Church & Clergy Tax Guide

The preceding chapters have described several items that you must include in computing your total income and some of the exclusions that are not included in total income. After your total income is computed (and reported on Form 1040, line 9), you then compute your AGI by deducting various adjustments to gross income. Adjustments to gross income and the more important itemized and business deductions will be summarized in this chapter from both an employee and a self-employed perspective.

You may deduct certain adjustments from gross income in computing your adjusted gross income. The adjustments are reported and deducted on Form 1040, line 10. They are computed on lines 11–26 (Form 1040, Schedule 1). For 2024, these adjustments include the following:

After you have figured your adjusted gross income, you are ready to either (1) subtract itemized deductions, or (2) subtract your applicable standard deduction. For the most part, itemized deductions are deductions for various kinds of personal expenses that are grouped together on Schedule A (Form 1040). They include deductions for medical expenses, taxes and interest you pay, charitable contributions, casualty and theft losses attributable to a federally declared disaster, and various miscellaneous deductions. Many of these deductions will be summarized below. Ordinarily you should itemize deductions only if they total more than your standard deduction. The standard deduction amounts for 2024 are set forth in Table 7-1.

Table 7-1: Standard Deduction Amounts for 2024

If a single taxpayer is blind or age 65 or older, the standard deduction is increased by an additional $1,950 (or by $3,900 if the taxpayer is both blind and at least age 65). If either married taxpayer (assuming they file a joint return) is blind or age 65 or older, the standard deduction is increased by an additional $1,550 ($3,100 if both).

Most employees incur various “employee business expenses” in the course of their employment. Common examples include:

Most of these expenses are explained in this section. There are four ways that churches and church staff handle these expenses, and each is associated with important tax consequences with which church leaders should be familiar.

The Tax Cuts and Jobs Act of 2017 suspended all miscellaneous itemized deductions that were subject to the 2-percent floor under prior law. As a result, taxpayers may not claim any of the above-listed items as itemized deductions for the taxable years to which the suspension applies. This provision is effective for taxable years beginning after December 31, 2017, but does not apply for taxable years beginning after December 31, 2025, unless extended by Congress.

As a result of these three factors, many references to “deductible expenses” throughout this section have been retained.

Here are some common examples of nonaccountable reimbursement arrangements that should be avoided. If you currently have any of these arrangements, your church should consider switching to an accountable reimbursement plan.

To be an accountable plan, your employer’s reimbursement or allowance arrangement must comply with all four of the following rules:

These four arrangements are addressed more fully under “Reimbursement of Business Expenses” on page . For now, note that an accountable plan can minimize the adverse tax impact of the ban on an itemized deduction for unreimbursed and nonaccountable reimbursed employee business expenses.

Note that this section describes several kinds of employee business expenses that no longer are deductible as itemized expenses on Schedule A (Form 1040). The cautionary note above explains three reasons this information remains relevant.

Transportation expenses are expenses you incur for business transportation while not traveling away from home (as explained in the next section on travel expenses). These expenses include the cost of transportation by air, rail, bus, taxi, etc., and the cost of driving and maintaining your car. Transportation expenses include the ordinary and necessary costs of all the following:

Transportation expenses do not include expenses you have while traveling away from home overnight. Those expenses are travel expenses as explained in the next section of this chapter. However, if you use your car while traveling away from home overnight, use the rules in this chapter to figure your car expense deduction.

This terminology is confusing. Note that transportation and travel expenses are distinct concepts for tax purposes. Generally, transportation expenses are all the expenses associated with local transportation for business purposes (excluding commuting), while travel expenses are all of the expenses associated with travel (including meals and lodging) while away from home overnight for business purposes.

Temporary work location

If you have one or more regular work locations away from your home and you commute to a temporary work location in the same trade or business, you can deduct the expenses of the daily round-trip transportation between your home and the temporary location, regardless of distance, on Schedule C (Form 1040) if you are self-employed. If your employer reimburses these expenses under an accountable plan, the reimbursements are not taxable income to you, so there are no expenses to deduct.

If your employment at a work location is realistically expected to last (and does in fact last) for one year or less, the employment is temporary unless there are facts and circumstances that would indicate otherwise.

If your employment at a work location is realistically expected to last for more than one year, or if there is no realistic expectation that the employment will last for one year or less, the employment is not temporary, regardless of whether it actually lasts for more than one year.

If employment at a work location initially is realistically expected to last for one year or less, but at some later date, the employment is realistically expected to last more than one year, that employment will be treated as temporary (unless there are facts and circumstances that would indicate otherwise) until your expectation changes. It will not be treated as temporary after the date you determine it will last more than one year.

If the temporary work location is beyond the general area of your regular place of work and you stay overnight, you are traveling away from home. You may have deductible travel expenses as discussed later in this chapter.

No regular place of work

If you have no regular place of work but ordinarily work in the metropolitan area where you live, you can deduct daily transportation costs between home and a temporary work site outside that metropolitan area.

Generally, a metropolitan area includes the area within the city limits and the suburbs that are considered part of that metropolitan area.

You cannot deduct daily transportation costs between your home and temporary work sites within your metropolitan area. These are nondeductible commuting expenses.

Two places of work

If you work at two places in one day, whether for the same employer or different employers, you can deduct the expense of getting from one workplace to the other if you are self-employed. If your employer reimburses these expenses under an accountable plan, the reimbursements are not taxable income to you, so there are no expenses to deduct.

If for some personal reason you do not go directly from one location to the other, you cannot deduct more than the amount it would have cost you to go directly from the first location to the second.

Transportation expenses you have in going between home and a part-time job on a day off from your main job are commuting expenses. You cannot deduct them.

Commuting expenses

You cannot deduct the costs of taking a bus, trolley, subway, or taxi, or of driving a car between your home and your main or regular place of work. These costs are personal commuting expenses. You cannot deduct commuting expenses, no matter how far your home is from your regular place of work. You cannot deduct commuting expenses even if you work during the commuting trip. IRS Publication 463 notes:

Daily transportation expenses you incur while traveling from home to one or more regular places of business are generally nondeductible commuting expenses. However, there may be exceptions to this general rule. You can deduct daily transportation expenses incurred going between your residence and a temporary work station outside the metropolitan area where you live. Also, daily transportation expenses can be deducted if: (1) you have one or more regular work locations away from your residence or (2) your residence is your principal place of business and you incur expenses going between the residence and another work location in the same trade or business, regardless of whether the work is temporary or permanent and regardless of the distance.

