Handle pass-through expenses.

@qbteachmt

I don't think you realize that we don't disagree here.

My advice was only meant to reflect what to do in cases of true reimbursements.

The original post asked specifically about unmarkedup subcontractors.

It was that particular type of item that i was specifically responding to.

I should have made that more clear in my response.

You're exactly right on the lemonade and robot examples.

But if I get hired to run a lemonade stand, and the person who hired me would also like some linens used on the table (not something I normally provide)--- well, I might say, "I can do that but it will have to be ordered special.  Would you like to pay the linen bill directly or should I order and you just reimburse me through my invoice?"  

If she chooses to simply reimburse me, I can absolutely take care of the expense the way I describe.  Ditto if I hire a staffing company to professionally pour out the lemonade.

etc. etc.

Well, @Rustler and @qbteachmt, then I guess I'm mystified.

I am not an accountant, so I can only speak to what I've been shown by others.

However, I'm confused as to why Quickbooks would allow, and even *facilitate*, reimbursements from clients of paid subcontractor fees and/or job materials, and pass through expenses to vendors in general, if this was not a completely kosher practice?  

I'm in restaurants, so the only time we use this kind of thing is in the kind of scenario I described -- ie: doing a catering gig and passing along third party vendor expenses so the client can pay one bill rather than paying all vendors separately... especially when acting as the default 'coordinator' for all said subcontractors.  

However, in my past life, I did some work for a landscape designer.  Her subs *and* items she purchased from vendors under her wholesale account on the client's behalf were billed this way as well, with only her mark-up (if any) going toward income.

Again, my question is, why would Quickbooks facilitate, even BAKE IN something that isn't a kosher practice?  In all the scenarios I have described, where the box was checked to "Bill" a client or customer for an expense, *never* did I have to choose where that particular part of the payment to me would be booked.  QB *automatically* assigned it to whatever account the original reimburseable expense was hitting.  In addition, they specifically *restricted* using the feature only to expense accounts, not to anything booked to cost of goods sold.

Any ideas?  I can't think of another reason for that kind of functionality...

Hello everyone, 

What a great discussion! I can see there is a lot of passion around this topic. @Anonymous, @Raywhite28, @qbteachmt, @Rustler, @lynda, @ParkwayInc and everyone else on the thread, thank you for providing valuable insight into this complicated income reporting scenario. And thank you to @Anonymous in particular for initiating such a spirited (and clearly needed) discussion. 

Everyone has approached the issue of income reporting protocol for subcontractors of contractors in a different way. All of these answers push the conversation towards the ultimate goal of resolution. @lynda, you're answers are always concise, encouraging and thoughtful! @Anonymous, I love how you look at the problem holistically and point out the fundamental complexity of the question as it pertains to different industries (namely food and service). @ParkwayInc, please keep posing fantastic, challenging critical-thinking questions (and keep being amazing). @qbteachmt, you have so much expertise and amazing insight. I really appreciate how you've used simple analogies as heuristics to explain the reporting process. @Rustler, thank you for providing official notation, it's important to bring documentation into conversations. And of course, @Raywhite28, thank you for those helpful links about company policy - clearly 1099 questions are something many of us in different communities think about. 

I'd love if we could collectively nail down specifics (or pose different questions and challenging scenarios) to turn this conversation into learning material. I'm happy to be the point person and open to collaborating with anyone. This content would be really valuable for other users!  

Please continue this conversation. We encourage it! Going forward, please keep judgements about the value of other user's perspectives out of the conversation. Be as objective as possible. This community is a place for civil discourse. To this point, the conversation has been mature. Please keep it that way :smileyhappy:. 

Back to @Anonymous's original question, if you were in their shoes, what would you do? 

Ok, so lots of discussion and lots of different scenarios!

@qbteachmt

I appreciate what you and @Rustler are saying.  

But I think where we are missing each other ... perhaps because of our examples.  Either the ones we've explicitly used, or the ones we are simply thinking of as we speak.  Also too, there are a couple of different things at play... levels of advice where one is talking about what is maybe optimal from a QB process standpoint where another is talking about 1099 complications and another about audit vulnerability.  These are all important, but they are also different things that can, I think, cause us as contributors to misunderstand the other.  

