Resolving ProConnect Tax diagnostic Ref. 6334 for S corporation unreimbursed expenses

The following informational diagnostic may generate when entering unreimbursed expenses on an S corporation Schedule K-1 return:

S-Corporation #: Unreimbursed Expenses have been entered on an S-Corp K-1. Several Tax Court cases have held that Unreimbursed Expenses are not deductible by S-Corporation Shareholders on Schedule E.  See the Help for input code "Unreimbursed Expenses (Enter as positive) (Adjust)" in the S-Corporation K-1 Input Screen for more detail. (ref. #6334)

Understanding diagnostic Ref. 6334:

Tax courts have generally held that unreimbursed expenses aren't deductible by S corporation shareholders (TC Memo 1989–207 and TC Memo 1997–446).

You can treat the unreimbursed expenses as contributions for capital, or allow them as an employee business expense on Schedule A subject to the 2% adjusted gross income (AGI) limitation.

See IRS Instructions for Schedule A for more information.

If the unreimbursed expense is allowable for the shareholder:

1. Go to Input Return ⮕ Income ⮕ Passthrough K-1 ⮕ S-Corp Info. 
2. Select the Less Common Scenarios tab. 
3. Scroll down to the Separately Stated Income and Deductions section.
4. Enter the amount in Unreimbursed expenses (enter as a positive) [Adjust]. 
   • If the standard mileage rate is used on a vehicle, the mileage deduction and business portion of parking fees and tolls, interest, and property taxes carry here automatically. 
   • If the actual expense method is used, the business portion of all actual expenses carries here automatically. 
   • The program reports the amount as a separate line item on Schedule E, page 2, with the description UPE.
   • If passive rules apply, current year losses will be allowed before the unreimbursed expenses.  This amount reduces self-employment income if the K-1 is nonpassive and you have an entry in "Net Earnings From Self-Employment" for the K-1.