Ever wonder how to reimburse yourself from your business? Depending on your business entity type, you may or may not have to worry about it.
Reimbursement with Sole Proprietorships
With sole proprietorships, there's no need for any type of formal reimbursement. You become a sole proprietorship by default in the moment you begin selling online. From an IRS standpoint, there is no registration required. It’s as simple as that.
Most resellers don’t have separate phones, cars, or offices for their businesses. That being the case, the line between business and personal usage can get fuzzy. Luckily, the IRS allows us to deduct the business portion of usage in those areas.
For example, let's say 4,000 of the 8,000 miles I drive during the year are directly related to my business. I can deduct those 4,000 miles (58 cents per mile for 2019) on Schedule C of my personal income tax return.
Say I personally paid $1,500 for my cell phone during the year. If 60% of the usage was business related, I can deduct $900.
Let's say I had a qualifying home office space that was 300 square feet of my 1,200 square foot apartment. I can deduct $1,500 utilizing the simplified home office deduction method ($5 square foot up to 300 square feet). Or I can deduct 25% (300 sq ft / 1,200 sq ft) of my shared home expenses utilizing the regular method. (Shared expenses include costs such as rent, mortgage interest, home insurance, utilities, & depreciation.)
All of those deductions are fairly simple to take advantage of on your Schedule C as a sole proprietor.
The same treatment will be applied if you form a single-member LLC. The IRS will consider to you be a “disregarded entity,” which means you will be taxed the same as if you were a sole proprietor.
But, when you form a multi-member LLC or an S corp, you now have a legally separate entity and are no longer eligible to directly deduct the expenses shared between business and personal use.
Many new multi-member LLC members are so accustomed to deducting these expenses directly on their tax returns. So it’s not uncommon for them to continue to do so even when they are no longer sold proprietors. But the IRS is not a fan of this treatment.
Luckily, there is a way to still get the equivalent benefit of those deductions.
Multi-member LLCs and Partnerships
If you are an owner of an LLC, you are an LLC member. If you are an owner of a partnership, you are a partner. LLCs have operating agreements, and partnerships have partnership agreements. In order to deduct personally incurred business expenses, these businesses need to choose one of the the below methods for deducting business expenses paid for personally.
Reimburse partners/members for business-related expenses.
Require owners to pay expenses personally – unreimbursed partnership expenses (UPE)
It's usually one or the other, and it needs to be specified which you are using in your operating/partnership agreement.
The first way is basically the same as an accountable plan, which well talk about in a minute, but since accountable plans only apply to employees, and as a member or partner you’re technically not an employee, we don’t call it that. I just call it a reimbursement arrangement. If you use personal funds to buy business supplies, or for the business to take the mileage or home office deduction, it will have to reimburse you and deduct those reimbursements, which are nontaxable to you as the individual.
The second way is not to worry about reimbursements but rather to deduct what’s called unreimbursed partnership expenses on the personal tax return. So if the LLC/partnership requires owners to pay expenses personally (i.e., there is no right to reimbursement), then these owners can deduct their unreimbursed partnership expenses on their personal returns.
So that is for MMLLCS & Partnerships.
S Corporations and Accountable Plans
As an S corp you are both the owner as well as an employee. Remember with an S corp you have to pay yourself a reasonable W-2 salary. As an employee you can take advantage of what’s called an accountable plan. This is basically the same thing as the reimbursement arrangement we just talked about.
An accountable plan is just a fancy way of saying that you have a system in place to reimburse employee or owner expenses. The benefit is that the expenses will be deductible to the business and nontaxable to the individual.
Ideally, you will have this arrangement formalized in a simple document (like this one) that specifies the process of receiving reimbursement.
For expenses to qualify as deductible to the business as part of an accountable plan, the plan must incorporate the 3 following rules:
- The expenses must be business related
- You need to submit for reimbursement within a reasonable period of time (within 60 days) after incurring the expenses
- You need to return any excess reimbursement within a reasonable period of time (within 120 days)
Simple enough right?
So here’s what you actually do after you form your entity.
- Draft up a simple document (whether it's one of the reimbursement arrangements for LLCs/Partnerships or an accountable plan for an S corp) that states how expenses will or will not be reimbursed.
- Establish a frequency (monthly, quarterly, etc.) of updating a record to reflect the expenses for the period that you have incurred personally on behalf of the business.
- Transfer that amount from your business bank account to your personal bank account.