I think it might be helpful to divorce what is ALLOWABLE from what is STANDARD from what is MOST THOROUGH/SAFE/USER FREINDLY from a workflow perspective when using software like Quickbooks.

WHAT IS ALLOWABLE?

I think it is safe to look to how the IRS describes how to treat reimburseable expenses of a particular type to an independent contractor to shed some additional light on this issue.  

The IRS does in fact provide guidance to businesses on how to treat reimbursements to independent contractors.  Independent Contractors are vendors.  So clearly they know of and allow them (reimbursements to vendors) to happen, clearly there is such a thing as reimbursements to vendors at all, otherwise the guidance would be "NO". 

But they don’t just say that.  Here is a link to a web article. I am linking to this because it quotes the part of the IRS publication addressing this in part AND also links to that IRS publication in full.  This article was published in 2015.  From what I have gathered in my (SHORT) time on this topic, there have been further guidances issued regarding the specifics of meals and travel since then... making it even more clear that the practice of reimbursing some 1099 contractors for certain expenses in fact does happen and is 'kosher' within limits. 

To summarize, they say to:

1. Document what is to be reimbursed as a function of the working relationship.  Does your contract say, for instance, that your service fee is X plus any out of pocket expenses?  2.  Keep back up of each expense and bill for the exact amount incurred out of pocket (unless in the case of mileage reimbursement, obviously).  You must retain the back-up of what you billed for reimbursement in order to substantiate you treating the payment in that manner (in case of audit).
2. If you are given or receive MORE than your actual expenses you must return the overage to the client *or* call the overage income.  IE: if part of your contract as a service provider (say a consultant of some kind) is a per diem for travel of $300/day... but once you add up all your expenses, you only spent $250/day -- the extra $50/day must be treated as income or returned to the client.
3. If you are reimbursed for something that would NOT be a business expense to your business if you were not reimbursed for it, then you cannot call it a reimbursement and must call it income.  The IRS gives the example of an employee being reimbursed for travel from home to the office by their company.  But travel from home to office is not a legit deductable employee expense for unreimbursed business expenses.  Therefore, if it is 'reimbursed' it is income to the employee.  Likewise, if a consulting contract allowed for you to be 'reimbursed' for your out of pocket expenses on boarding your dog at the last minute to accomodate a clients needs, that's great!  But it would be income, not a true reimbursement of business expense -- since you could not write that off as a business expense if you were not reimbursed for it.

Essentially what the IRS is doing is asking independent contractor / client(customer) relationship to mirror an accountable plan for employee reimbursement in its nature.  To be specific, documented, and exact in monetary nature.  A company could not "reimburse" an employee for their time via an accountable plan... so clearly what is reimbursed needs to be outside of the primary reason for the monetary relationship in the first place.

According to the IRS, if these requirements are met, then these reimbursements should NOT be included on any 1099 reporting by the client for your services as an independent contractor.  Therefore, the IRS is basically saying that these items *are not income* to the independent contractor.  However, they also caution that since they are reimbursements, not income, then the original costs are also *not expenses*, and should not be treated as such.

HOWEVER:  Just because it is LEGAL with the IRS to treat some payments as something other than income, does NOT mean it is standard, or adviseable, or good business practice for your business, or even the easiest way for you to do things...

WHAT IS STANDARD?

To my mind, this is where the rubber meets the road.  It is also, I think, where a lot of our discussion is swirling around.  What is kosher to be designated a reimbursement for one may be anything but for another.  And just because something is legal, doesn't mean it constitutes the best or most defensible practice for your business.  so: 

1. It seems clear that anything involved in Cost of Good Sold is not allowable in this area.  I didn't see anything strictly prohibiting it per se.  But since the IRS repeatedly talks about "expense" in the context of reimbursement, and since "expense" in the accounting world doesn't just mean 'something I spent money on', it seems safe to assume.  Cost of Goods Sold purchases are qualitatively different from expenses.  Not only are they treated differently on tax returns, it's right in the name -- you are *selling* something.  So it is not additional or adjunct to what you are truly engaged in selling to your customer!  Plus, as @qbteachmtpointed out, there are all kinds of implications with sales tax... not to mention its cousin -- re-sale permit status, non-profit status, etc etc.  Too many factors.
2. I would guess that this kind of thing is MUCH more standard around service businesses than around product based businesses, given the above.  In thinking more about this over the weekend, I actually realized I have seen this more often than I originally realized:  

