Partner Paid LLC Expenses Personally: Reimburse or Contribute?

Can a partner pay LLC costs personally and be paid back?

Yes. A partner in a multi-member LLC taxed as a partnership can pay an LLC cost from a personal card or account. The cost is then settled one of three ways: the LLC repays the partner, the partner leaves the money in as a capital contribution, or the partner deducts it on their own Schedule E as an unreimbursed partnership expense. Each cost gets one treatment, never two. A fourth route, a loan to the LLC, is in contribution or loan to your LLC.

The capital and basis columns show only what the payment itself does. In the first two rows the cost also lowers each partner's share of profit, and with it their capital account and basis.

A case is not simple when the operating agreement is silent on partner-paid costs, payments are unequal or run for more than one year, the books never recorded who paid, partners remember the arrangement differently, the cost came before the LLC existed, or a Form 1065 or Schedule K-1 is about to go out.

Gather the operating agreement and any amendments, invoices and receipts, card or bank statements, the date each cost was paid, and each partner's capital account balance from the books.

Should the LLC reimburse the partner or treat it as a capital contribution?

Both leave the cost on the LLC's books. They differ in whether the partner's money comes back now or stays in the LLC.

• Reimburse. The LLC records the cost on the date the partner paid it, records the amount it owes the partner, and books the repayment against that amount, not as a draw. Repayment adds no contributed capital, so the capital account does not change. While the LLC owes the partner, that amount can count as a partnership liability, and basis follows a partner's share of partnership liabilities (26 U.S.C. § 752); see contribution or loan to your LLC.
• Capital contribution. The LLC records the same cost and credits the partner's capital account instead of paying cash. The partner's basis goes up by the money contributed (26 U.S.C. § 722; Publication 541), and so does the capital account on the books (26 CFR 1.704-1(b)(2)(iv)).

A contribution is not a gift. It stays in the partner's capital account, and whether and when it comes back depends on the agreement. A partner who wants the money back on a schedule needs a reimbursement or a loan.

A capital account is not tax basis. Publication 541 says basis is figured without regard to any amount in the partnership's books as a capital account. Partner capital accounts covers how to keep them.

Is a partner-paid cost deducted on the partnership return or on each partner's personal return?

A partner-paid LLC cost is deducted on the partnership return, Form 1065, in almost every case. The LLC deducts its ordinary and necessary business costs on Form 1065, and each partner gets a share on Schedule K-1 and reports it on their own return (Publication 583; Instructions for Form 1065). The agreement sets each partner's share (26 U.S.C. § 704(a)).

A cost the partner paid and the LLC then repaid, or credited as a contribution, is the LLC's cost and is deducted once, on Form 1065. The partner does not enter it again. A personal cost is not an LLC cost; see personal bills paid from the business account.

When can a partner deduct unreimbursed partnership expenses on their own tax return?

A partner can deduct an unreimbursed partnership expense (UPE) on their own return only when the partnership agreement requires the partner to pay it, the LLC does not repay it, and it is an ordinary and necessary trade or business expense under section 162, meaning a common, helpful cost of running the business. The Schedule E instructions set all three conditions. The partner answers Yes to the Part II question about unreimbursed partnership expenses, reports it on a separate line of Schedule E, Part II, marked "UPE", and does not net it against anything else. If the expense is from a passive activity and the partner must file Form 8582, it is not reported on a separate line; have the facts reviewed.

This route has consequences:

• Only the paying partner gets the deduction. An LLC deduction is shared by all partners under the agreement.
• Self-employment tax. The Schedule K-1 instructions tell a general partner to reduce the box 14, code A amount by unreimbursed partnership expenses claimed before entering it on Schedule SE. Whether an LLC member counts as a limited partner for self-employment tax depends on 26 U.S.C. § 1402(a)(13); this page does not decide that.
• The cost must stay unreimbursed. If the LLC repays the same cost, it is out of this route.
• Not for formation or start-up costs. Outside the partnership's election, 26 U.S.C. § 709(a) allows no deduction to the partnership or any partner for organizing the partnership, and 26 U.S.C. § 195(a) allows none for start-up expenditures.

