Business Expenses Paid out of Pocket by Shareholder(s) of S Corporation

Shareholder(s) and the corporation are two separate entities. The IRS recommends opening business-only banking accounts for any business. It is preferable to have the entity pay for all of its business expenses form the entity’s account and to have one credit card that is used solely for business expenses.

However, even when you do maintain separate business and personal banking accounts, you may occasionally pay for business expenses out of your own pocket. Examples of this include costs incurred while traveling to a client or purchases of business supplies. When this happens, you need to know:

  • how can the business owner receive the money owed to him or her in favor of taxpayer, and
  • what is the proper method of recording these transactions?

Every business costs and expenses paid by the shareholder-employee are deductible. A common practice is to reimburse such expenses to employee (shareholder). If the company has an “accountable” plan, such expenses do not have to be included in an employee’s wages.

What is an Accountable Employee Business Expense Reimbursement Plan?

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.
According to IRS Publication 15, in order to be an accountable plan, an expense reimbursement plan or advance payment program must meet the following conditions:

  • Business connection – The expense must have been incurred in the performance of services as an employee of the employer.
  • Substantiation – The employee must substantiate his business expenses by providing the employer with evidence of the amount, time, place, and business purpose of the expenses within a reasonable period of time after they are paid or incurred.
  • Returning excess amounts – Amounts paid by the employer that exceed amounts spent by the employee must be returned to the employer within a reasonable period of time.

There are two methods of determining the reasonable period of time for substantiation and returning excess amounts:

  • Fixed-date method – The expense must be substantiated by the employee within 60 days of being paid or incurred, and the excess amount of any advance must be returned to the employer within 120 days of when the expense was paid or incurred.
  • Periodic statement method – The employer can issue a periodic statement to the employee detailing amounts that have been paid and not substantiated and require the employee to either substantiate the excess amount or return it to the employer within 120 days of receiving the statement.

What Kind of Valid Business Expenses May Be Incurred by Employees?

Expenses incurred by an employee are defined as valid business expenses only if they are considered to be necessary for the operation of the business and they are properly documented. Out-of-pocket expenses are business expenses that are incurred by an employee but are not directly paid for by the business. This would include expenses that have been paid for with cash, personal check, or an employee’s personal credit card.
In addition to the direct expenses described above, some employee-incurred expenses may be indirect expenses. For instance, when an employee uses his personal vehicle for company business, his employer may choose to not reimburse him for direct expenses, such as gasoline, oil, insurance, depreciation and maintenance. Instead, he would be reimbursed at a set rate, such as a certain number of cents per mile driven on business.

How to Comply with the IRS’ Rules for Expense Reimbursements?

Expenses incurred by employees in the course of business should be costs incurred by the employer, not by its employees. If the employer establishes an accountable plan, and the employees submit properly documented expenses under that plan, then the reimbursements are not taxable income. The key to maintaining any accountable plan is to properly substantiate expenses. You must keep copies of any receipts paid out-of-pocket to deduct them. Attach the receipts to a copy of the reimbursement check, and keep them in your files as proof of the business purpose for the check. By accountable reimbursement, the burden of proof is shifted from the employee to the corporation.
All tax deductible business expenses that are paid directly by your business immediately become tax deductions for your business. However any tax deductible business expenditures that you personally pay on behalf of your business, can only be considered tax deductions for your business at the point in time that your business reimburses you for these expenditures. This is generally accomplished by having your business write a reimbursement check made out in your name.

Strategy – Pay all your business expenses directly out of business funds, or have your business reimburse you immediately for any and all business expenditures you pay (out-of-pocket) on behalf of your business.
For example, let’s say you spent $40 on office supplies. Write a check payable to yourself for $40, and then categorize the expense to the appropriate expense account.

If reimbursement is not required immediately, or if funds are not available, the expense should still be recorded. Record the expense in the appropriate account and the amount owed to the shareholder to a shareholder’s credit account. Let’s say you made an out-of-pocket purchase totaling $150 for office supplies, but does not require immediate reimbursement. You have, in effect, lend money to your company. You can track these purchases in QuickBooks with an Other Current Liability account.

In your Chart of Accounts, create a “shareholder credit” account using the type Other Current Liability. You’ll use this account to track all the money you spend in your business. In QuickBooks, click on the “chart of accounts” icon. Find the “Shareholder credit” Account on the chart list. Enter the transaction details including: the date of purchase, the name of the business where the supplies were purchased from, and the amount. The amount of the credit account is increased showing what is due to the owner for later payment.
It’s a good idea to zero out your “shareholder credit” account at the end of the year, since this liability is not relevant to your business’s financial health as a liability to a bank or credit card company would be. You can do that in either of these two ways.

  •  Write a business check for the money owed to yourself.
  • Reinvest the money in your company by moving it to an equity account.