Example:
In 2025 you sometimes use your cell phone to make business calls while commuting to and from work. Sometimes another church employee rides with you to and from work, and you have a business discussion in the car. These activities do not change the trip from personal to business. Hamblen v. Commissioner, 78 T.C. 53 (1981).

Example:
The Tax Court upheld an IRS assessment of a negligence penalty against a pastor who attempted to deduct commuting expenses as a business expense. The court concluded that “the record in this case is replete with examples of [the pastor’s] negligence. [He] claimed deductions for numerous items which in many cases are either nondeductible or lack substantiation. Accordingly, we find that [the pastor is] subject to the addition to tax for negligence for all the years at issue.” Clark v. Commissioner, 67 T.C.M. 2458 (1994).

Parking fees

Fees you pay to park your car at your place of business are nondeductible commuting expenses. You can, however, deduct business-related parking fees when visiting a customer or client. But see the cautionary note on page .

Office in the home

If you have an office in your home that qualifies as a principal place of business, your daily transportation costs between your home and another work location in the same trade or business may be deductible as a business expense on Schedule C (Form 1040) if you are self-employed; if your employer reimburses these expenses under an accountable plan, the reimbursements are not taxable income to you, so there are no expenses to deduct. See “Office in the home” on page  for assistance in deciding whether your home office qualifies as a principal place of business.

Examples of transportation expenses

The following examples show when you can deduct transportation expenses based on the location of your work and your home.

Example:
Pastor D lives in Town A and pastors a church in Town A. The church provides him with an office on the church’s premises. Pastor D owns a home that is located 10 miles from the church. He drives to work each day. The transportation expenses he incurs in driving to and from work are nondeductible commuting expenses. This means Pastor D cannot deduct them on his tax return, and his church cannot reimburse them under an accountable expense reimbursement arrangement.

Example:
Same facts as the previous example, except that Pastor D takes a bus or subway to work each day. The transportation expenses he incurs in riding to and from work are nondeductible commuting expenses. This means Pastor D cannot deduct them on his tax return, and his church cannot reimburse them under an accountable expense reimbursement arrangement.

Example:
Pastor G lives in Town B and pastors a church in Town B. The church provides him with an office on the church’s premises. Pastor G owns a home that is located 10 miles from the church. Several days each month, he drives from his home to a local hospital to visit members of his congregation. The IRS ruled in 1999 that “if a taxpayer has one or more regular work locations away from the taxpayer’s residence, the taxpayer may deduct daily transportation expenses incurred in going between the taxpayer’s residence and a temporary work location in the same trade or business, regardless of the distance.” Clearly, visiting the hospital is “in the same trade or business” of a pastor. The question is whether the hospital qualifies as a “temporary work location.” If it does, the expenses the pastor incurs in traveling from home to the hospital are a business transportation expense that can be reimbursed by the church under an accountable arrangement. If the church does not reimburse these expenses, they are not deductible by Pastor G, since after 2017 no itemized deduction is allowed for unreimbursed (and nonaccountable reimbursed) employee business expenses.

As noted above, a temporary work location is one where you expect to work no more than one year or less. Neither the IRS nor any court has addressed the question of at what point a hospital that is regularly visited by a pastor ceases to be a “temporary work location.” All that can be said is that at some point a local hospital that a pastor regularly visits over a period of time equal to or exceeding one year may cease to be a temporary work location. However, if Pastor G goes on to the church after stopping at the hospital, the miles he drives from the hospital to the church would constitute a transportation expense. The same is true at the end of the day—miles he drives from the church to the hospital are a transportation expense, even if the hospital is on the way to the pastor’s home. While not deductible by Pastor G as an employee business expense on Schedule A (Form 1040), they would be reimbursable by the church under an accountable arrangement. IRS Revenue Ruling 99-7.

Example:
Pastor J lives in Town A and pastors a church in Town A. She also has agreed to serve as an interim pastor for a church in Town B. She drives to Town B on Sunday afternoons to conduct a service and returns home the same day. She expects this assignment to last no more than six months. Prior to 2018, if a taxpayer had a regular work location away from his or her residence, the taxpayer could deduct daily transportation expenses incurred in going between the taxpayer’s residence and a temporary work location in the same trade or business, regardless of the distance. This was based on IRS Revenue Ruling 99-7, summarized above, in which the IRS ruled that “a taxpayer may deduct daily transportation expenses incurred in going between the taxpayer’s residence and a temporary work location outside the metropolitan area where the taxpayer lives and normally works.” After 2017 no deduction is allowed for employee business expenses, although they can constitute nontaxable reimbursements under an accountable plan if the requirements for such a plan are met (see above and “Reimbursement of Business Expenses” on page ) and may be deductible as business expenses on Schedule C (Form 1040) by self-employed staff. See Chapter 2 for an analysis of self-employed status.

You can compute your transportation expenses in one of two ways: (1) using the standard mileage rate; or (2) figuring actual expenses. Both of these options are explained below.

Method 1—standard mileage rate

The standard mileage rates for miles driven during 2024 are summarized in Table 7-2.

Table 7-2: Standard Mileage Rates for 2024

Since no itemized deduction is allowed after 2017 for unreimbursed (and nonaccountable reimbursed) employee business expenses, the relevance of the standard mileage rate is limited to (1) computing transportation expenses that are reimbursable under an accountable reimbursement plan and (2) computing the business expenses reported by self-employed persons on Schedule C (Form 1040).

Table 7-3: Business Use of a Car – A Comparison of the Major Tax Options

Car Owner: Minister
Method: Actual Expenses
Characteristics: Minister computes actual expenses of operating car for business use. Actual expenses include gas, oil, tires, repairs, tune-ups, batteries, washes, insurance, depreciation, interest on car loans, taxes, licenses, garage rent, parking fees, and tolls. Annual depreciation deduction is limited by “luxury car” rules.
Tax Consequences: There is no employee business expense itemized deduction for unreimbursed and nonaccountable reimbursed expenses. Self-employed ministers can deduct expenses allocable to the business use of their car, and not reimbursed under an accountable plan, as a business expense on Schedule C (Form 1040). Deduction on Schedule C is allowable only if records substantiate the amount, date, place, and business purpose of each expense. Employer’s reimbursement of these expenses is not taxable to an employee or self-employed person if accountable. In many cases a larger deduction will be available than with the standard mileage rate—but the trade-off is that the recordkeeping requirements are much more complex.

