Source: http://traderstatus.com/traders/trader-entity/partnership-operating-agreements/
Timestamp: 2017-03-01 19:53:51
Document Index: 271885445

Matched Legal Cases: ['§162', '§162', '§162', '§162', '§212', '§280', '§280', '§280', '§280', '§280', '§280', '§761']

Partnership & Operating Agreements – TraderStatus.com
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Expense Reimbursement Clause
A partnership agreement is used for partnerships whereas an operating agreement is used for Limited Liability Companies (LLC’s). A corporation has minutes. These determinations are made under State law and how the entity is treated for federal income tax purposes does not matter.
Most multi-member LLC’s are taxed as a partnership. Therefore the two terms: “LLC” and “partnership” may occasionally be found to be used interchangeably.
A multi-member LLC has members or principals while a partnership has partners, and the three terms: “members,” “principals” and “partners” may occasionally be found to be used interchangeably.
An s-corporation (s-corp) is an income tax classification. Prior to 1996 all s-corps were corporations. But starting with the so-called “check the box” regulations (Treasury Decision 8697) that were adopted in 1996, an s-corp is an income tax classification that can also be used by partnerships and LLCs and rarely by individuals.
Here is a collection of information regarding boilerplate partnership agreements and operating agreements: unreimbursed expenses clause that may be inserted in the agreements (this is required if any tax deductions for unreimbursed partnership/LLC entity expenses are going to be taken directly on From 1040, Schedule E, Part II) – generally not applicable with an s-corporation or c-corporation.
reimbursed expenses clause that may be inserted in the agreements (this requires that the entity shall pay or reimburse or treat as a capital contribution or a loan all expenses in order to have them deductible on the entity’s tax return) – generally a good idea for an s-corporation or c-corporation.
unreimbursed expenses for an s-corporation have their own unique problems
nominee account clause that may be inserted in agreements (regarding the bare legal title on accounts)
The following paragraphs are provided “as is” to give you ideas of what might be involved. A qualified attorney should be retained to prepare appropriate documents for signature. We are not attorneys, we do not practice law and we do not recommend acting until you retain a qualified attorney on your own.
Business activities should be kept separate from personal activities . It is preferable to have the entity pay for all of its business expenses form the entity’s checking account and to have one credit card that is used solely for business expenses (no personal expenses).
It is also common that from time-to-time the partners/members need to pay for business expenses out of their own pocket. There should be an agreement, an understanding, about just how to handle these payments. One method is for an “expense report” with attached invoices to be submitted to the entity for reimbursement payments made by the entity back to the owner. With this method the owners generally may not deduct expenses directly on their own Form 1040 tax return. Rather the deduction runs through the entity, most preferably with a cash reimbursement made in the same year as the owner incurred the expense on behalf of the entity and paid for that expense.
Another method is for the entity to require the owners to pay for business expenses without getting reimbursed.
Unreimbursed Business Expenses paid by the owners of the business The Partnership’s Partnership Agreement or the LLC’s Operating Agreement might contain a clause saying that it is agreed that each (general partner or active member) is expected to incur and pay these types of expenses as a condition of ownership in the venture. This clause allows the expenses paid for by the owner to be fully deductible without limitation on their personal From 1040, Schedule E, Part II, when appropriate. (Internal Revenue Code §162)
Caution: According to the Tax Court, unless an agreement between a partnership and a partner states otherwise, then by default a partner cannot deduct expenses on his or her personal tax return if they were incurred on the partnership’s behalf, because it is not “necessary” that a partner pay for them with his own funds. The logic being that IRC §162 requires such deductions be “ordinary and necessary.” (this also holds true regarding LLC members of an LLC taxed as a partnership)
Note: When there is no such clause regarding Code §162 “ordinary and necessary” and “trade or business” Unreimbursed Business Expenses that allows for an “above the line” deduction on Schedule E, Part II, nonetheless it may be possible to take these as itemized deductions as IRC §162 “trade of business expenses” or IRC §212 “expenses for production of income” investment related expenses on their personal Form 1040, Schedule A, line 23, when appropriate. Similarly, shareholders, employees. limited partners, and non-management owners may also be allowed an itemized deduction for such expenses incurred. (Craft, T.C. memo 2005-197)
There are two exceptions: (1) performing artists with AGI under $16,001 and more than one employer (2) educators to the extent of $250 in expenses annually.
