her Schedule E (the same tax form where the partner’s share of partnership income is reported). To be eligible for this tax-favored treatment, however, the unreimbursed expenses must be of the kind the partner is expected to pay out of his or her own pocket per the partnership agreement or firm policy.In theory, the agreement or policy can be written or unwritten.
The Schedule E instructions direct the partner to report the deduction for unreimbursed expenses on a separate line below the line reporting the partner’s share of income from the firm. The deduction can be described as “unreimbursed partnership business expenses.”
Of course, if the expenses in question are for meals or entertainment, only 50 percent of the costs can be deducted on Schedule E. The partner should also include the deductible amount as an expense for self-employment tax purposes on his or her Schedule SE. That way the partner receives an SE tax benefit as well as an income tax benefit.
Here’s the problem: Partners cannot deduct expenses they could have turned into the firm and been reimbursed. In other words, there’s no deduction for “voluntary” out-of-pocket expenses (consistent with the principle that no good deed goes unpunished).
The best way to eliminate any doubt about the proper tax treatment of unreimbursed partnership expenses is to install a written policy that clearly states what will and will not be reimbursed by the firm. That way, your partners can deduct their unreimbursed firm-related expenses without running afoul of IRS rules.
In general, taxpayers can deduct only 50% of business-related meal and entertainment expenses. The 50% limit applies to expenses including
- Traveling away from home (whether eating alone or with others) on business;
- Entertaining customers at your place of business, a restaurant or other location;
- Attending a business convention or reception, business meeting or business luncheon at a club.
– Source: IRS Publication 463,
Travel, Entertainment, Gift and Car Expenses