• JANITORIAL/CLEANING SERVICES:  Reimbursing a janitorial contractor for the cost of cleaning supplies because your supply has run out and they went ahead and purchased replacements for you.  Quite often cleaning individuals, and even services, specifically state that expendable supplies like soap, bleach, filters, etc etc must be provided by the client.  Many people are particular about the products to be used, particularly in their homes, so it makes sense.
• CONSULTANTS:  Reimbursing a consultants for travel to a franchise store or off-site location.  Quite often consultants build reimbursements for things like travel and incidental expenses into their contracts -- as well as any more direct business charges like copying or submissions they incur on behalf of the company they are consulting with.  The alternative is to give a person who doesn't work for your company some way to spend your company's money directly *or* to have them repeatedly have to have someone else engage in purchasing items.  These can both be *really* onerous to facilitate, particularly with large companies or remotely located work.
• PUBLIC RELATIONS FIRMS:  PR firms tend to bill clients for reimbursements for things like parking and travel for client events or meetings, fees associated with placing client advertising, client-specific telephone expenses, client-specific dinners/meetings...etc.  This is fairly standard practice.  What the PR firm is typically selling is a service -- their expertise at coordinating and as a facilitator of getting noticed.  They are not operating, nor typically touting themselves, as resellers of particular apps, upsell purchases, advertising portals, targeted click ads, etc etc.
• BOOKKEEPER:  I can't believe I forgot myself!  I don't use this kind of thing often, but here are some instances when I do - I may file a form on a clients behalf and pass along the certified mail charge directly to them.  Or file a fee online that requires credit card payment only, so advance the payment when I file and then include a reimbursement for the fee on my next bill.
• INTERIOR DESIGNER:  This one is kind of on the fence a bit... they may hire a landscape designer to create a stunning back porch on your behalf, then just add the direct cost to your bill.  But, it's this kind of example that gets into the trickiness that can insue from a logistics standpoint. 

Just a few examples, but I think they demonstrate well what kind of expenses we are talking about here.  Still, as some of the posts correctly pointed out, just because something is technically OK to do, does *not* mean it is standard practice for the industry. 

And just because something may be OK to do and may be standard practice for the industry, does *not* mean it will necessarily be the best way for you to handle things from a clarity of bookkeeping, audit protection, and streamlining of processes perspective.

WHAT IS YOUR BEST PRACTICE?

Here is a short list of questions that have occurred to me as I have been wrestling with this topic over the past few days -- both as a bookkeeper, a small business owner, and a service provider.  In short, I can see this issue from all three perspectives:  receiving money, reimbursing money, and making sure it is all booked and gets captured correctly on all sides.  What I don't have is the specifics on the tax angle, and anything other than a gut instinct (*informed* guts, but guts none the less) on what any given industry might be able legally to treat this way.

STEP ONE:  FIGURE OUT WHAT IS ALLOWABLE AND WHAT IS STANDARD FOR *YOUR* BUSINESS.

---- This means for real.  You can read all you like on this site or others.  But while all of our talk might be helpful to get you thinking about potential items to investigate and ask about, nothing can really replace the personalized advice of an actual accountant on this stuff.

Here is what I mean by "Personalized Advice"

1. They are familiar with 1099 based tax filers.
2. They are *very* familiar with service based companies -- be it 1099 or otherwise.
3. They are ideally familiar with doing taxes for people in your particular industry.
4. They are absolutely familiar with doing taxes for people in your particular *state*.

Reach out on the web or locally to people in your industry.  Ask them who they are using and what they have encountered in terms of standards for the industry.  Then choose someone (or several someones) to engage in a formal conversation.

-----  This also means for real.  Here is what I mean by “Formal Conversation”

1. You pay them for their time.
2. You come prepared with your books.
3. You come prepared with real world examples of what you need advice on.
4. After the meeting, you pay the bill promptly and send an email *summarizing* the advice and/or resources they gave you along with a thank you and a request to please *correct* you if you have interpreted any of the finer points of your time together in error.

