BGBC Partners, LLP Tax Update:
Corporate Expenses Paid by Officers and Shareholders
Does your store operate as a C or S corporation? If so, you may have had situations in the past where you’ve had to personally incur expenses on behalf of your corporation. Maybe you were at a warehouse retailer (like Costco) and saw a great deal on office supplies, but did not have the corporate checkbook or credit card with you at the time. So to take advantage of the bargain, you took out your wallet and made the purchase on behalf of the business. Or perhaps the business is struggling to pay the bills and in order to keep operations going, you cover some of its expenses.
In general, you cannot deduct an expense you incur on behalf of your corporation, even if it is a legitimate “trade or business” expense and even where the corporation is financially troubled. This is because a taxpayer can only deduct expenses that are his own. And since the tax laws stipulate that your corporation's legal existence as a separate entity must be respected, the corporation's costs are not considered yours and thus cannot be deducted by you - even if you pay them.
What's more, the corporation won't be able to deduct them either because it didn't pay them, you did, and the IRS requires that a party must bear the economic burden of an item before it can be deducted. This applies to both C corporations and S corporations. Accordingly, it is wise to avoid the general practice of having your corporate shareholders or executives pay the company’s expenses. However, there are some potential workarounds to prevent the losing of the deduction.
One potential solution is to take the position that you are a corporate executive who incurred these costs as an essential part of your duties as an executive. This position converts the costs to deductible “ordinary and necessary” expenses related to your “trade or business” of being an executive. If you wish to set up an arrangement providing for such payments and safeguarding their deductibility, a provision should be included in your employment contract stating the types of authorized expenses which fit into your scope of duties. For example, you may be authorized to attend out of town business conferences on the corporation's behalf at your personal expense.
Alternatively, an accountable plan can be put in place under which the corporation reimburses you for the expenses you incur. This will allow the corporation to deduct the amount of the reimbursement.
Finally, you as the owner can loan the funds to the corporation which then pays the expense directly. This allows the corporation a deduction.
Unlike a corporate shareholder, partners of partnerships (and members of limited liability companies) have a mechanism with which to offset their income from the entity with expenses personally paid on its behalf. That’s because, unlike the corporate entity form, partnerships (and limited liability companies treated as a partnership) are in some cases (including this one) not considered entities separate from their owners. Partners/members may subtract their out-of-pocket expenses from their income as reported on Schedule E of Form 1040. They simply add a separate line item titled “Unreimbursed Partnership Expenses” below the line reporting the partnership income and enter the expense amount as a negative number, thus offsetting the income by the amount of the expenses.
As you can see, without proper planning the ability to deduct expenses paid by shareholders and executives may be lost. In order to make sure you get the maximum tax benefit from any costs you are paying on behalf of your C or S corporation, we recommend that you contact a qualified CPA.
BGBC Partners, LLP is a full service certified public accounting and business consulting practice.
For more information, contact Brad Bell, CPA or Steve Reed, CPA/ABV/CFF at BGBC Partners, LLP (317-633-4700).