Car Owner: Minister

Method: Standard Mileage Rate

Characteristics: Multiply current standard mileage rate by miles driven for business during the year. Must be used in first year a car is used for business purposes. Cannot be used for leased vehicles.

Tax Consequences: There is no employee business expense itemized deduction for unreimbursed and nonaccountable reimbursed expenses. Self-employed ministers can deduct expenses allocable to the business use of their car, and not reimbursed under an accountable plan, as a business expense on Schedule C (Form 1040). Ministers must maintain records documenting the business nature of their business miles. Employer’s reimbursement of these expenses is not taxable to an employee or self-employed person if accountable. Ministers can still deduct parking fees and tolls. Most ministers use this method because of its simplicity.

Car Owner: Church

Method: Church-owned vehicle; no personal use permitted

Characteristics: Church owns vehicle. Vehicle kept on church’s premises. Written church policy prohibits personal use (including commuting). Minister using car does not live on church’s premises. Church reasonably believes the vehicle is not used for any personal use.

Tax Consequences: There is no income to report (since no personal use is allowed).

Car Owner: Church

Method: Church-owned vehicle; no personal use allowed except for commuting (for security or other noncompensatory reasons)

Characteristics: Church owns vehicle. For noncompensatory reasons (such as vehicle security), the church requires the minister to commute. Written church policy prohibits personal use (except commuting). Minister using car is not a “control employee” (defined under “Personal use of a church-provided car” on page ). Church reasonably believes the vehicle is not used for any personal use.

Tax Consequences: There is no income to report (since no personal use is allowed)—except for $3 per round trip commute or $1.50 per one-way commute. No recordkeeping is required (since no personal use is allowed) except number of commutes.

Car Owner: Church

Method: Church-owned vehicle; no restrictions on personal use.

Characteristics: None.

Tax Consequences: Personal use must be valued and reported as income on the minister’s Form W-2 or 1099-NEC. Use the general valuation method (discussed earlier) unless the church has elected one of the three special valuation rules.

Overview

The simpler and more common method of computing your transportation expenses is to multiply the standard business mileage rate by the number of business miles you can substantiate. The standard mileage rate applies to all business miles. You may use the standard mileage rate instead of figuring your actual operating and fixed expenses, including depreciation, fuel, and repairs, in computing your deductible costs in operating a car. You generally can use the standard mileage rate whether or not you are reimbursed and whether or not any reimbursement is more or less than the standard mileage rate.

Choosing the standard mileage rate. If you want to use the standard mileage rate for a car you own, you must choose to use it in the first year the car is available for use in your work. Then, in later years, you can choose to use either the standard mileage rate or actual expenses.

If you want to use the standard mileage rate for a car you lease, you must use it for the entire lease period. You must make the choice to use the standard mileage rate by the due date (including extensions) of your return. You cannot revoke the choice. However, in later years, you can switch from the standard mileage rate to the actual expenses method. If you change to the actual expenses method in a later year, but before your car is fully depreciated, you have to estimate the remaining useful life of the car and use straight line depreciation.

Personal property taxes. If you itemize deductions on Schedule A (Form 1040), you can deduct on line 5(c) state and local personal property taxes on motor vehicles. You can take this deduction even if you use the standard mileage rate or if you do not use the car for business.

Parking fees and tolls. In addition to using the standard mileage rate, you can deduct any business-related parking fees and tolls. (Parking fees you pay to park your car at your place of work are nondeductible commuting expenses.)

Example:
Pastor A purchased a car in 2024 for business use. He drove the car 1,000 miles each month for business purposes during the year. No itemized deduction is allowed after 2017 and through 2025 for unreimbursed (and nonaccountable reimbursed) employee business expenses, so these expenses are not deductible. However, if they are reimbursed by the church, and if the requirements for an accountable reimbursement plan are met, they are not reported as taxable income to Pastor A. The requirements for a reimbursable plan are summarized at the beginning of this section (see “Business and Professional Expenses” on page ) and in Section E (“Reimbursement of Business Expenses” on page ). While the IRS has not addressed the issue, it is likely that the church could use the standard mileage rate to compute the amount of its reimbursement.

Reimbursing business miles using the standard mileage rate

Many churches have adopted an accountable reimbursement arrangement that reimburses the business miles of employees using a mileage rate. Some churches use the IRS-approved rate, while others use a rate that is either higher or lower than the IRS rate. Listed below are the rules that apply to a church’s use of the standard mileage rate.

Example:
A church reimburses business miles driven by employees at the IRS-approved rate. In 2024 the church bookkeeper drove 300 miles each month on church business. The church treasurer reimbursed the bookkeeper for all miles under an accountable plan using the IRS-approved standard mileage rate. The reimbursements are not reported as taxable income to the bookkeeper.

Example:
A church maintains an accountable reimbursement arrangement. In 2024 it reimbursed employees’ business miles at a rate of 75 cents per mile. Karen, a church employee, properly substantiated all her business expenses for 2024, including 6,000 miles that she drove her car for church-related business. The church did not require Karen to return the amount by which her reimbursements exceed the IRS-approved rate. The fact that the church reimbursed Karen’s car expenses at a rate in excess of the IRS-approved rate will not render the entire reimbursement arrangement nonaccountable. Rather, only the amount by which the church’s reimbursement rate exceeds the IRS rate (67 cents per mile for 2024) is treated as nonaccountable. The excess cannot be claimed as a deduction since it exceeds the IRS-approved rate. Further, as noted below, the excess reimbursements will be subject to tax withholding, assuming that Karen is not a minister (or a minister who has elected voluntary withholding).

Example:
A church reimburses employee business miles under an accountable plan at a rate of 30 cents per mile in 2024. This reimbursement rate is less than the IRS-approved rate (67 cents per mile). No itemized deduction is allowed after 2017 and through 2025 for unreimbursed (and nonaccountable reimbursed) employee business expenses, and so no deduction is allowed for the unreimbursed expenses (i.e., below the IRS mileage rate).

Example:
During 2013 a pastor traveled extensively in the United States and abroad. He claimed an itemized deduction for unreimbursed business expenses of $20,334. The pastor computed this deduction by multiplying the standard business rate times the 35,989 miles he claimed he drove his vehicle for business purposes during the year. To substantiate the mileage claimed, the pastor produced a calendar log and a mileage log. The calendar log shows 43,996 business miles, and the mileage log shows 44,093 business miles.