Caution: Different rules for S-Corporations. Unreimbursed expenses incurred by non-employee S-corporation shareholders are generally not deductible (Russell v. Commissioner TC Memo 1989-207 and Foust v. Commissioner TC Memo 1997-446). An S corporation’s expenses are deductible at the corporate level only, and cannot be deducted by shareholders.
In the case of Richard R. Russell, the S corporation’s shareholders personally paid for expenses they incurred in conducting the corporation’s business. The shareholders did not seek reimbursement from the corporation, and deducted the expenses as business expenses on Schedule C of their personal tax returns. The IRS disallowed all of the deductions on the grounds that the taxpayers did not individually operate a trade or business. The shareholders argued that the S corporation’s income or loss would pass through to them anyway, so it did not matter whether the expenses were deducted on their returns or were passed through by the corporation. The Tax Court disagreed with the shareholders. None of the expenses were allowable, even though they were legitimate and were incurred on behalf of the corporation. The corporation and its shareholders are separate and distinct entities, and one entity cannot take the deductions of another. Thus, neither the corporation nor the shareholders could deduct the expenditures. (The shareholders should, however, be entitled to increase stock basis for the expenditures made on behalf of the business.)
If the corporation had simply reimbursed the shareholders for the expenses, the corporation would be entitled to the deductions, and the expenses would pass through to the shareholders. If the reimbursements caused the corporation to be short of cash, the shareholders could lend the funds to the corporation. As an alternative, the corporation could pay the expenses directly, using funds borrowed from the shareholders. Such loans should be carefully documented and bear a fair market interest rate to avoid an IRS argument that they do not represent valid indebtedness. https://belkcollegeofbusiness.uncc.edu/haburton/acct-6130-taxation-of-pass-through-entities/
S Corporation Taxation by Robert W. Jamison
S Corporation Taxation Guide by Robert W. Jamison
A work-around: A shareholder is not entitled to a business deduction for the payment of expenses of a corporation that he or she controls. Rev. Rul. 71-36 which says pretty clearly: “…the sums advanced by him were expenses incurred in carrying on the business of the corporation, the business to which these expenses pertained was not the taxpayer’s business, but that of the corporation. Accordingly, the advances made by the taxpayer are not deductible in the years paid as ordinary and necessary business expenses under section 26 USC 162 of the Code.”
Instead, in order to obtain the tax deduction, the amount of the expense payments is reimbursed to the shareholder by the corporation or it is treated as a loan from the shareholder to the corporation (as long as the parties intended the payment to be treated as a loan and there is an obligation on the part of the corporation to make repayment). Edward Katzinger Co. v. Comr., 44 BTA 533, aff’d, 129 F.2d 74 (7th Cir. 1942). Otherwise, the payment is treated as a capital contribution. In either case, the shareholder has made the economic outlay required to increase basis. See Rose v. Comr., No. 07-12245 (11th Cir. 4/24/08) (Remanded to Tax Court on question whether shareholder’s payment of S corporation’s debt had economic substance where shareholder satisfied corporation’s debt by forgiving debt owed him by creditor of S corporation).
The Home Office Deduction for an active shareholder/employee of the s-corp apparently would be limited to a Schedule A deduction as an Employee Business Expense.
If the s-corp happened to own the shareholder’s residence or a portion thereof, then the deduction for home office might be deducted on the From 1120S itself, which in turn passes thru to the shareholder’s Schedule E.
