A Pastor and His Business Expenses
What are the advantages of the church reimbursing the pastor for his business expenses rather than claiming them on his tax return?
Pastors may now be targets for IRS audits on professional expenses. The IRS regulations state that an employee must be accountable for professional expenses either to the IRS through schedules 2106 and schedules A miscellaneous, or to their employers by reimbursement. We recommend the reimbursement method. It will prevent an audit by the IRS for those areas now targets – you eliminate schedules 2106 and A miscellaneous from your tax return. It will also save taxes as a portion of expenses listed on your 1040 will be subject to limitations (the Dalan ruling* and 2% of Adjusted Gross Income). They are not subject to limitations if reimbursed. You do not report the reimbursed amount on the Pastor’s W-2. It is not income.
How does a church set up an expense reimbursement account for its pastor?
The church pays the Pastor a salary and reimburses all his professional expenses separately (from the general operating budget). This keeps the Pastor’s salary and professional expenses totally separate. Note, the Pastor must account to the church with receipts/mileage logs for those expenses to be reimbursed. This is the best method to use.
1. The Pastor accounts to the treasurer/bookkeeper monthly with his expenses and gets reimbursed with a separate expense check out of the professional expense category in the budget.
2. If the Pastor does not use the total amount of budgeted expenses by the end of the year, he loses it – the unused portion belongs to the church. IT DOES NOT BECOME SALARY.
If you do not follow the procedures as the IRS stipulates for reimbursement, and they audit your return, they will declare your reimbursement as nonaccountable professional expenses. They will add your reimbursed expenses to your income and they will require you to file Form 2106 and Schedule A Miscellaneous with that year’s return and then apply the Dalan ruling* and the 2% limitation.
What expenses are considered reimbursable business expenses?
The following are examples of reimbursable business expenses:Education – Tuition, fees, books, supplies, and (if the school is away from the pastor’s home area) transportation, meals, and lodging are reimbursable. Education expenses which qualify your pastor for a new trade or business (such as carpentry, etc.) are not reimbursable.Meal & Entertainment – Reimburse a pastor 100% of his cost for meals and entertainment. When his spouse is present because the spouse of the person being entertained is present, her meal is reimbursable. The cost of meals for the pastor’s children are never deductible.Mileage – The pastor should keep a log of his miles (including the mileage at the beginning and end of each year) and be reimbursed for his business miles at the standard mileage rate.Travel – The cost of train, airplane, boat, bus fare, auto rental, taxi, hotel, motel, meals, gratuities, telephone, travel insurance, baggage charges, cleaning, and laundry costs are reimbursable when a pastor travels on business. A pastor might travel to attend a church convention, a speaking engagement, to lecture, to perform a wedding or a funeral, to provide pulpit supply, an evangelistic meeting, on deputation, to church camp, etc.
What expenses are not considered reimbursable business expenses?
Clothing which is adaptable for general wear, one subscription to a local newspaper (which the IRS claims must be personal), magazine subscriptions, tapes, and books which are purchased for personal reasons, travel expenses which relate to anyone other than the person earning an income, commuting miles, contributions, tithes, offerings, tuition expenses for your dependents, education expenses which do not relate to your ministry, taxes, or personal use of your computer.
What is required to substantiate expenses?
A taxpayer must substantiate by adequate records or by sufficient oral or written evidence the following types of expenses:
1. Traveling expenses including meals and lodging while away from home.
2. Entertainment expenses.
3. Business gifts.
Since 1985, taxpayers have been required to answer questions on their returns regarding the business use of an automobile including:
1. The total number of miles driven during the year.
2. The total number of business miles driven during the year.
3. Whether the vehicle was used for commuting and, if so, the distance normally commuted.
4. Whether the vehicle was available for personal use in off-duty hours.
5. Whether another vehicle was available for personal use.
6. Whether adequate records or sufficient evidence exists to justify the deduction and whether or not the evidence is written.
Taxpayers are required to substantiate the following elements:
1. The amount of each expense or other item.
2. The time and place of the travel, entertainment, amusement, recreation, or the date and description of the gift.
3. The business purpose of the expense or other item.
4. The business relationship to the taxpayer of the persons being entertained, or receiving the gift.
Adequate records or sufficient evidence include the following:
1. Account books, diaries, and logs.
2. Documentary evidence (receipts, paid bills).
3. Trip sheets.
4. Expense reports.
5. Written statement of witnesses.
If a taxpayer does not have adequate records to substantiate his expenses, or if he cannot supply sufficient oral or written evidence thereof, no tax deductions or credits will be allowed with respect to an item. It should be noted that Congress has emphasized that different types of evidence have different degrees of probative value and that oral evidence alone has considerably less probative value than written evidence. *The Dalan Ruling – In January of 1990, the IRS took another step toward reducing the amount of professional expenses ministers can deduct on their tax returns. It involves a case known as the Dalan Case. In effect, the IRS ruled that, beginning in 1988, ministers would not be able to deduct all of their professional expenses because of earning nontaxable income. For example, the Housing Allowance: Pastor Smith earns $35,000 per year of which $30,000 is housing allowance. His professional expenses amount to $7,000 for the year. Since forty-six percent of his income is non-taxable ($30,000 divided by $65,000), $3,220 of his expenses are non-deductible ($7,000 x 46%). If Pastor Smith is reimbursed by his church for professional expenses, then the Dalan ruling has no effect on the minister.