We have come a long way since the first plastic credit card was issued by American Express back in 1958. Today there are more than 640 million of them in circulation in the United States with a total credit card debt approaching $1 trillion. Many churches have succumbed to the appeal of credit cards. Whether your church has one, or is considering getting one, there are several issues for you to consider.
In the previous two editions of Church Treasurer Alert the following issues were covered:
- Does our church need a credit card?
- What is the difference between a credit card and a debit card?
- What happens if our card is stolen?
- Selecting a credit card
- What is credit card “blocking”?
- Avoiding credit card fraud
- Disputes on how much you owe
- Disputes over the quality of purchased goods
- Unauthorized charges
- Criminal liability
In this article several tax issues associated with the use of church credit cards will be addressed.
11. What are the tax issues?
There are several tax issues associated with the use of church credit cards. Consider the following:
(a) payment of business expenses
The main reason for providing credit cards to employees is to make purchases simple and convenient. Credit cards may be used to purchase items for the church, pay church expenses, or pay travel and other business expenses. However, church leaders should recognize that credit card purchases can be made pursuant to either a nonaccountable or an accountable arrangement, and that the tax consequences are dramatically different depending on which option is used.
An accountable reimbursement arrangement is one that meets the following four requirements: (1) reimbursed expenses must have a business connection, meaning that they must have been incurred by an employee while performing services for an employer; (2) the employee must adequately account to the employer for these expenses within a reasonable period of time (not more than 60 days after an expense in incurred); (3) the employee is required to return any excess reimbursement within a reasonable period of time (not more than 120 days after an excess reimbursement is paid); and (4) the employer’s reimbursement of an employee’s business expenses comes out of the employer’s funds and not by reducing the employee’s salary.
Adequately accounting to one’s employer means that the employee submits adequate documentation to the employer of the business nature of each expense charged to the church’s credit card. In the case of travel, car, and entertainment expenses, the employee must submit evidence showing the date, amount, location, and business purpose of each expense. For entertainment expenses, an adequate accounting also must demonstrate a “business relationship” (i.e., information about the persons who were entertained that shows their business relationship to the employee).
Key point. Cell phone and computer expenses are subject to even stricter substantiation requirements.
If a church maintains an accountable reimbursement arrangement, then its payment of employees’ charges to a church credit card will not constitute taxable income to the employee, and the employee has no expenses to deduct.
A nonaccountable reimbursement is one that fails to meet one or more of the four requirements for an accountable arrangement. It is very common for churches to pay credit card charges without meeting all four of these requirements. Perhaps the most common example would be payment of credit card charges without requiring adequate substantiation from the employee who incurred the charges. Church leaders should understand that these payments represent nonaccountable reimbursements, and they should be familiar with the following two tax consequences.
(1) The full amount of the church’s nonaccountable reimbursements must be reported as income on the employee’s W 2 form. An employee can deduct these expenses on his or her tax return only as a miscellaneous itemized deduction on Schedule A to the extent they exceed 2 percent of adjusted gross income. These rules can be harsh, since the church’s reimbursements are fully reported as income to the employee who in many cases is unable to claim any deduction because of insufficient itemized expenses to use Schedule A.
Tip. Church staff members who report their income taxes as employees cannot deduct any of their unreimbursed business expenses if they have insufficient itemized deductions to use Schedule A. If their church reimburses some or all of their expenses under a nonaccountable arrangement, then all of the reimbursements must be reported as taxable income without any offsetting deduction. As a result, churches should avoid nonaccountable reimbursement arrangements.
(2) If a church pays an employee’s credit card charges under a nonaccountable arrangement, and those payments are not reported as taxable income in the year the payments are made, then: (a) The employee is subject to back taxes plus penalties and interest on the unreported income. (b) If the credit card charges were incurred by an officer or director of the church (a “disqualified person”), or a relative of such a person, they will expose the recipient and possibly other members of the church’s governing board to “intermediate sanctions” in the form of substantial excise taxes since the IRS now views these benefits as “automatic” excess benefits unless reported as taxable income by the church or recipient in the year provided. These excise taxes can be substantial (up to 225 percent of the amount of the excess benefit). Consider the following example.