Without an agreement term requiring the partner to pay, the Schedule E instructions do not allow this route and the cost is repaid or contributed. Have the agreement reviewed before claiming it.

A partner paid for our domain, filing fees or legal fees before the LLC had a bank account: how do we compensate them?

A cost paid before the LLC had a bank account is repaid or left in as a contribution, like any other cost. What changes is how the LLC deducts it, which depends on what it was for.

• Creating the LLC. Legal fees for the operating agreement, accounting fees for setup and state filing fees are organizational costs (26 CFR 1.709-2). They qualify when incurred from a reasonable time before the LLC begins business until the due date, extensions not counted, of the return for the year it begins business.
• Getting the business ready to open. A website domain or software subscription is a start-up expenditure when it would be deductible for an existing business (26 U.S.C. § 195(c)).
• After the business has begun. Running costs, such as a software subscription, are ordinary operating costs on Form 1065, and a domain or other purchase follows the tax rules for that kind of asset. Fees for creating the LLC stay organizational costs inside the period above.

For organizational and start-up costs, the LLC may deduct a limited amount in the year the business begins and spread the rest, unless it chooses on its timely Form 1065, extensions included, to capitalize them instead. Either choice cannot be undone (Instructions for Form 1065; 26 CFR 1.709-1(b); 26 CFR 1.195-1(b)). The partner who paid cannot claim these costs personally. Amounts, timing and recording are in start-up costs paid personally before the LLC.

Repayment has one extra rule. If the partner also moves property into the LLC, such as a domain registered in the partner's name, the repayment can be tested as a sale of that property to the LLC, with narrow exceptions in 26 CFR 1.707-4(d). Have the facts reviewed.

What records and written agreement do we need so the choice holds up?

For each payment, keep the invoice or receipt showing the business purpose, the statement showing which partner paid and when, and a note of what the partners chose: repay, contribute or Schedule E. Publication 583 says proof of payment alone does not establish a deduction, so keep the invoice too. Enter the decision in the books on the date it is made, with a short email or signed note from every partner.

A partnership agreement can be oral or written (Publication 541), but a written one is easier to prove to a lender, the IRS or a partner who remembers it differently. It should say:

• whether partners may pay LLC costs personally, and up to what amount;
• whether a partner-paid cost is repaid within a set time or credited as a contribution by default;
• which costs, if any, each partner must bear personally, which is what makes a Schedule E deduction possible;
• how contributions affect capital accounts and payouts.

The agreement for a tax year includes changes that all partners agree to, or that the agreement lets the partners adopt another way, up to the filing date of that year's return, without counting extensions (26 U.S.C. § 761(c); Publication 541). If the agreement is silent, local law fills the gap. The IRS sources do not say whether a change made after a cost was paid can support a Schedule E deduction for it. That is a question of facts, so write the requirement before the cost is paid.

How is a contribution shown on the K-1?

Item L of the partner's Schedule K-1 shows it on the line "Capital contributed during the year": cash plus the adjusted tax basis of any property contributed (Instructions for Form 1065). Schedule M-2, line 2a, totals the money contributed by all partners. The cost itself also reduces "Current year net income (loss)" for each partner by their share. A reimbursement adds nothing to that line.

Item L reports each partner's capital account by the tax-basis method, so books that keep capital accounts another way may need restating before the K-1 goes out. It can also differ from the partner's basis, mainly because basis includes a share of partnership debt, and each partner keeps their own basis record (Schedule K-1 instructions). A partnership that meets all four requirements of Schedule B, question 4, need not complete item L or Schedule M-2. If the capital accounts were never kept, see rebuilding partnership capital accounts.

Do unequal payments change ownership or profit shares?