Then, you move forward with step two… knowing exactly which kinds of expenses can even be considered for treatment as strict reimburseables vs which cannot.   AND MOST IMPORTANTLY -  KNOWING IF THERE ARE ANY FEDERAL OR STATE OR LOCAL IMPLICATION OF TREATING THEM AS ONE VS THE OTHER, if you are capable of choosing from a tax perspective.

STEP TWO:  GETTING REAL ABOUT THE PROCESS

As I’ve said a lot in this article, just because you can do something, doesn’t mean you should.  To my mind, there are a number of factors that might influence whether or not you choose treat a potentially reimburseable expense as one in your business workflow.  Of course, this list ASSUMES you’ve already determined that these expenses are capable of being seen as reimburseable in the way you are incurring them, and that you have explored that with an accountant, AND that you have met the requirements I briefly went over about how these reimbursements must be accounted for to clients.

That all said, here we go – given all you’ve learned about these expenses for your business, from what I can see you are left with three options (or maybe three and a half).

1. FORGET IT – JUST FOLD ALL YOUR EXPENSES INTO YOUR FEES AND STOP TRACKING THEM BY CLIENT IN GENERAL. ß clearly the easiest, and certainly one that looks good given the OBSCENE length of this post!
2. BILL IT – By this, I mean:
   1. Give your client a bill for all your expneses.
   2. Call the payment they gave you a type of income – perhaps something offset from everything else as I believe someone at some point might have described, so you can see that things are matching up.
   3. Call the expenses themselves expenses, categorized just like you would any other business expense you were not passing along to the client directly. (Or maybe even setting them off in a separate account set as ones you had passed off – again, I think someone described something like this).

In this scenario, your expenses are going against your income at the end of the day… so your net profit is the same according to your profit & loss.  Depending upon your expenses, your state and local, and basically what your accountant meeting revealed, this may or may not mean you have different tax liabilities.

1. EXPENSE IT – By this I mean, giving the client a list of expenses, just like an employee would, for reimbursement. Then:
   1. Call the payment they gave you a reimbursement.
   2. Call the expenses themselves that await reimbursement essentially an asset you are owed by the company… or as someone else described it, a kind of due to/from list.

Here is where the ½ choice comes in.  When it comes to number 3, you could:

1. Book all reimburseable costs to a due to/from account.
2. Put the charges on your clients invoice as a reimburseable amount that points back to that same due to/from account.
3. This essentially zeroes out the amount they owe you for these charges you incurred on their behalf once their bill is paid.

OR you could:

1. Utilize double sided items as described by @qbteachmt I suppose.
2. This basically standardizes the above.

OR you could use the Quickbooks ability to mark a cost or an item as billable to a client, as I described previously.

I previously asked why in the world QB would build such functionality in if it was not kosher.  I should have phrased that question differently – Why would QB build in such functionality if it were NEVER of use in a Kosher manner.

While I realize QB is not a robot accountant, I do have to give QB some credit… They quite often err on the side of caution… not allowing their program to engage in practices by default that are potentially wrong-headed or harmful – sometimes not without A LOT of work-around.  Sometimes not at all!  Which can be VERY frustrating if you actually know what you are doing and why you are doing it… but that’s another post.

The point is, what was bothering me about this whole discussion was why something would be not only possible, but a touted FEATURE inside Quickbooks if its use would ALWAYS be the wrong choice?

I think this idea is actually the answer.  I think what that feature is doing in Quickbooks might be Quickbooks’ way of accomplishing those two halves of #3 in a streamlined and easy to do/done for you manner.

In other words, it might be a built in back end process that turns something you enter into a billable / reimburseable cost without having to go in and create a whole balance sheet account listing all billable costs, perhaps one for each client etc. etc.

Instead, it is keeping the actual monetary transaction and the association with a particular expense category *intact*, so no alternative reimburseable expense accounts need to be made.  What would similarly happen with an item, I would guess.

The beauty is that the amount stays intact as well.  And the vendor information for the cost itself. 

