Unreimbursed Partner Expenses: When the Operating Agreement Needs a Provision

Partners who pay business expenses out of their own pocket may be able to deduct those expenses on their individual return. These are called unreimbursed partner expenses (UPE), and the operating agreement plays a role in whether the deduction is available and how it works.

What Are Unreimbursed Partner Expenses?

An unreimbursed partner expense is a business expense paid by a partner on behalf of the partnership that the partnership does not reimburse. Common examples include travel to partnership properties, professional development related to the partnership's business, and vehicle expenses for partnership activities.

Unlike employees, partners cannot deduct unreimbursed expenses as employee business expenses. Instead, they claim the deduction as an adjustment to their partnership income. The expense reduces the partner's net income from the partnership on their individual return.

How Does the Operating Agreement Affect This?

The IRS looks at the operating agreement to determine whether an expense qualifies as a UPE. The key factor is whether the partner was required or expected to pay the expense under the terms of the agreement.

Operating agreement requires the expense. If the agreement explicitly requires a partner to incur certain expenses as a condition of their role (for example, a managing partner who must travel to property sites), the deduction is more clearly supported.

Operating agreement is silent. If the agreement says nothing about partner-paid expenses, the deduction may still be available if the expense was ordinary and necessary for the partnership's business. But the lack of a provision can create ambiguity.

Operating agreement provides for reimbursement. If the agreement has a reimbursement provision and the partner chose not to seek reimbursement, the deduction may be disallowed. The IRS could argue the partner voluntarily declined reimbursement.

What Should the Operating Agreement Include?

If partners routinely incur business expenses on behalf of the partnership, the operating agreement should address whether those expenses are reimbursable or are expected to be borne by the partner. A clear provision removes ambiguity and supports the deduction on the partner's return.

The provision does not need to be complicated. A statement that certain categories of expenses are the responsibility of the individual partner, and are not subject to reimbursement by the partnership, is sufficient to establish the framework.

How Is the Deduction Claimed?

The partner reports unreimbursed partner expenses on their individual return as a deduction against their partnership income. The deduction is taken "above the line" as an adjustment to income, which means it reduces adjusted gross income rather than being an itemized deduction.

The partner should maintain records of the expenses, including receipts and documentation of the business purpose. The deduction is reported in the same section of the return where partnership income flows through.

The Decision Matrix helps identify which provisions fit your deal structure. The Tax Review Checklist covers the full set of provisions to evaluate in your operating agreement.

This post is educational and does not constitute tax or legal advice. Consult your CPA or tax advisor for guidance specific to your situation.

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