I picked up a new client who has a SMLLC taxed as a disregarded entity that has ownership in a S-Corp. The prior CPA reported the K-1 on my clients Schedule C (no reference on E) and then deducted expenses against that income. I discussed this with the prior CPA and he said that he could not find anything in his research that told him he could not do that. His thought process is that disregarded entities are reported on the Sch C, and the expenses are valid.
I do not agree with this approach and do not plan on taking this approach with my client moving forward. My recommendation would be to have the S-Corp reimburse the expenses. However, if there is validity to his stance I would like to know. The issue that I have is the prior CPA is still preparing the S-Corp return and the other owners personal tax return. Because he "could not find anything that told him he could not do that" I believe that he is going to require me to find definitive proof that he is incorrect before he changes how he is handling the S-Corp return.
If you can point me to regs, court cases, or other info that specifically states that a K-1 cannot be reported on Sch C, that would be greatly appreciated.