My suspicion:  I think this is Quickbooks way of consolidating a lot of information and keeping it’s information supply chain closer to the original cost, so to speak.  It’s QB way of accomplishing what others have described here how to do in different ways. 

STEP THREE:  GETTING REAL ABOUT CHALLENGES

All of this is great.  Maybe using the billable items with a check mark via Quickbooks sounds great, but BEWARE.  There are a few more questions you have to ask yourself first.

1. Reimbursed expenses are not to be included in your 1099 as an independent contractor. *Can you rely upon your customer to actually leave them off?*
   1. It may be easier to get this to happen by separating reimburseables into a separate bill.
   2. Obvioulsy relationship with your customers and the frequency of these things happening are factors.
   3. Checking up on 1099 amounts being reported / showing in their books before year end can identify the need for corrections before things get tight time-wise.
   4. Help your clients out with totals by category on reimbursements for easy coding on their end.
   5. If part of the reimbursement is for another independent contractor, I would bill completely separately, include all 1099 information with the bill and speak with the bookkeeper directly about year end 1099s for both you and the sub. Better yet, have them pay the sub directly.

If this all sounds like something that you would most likely have to do with your clients and a real drag to do in the bargain AND if the tax implication are little to none for you on reimbursements in general, then skip the headache maybe and just call it all income and expense, and do the 1099s for any subs from your own company.

1. See above:  1099 issuances for other independent contractors make who is responsible for what in terms of tax reporting more complicated.  Make sure you have all that worked out in advance with clients if you are going to do this.

In short, when it comes to items that are truly legitimately countable as reimburseable expenses from clients:

• if you find yourself having to jump through a lot of process hoops, or having to have a lot of corrective conversations with clients in order to utilize the strict reimbursement as a feature (either the auto-version or by keeping due to/from accounts), then it may not be worth it to you to keep reimbursement income off of your income totals entirely. Instead, take the advice of others and separate it out through the use of other account sets.
• However, if on the other side you are finding a number of reimburseable (or billable) expenses are getting missed and not making it to the client invoices for payment, then you may want to utilize the QB feature to streamline the capture and report process.

Hey guys.  I’m a bookkeeper.  Who has been working with essentially one industry set for 20 years.  Rules change, they get refined and re-defined.  I’ve even learned new things about this industry I’ve known and loved on occasion – things I just missed for whatever reason up to that point.  And I’ve been on the other side of it too… breaking it to an accountant or other bookkeeper that actually x, y, or z is taxable for restaurants, etc.  It’s part of learning!  I honestly don’t know *what* people who aren’t in a niche do… how they can keep up is a mystery to me.

That being said, I’m all about being corrected and learning/expanding my knowledge.  While not common, this issue *does* have implications for my clients and is something I have encountered!

This is a free site.  So, obviously, if anything I’ve said above is just 100% wrong I want to know about it.  But I want to know about it in a way that teaches me about why it is wrong and what documentation I have missed in the public sphere that explains that.  Like, IRS site or whatever.  If something is 100% wrong all the time or never allowed.  Tell me.  But also tell me where I can find more on that info... where those rules are documented.  That is helpful if I ever want to pass along your insights to others!  Without it, it is just another set of input that is second-hand in nature… which is obviously what I’m already working with!

For the business owners out there & @Anonymous  Whatever you decide, as I stated right from the start, the first and most important step is to get with a great accountant in your area with some expertise in your industry and with your filing type (Sched C, S-Corp etc.) and have a real conversation about what is best for your industry and the kinds of work you are doing.

Then find a great bookkeeper to help facilitate the process of implementing how it will get done – in a way that is sure to CAPTURE, DOCUMENT, ARCHIVE, AND PASS ALONG all the amounts you are entitled to for your business – both to your client, any subcontractors, and to IRS and other agencies.

Fortunately, there is this little site I know that has localized lists of great accountants, bookkeepers, and Quickbooks experts.  Maybe you’ve heard of it?  

*kristen

Hello everyone!

Thank you so much for your amazing participation in this thread. I am going to close the conversation at this point. If you would like to continue a separate conversation, please do so in another thread (which would be productive!).

Thanks again to @Anonymous for starting the conversation. @Anonymous, you can post additional clarifying questions if you want or need. We hope the answers provided were satisfying!