The taxpayers, members of an LLC, filed their Arizona resident individual income tax return for tax year 2006 claiming Schedule C expenses they paid on behalf of the LLC. The Arizona Department of Revenue disallowed the total deduction claimed, permitting a lesser deduction of 16.67 percent (the taxpayers’ membership interest in Class A, one of the two classes of interests) of the verified expenses originally claimed on Schedule C. Generally, a taxpayer may deduct unreimbursed ordinary and necessary partnership expenses he or she paid on behalf of the partnership on Schedule E if the taxpayer is required to pay those expenses under the partnership agreement. In this case, however, the LLC operating agreement did not require that the taxpayers pay expenses or categories of expenses on behalf of the LLC. Because there was no indication in the record that the taxpayers were required to pay certain expenses, the taxpayers were not entitled to a deduction of the LLC expenses they paid. Arizona Dep’t of Rev. Hearing Office Decision No. 201200088-I (Sept. 28, 2012, released Oct. 30, 2012).
Co-author - Patrick Smith, Director Baker Tilly Virchow Krause, LLP
Mr. Ely is a partner and Messrs. Thistle and Rhyne are associates with the multistate law firm of Bradley Arant Boult Cummings LLP in its Birmingham, Alabama office. Mr. Ely is Chair of the firm’s State & Local Tax Practice Group. Messrs. Ely, Thistle, and Rhyne co-author a chapter on the state taxation of PTEs in the treatise “Keatinge, Conaway and Ely on Choice of Business Entity” (West). Mr. Smith is the Tax Director at Baker Tilly Virchow Krause, LLP and is head of State & Local Tax Services for the firm’s Chicago office. Mr. Smith is a co-author of “State Taxation of Pass-Through Entities and Their Owners,” a treatise published by Warren Gorham and Lamont/West since 2005. Messrs. Ely and Smith have co-presented on this topic at NYU’s Institute on Federal Taxation, as have Messrs. Thistle and Smith for a webinar hosted by Strafford Publications in early June.