Avoid using shareholder Loans for Due To or Due From shareholder transactions. Shareholder Loans should only be used for real loans that have a note instrument, an interest rate assigned, and regular payments made.

How Can Business Expenses Become Taxable Wages?

If an employer does not have an accountable plan in place, then IRS Publication 15 states: “Payments to your employee for travel and other necessary expenses of your business under a nonaccountable plan are wages and are treated as supplemental wages and subject to the withholding and payment of income, social security, Medicare, and FUTA taxes.” So even if the business expenses are valid and necessary, if the employer does not have an accountable plan, then any reimbursements are taxable income.
On the other hand, if the employer has an accountable plan, but the employee fails to properly substantiate the expenses within a reasonable time, or the employee fails to return excess advance payments, then any reimbursements could become taxable income. In addition, if any indirect expenses are paid in excess of IRS limitations, then the excess is taxable income. For instance, in 2012 the federal rate for business travel is 55 cents per mile. If the employer pays 60 cents per mile, then the additional 5 cents per mile is taxable income.

Unreimbursed Business Expenses of Employees

Never pay business expenses personally without reimbursing yourself, or any other owner(s) – immediately. If you fail to have your business reimburse you for these business expenses, the only way you can take them as a tax deduction is to show them on your personal income tax return (Form 1040) as “Non-reimbursed Employee Business Expenses” as long as the shareholder was paid salaries as an employee.
Expenses must be ordinary and necessary. they include unreimbursed office supplies, reference materials, meals and entertainment, and travel, etc. But payment of business liability insurance, rent or mortgage do not qualify. There are four hurdles to deduct the Unreimbursed Business Expenses of Employees

  • If a reimbursement policy exists, you must seek reimbursement. Taxpayers should request a statement from their employer for expenses the employer is not reimbursing. You may not deduct reimbursable expenses. IRS auditors may request this documentation for unreimbursed expenses on Form 2106.
  • After reporting the unreimbursed expenses on Form 2106, the net amount of business expenses are carried forward to Form Schedule A, ‘Itemized Deductions’ where these amounts would be categorized as “Miscellaneous Itemized Deductions”.
  • These non-reimbursed business expenses must first exceed 2% of your “Adjusted Gross Income”. It’s only those in excess of the 2% figure that can be taken as a tax deduction on your personal tax return.
  • Deductible business expenses can be further reduced or completely phased out should a taxpayer be subject to Alternative Minimum Tax (AMT). When a taxpayer is in AMT, unreimbursed business expenses and other miscellaneous itemized deductions are added back to income thus increasing taxable income and potentially increasing the tax liability.

Unreimbursed Business Expenses by Nonemployee Shareholder(s)

Unreimbursed expenses incurred by non-employee S-corporation shareholders are generally not deductible (TC Memo 1989-207 and TC Memo 1997-446). 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, 1971-1 C.B. 51 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.”

A work-around: 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.

In another way, the amount of the payment is treated as a loan by the shareholder to the corporation if 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. 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. The unreimbursed expenses can be treated as contribution of capital. In either way, the shareholder has made the economic outlay and should, be entitled to increase stock basis for the expenditures made on behalf of the business.

37 Comments

  1. That is a really good tip especially to those new to the blogosphere. Brief but very accurate info… Appreciate your sharing this one. A must read post!

  2. Physicians says:

    Pretty section of cоntent. I just stumblеd upon уouг web ѕite and
    іn acceѕsіοn саpіtаl to аѕsert thаt I acquirе in fact еnjoyed account youг blog posts.

    Аnу way Ι wіll be ѕubscribing tο youг augment and even I асhievement you aсcess сonsistently fast.

    Ηеre іѕ my blog pоst; Physicians

  3. Scot Gillece says:

    Its like you read my mind! You seem to know a lot about this, like you wrote the book in it or something. I think that you can do with a few pics to drive the message home a bit, but other than that, this is wonderful blog. A fantastic read. I will certainly be back.

  4. It’s in point of fact a nice and useful piece of info. I am satisfied that you just shared this useful info with us. Please keep us up to date like this. Thank you for sharing.

  5. This blog is good. I’ll post a link to it on facebook today.

  6. PTP site says:

    Thanks on your marvelous posting! I actually enjoyed reading it,
    you are a great author.I will make sure to bookmark your blog and may come back in the foreseeable future.
    I want to encourage you continue your great posts, have a
    nice morning!

  7. I got this website from my buddy who informed me
    on the topic of this website and at the moment this time I am browsing this site and reading very informative posts at this time.

  8. I was very pleased to find this website. I wanted to thank you for your time for this wonderful read!! I definitely enjoyed every little bit of it and I have you bookmarked to check out new stuff on your blog.