The Tax Court conceded that the pastor drove some number of miles in connection with his job but concluded that there was insufficient evidence in the record to make a finding as to the exact number of miles driven. [His] logs were inaccurate, they were not contemporaneous, and they lacked the specificity required for a deduction under section 274(d).” The court noted that the pastor’s defense to the irregularities and omissions was that “to assure that the mileage was not overstated, fewer miles were used to compute the deduction [than were actually recorded in the logs].” It concluded that “the fact that he claimed a deduction for only a portion of those miles does nothing to prove that the miles for which they claimed a deduction were properly substantiated.” Burden v. Commissioner, T.C. Summary Opinion 2019-11.

Example:
A church requires its pastor to substantiate once each year (in December) all the business miles he drove his car that year. He is then reimbursed for these miles at the IRS-approved standard mileage rate. This is not an accountable arrangement since the pastor is not required to substantiate business miles within a “reasonable time.” The income tax regulations specify that 60 days is presumed to be a reasonable time. As a result, the church must report all the reimbursements as income on the pastor’s Form W-2.

Example:
Each month Pastor R orally informs the church treasurer how many business miles she drove her car for the previous month. The treasurer reimburses Pastor R for these miles at the IRS-approved rate. This is not an accountable arrangement, since Pastor R does not adequately document the amount, date, place, and business purpose of her business miles. As a result, the church must report these reimbursements as income on Pastor R’s Form W-2. The income tax regulations specifically prohibit “accounting” to an employer by means of a taxpayer’s own oral or written statements. Therefore, a minister will not adequately account to his or her church by orally informing the church treasurer of the amount of business expenses incurred during a particular month, or by signing a statement that merely recites what the minister’s business expenses were.

Withholding taxes

Ministers’ wages are not subject to income tax withholding unless voluntary withholding is elected. But nonminister employee wages are subject to withholding (of income taxes and the employee’s share of Social Security and Medicare taxes). The IRS maintains that employers must withhold payroll taxes from any mileage rate reimbursement that exceeds the IRS-approved rate. The IRS has provided the following clarification with regard to the timing of withholding:

In the case of a mileage allowance paid as a reimbursement, the excess . . . ​is subject to withholding and payment of employment taxes in the payroll period in which the payor reimburses the expenses for the business miles substantiated. In the case of a mileage allowance paid as an advance, the excess . . . ​is subject to withholding and payment of employment taxes no later than the first payroll period following the payroll period in which the business miles with respect to which the advance was paid are substantiated. If some or all of the business miles with respect to which the advance was paid are not substantiated within a reasonable period of time and the employee does not return the portion of the allowance that relates to those miles within a reasonable period of time, the portion of the allowance that relates to those miles is subject to withholding and payment of employment taxes no later than the first payroll period following the end of the reasonable period. Rev. Proc. 2008-72.

Method 2—actual cost method

Since no itemized deduction is allowed after 2017 and through 2025 for unreimbursed (and nonaccountable reimbursed) employee business expenses, the relevance of the actual cost method is limited to (1) computing transportation expenses that are reimbursable under an accountable reimbursement plan and (2) computing the business expenses reported by self-employed persons on Schedule C (Form 1040).

Few people use this method, because it is complex and time-consuming. Using the standard mileage rate is much easier. While using the actual cost method takes discipline and perseverance, some studies suggest that you will have a higher deduction or reimbursement using this method than the standard mileage rate, especially if your car is relatively new. The question is whether you consider the potential savings in taxes worth the extra inconvenience.

Actual transportation costs include the cost of local business travel by air, rail, bus, or taxi, and the cost of driving and maintaining your car, but not the cost of meals or lodging. You may not deduct the costs of commuting (e.g., by bus, subway, taxi, train, or car) between your home and your main or regular place of work. These costs are nondeductible personal expenses.

Example: Pastor F drives her car to and from work on most days but occasionally takes a bus. The cost of traveling to and from work (whether by bus or in her own car) is a commuting expense that is not deductible by Pastor F whether she reports her income taxes as an employee or as a self-employed person.

The most important transportation expense is your car. If you are required to use your car in your work, then actual expenses include the cost of depreciation, licenses, gas, oil, tolls, lease payments, insurance, garage rent, parking fees, registration fees, repairs, and tires. If you have fully depreciated a car that you still use for business, you can continue to claim your other actual car expenses. These items can be reimbursed by an employer under an accountable plan or deducted by a self-employed person on Schedule C (Form 1040).

Business and personal use

If you use your car both for business and personal purposes, you must divide your expenses between business and personal use. For example, if you drive your car 20,000 miles during the year (12,000 miles for business and 8,000 miles for personal use), you can claim only 60 percent ($12,000 / 20,000) of the cost of operating the car as a business expense.

Depreciation and section 179 deductions

Generally, the cost of a car, plus sales tax and improvements, is a capital expense. Because the benefits last longer than one year, you generally cannot deduct a capital expense. However, you can recover this cost through the section 179 deduction (the deduction allowed by section 179 of the tax code), special depreciation allowance, and depreciation deductions. Depreciation allows you to recover the cost over more than one year by deducting part of it each year. Computing depreciation and the section 179 deduction for the business use of a car is a complex task that is explained fully in IRS Publication 463 (available on the IRS website, IRS.gov). A few minutes perusing this information will demonstrate why most church employees use the much simpler standard mileage rate rather than actual expenses to compute costs associated with the business use of a car.

Example:
A church hired a pastor whose home was 70 miles from the church. The pastor chose to remain in his home and commute to and from work at the church every Sunday and Wednesday. The pastor claimed a business expense deduction for depreciation on the car he used in commuting to and from work. To substantiate this deduction, he produced a letter signed by the six officers of the church stating that he was their pastor and containing a schedule of business miles traveled. The pastor claimed that he used his car to travel 12,643 business miles during the year under examination, which he claimed represented 70 percent of the total miles traveled during the year.