If the shareholder owns the residence and if the s-corp were to pay rent to the shareholder, then IRC §280A(c)(6) denies most offsetting deductions.
IRC §280A(a) General rule
IRC §280A(c) Exceptions for certain business or rental use; limitation on deductions for such use
Interpretation: This means that unless the s-corp owns the residence or at least owns a portion of the residence, then the home office deduction is not allowable for a home owned by the shareholder.
IRC §280A(c)(5) Limitation on deductions
IRC §280A(c)(6) Treatment of rental to employer
Therefore perhaps the best manner in which to claim the home office tax deduction requires the s-corp to require the shareholder/employee to make the space available for the convenience of the employer and then to actually pay a reimbursement to the shareholder/employee for the actual out-of-pocket costs incurred by the shareholder/employee in providing the home office space to the s-corp. Generally, §280A(c)(5) limits some of the home office deduction for the year to the taxable income from the related business enterprise. That currently non-deductible portion generally is deferred until the following year(s).
also see The Best Way to Claim a Home Office Tax Deduction for the Owner of a Corporation.
also see Rent an Office in Your Home to Your Corporation? Avoid This Big Mistake.
also see IRS Program Manager Technical Advice 00431, March 19, 2011.
You can deduct unreimbursed ordinary and necessary expenses you paid on behalf of the partnership if you were required to pay these expenses under the partnership agreement. See the instructions for Schedule E, line 27 on page E-9 for how to report these expenses. http://www.irs.gov/pub/irs-pdf/i1040se.pdf
If the partnership’s agreement or practice requires a partner to pay certain partnership expenses from his own funds, with no right to reimbursement from the partnership, the partner is entitled to deduct these as trade or business expenses on his personal return. Because the partner is not an “employee,” the 2%-of-AGI limit of IRC Sec. 67(a) does not apply. (The deduction is still subject to other applicable limitations, such as the Section 274 limitation on the deductibility of travel and entertainment expenses.) If the partnership would honor a request for reimbursement, the expense is not deductible. While the “requirement” that the partner incur the expense without right of reimbursement need not be in writing, it is a question of fact, and may be the subject of IRS dispute. As a consequence, the partners will benefit by making this requirement explicit, either as a provision of their partnership agreement or through a written policy of the partnership.
No Reimbursement For Partnership Expenses. Each partner shall be required to incur those reasonable and necessary expenses as determined appropriate for the effective operation of the partnership, and such expenses will be made without reimbursement by the Partnership.
Capital Contribution. Each partner who pays a liability of the partnership upon submission of proof of such payment, will have made an indirect contribution to such partner’s capital account.
Note: Unreimbursed payments of a partnership’s expenses by a partner should be treated as additional capital contribution to the partnership, and the partnership should be treated as having paid these expenses, pursuant to TAM 8442001.
Reimbursements for Business Expenses paid by the owners of the business (sample clause): Reimbursement For Partnership Expenses.
Each partner shall be entitled to reimbursement for the reasonable and necessary expenses incurred by the Partner on behalf of the Partnership. In order to receive reimbursement, a Partner must submit a written itemized report of all expenses for which reimbursement is sought, submit the expense report to the other Partners, and enter the expense report with the Partnership books and records. [CAUTION: when inserting this clause, no unreimbursed expenses made by a Partner generally will be allowed as a tax deduction on the Partner’s own From 1040, Schedule E, Part II]
Reimbursement For S-Corporation Expenses. The stockholders hereby authorize the president to establish, implement and modify a written accountable plan for payment or reimbursement of actual and necessary business expenses that are incurred or paid by an employee, officer, director or shareholder, subject to substantiation, pursuant to Internal Revenue Code Section 62(a)(2)(A) and Reg. Section 1.62-2.
