The following insights are drawn from an analysis by Richard Hammar and interviews with Frank Sommerville, an attorney, CPA, and editorial advisor, and Ted Batson, an attorney and CPA with the accounting firm CapinCrouse. Read the full analysis, “Integrating Tax Reform for 2018—and Beyond,” in the upcoming May/June issue of Church Law And Tax Report.
Prior to The Tax Cuts and Jobs Act of 2017, certain business expenses were deductible if, in aggregate, they exceeded 2 percent of the taxpayer’s adjusted gross income (AGI), Hammar said.
Some expenses subject to the 2 percent AGI floor included:
- overnight out-of-town travel;
- local transportation;
- meals (subject to a 50 percent AGI floor);
- entertainment (subject to a 50 percent AGI floor);
- home office expenses;
- business gifts;
- dues to professional societies;
- work-related education;
- work clothes and uniforms if required and not suitable for everyday use;
- malpractice insurance;
- subscriptions to professional journals and trade magazines related to the taxpayer’s work; and
- equipment and supplies used in the taxpayer’s work.
The new law, however, “suspends all miscellaneous itemized deductions that are subject to the 2 percent floor,” Hammar said.
The inability to itemize and deduct business expenses “will hit some clergy hard,” Hammar said. He suggested this possible workaround: “Churches could reimburse employees’ business expenses under an accountable expense reimbursement arrangement.”
To be considered accountable, a church’s reimbursement arrangement must comply with the following four rules:
- Expenses must have a business connection—that is, the reimbursed expenses must represent expenses incurred by an employee while performing services for the employer.
- Employees are only reimbursed for expenses for which they provide an adequate accounting within a reasonable period of time (not more than 60 days after an expense is incurred).
- Employees must return any excess reimbursement or allowance within a reasonable period of time (not more than 120 days after an excess reimbursement is paid).
- The income tax regulations caution that in order for an employer’s reimbursement arrangement to be accountable, it must meet a “reimbursement requirement” in addition to the three requirements summarized above. The reimbursement requirement means that an employer’s reimbursements of an employee’s business expenses come out of the employer’s funds and not by reducing the employee’s salary.
“I have advocated for years that churches need to get on board with an accountable expense reimbursement plan,” said Sommerville. He then added, “Frankly, I applaud the elimination of the deduction for the unreimbursed employee business expenses,” explaining that far too many churches simply do not properly review and report taxable employee business expense reimbursements. “I’m handling an IRS exam right now on a pastor who didn’t do it right,” he said. “Pastors just don’t do it right. It’s a complicated process.”
Batson, however, is not convinced that an accountable expense reimbursement plan is practical or affordable for many smaller churches.
Churches would need to carefully consider whether or not they can afford reimbursing a pastor’s business expenses, Batson explained, because it would mean more out-of-pocket expenses for the church. Prior to the new law, he said, pastors could claim a “tax benefit,” but now that is no longer the case.
Paying for a pastor’s business expenses could be very difficult for a small church on a tight budget. To emphasize his point, Batson gave this scenario:
A pastor of a rural church makes weekly and multiple visits to homebound parishioners and to hospitalized members. Because the congregation is spread across many miles of countryside, the pastor puts in an average of 10,000 miles per year. At a mileage rate of 54.5 cents a mile, the pastor would incur an expense of $5,450.
Reimbursing a travel expense like that, Batson said, would greatly stretch or even break the budget of a small church and also create a system that’s difficult for a smaller church to manage. Unlike larger churches, smaller churches often lack the staff size and well-defined financial systems that allow them to make use of such a plan. "This will create a quandary for small churches: they will either need to find a way to accommodate an accountable expense plan, perhaps with a cap, or the pastor will suffer the brunt of the tax law change," Batson explained.
Sommerville feels setting a cap could make such an accountable plan work for smaller churches. They would just need to establish and adhere to certain stipulations on spending, which includes setting a reasonable and affordable cap. “You let the pastor know that you are going to reimburse his or her expenses up to $4,000, $5,000, or whatever the church can afford.”
Along with that, Sommerville said that the church treasurer or financial manager must commit to reviewing and approving the expense for which the pastor is seeking reimbursement. And that can sometimes create a problem. Nobody wants to get on the pastor’s bad side, he said. Even so, it’s a financial manager’s job to hold a pastor and all church staff accountable for the use of the church’s funds—and an accountable reimbursement plan would help a church financial manager do just that.
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