The IRS disallowed the claimed depreciation deduction, and the Tax Court agreed. It noted that the evidence showed that 11,523 of the 12,643 miles traveled were commuting miles from the pastor’s home to the church and that “it is well settled that the cost of commuting between one’s residence and regular place of employment is a nondeductible personal expense.” The remaining 1,120 miles were used for business purposes since they represented travel to transport church members to various functions at other churches. Therefore, these miles qualified as business miles, and a depreciation deduction was allowable for the total amount of depreciation for the year multiplied by the “business use percentage” (the percentage of total miles that the car was used for business purposes, or 1,120 divided by 12,643). Clark v. Commissioner, 67 T.C.M. 2458 (1994).

Example:
The Tax Court refused to allow a minister to use the actual expense method to compute a deduction for the business use of his car since he could not prove the percentage of his total miles that the car was used for business purposes. The pastor often traveled by car in connection with his ministry, and he reported travel expenses on his tax returns using the actual expense method. The IRS audited the minister and recalculated his expenses using the standard mileage rate. The IRS reasoned that the pastor must use the standard rate method to determine car expenses since he failed to prove the total miles driven each year.

The IRS conceded that the pastor drove 13,170 business miles in the year under examination and at least 12,274 business miles in the following year. These miles were not computed using a mileage log but by “reconstructing” the number of business miles by referring to actual receipts. However, during the years in question, the pastor kept no documentation that showed the personal use of his car or the total miles driven. The IRS claimed that without adequate substantiation of the total number of miles driven, it was unable to determine a business use percentage of the miles, and accordingly, the pastor could not use the actual expense method for either year.

In using the actual expense method, a taxpayer multiplies expenses incurred in owning and operating a car by the business use percentage—the percentage of total miles the car is used for business purposes. If a taxpayer can prove business miles but not personal miles or total miles, then the business use percentage cannot be calculated, and the actual expense method cannot be used. Rather, the taxpayer must use the standard mileage rate (multiplying business miles by the applicable standard mileage rate). Parker v. Commissioner, 65 T.C.M. 1740 (1994). See also Shelley v. Commissioner, T.C. Memo. 1994-432 (1994).

Employer-provided cars

Many churches provide their minister with a church-owned car that the minister is free to use for both personal and business purposes. The minister’s personal use of the car must be valued and reported by both the church and minister as taxable income to the minister. The methods that can be used for computing the value of the personal use of the car are discussed under “Personal use of a church-provided car” on page .

However, note that if the church board adopts a resolution restricting use of the car to church-related activities, then the minister reports no income or deductions (use of the car is a nontaxable, noncash working condition fringe benefit); and better yet, no accountings, reimbursements, allowances, or recordkeeping is required. This assumes that the car is, in fact, used exclusively for church-related purposes. For churches and ministers to realize these tax benefits, the following conditions must be satisfied:

Commuting is always considered to be personal use of a car, and accordingly, the procedure discussed in the preceding paragraph would not be available if a church allowed its minister to commute to work in a church-owned vehicle. Fortunately, the regulations permit certain church employees who use a church-owned vehicle exclusively for business purposes except for commuting to receive all of the benefits associated with business use of a church-owned vehicle if certain conditions are satisfied. These rules are explained under “Personal use of a church-provided car” on page .

Travel expenses are your ordinary and necessary expenses while traveling temporarily away from home for your work or business. Employers can reimburse these expenses under an accountable plan that avoids reporting them as income to an employee and by self-employed persons on Schedule C (Form 1040). However, travel expenses do not include expenses that are lavish or extravagant or that are for personal or vacation purposes. Travel expenses do not include expenses for transportation while not traveling away from home or expenses for entertainment. These expenses are discussed elsewhere in this chapter. Travel expenses include

Away from home

Your expenses must be for travel or temporary living (including meals and lodging) while you are away from home. You are considered to be traveling away from home if

This does not mean napping in your car. You do not have to be away from your home from dusk to dawn, as long as your relief from duty is long enough to get necessary sleep or rest. To satisfy these requirements, a trip ordinarily must be overnight.

Example:
Pastor W travels to another city to conduct a funeral service for a former member of his congregation. He leaves at 7:00 a.m. and returns home that evening at 6:00 p.m. Expenses incurred by Pastor W in making the trip are not travel expenses, since he was not away from home overnight or for a sufficiently long period of time that required sleep or rest. Pastor W’s car expenses constitute transportation expenses but not the cost of meals. The deductibility of these expenses is explained fully under “Transportation expenses” on page .

Example:
Same facts as the preceding example, except that Pastor W left home at 7:00 a.m. and did not return home until 11:00 a.m. the next day. Since this trip was overnight, the car, meals, and lodging expenses incurred by Pastor W are travel expenses. Since no itemized deduction is allowed after 2017 for unreimbursed (and nonaccountable reimbursed) employee business expenses, the relevance of travel expenses is limited to (1) computing transportation expenses that are reimbursable under an accountable reimbursement plan and (2) computing the business expenses reported by self-employed persons on Schedule C (Form 1040).

Your tax home

It is important to determine where your tax home is since you may deduct travel expenses only to the extent that they are incurred while you are traveling away from your home. Generally, your tax home is your regular place of employment or work, regardless of where you maintain your family home. It includes the entire city or general area in which your work is located.

Determining temporary or indefinite

You will be considered away from home, and your travel expenses (including meals and lodging) will constitute travel expenses, if you are away from home on a temporary rather than on an indefinite basis. As a result, you must determine whether your assignment is temporary or indefinite when you start work. If you expect a job to last for one year or less, it is temporary unless facts and circumstances indicate otherwise. Employment that is initially temporary may become indefinite due to changed circumstances. A series of assignments to the same location, all for short periods but that together cover a long period, may be considered an indefinite assignment.

On the other hand, if your assignment or job is indefinite, the location of the assignment or job becomes your new tax home, and you cannot deduct your travel expenses while there. An assignment or job in a single location is considered indefinite if it is realistically expected to last for more than one year, regardless of whether it lasts for more than one year. If your assignment is indefinite, you must include in your income any amounts you receive from your employer for living expenses, even if they are called travel allowances and you account to your employer for them.

Example:
The United States Tax Court ruled that an itinerant evangelist was not able to deduct his travel expenses, since he was never “away from home.” A full-time evangelist did not have a church or a fixed base of operation for the conduct of his ministry. He and his spouse travel throughout the United States in a recreational vehicle and conduct religious services at churches for either a few days or a few weeks. The couple does not own or rent a residence. The couple’s federal tax return was audited, and the IRS denied any deduction for the couple’s travel expenses. The Tax Court agreed, noting that the tax code allows deductions for traveling expenses only if the expenses are incurred while “away from home.” The court concluded: “Where the taxpayer has neither a principal place of business nor a permanent residence, he has no tax home from which he can be away. His home is wherever he happens to be.” Boyd v. Commissioner, T.C. Summary Opinion 2006-36.