Unequal payments do not change profit or loss shares unless the partnership agreement ties those shares to capital. The agreement generally sets each partner's share of income, loss and deduction (26 U.S.C. § 704(a)), and the profit and loss percentages in item J of the K-1 follow it (Instructions for Form 1065). Payments left in as contributions raise capital accounts and basis. The capital percentage in item J is the share a partner would receive if the partnership liquidated, so it moves with capital accounts if the agreement pays out by capital account balances (Instructions for Form 1065; 26 CFR 1.704-1(b)(2)(ii)).

If the agreement does not say how a partner shares an item, or an allocation in it lacks substantial economic effect, the share follows the partners' interests in the partnership, and relative contributions are one factor (26 U.S.C. § 704(b); 26 CFR 1.704-1(b)(3)). To let payments change ownership or profit shares, amend the agreement and have the new allocations reviewed; see splitting ownership between LLC partners.

What if partners keep paying personally all year?

A standing habit needs a fix in how costs are paid, not a year-end label. Four steps:

1. Move recurring costs, such as software and subscriptions, to an LLC card or account.
2. For costs that still go through a partner, reimburse on a set schedule against receipts, or write one default rule into the agreement.
3. Record each payment when it happens, with the partner's name and the treatment chosen.
4. Before the Form 1065 is prepared, total each partner's payments by treatment and tie them to the capital accounts.

Payments that ran for several years with no record of who paid are harder. The treatment of each, the capital accounts and any Schedule K-1 already filed all depend on records that may not exist. Have the books reviewed before the next return; see bookkeeping help.

Example

These examples are illustrative and use US dollars.

Repaid before the LLC had a bank account

Partner A of a two-partner design LLC puts $1,200 of domain and software on her card before the LLC opens a bank account. Assume the domain is registered to the LLC, these would be deductible costs in an open business, they are the LLC's only start-up costs, the partners share profit equally and have enough basis, and the business begins later that year. The LLC repays A $1,200 that year and records the cost as its own. The repayment adds no contributed capital. In the year the business begins, the LLC deducts the cost as a start-up cost unless it chooses to capitalize it. The deduction lowers each partner's capital account and basis by $600.

Left in as a contribution

Partner B pays $3,000 of legal fees personally for a client contract review and does not want repayment. The LLC records the $3,000 expense and credits B's capital account $3,000, and B's basis rises by $3,000. Item L shows $3,000 of capital contributed by B. With a 50/50 profit split, the expense also lowers each partner's share of profit by $1,500, which flows through to each partner's capital account and basis.

An unreimbursed partnership expense

Partner C pays $800 a year of client travel. The partnership agreement says each partner covers their own client travel, and the LLC does not repay it. The LLC records nothing. C deducts $800 on a separate Schedule E line marked "UPE". If C is treated as a general partner for self-employment tax, C reduces the box 14, code A amount by $800 before Schedule SE. The other partners' shares do not change.

Different for you?

• Partners have paid unequal amounts for more than one year, the books never recorded who paid what, or a Form 1065 or K-1 is coming: each payment has to be classified and the capital accounts tied to the K-1s, and the operating agreement may need a change a lawyer should draft; see bookkeeping help and catching up on overdue books.
• Your LLC is taxed as an S corporation: shareholders follow different rules; see reimbursing owner expenses.
• One person owns the LLC: see business expenses on a personal credit card.
• The only owners are spouses: an LLC they own entirely as community property can be reported as a disregarded entity instead of a partnership (Revenue Procedure 2002-69), and then none of this applies. Switching from partnership returns already filed is treated as a conversion, so have it reviewed; see spouse and family LLCs.
• The partner meant to lend the money: a loan has its own record and terms; see contribution or loan to your LLC.
• Partners are paid for work or take cash out: see guaranteed payments versus partner draws.
• A partner moved a domain, equipment or other property into the LLC and was repaid: the sale test above applies; see putting personal assets into your LLC and have the facts reviewed.
• Your ownership split needs to change: see splitting ownership between LLC partners.