- Split out and classify the amount transferred to the appropriate expense categories within whatever bookkeeping system you use.
Now you have additional deductions on your books and more (nontaxable) cash in your pocket.
One thing many people do that the IRS frown upon is taking the above-mentioned deductions without having actually reimbursed themselves through an accountable plan.
When you do this, you are getting the benefit of a tax deduction without incurring the usual outlay of cash. Keeping the cash and taking the deduction simultaneously is bad.
One method some CPAs use to get around that situation is to “reclassify” distributions as reimbursements.
This simply means that you just consider a portion of the distributions you took during the year as reimbursements. If you are reclassifying distributions that were taken more than 60 days prior, however, it won’t meet the “reasonable time” requirement and technically wouldn’t qualify (although that doesn’t stop many people from doing it anyway). But even though the IRS likely won’t catch it, it’s best just to do it correctly from the beginning.
In summary, if you have a separate business structure such as a multi-member LLC, it should be making periodic reimbursements to you that are substantiated in writing. Those reimbursements should be governed by a reimbursement arrangement or accountable plan.
If you do it that way, you won't miss out on being able to properly deduct business expenses that you personally incur.
Thanks for clarifying the rules on reimbursements, even for single-member LLC’s I’m particularly glad to see the mention of mileage deductions. I used to have a brick and mortar business selling GPS trackers to small business fleets.
I used to track my business miles with the old-fashioned Dome milage log. A real pain. When I put a tracker on my own car … wow … I was easily losing over 1200 business-related miles a year that I had neglected to log. That would be almost $700 at today’s rates. Even small-time resellers and bloggers really need to track their miles diligently. Those trips to UPS or the post office can really add up.
Absolutely! Small businesses lose so much money each year for either not tracking or failing to deduct their business miles.
I am a Sole Proprietor entity, but I have joined a direct sales company and converted my bedroom into an office and I do alot of events, traveling, etc. And i have purchase things for my business but i been working under the Sole Proprietor entity.
Can i still deduct my expenses?
You definitely can as long as you use the room regularly and exclusive for your business. Most expenses that you incur in the course of business will be deductible 🙂
Is there a legal time limit for reimbursing for expenses / purchases from an LLC or S corp, or even a Sole Prop before the expense would not be eligible or must have some sort of devaluation included in the reimbursement?
I am a sole proprietor of a new business and use my vehicle for business mileage. Can I put the business miles on an expense report with the proper documentation and pay myself for them and charge it to the company? Or must I just use the amount as a deduction on schedule C?
You would only actually reimburse yourself from the business if you have a partnership or S corp. With a single member LLC or sole proprietorship, you just take the deduction on the Sch C.
Do you think that home office depreciation can be considered a reimbursable expense? I read mixed opinions on this one. Thank you!
Yes, that should be okay. Just be aware that the depreciation should be “recaptured,” (taxed) if you ever sell the home.
Members of LLCs taxed as a Partnership cannot have an accountable plan with the LLC because partners are not considered employees of the LLC and the accountable plan is between employee and employer. If, however, the LLC is taxed as an Corporation, then the accountable plan will work. However, not all is lost. The Members treated as Partners have Unreimbursed Partners Expenses which can be directly deducted against K-1 income , marked on form as UPE. The operating agreement must state that the certain expenses are not going to be reimbursed and must be paid by the members. Here, the partners’ unreimbursed expenses are not subject to the limitation for employees, simply because they not employees.
Hi, really great article and exactly what I was looking for. Could I please confirm with you that this applies to my situation? I formed an LLC (Single member) with an S Corp Designation. Prior to formation, I personally paid for organizational costs to form the company. My plan is to write a check from the business to me personally for reimbursement, and then deduct as expenses on my business taxes (up to $5k for organizational).
Hi Tim – Yes that’s how I would do it. Another option would be to treat that as an equity investment, but I like the idea of deducting it better.
Helping two people who started a LLC; prior to opening a separate bank account for their business, they each paid for business expenses from their own personal bank account. How do I account for these expenses on their financial statements? If I “debit” expenses, what do I “credit”? Equity account for each person? Business has not reimbursed each owner for these expenses.
so if a 3 member llc of partners are not reimbursed by llc for mileage
where do they claim the mileage on their taxes? on schedule c? or would they have a separate line on k-1?
Yes on the K-1: https://www.hrblock.com/tax-center/filing/adjustments-and-deductions/unreimbursed-partnership-expenses/