What travel expenses are deductible

Once you have determined that you are traveling away from your tax home, you can determine what travel expenses are deductible (if self-employed) or reimbursable (by an employer under an accountable plan).

Travel in the United States

Since no itemized deduction is allowed from 2018 through 2025 for unreimbursed (or nonaccountable reimbursed) employee business expenses, the relevance of domestic travel expenses is limited to (1) computing travel expenses that are reimbursable under an accountable reimbursement plan and (2) computing the business expenses reported by self-employed persons on Schedule C (Form 1040).

Entirely for business

If your trip was entirely for business, you may deduct your ordinary and necessary travel expenses on Schedule C (Form 1040) if self-employed. These expenses would be reimbursable by an employer under an accountable plan and would not constitute taxable income.

Primarily for business

If your trip was primarily for business and, while away at your business destination, you extend your stay for a vacation, make a nonbusiness side trip, or have other nonbusiness activities, travel expenses to and from your business destination as well as any business expenses incurred while at your business destination are deductible (if self-employed) or reimbursable by an employer under an accountable plan and do not constitute taxable income.

Example:
You work in Atlanta and make a business trip to New Orleans. On your way home, you stop in Mobile to visit relatives. You spend $1,300 for the nine days you are away from home for travel, meals, lodging, and other travel expenses. If you had not stopped in Mobile, you would have been gone only six days, and your total cost would have been $900. Travel expenses are limited to $900.

A key question is whether a trip is primarily for business or personal reasons. The task of differentiating between business and personal trips will be relatively easy in some cases but difficult in others. IRS regulations provide the following assistance:

Whether a trip is related primarily to the taxpayer’s trade or business or is primarily personal in nature depends on the facts and circumstances in each case. The amount of time during the period of the trip which is spent on personal activity compared to the amount of time spent on activities directly relating to the taxpayer’s trade or business is an important factor in determining whether the trip is primarily personal. If, for example, a taxpayer spends one week while at a destination on activities which are directly related to his trade or business and subsequently spends an additional five weeks for vacation or other personal activities, the trip will be considered primarily personal in nature in the absence of a clear showing to the contrary. Treas. Reg. 1.162.

Primarily for personal reasons

If your trip was primarily for vacation, the entire cost of the trip is a nondeductible personal expense except for any expenses incurred while at your destination that are directly and properly allocable to your business. A trip can be a vacation even though a promoter advertises that a trip to a resort or on a cruise ship is primarily for business. The scheduling of incidental business activities during a trip, such as watching instructional videos or attending seminars, will not convert a vacation into a business trip.

Example:
Pastor T lives in Minnesota. In January she is invited by a pastor friend in Florida to visit for a week. While in Florida the pastor friend invites Pastor T to conduct a worship service on a Sunday morning. Pastor T does so. IRS Publication 463 states: “If your trip was primarily for personal reasons, such as a vacation, the entire cost of the trip is a nondeductible personal expense. However, you can deduct any expenses you have while at your destination that are directly related to your business.”

Example:
Assume that Pastor T is invited by a church in another state to come for a weekend and conduct three worship services. Pastor T’s trip is for business purposes. Since no itemized deduction is allowed after 2017 for unreimbursed (and nonaccountable reimbursed) employee business expenses, the relevance of travel expenses is limited to (1) computing transportation expenses that are reimbursable under an accountable reimbursement plan and (2) computing the business expenses reported by self-employed persons on Schedule C (Form 1040).

Example:
The Tax Court acknowledged that a pastor’s records “reflected the amounts expended for travel, meals and entertainment, and parking” but not “the time, place, and business purpose of each expenditure. Although he testified generally that these expenses were incurred in connection with his profession, there is insufficient information to meet the [substantiation] requirements.” The court “had no doubt that the pastor incurred travel and related expenses in connection with his profession; however, we are unable to find in his favor without more specific information. Accordingly, he is not entitled to deduct the travel, meals and entertainment, or parking expenses.” Bernstine v. Commissioner, T.C. Summ. Op. 2013-19.

Example:
A pastor claimed a deduction of $10,897 for traveling expenses. He testified that the amount included expenses of his domestic and international travel during 2013. In rejecting any deduction for travel expenses, the IRS and the Tax Court noted that the pastor had failed to offer any bills, receipts, or other records to substantiate traveling expenses.

Further, the court noted that if the pastor was entitled to reimbursement of his domestic travel, then his traveling expenses would not have been necessary expenses deductible under the code. The IRS and the court also denied a deduction of $4,000 for expenses incurred in travel to South Africa on two occasions in 2013. While in South Africa, the pastor gave a prayer of dedication during a renewal of marriage vows ceremony and engaged in sightseeing activities, including visits to the Apartheid Museum, the Robben Island Museum, Nelson Mandela’s residences in Johannesburg and Soweto, Bishop Tutu’s residence, and the botanical gardens. The court noted that for his traveling expenses to South Africa to be deductible, he would have to show that the trip primarily related to his trade or business (i.e., his pastoral responsibilities). The court concluded that he failed to do so. It added:

[The pastor’s] calendar and mileage logs contain little more than annotations that he traveled to South Africa. And while he testified that he carried out daily devotions with the people who accompanied him on the trip and, during the rest of the trip “there were other engagements, such as . . . ​speaking engagements,” his testimony was too vague for us to conclude that the trip primarily related to his pastoral responsibilities. Likewise with the trips to the Dominican Republic, where, although he conducted a revival ceremony, his wife had family and he engaged in recreational activities and went sightseeing. He failed to show that [his] travel in 2013 either to the Dominican Republic or to South Africa primarily related to his trade or business. We conclude that his traveling expenses were personal expenses and not deductible for federal income tax purposes. Burden v. Commissioner, T.C. Summary Opinion 2019-11.

Sabbatical leave

Some churches grant their pastor a sabbatical from a few weeks to a year or more. In most cases the sabbatical is for no specific purpose other than rest and rejuvenation, while in others it is to enable the pastor to pursue research or other activities directly related to ministry. Any compensation the pastor receives from the church during the sabbatical represents taxable income and must be so reported by the church. But what about travel expenses (i.e., transportation, lodging, meals) incurred by the pastor while on sabbatical? Can these expenses be reimbursed by the church under an accountable reimbursement policy?