  9. I have been browsing online more than 3 hours today, yet I never found any interesting article like yours. It is pretty worth enough for me. Personally, if all webmasters and bloggers made good content as you did, the internet will be a lot more useful than ever before

  10. Letty Garde says:

    Do you mind if I quote a couple of your posts as long as I provide credit and sources back to your weblog? My website is in the very same niche as yours and my visitors would certainly benefit from a lot of the information you provide here. Please let me know if this alright with you. Many thanks!

  11. I can see you’re an expert at your field! I am launching a web site soon, and your data is going to be very fascinating for me.. Thanks for all your aid and wishing you all the success.

  12. Wow! This can be one particular of the most beneficial blogs We have ever arrive across on this subject. Basically Fantastic. I am also an expert in this topic so I can understand your hard work.

  13. Nice post. I was checking continuously this blog and I’m inspired! Extremely helpful info particularly the remaining section :) I deal with such info a lot. I was looking for this particular info for a very long time. Thank you and best of luck.

  14. This iѕ very fasсinаting, You are an overly profeѕsional blogger.
    I’ve joined your feed and stay up for looking for more of your fantastic post. Additionally, I have shared your site in my social networks

    Stop by my webpage – Http://Www.Realtimeathletes.Com/

  15. I think this is one of the most vital info for me. And i am glad reading your article. But wanna remark on few general things, The web site style is ideal, the articles is really nice : D. Good job, cheers

  16. What’s Taking place i am new to this, I stumbled upon this I’ve found It positively useful and it has helped me out loads. I’m hoping to give a contribution & aid other customers like its helped me. Good job.

  17. you’re truly a just right webmaster. The web site loading pace is incredible. It sort of feels that you are doing any distinctive trick. In addition, The contents are masterpiece. you have performed a wonderful activity in this subject!

  18. My Site says:

    Howdy! I could have sworn I’ve visited this website before but after browsing through some of the posts I realized it’s new to me.
    Nonetheless, I’m definitely delighted I discovered it and I’ll be book-marking
    it and checking back regularly!

  19. Windy Boros says:

    I like this weblog so much, saved to fav.

  20. These are in fact wonderful ideas in about blogging.
    You have touched some nice factors here. Any
    way keep up wrinting.

  21. smalan says:

    Very nice post. I just stumbled upon your blog and wished to say that I have really enjoyed browsing your blog posts. In any case I’ll be subscribing to your rss feed and I hope you write again soon!

  22. Armando says:

    Very interesting site! I’m looking forward to reading more articles from you & sharing more of your insights & tips. Please keep up the excellent work.

  23. Gil Gunnoe says:

    I enjoy, result in I discovered just what I was having a look for. You have ended my four day lengthy hunt! God Bless you man. Have a great day. Bye

  24. That is the best weblog for anybody who wants to find out about this topic. You realize so much its virtually hard to argue with you (not that I actually would want…HaHa). You undoubtedly put a new spin on a topic thats been written about for years. Great stuff, just nice!

  25. I have read a few good stuff here. Definitely worth bookmarking for revisiting. I surprise how much effort you put to create such a magnificent informative site.

  26. Myron Keuper says:

    I actually like your writing style, superb information , appreciate it for posting : D.

  27. You are so interesting! I do not believe I have read through a single thing like that before. So wonderful to find somebody with some genuine thoughts on this topic. Seriously.. many thanks for starting this up. This website is something that is needed on the web, someone with a bit of originality!

  28. I like the valuable information you provide in your articles. I’ll bookmark your blog and check again here regularly. I am quite sure I’ll learn many new stuff right here! Best of luck for the next!

  29. John Kiefer says:

    Nice subject: Business Expenses Paid out of Pocket by Shareholder(s) of S Corporation – Du&. This really answered my drawback, thank you!

  30. Hot subject: Business Expenses Paid out of Pocket by Shareholder(s) of S Corporation – Du&. This really answered my downside, thank you!

  31. Good post. I’m going through many of these issues as well..

  32. Spot on with this write-up, I really assume this subject: Business Expenses Paid out of Pocket by Shareholder(s) of S Corporation – Du& needs far more consideration. I’ll most likely be again to read way more, thanks for that info.

  33. Good post: Business Expenses Paid out of Pocket by Shareholder(s) of S Corporation – Du&. I’m impressed, I need to say. Actually rarely do I encounter a weblog that’s both educative and entertaining, and let me let you know, you have hit the nail on the head. Your concept is excellent; the difficulty is one thing that not sufficient individuals are speaking intelligently about. I’m very completely happy that I stumbled across this in my search for one thing relating to this.

  34. Outstandingly illuminating many thanks, It is my viewpoint your current subscribers may just want a very good deal more blog posts similar to this keep up the excellent subject material.

  35. I am so happy to read this. This is the type of manual that needs to be given and not the accidental misinformation that’s at the other blogs. Appreciate your sharing this best doc.

  36. I truly appreciate this article post.Really thank you! Will read on…