S-Corps and 1040 (Schedule C)

[sriman]

I need help. I just took on a new client in the real estate business in Houston, TX. I looked at his 2006 tax return which was prepared by another CPA. On the 2006 return, my client reported income from his S-Corp on Schedule E. He then claimed expenses on his 1040 Schedule C for his personal vehicle, depreciation on his personal vehicle and other expenses which he said was incurred by him to try to generate projects the S-Corp. He told me some of the projects are income producinig while others are not. He told me these were investigative and planning costs to get new deals. How should I handle his 2007 return? I thought costs should match income, and if these are investigative costs, they should belong to the S-Corp. Am I wrong on this point? Please help, I am starting this new practice and do not want to lose a client.

[Uncle Sam]

S Corps

Those "Schedule C" expenses properly belong (assuming he has full documentation) reimbursed expenses off the S Corp (wouldn't be taxable to him IF provided under an accountable plan) OR as Miscellaneous Itemized Deduction, subject to 2%. S Corp owners are NOT like partners, that can claim unreimbursed expenses as an additional line to amounts reported on K-1 on the back ot Schedule E.

[sriman]

Uncle Sam,

There was not accountable plan. Also the expenses were not requried by the S-Corp. My client saind he does not feel like the other shareholders should have to take on any of his costs for searching on prospective items. So, you are saying I should put the expenses on Schedule A of the 1040 limited to 2%?

[Uncle Sam]

S Corps

Yes - that's your only option based on what you're telling us.

[Bees Knees]

The expenses may not be deductible at all, not even on Schedule A.

If the employee/shareholder is not required to pay the expenses out of pocket, they may not pass the ordinary and necessary expense test of Section 162. For a business expense to be deductible, it has to be ordinary and necessary. The fact that the S corporation says it should not have to incur the expense is a possible argument IRS could make indicating it is not ordinary and necessary.

An example of an employee business expense, deductible on Schedule A, is when the employer says, I will pay you X dollars, but you have to drive at your own expense to meet with my clients.

An example of an employee expense not deductible on Schedule A, is when the employer says, I will pay you X dollars and reimburse all ordinary and necessary costs to do your job. The employee does that, but does not submit all expenses for reimbursement, because the employee feels some of the expenses are not expenses the employer would approve of paying.

If the employer is willing to pay for all ordinary and necessary expenses for the employee, and the employee thinks certain expenses do not fall within that category, he/she cannot deduct them as unreimbursed expenses on Schedule A.

At any rate, the only time you could ever deduct unreimbursed employee business expenses on Schedule C rather than Schedule A is in the case of a statutory employee.