IRS acknowledges partner expenses.

• Author: Wendland, Sherri L.

In Letter Ruling (TAM) 9316003, the IRS has acknowledged the validity of allowing partners to deduct business expenses incurred on behalf of their partnerships against partnership income in arriving at adjusted gross income. The facts and holding of this ruling are very similar to the decision in Klein, 25 TC 1045 (1956). In both the ruling and in Klein, a partner incurred business travel and entertainment expenses on behalf of the partnership. In the ruling, the partnership had previously had a partnership agreement that was silent as to partner expenses and reimbursements. The partnership agreement was later amended to specifically state that partners could not seek reimbursement from the partnership for such expenses but would be required to pay those expenses out of their own pockets. Prior to this amendment, the partnership's established practice was that it would not reimburse these expenses.

The court and the Service now agree that although partners are not in the trade or business of the partnership, ordinary and necessary business expenses incurred by a partner on behalf of the partnership, when those expenses are not to be reimbursed by the partnership, are very similar to a special allocation of expenses to a partner via the partnership agreement. Since the substance would be the same, the deduction of actually incurred expenses by the partner is consistent with the rationale of special allocations of such expenses had the partnership paid those expenses on the partner's behalf.

Since case law had previously sanctioned this treatment, the letter ruling, although generating much interest in the business community, merely restated what was already thought to be the law. Taxpayers now, however, should feel comfortable deducting these expenses on Schedule E without fear of IRS challenge.

The ability to deduct these expenses directly against partnership income "above the line" may be significant. Most obviously, if such expenses were deemed to be miscellaneous itemized deductions (as the ruling implied), they would be subject to a 2% floor requirement and, if significant in amount, could create alternative minimum tax complications. Also, depending on the tax structure of a particular state, the deduction "above the line" could create a tax benefit not available for itemized deductions.

Another significant aspect of being able to deduct these expenses above, the line is that income from self-employment will be reduced by these...