It is normal for a minister to incur out of pocket business expenses throughout the year as he goes about conducting business for the church. However, many ministers and church treasurers are not familiar with how these expenses are to be accounted for and reported.
Expenses covered under an accountable plan would include auto expenses, entertainment, conventions and conferences, professional books and magazines, travel expenses (air, motel, etc), and a variety of other expenses incurred in the regular course of the minister carrying out his duties. While the discussion here will center on expenses of the minister, it should be noted that the rules for business and professional expenses are the same whether the person is a minister or a church-related employee. Therefore, while minister may be used in the discussion on business and professional expenses, the church treasurer should be aware that the same principals will apply to other employees of the church.
Business and professional expenses can be accounted for in one of three ways:
1. Un-reimbursed Expenses – Some churches don’t reimburse their minister’s business and professional expenses. As discussed earlier, most ministers are employees of the church for federal income tax purposes and therefore can deduct their business expenses only as a miscellaneous itemized deduction on Schedule A (of Form 1040), and then only to the extent that such expenses exceed 2% of adjusted gross income. If on the rare occasion that the minister is considered self-employed by the IRS, he or she can deduct business expenses directly on Schedule C, whether or not they are able to itemize their deductions. Hoping to be able to claim un-reimbursed expenses on Schedule A, or even on Schedule C, is the least advantageous tax position for the minister.
2. Non-accountable Reimbursed Expenses – This method is very risky. It is common for a church to reimburse a minister’s business expenses without requiring any substantiation of actual expenses or a return of reimbursements in excess of substantiated expenses. If the minister is counted as an employee for income tax purposes, the full amount of the church’s reimbursements, under a non-accountable plan, must be reported as income on the minister’s W-2 form. The minister must then deduct his or her expenses on Schedule A of the Form 1040 as discussed under un-reimbursed expenses directly above. If the minister is considered self-employed, again very unlikely, these reimbursements are reported as income on Form 1099 and deducted using Schedule C (1040) as indicated above. Simply indicating that the check is for business expenses does NOT automatically classify it as such unless tangible proof, such as a receipt, is provided.
3. Accountable Reimbursed Expenses – This method is considered by far the most accurate and most desirable by the IRS – and should be the method insisted upon by the church treasurer. If the church adopts this method, then none of the church’s reimbursements needs to appear on the minister’s W-2 form, and there are no expenses for the minister to deduct or show on his tax return. To qualify, the accountable reimbursement plan must satisfy the following four requirements:
- Business Connection – The expenses must be incurred as a normal part of the minister or employee’s work requirements. An important point to note, however, is that the business connection requirement will not be satisfied if the employer “arranges to pay an amount to an employee regardless of whether the employee incurs or is reasonably expected to incur business expenses.”
- Substantiation – The business expenses of the minister must be substantiated to the church within a reasonable period of time. The IRS notes that a reasonable period of time is 60 days after an expense is incurred. However, the church can make that period shorter. Substantiation must be provided as to the amount, time, place, and business purpose of the expense.
- Returning Excess Reimbursements – The reimbursement arrangement, to be accountable, must require the minister to return to the church within a reasonable period of time (not more than 120 days according to the IRS) any amount paid under the arrangement in excess of the expenses substantiated.
- Employer Funds – To be an accountable plan, the reimbursement must come out of the church’s funds and not by reducing the minister’s salary.
Because an accountable reimbursement plan is as important as the minister’s housing allowance, it is imperative that the church treasurer have sufficient knowledge of such plans to assist the minister in creating a plan that meets the guidelines of the IRS. Under this type of an arrangement, the minister reports his expenses to the church treasurer, rather than the Internal Revenue Service. Because of the vital role that treasurers play in this process, additional information on accountable plans is provided in the following sections.