Opinion ID: 2655854
Heading Depth: 3
Heading Rank: 1

Heading: Unreimbursed partnership expenses

Text: The first element examined by the tax court was whether McLauchlan “was required to pay” any of the expenses at issue per either the partnership agreement or routine practice equal to an agreement. Id. at 1052. 3 The AR partnership agreement expressly provided that expenses partners incurred for “business meals, automobiles, travel and entertainment, conventions, continuing legal education seminars and professional organizations” — termed “indirect expenses” by the tax court — would be borne by the partner unless approved for reimbursement by the managing partner. The testimony did not demonstrate that AR had a routine practice requiring partners to pay any AR expenses outside the terms of the partnership agreement, contrary to McLauchlan’s assertions. Accordingly, expenses McLauchlan claimed as deductions beyond those identified in the partnership agreement, such as for advertising, contract labor, home insurance, interest, office supplies, utilities, and wages, were expenses McLauchlan chose to incur, rather than ones called for by AR’s partnership agreement. They therefore were not deductible on McLauchlan’s individual tax return. See id. Having identified the expenses McLauchlan was required by AR’s partnership agreement to incur, the tax court went on to determine, with the exception of the automobile expenses, whether those required expenses were holding that deduction of the depreciation expense for 2006 as well as the charitable deductions for 2005 and 2006 would be allowed. 3 The rule in Klein states that a partner must be “required to pay certain expense[s] out of [the partner’s] own funds” in order to deduct the same on his individual return. 25 T.C. at 1052 (emphasis added). We maintain the terminology of the tax court and begin with whether expenses are “required.” That is not to say the partnership agreement must read as a mandate demanding partners incur certain expenses in order for those to be deductible. Rather, it must be clear that the expenses were identified in some manner as ones the partners had agreed they would incur or by routine practice understood as necessary for partners to incur in the business of the partnership. 6 Case: 12-60657 Document: 00512551524 Page: 7 Date Filed: 03/06/2014 No. 12-60657 reimbursable by the partnership. 4 The AR partnership agreement specifically provided that the following were reimbursable if approved by a managing partner: expenses partners incurred for reasonable travel, client maintenance and development expenses, interoffice travel involving an automobile, automobile lease and rental expenses for client travel, business meals and entertainment, and continuing legal education. The court also determined that expenses for state bar membership and professional organizations were reimbursable as a matter of routine practice. AR’s chief financial officer during the relevant years testified that AR had a fairly liberal reimbursement policy. The tax court concluded that reasonableness was the determinative criterion for reimbursement of AR expenses. All of the expenses the tax court identified as indirect expenses that McLauchlan was required to incur were also found to be reimbursable by either AR’s written policy or routine practice. The tax court concluded, therefore, that McLauchlan was not required ultimately to bear any of these expenses. See Wallendal v. Comm’r, 31 T.C. 1249, 1252 (1959) (providing for deduction when “expenses shall be borne by particular partners out of their own funds”). Moreover, the court noted that McLauchlan failed to present any evidence of specific expenses for which AR had denied him reimbursement. The tax court concluded McLauchlan was not required to pay, without reimbursement, any of the claimed expenses at issue and thus they were not properly deductible as unreimbursed partnership expenses. See id. McLauchlan urges that partners at AR were expected to self-fund various business expenses without reimbursement, including expenses for 4 The court declined to assess whether the automobile expenses were reimbursable because it alternatively found that those expenses were not properly substantiated, and therefore not deductible. We will address the automobile expenses and substantiation requirement separately in Section II.b. 7 Case: 12-60657 Document: 00512551524 Page: 8 Date Filed: 03/06/2014 No. 12-60657 cellular phones, office furniture, advertising, computers, home office, and a number of other expenditures. The tax court declined to credit McLauchlan’s vague and general testimony regarding expenses he was allegedly expected to incur as a partner without reimbursement. It concluded it was self-serving, unverified, and undocumented and therefore the court was not required to accept it. See Shea v. Comm’r, 112 T.C. 183, 189 (1999). McLauchlan also disputes the concept that expenses are deductible only if AR required him to incur them. He argues that all of his expenses should be deductible because they were partnership-related expenses for the benefit of the partnership. This argument ignores the general rule that a partner may not deduct expenses of the partnership on his individual return, even if they are incurred in furtherance of partnership business. Cropland Chem. Corp., 75 T.C. at 295. McLauchlan also challenges the tax court’s use of “unreimbursable” as an element of deductibility. He contends the tax court’s analysis has expanded the legal rule regarding deductibility of partnership expenses creating an additional requirement that expenses not be reimbursable by the partnership. He argues this additional requirement creates a rule that a partner must seek reimbursement for every expense and document the denial of such a request before claiming a deduction. McLauchlan again asserts that partners at AR regularly incurred expenses that they did not submit for reimbursement and that reimbursements were not unlimited or automatic. He argues he therefore should be able to deduct his unreimbursed expenses regardless of whether they were in fact reimbursable. The requirement that an expense not be reimbursable by the partnership in order to be deductible flows from the fact that partnership expenses may only be deducted on an individual partner’s tax return if the partnership agreement provides “such expenses shall be borne by particular partners out of their own funds.” Wallendal, 31 T.C. at 1252 (emphasis added). It follows 8 Case: 12-60657 Document: 00512551524 Page: 9 Date Filed: 03/06/2014 No. 12-60657 that, if a partnership agreement provides for reimbursement of an expense, it is not one a partner is required to bear out of his own funds. The tax court was correct in its assessment that the agreement of the partners must require the partner to “bear the . . . unreimbursed expenses out of his personal funds” in order for the same to be deductible from his individual gross income. Klein, 25 T.C. at 1052. Additionally, if a partner has a right to reimbursement and does not elect to pursue it, that partner should not be entitled to deduct the expenses. See Occhipinti v. Comm’r, 28 T.C.M. 978 (1969), aff’d sub nom. Bayou Verret Land Co. v. Comm’r, 450 F.2d 850 (5th Cir. 1971) (disallowing deductions for partnership expenses if they were reimbursable by the partnership and partner failed to seek reimbursement). To conclude otherwise would allow a taxpayer to convert an expense of the partnership into one of his own simply by failing to seek reimbursement. See Orvis v. Comm’r, 788 F.2d 1406, 1408 (9th Cir. 1986) (reasoning, in the context of deduction of necessary business expenses, that a deduction is not allowed when an employee fails to seek reimbursement for an employment expense when entitled to do so). The AR partnership agreement specifically provided for expenses McLauchlan was required to incur. Any additional expenses McLauchlan chose to incur, such as those for advertising, contract labor, home office, or supplies, are not deductible as partnership expenses. Further, AR’s reimbursement practices show that the remainder of McLauchlan’s expenses, ones he was required to incur, were all reimbursable per AR’s liberal reimbursement policy. McLauchlan did not present evidence of specific expenses he was required to incur without reimbursement. Because all of McLauchlan’s claimed expenses either were reimbursable by the partnership, or were not partnership expenses McLauchlan was required to incur, we affirm 9 Case: 12-60657 Document: 00512551524 Page: 10 Date Filed: 03/06/2014 No. 12-60657 the tax court’s conclusion disallowing McLauchlan’s deductions. See Klein, 25 T.C. at 1051-52.