In answering this question, keep the following points in mind:

Travel outside the United States

Since no itemized deduction is allowed after 2017 for unreimbursed (or nonaccountable reimbursed) employee business expenses, the relevance of travel expenses is limited to (1) computing travel expenses that are reimbursable under an accountable reimbursement plan and (2) computing the business expenses reported by self-employed persons on Schedule C (Form 1040).

If any part of your business travel is outside the United States, some of your deductions for the cost of getting to and from your destination may be limited How much of your travel expenses will be deductible (if self-employed) or reimbursable by an employer under an accountable plan depends in part on how much of your trip outside the United States was business related.

The tax code and regulations directly address foreign business trips. Following is a summary of the rules.

Foreign travel entirely for business

If your trip to a foreign country is entirely for business, then all your travel expenses are deductible (if self-employed) or reimbursable by an employer under an accountable plan. Travel expenses include such items as transportation, meals, and lodging.

Some foreign trips are treated as if they were entirely for business, even though they were not. As a result, all travel expenses are deductible (if self-employed) or reimbursable by an employer under an accountable plan. Here are the four “safe harbors” recognized by the tax code and regulations:

Travel primarily for personal reasons

If you travel outside the United States primarily for vacation, the entire cost of the trip is a nondeductible personal expense. This is true even if you spend some time attending brief professional seminars or a continuing education program. Registration fees and any other expenses that were directly related to your business can be reimbursed by your employer’s accountable reimbursement plan or deducted by a self-employed person.

Luxury water travel

If you travel by ocean liner, cruise ship, or other form of luxury water transportation for the purpose of carrying on your trade or business, there is a daily limit on the amount that can be reimbursed under an accountable plan or deducted by a self-employed person on Schedule C. You cannot deduct more than twice the federal per diem rate allowable at the time of your travel. For purposes of this limit, the federal per diem is the highest amount allowed as a daily allowance for living expenses to employees of the executive branch of the federal government while they are away from home but in the United States. The daily limit on luxury water travel does not apply to expenses you have to attend a convention, seminar, or meeting on board a cruise ship (see below). See IRS Publication 463 for the current per diem rates.

Conventions

Since no itemized deduction is allowed in 2018 through 2025 for unreimbursed (or nonaccountable reimbursed) employee business expenses, the relevance of convention expenses is limited to (1) computing transportation expenses that are reimbursable under an accountable reimbursement plan and (2) computing the business expenses reported by self-employed persons on Schedule C (Form 1040).

You may deduct travel expenses for yourself, but ordinarily not those of your family, in attending a convention if you can show that your attendance benefits your own work or business. If the convention is for investment, political, social, or other purposes unrelated to your profession or business, you cannot deduct the expenses.

Ordinarily, no deduction will be allowed for expenses in attending a convention, seminar, or similar meeting that does not offer significant business-related activities, such as participation in meetings, workshops, lectures, or exhibits held during the day. Nonbusiness expenses, such as social or sightseeing expenses, are personal expenses and are not deductible.

Your appointment or election as a delegate does not determine whether you can treat travel expenses as a business expense. You can deduct your travel expenses only if your attendance is connected to your own trade or business.

Example:
Pastor O is the lead pastor of a church. He and his spouse attend an annual church convention in another state. The trip lasts six days. Pastor O attends business sessions and visits an exhibit area during the day. His spouse spends most of her time visiting with friends and relatives and occasionally attends business sessions and visits exhibits. She also assists her husband in entertaining friends. Pastor O can deduct the travel expenses he incurs in attending the convention (on Schedule C of Form 1040 if self-employed), or they can be reimbursed by the church if the requirements for an accountable plan are met (in which case the reimbursements are not included in Pastor O’s taxable income, so no business deduction is necessary). However, the travel expenses of Pastor O’s spouse represent taxable income to Pastor O.

Convention agenda

The convention agenda or program generally shows the purpose of the convention. You can show your attendance at the convention benefits your trade or business by comparing the agenda with the official duties and responsibilities of your position. The agenda does not have to deal specifically with your official duties and responsibilities; it will be enough if the agenda is so related to your position that it shows your attendance was for business purposes.

If your expenses are paid by reimbursement or allowance, certain limitations may apply (see “Recordkeeping” on page  and “Reimbursement of Business Expenses” on page ).

You may deduct only 50 percent of your business-related meal expenses incurred while traveling away from home. You must show that the meal expense is directly related to the active conduct of your trade or business. Further, no deduction will be allowed for lavish or extravagant expenses.

Conventions held outside North America

Since no itemized deduction is allowed in 2018 through 2025 for unreimbursed (or nonaccountable reimbursed) employee business expenses, the relevance of foreign travel expenses is limited to (1) computing travel expenses that are reimbursable under an accountable reimbursement plan and (2) computing the business expenses reported by self-employed persons on Schedule C (Form 1040).

Self-employed workers can deduct expenses incurred in attending a convention, seminar, or similar meeting held outside North America if the meeting is directly related to their trade or business. Also, it must be as reasonable to hold the meeting outside North America as in it. If the meeting meets these requirements, you also must satisfy the rules for deducting expenses for business trips in general, ​discussed above.

If you are an employee, your employer can reimburse these expenses under an accountable plan (the reimbursements are not taxable income to you, so there are no expenses to deduct). See “Reimbursement of Business Expenses” on page .

The following factors must be considered in deciding if it was reasonable to hold the meeting outside North America: (1) the purpose of the meeting and the activities taking place at the meeting; (2) the purposes and activities of the sponsoring organizations or groups; (3) the homes of the active members of the sponsoring organizations and the places at which other meetings of the sponsoring organizations or groups have been or will be held; and (4) other relevant factors you may present.

Cruise ships

Since no itemized deduction is allowed in 2018 through 2025 for unreimbursed (or nonaccountable reimbursed) employee business expenses, the relevance of cruise ships expenses is limited to (1) computing transportation expenses that are reimbursable under an accountable reimbursement plan and (2) computing the business expenses reported by self-employed persons on Schedule C (Form 1040).