A church assessed intermediate sanctions against the senior pastor of a church as a result of the use of a church credit card by the pastor’s son to pay for car expenses. The church insisted that its credit cards could only be used for church business and not for any personal use. In the event of personal use, the person utilizing the card was obligated to fully reimburse the church. However, the IRS noted: “The church retained its credit card statements and a few receipts. It did not note any business purpose or relationship with respect to the entries on such statements. It did not maintain any records, account books, diaries, etc., to establish the business purpose or relationship of such expenditures.” The IRS concluded:
[The tax code] provides that expenses must be ordinary and necessary to be a business deduction. The expenses must be contemporaneously documented with time, place, business purpose, and business relationship. The church maintained credit card statements and a few receipts. However, neither the church nor the pastor’s son documented the business purpose or relationship of his expenditures. It does not appear that the son kept any account books, diary, or other records demonstrating that the charges he made on the church credit cards were for business purposes.
As a result, the IRS determined that the church’s reimbursements of the son’s credit card charges were nonaccountable, and, since neither the church nor the son reported these reimbursements as taxable income they constituted automatic excess benefits resulting in intermediate sanctions in the form of excise taxes of 25 percent of the amount of the excess benefits, plus an additional 200 percent of the amount of the excess benefits if the excess benefit transactions were not returned to the church within the period prescribed by law. IRS Letter Ruling 200435019.
Tip. Under some circumstances the excise taxes the IRS can assess for an excess benefit transaction can be abated.
The IRS has issued audit guidelines for its agents to follow when auditing corporate executives. The guidelines are instructive in evaluating the compensation packages provided to senior pastors and other church employees. The guidelines specify:
Many employers provide corporate credit cards to executives and other employees. The difference between the rank and file credit card accounts and those maintained for executives is generally the method of reimbursement. Top level executives are permitted to use the card at will. A monthly statement may be mailed directly to the employer and the account may be paid in full without the submission of a business expense report. Lower level executives are generally required to submit an expense report and are reimbursed for business related expenses. Personal expenses paid on behalf of executives are taxable fringe benefits that should be included in wages. The determination of whether the corporation has an accountable plan should be made at the beginning of the examination. If executives are not required to substantiate that the expenses charged to the corporate credit card were for business expenses, the reimbursement is considered to have been made under a nonaccountable plan and the entire reimbursement is taxable to the executive, and wages for employment tax purposes.
(b) frequent flier miles
Some church employees use their own credit card to purchase church supplies and equipment so that they will receive the frequent flier miles that will accrue to the purchases. To illustrate, assume that a church board authorizes the purchase of a copy machine for $5,000, and that the pastor purchases the machine with his personal credit card in order to obtain the frequent flier miles. He is later reimbursed by the church for this purchase. Is this arrangement appropriate?
One of the requirements for a church to maintain its exemption from federal income taxation is that none of its income or assets “inures” to the benefit of a private individual, other than as reasonable compensation for services rendered. There is no materiality requirement. Any distribution of a church’s income or assets for the private benefit of an individual may constitute prohibited inurement. The IRS has observed that “those in control may not, by reason of their position, acquire any of the charitable organization’s funds [or assets]. If funds [or assets] are diverted from exempt purposes to private purposes, exemption is in jeopardy… . The test is whether, at every stage of the transaction, those controlling the organization guarded its interests.”
It is certainly possible that the IRS would view the use of a pastor’s personal credit card to purchase church assets in order to divert frequent flier miles to his or her account as an example of prohibited inurement. Because of this risk, church leaders are advised to consult with a tax professional before pursuing such an arrangement.
(c) paying taxes by credit card
Beginning in 2006, employers can pay the balance due shown on Form 941 (Employer’s Quarterly Tax Return) by credit card. Do not use a credit card to pay taxes that were required to be deposited. For more information on paying payroll taxes with a credit card, visit the IRS website (www.irs.gov) and type “e-pay” in the search box.
(d) charitable contributions
Charitable contributions to your church can be made by credit card. Contributions charged on a credit card are deductible in the year the donor makes the charge.
This article first appeared in Church Treasurer Alert, November 2007.