Driving the Car for the Partnership — or what you should know about unreimbursed partner expenses
February 11, 2012
Every year I do a tax seminar for the local Child Development Council, a nonprofit agency that provides training and support for child care providers in the area. Attendees are always sole proprietors, so I spend quite a bit of time on Schedule C, which is the form sole proprietors file to report business income and expenses. But this year I had a woman who had formed a partnership for her day care business. We talked about the deductibility of mileage for business use of a vehicle, and she asked me, “If I use my vehicle for my day care a lot more than my partner, and I go out and buy things for the partnership, where can I deduct those expenses?” I knew there was a way to do this, although I didn’t have the particulars on the line of the form where she could deduct this, so I took her question home and researched it before I sent her a reply.
The answer to the question is not too complicated. She could either get reimbursed by the partnership for the use of her vehicle, and for those business-related supplies she purchased out of pocket. Or, under a second method, if there was a provision in her partnership agreement, she could deduct those expenses off her personal return. [Point of information: to do this, enter the expenses on Schedule E, page 2, line 28 on its own line, not combined with other partnership income. With a notation of "UPE" in column a, enter the losses in column h (for nonpassive losses only!), and they will net out on line 31 and 32 of the form.]
But then I wondered, is there any difference between the two methods of recognizing the expenses?
So I worked through a simple example. A partnership with 2 partners, A and B, with income split 50/50. Their business has income of $1,000 before Partner A’s vehicle expenses of $500 are factored in. Under the partnership-reimbursement method, the partnership would make $1,000 minus the $500 auto expense, and each partner would recognize $250 income. Under the second method, the income would be split so that each partner recognized $500 income. But Partner A would have unreimbursed expense of $500, which she then writes off her Schedule E, giving her net income of $0 from the partnership. Partner B would recognize $500 of income that same year.
This is probably why the IRS states that using the second method requires that the partnership allow it in the written partnership agreement. Otherwise, in a partnership with a 50/50 split, you could have some very lopsided results!