IRS Letter Ruling 0706018
Background. Many churches have obtained credit cards for their pastor or another staff member. If a few basic rules are followed, this can be a convenient way to handle business expenses. Unfortunately, church treasurers often are not aware of these rules, and this can result in problems for the person who uses the card. A recent IRS ruling addresses the ideal way to handle employer-provided credit cards.
Facts of the case. An employer has several employees who travel on business and incur travel and entertainment expenses. The employer implements a business expense reimbursement program using credit cards. Here are the features of the plan:
- the employer obtains a credit card in each employee’s name
- use of credit cards is restricted by policy to business travel and entertainment expenses
- monthly credit card statements are sent directly by the credit card company to employees
- employees are responsible for the payment of all charges, unless an expense report is submitted to the employer
- if an employee submits a business expense report to the employer that meets certain requirements, the employer pays those expenses directly to the credit card company
- a business expense report must be submitted within one week after incurring an expense
- business expense reports for travel expenses (transportation, meals, lodging while away from home overnight) must show (1) the business purposes of the trip, (2) the amount of each expense, (3) dates of travel, and (4) travel locations
- business expense reports for entertainment expenses must show (1) the business purpose of the entertainment including a description of the business activity conducted, (2) an identification of the person or persons entertained sufficient to establish a business relationship with the employer, (3) the amount of each separate expenditure for entertainment, (4) the date of the entertainment, (5) the location of the entertainment, (6) the type of entertainment (if not apparent from the designation of the place of entertainment), and (7) if the entertainment immediately precedes or follows a business discussion, the employee also must identify those persons entertained who participated in the business discussion, and the nature of the business discussion
- employees whose business expenses are supported by the expense report (and receipts) are “reimbursed” by the employer (it sends a check to the credit card company for the amount of the expenses)
- employees are required to return to the employer (within sixty days) any employer reimbursements in excess of substantiated business expenses
What the IRS said. The employer’s business expense reimbursement arrangement is “accountable” because it meets the following three requirements: (1) only those expenses with a “business connection” are reimbursed; (2) only those expenses that are properly substantiated (as to amount, date, location, and business purpose) are reimbursed; and (3) employees are required to return to the employer within sixty days any reimbursements in excess of substantiated expenses.
The IRS noted that reimbursements paid under an accountable plan are not reportable by the employer or employee as taxable income. This means that the reimbursements are not reported by the employer on the employee’s W-2, or on Form 941. Further, the employee does not report the reimbursements as income on his or her income tax return.
Key point. The IRS cautioned that if an arrangement does not satisfy one or more of the three requirements of an accountable plan, then all amounts paid under the arrangement are treated as paid under a “nonaccountable plan” and must be reported as income on the employee’s W-2 and Form 1040, and the employer’s Form 941. Further, such reimbursements would be subject to tax withholding for ministers who have elected voluntary withholding, and nonminister employees.
What about your church? Does your church make credit cards available to ministers or other staff members? If so, this ruling will provide you with useful guidance. Some churches will satisfy the requirements for an accountable plan summarized above, but many will not. It is fairly common for churches to simply provide a pastor with a credit card, in the pastor’s name, without any restrictions on use. There is nothing “wrong” with such an arrangement. It violates no law. But it is not the ideal arrangement for the pastor from a tax standpoint, since it will be a “nonaccountable” arrangement. As noted above, this means that the church will need to report all charges as taxable income on the minister’s W-2 and on its Form 941. The minister will then be able to claim a business expense deduction on Schedule A (Form 1040), but only if the minister uses Schedule A and only to the extent that the minister’s business expenses exceed 2 percent of his or her adjusted gross income.
If your church lets pastors or other staff members use a credit card, now would be a good time to reconsider such a practice in light of this ruling. If your arrangement is not accountable, consider making it accountable by conforming to the practices outlined above.
Example. Rev. G is senior minister of his church. The church reimburses him for all of his business expenses by means of a credit card (in the church’s name). However, Rev. G is not required to account for such expenses by providing the church treasurer with receipts documenting the amount, time, place, business purpose (and, in the case of entertainment expenses, the business relationship) of each expense. Rev. G simply informs the treasurer at the end of each month of the total expenses incurred during that month. Assume further that Rev. G cannot itemize deductions on Schedule A (he does not have sufficient deductions), and that he is an employee for income tax reporting purposes. If Rev. G receives reimbursements of $4,000 in 1997: (1) the church would report the entire reimbursements ($4,000) as income on Rev. G’s W 2, and Rev. G would report them as income (salary) on his Form 1040; (2) Rev. G cannot deduct the reimbursed expenses as adjustments to gross income (on Form 1040), since they are “nonaccountable” (i.e., he did not adequately account to the church for such expenses); (3) Rev. G cannot deduct the reimbursed expenses as a miscellaneous itemized deduction on Schedule A since he does not have sufficient expenses to itemize. In other words, all of Rev. G’s business expense reimbursements are includable in his income for tax purposes, but he cannot offset any of this income by deducting any portion of his business expenses. Even if Rev. G could itemize deductions, his nonaccountable reimbursed expenses would be treated just like unreimbursed expenses—they are deductible only as miscellaneous itemized deductions, and then only to the extent that they (along with most other miscellaneous expenses) exceed 2 percent of Rev. G’s adjusted gross income. These undesirable tax consequences could have been avoided had the church adopted an accountable reimbursement plan. Under these circumstances, the church would not have reported the $4,000 of reimbursements as income on Rev. G’s W 2, and Rev. G would not have to report the reimbursements or claim the expenses on his Form 1040.
Example. Rev. C has a church credit card (in the church’s name) on which he charges only church related business expenses. Each month, Rev. C submits a statement of all charges to the church treasurer along with an expense statement documenting the amount, date, place, business nature (and, in the case of entertainment expenses, the business relationship). This is a proper reimbursement policy, and as a result Rev. C need not report any of the charges as income and he need not deduct any expenses, and the church need not report any of the reimbursements as compensation on Rev. C’s W 2.
This article originally appeared in Church Treasurer Alert, April 1997.