LLC Operating Agreement must contain “minimum charge back” provisions (Treasury Relations Sections 1.704-2(f)(c) and 1.704-2(e)(3))
[name of nominee] agrees to use said account 1) solely for the purpose of conducting trading activities for the account of [the entity] and 2) for charging certain expenses related to the business activities of [the entity] and 3) for depositing and withdrawing funds to or from [the entity]. Any such withdrawal of [the nominee’s] contributed funds shall not be considered a violation of this agreement, even if said funds are used for the personal business of [the nominee], whether or not transferred directly to third party vendors. However, [the nominee] shall not be permitted to use funds in said account to trade solely for his own account. Any purchase or sale of assets, futures, commodities, contracts or securities referenced above shall be for the account of [the entity], and profits and losses from such activity shall be shared among the parties hereto.
Liability / Asset Protection clauses: – corporations and limited liability companies offer different legal protections. For asset protection, you need to look at the choice of entity’s “inside liability” and “outside liability.” Inside liability protects non-entity assets from liability that is directly and solely related to the business and not at all due to the negligence, mistake, oversight or the responsibility of the individual himself. Outside liability protects entity assets from liability that is directly and solely related to the individual and not at all due to the negligence, mistake, oversight or the responsibility of the business.
A creditor of the individual can seek an order by the court to have shares of stock in the corporation turned over to the creditor. Once this is done the individual has lost his investment in the company. But if the business was held in a limited liability company, then in many cases in order to protect the interests of any innocent LLC members with a new unwanted member (the creditor) the court will not order to turn over the ownership of the LLC to the creditor, rather a charging order is issued. The charging order assigns any future profit distributions and any distributions that are a return of capital. The creditor may even have to accept a K-1 from the LLC and pay the income taxes on any annual earnings of the business – but receive no cash from which to pay the income taxes with. Conversely, the other LLC members might be paid a GPP, providing them with ample cash with which to pay their income taxes.
§761(c) PARTNERSHIP AGREEMENT. – For purposes of this subchapter, a partnership agreement includes any modifications of the partnership agreement made prior to, or at, the time prescribed by law for the filing of the partnership return for the taxable year (not including extensions) which are agreed to by all the partners, or which are adopted in such other manner as may be provided by the partnership agreement.
In other words long after-the-fact or retroactive provisions in a partnership agreements are not allowable. All items must be in the verbal or written partnership agreement or otherwise adopted no later than the initial due date of the tax return. This is basically a trap for the unwary. For example: upon being audited, if it was found that the unreimbursed expenses clause or agreement was missing, inconsistently applied or otherwise defective in some way, it is too late to “fix it” once the IRS agent points if out to you. Once caught in this type of trap, “your goose is cooked.”
Each state (with the exception of Louisiana) has its own laws governing partnerships, contained in what’s usually called “The Uniform Partnership Act” or “The Revised Uniform Partnership Act” — or, sometimes, the “UPA” or the “Revised UPA.” These statutes establish the basic legal rules that apply to partnerships and will control many aspects of your partnership’s life unless you set out different rules in a written partnership agreement.
Name of the partnership. One of the first things you must do is agree on a name for your partnership. You can use your own last names, such as Smith & Wesson, or you can adopt and register a fictitious business name, such as Westside Home Repairs. If you choose a fictitious name, you must make sure that the name isn’t already in use
Partnership decision making. Although there’s no magic formula or language for divvying up decisions among partners, you’ll head off a lot of trouble if you try to work it out beforehand. You may, for example, want to require a unanimous vote of all the partners for every business decision. Or if that leaves you feeling fettered, you can require a unanimous vote for major decisions and allow individual partners to make minor decisions on their own. In that case, your partnership agreement will have to describe what constitutes a major or minor decision. You should carefully think through issues like these when setting up the decision-making process for your business.
As you can see, there are many issues to consider before you and your partners open for business – and you shouldn’t wait for a conflict to arise before hammering out some sound rules and procedures. A good self-help book, such as “The Partnership Book” by attorneys Denis Clifford and Ralph E. Warner (Nolo), can help you think through the details and put them in writing.