Contributed by: PhillipB, FreeTaxUSA Agent, Tax Pro
Many small businesses report their income and expenses as partnerships on IRS Form 1065. Expenses that are paid out of the partnership entity’s accounts will be deducted as partnership expenses on Form 1065 and will then be passed on to the partners on Schedule K-1.
But what if you are paying the expenses yourself rather than through the partnership? In this case, if you meet the following requirements, you can write off your unreimbursed expenses on Schedule E:
- The partnership agreement doesn’t allow the partnership to reimburse partners’ expenses.
- The partnership’s income is not from passive activities that require Form 8582 to be filed.
- Form 8582 is typically only filed if you have passive losses or prior year passive loss carryovers to report. You can read more on who needs to file it here.
Calculating the unreimbursed partnership expenses:
You will need to track your unreimbursed partnership expenses and keep records of those expenses with all your other tax documents. The detailed information for these expenses will only need to be provided to the IRS if the IRS sends you a letter requesting the information.
Keep a spreadsheet (or some similar record) with all the expenses categorized and totaled. Simple expenses like ordinary and necessary expenses (i.e. supplies, shipping costs, advertising) can be properly documented with receipts. For other expenses like personal vehicle expenses, home office expense, and business meals you will need to maintain receipts and other records for each type of expense:
- Personal Vehicle Expenses – Log business mileage each time you drive your vehicle with a business purpose. Track the total of all business miles for the year, beginning and ending odometer readings, and receipts for vehicle expenses if you deduct actual expenses. You will need to calculate what amount you can deduct on your own.
- Home Office Expenses - A completed copy of the worksheet to figure the deduction for business use of your home from IRS Publication 587 to calculate the expense. You will also want to keep a copy of Form 1098, property tax records, utility bills, maintenance expenses, rental agreements, and any other expenses for your home.
- Business Meals - Receipts of each business meal, and a journal of the business conducted at each business meal.
To report your unreimbursed partnership expenses in FreeTaxUSA, follow this menu path:
For partners with nonpassive income:
- After entering your K-1, select Income > Partnership Income (Schedule K-1) > select the +Add a Partnership K-1 button.
- Enter the partnership EIN and enter UPE for the name of the partnership.
- Answer yes to the material participation question, and the question about unreimbursed partnership expenses. Click Save and Continue.
- Continue to the screen labeled “Enter the partnership info from your Schedule K-1” (the screen where you normally enter K-1 information) and enter the sum of your unreimbursed partnership expenses in Box 1 – Ordinary Business Income (Loss) as a negative number. Scroll to the bottom and click Save and Continue.
For partners with passive income that doesn’t require Form 8582:
Follow the instructions from above with an exception to step 3. Instead of marking yes to the material participation question, you must answer no to that item. Doing so will report your unreimbursed partnership expenses as passive loss items on Schedule E.