Self-employed workers can deduct up to $2,000 per year of expenses incurred in attending conventions, seminars, or similar meetings held on cruise ships. All ships that sail are considered cruise ships. You can deduct these expenses only if all the following requirements are met:

Annual foreign earned income exclusion

If you meet certain requirements, you may qualify for the foreign earned income and foreign housing exclusions and the foreign housing deduction. If you are a U.S. citizen or a resident alien of the United States and you live abroad, you are taxed on your worldwide income. However, you may qualify to exclude from income up to $126,500 ($253,000 if married ) of your foreign earnings for 2024.

In addition, you can exclude or deduct certain foreign housing amounts, but the amount of qualified housing expenses eligible for the housing exclusion and housing deduction is limited. The limitation is generally 30 percent of the maximum foreign earned income exclusion. For 2024, the housing amount limitation is $37,950 ($126,000 × 30 percent) for the tax year. However, the limit will vary depending on the location of the qualifying individual’s foreign tax home and the number of qualifying days in the tax year.

The foreign earned income exclusion is limited to the actual foreign earned income minus the foreign housing exclusion. Therefore, to exclude a foreign housing amount, the qualifying individual must first figure the foreign housing exclusion before determining the amount for the foreign earned income exclusion.

You may also be entitled to exclude from income the value of meals and lodging provided to you by your employer.

To claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, you must satisfy all three of the following requirements:

The maximum annual exclusion is prorated on a daily basis if there is any part of the year that you do not qualify under either test.

If you qualify under any of these tests, you may also claim an additional exclusion based on what you spend for foreign housing. See the instructions for Form 2555 for details.

The foreign earned income exclusion and the foreign housing cost amount exclusion are figured on Form 2555, which must be attached to Form 1040. However, if you claim only the foreign earned income exclusion, you may be able to use Form 2555-EZ instead.

The minimum time requirements for bona fide residence and physical presence can be waived if you must leave a foreign country because of war, civil unrest, or similar adverse conditions in that country.

Foreign earned income is defined as wages, salaries, professional fees, and other amounts received as compensation for personal services performed in a foreign country. The place where you perform the services is what defines your income as foreign, not where or how you are paid. Foreign earned income does not include such items as interest, dividends, pensions, or annuities.

Net self-employment income is generally subject to self-employment tax even if it is nontaxable in computing income taxes due to the foreign earned income exclusion. However, if it was earned in a country that has a Social Security agreement with the United States, which is called a “totalization agreement,” it may be exempt from U.S. Social Security taxes, including the self-employment taxes.

Charitable travel

Treasury regulation 1.170A-1(g) specifies that “out-of-pocket transportation expenses necessarily incurred in performing donated services are deductible. Reasonable expenditures for meals and lodging necessarily incurred while away from home in the course of performing donated services also are deductible.” Therefore, unreimbursed travel expenses incurred while away from home (whether within the United States or abroad) in the course of donated services to a tax-exempt religious or charitable organization are deductible as a charitable contribution.

The topic of charitable travel is addressed under “Introduction” on page  and “Three important principles” on page .

Tour guides

Some ministers lead tours to the Holy Land (or other destinations) and receive free travel by a tour company if they recruit a specified number of tourists to go along. Is the value of the free travel provided to a minister under such arrangement taxable income? The IRS says that it is:

If you received a free tour from a travel agency for organizing a group of tourists, you must include its value in your income. Report the fair market value of the tour on Form 1040 [line 1] if you are not in the trade or business of organizing tours. You cannot deduct your expenses in serving as the voluntary leader of the group at the group’s request. If you organize tours as a trade or business, report the tour’s value on Schedule C (Form 1040). IRS Publication 17. See also Revenue Ruling 64-154; GCM 35232 (1973); Revenue Ruling 74-473.

Often a minister will recruit enough tour group members to receive multiple free trips (which are used by members of the minister’s family). The market value of these additional free trips also must be reported as taxable income by the minister.

Travel expenses of a spouse

Most ministers attend conferences and conventions in the course of their ministry. Common examples include seminars and denominational meetings. In some cases, ministers attend such events at their own expense, but often their travel expenses (including transportation, lodging, and meals) are reimbursed by their church. These are legitimate business expenses so long as the primary purpose of the travel is church business. This means the expenses may be deductible by the minister (if self-employed) or reimbursed by the church under an accountable arrangement. But what if the minister’s spouse goes along? Can the church reimburse the spouse’s travel expenses too? Are the tax consequences the same as for the minister, or do different rules apply? And what if the minister’s children come too? These are important questions.

Hundreds of IRS rulings and court decisions prior to 1994 addressed spousal travel expenses, with most of them concluding that an employer’s reimbursements of a spouse’s travel expense were includible in taxable income and were not deductible or reimbursable as business expenses.

In 1994 section 274(m)(3) was added to the tax code. This section disallows any deduction for amounts “paid or incurred” with respect to a spouse, dependent, or other individual accompanying the taxpayer on business travel, unless the following three conditions are satisfied:

Section 274(m)(3) eliminates any possibility of a deduction for a spouse’s (or child’s) travel expenses in most cases since a minister’s spouse (or child) rarely is an employee of the church.

Section 274(m)(3) also led many to conclude that a church’s reimbursements of family members’ travel expenses had to be treated as taxable income. Here’s why. Section 132 of the tax code specifies that expenses paid by an employer on behalf of an employee represent a nontaxable working condition fringe benefit so long as the employee could have deducted the expense if he or she paid it directly. Since section 274(m)(3) prevents a deduction for the travel expenses of a minister’s spouse in most cases, the implication was that any reimbursement of such expenses by a church had to be reported as taxable income. In short, not only were the travel expenses incurred by a spouse or child not deductible, but a church’s reimbursement of these expenses had to be reported as taxable income.

Example:
Pastor C and his spouse attend a church convention. The spouse is not an employee of the church, and she has no official duties at the convention. The church reimburses the travel expenses of both Pastor C and his wife (including transportation, lodging, and meals). According to section 274(m)(3) of the tax code, the travel expenses of Pastor C’s spouse are not deductible (by either her or Pastor C), since she is not an employee and her presence at the convention did not serve a legitimate business purpose. Further, since her business expenses were not deductible, the church’s reimbursements of her expenses represented taxable income.

IRS regulations

IRS regulations clarify that section 274(m)(3) does not prevent an employer’s reimbursement of the travel expenses of an employee’s spouse or family member from qualifying as a nontaxable working condition fringe benefit so long as these conditions are met:

If a spouse is not a church employee and the spouse’s presence on a trip does not serve a legitimate business purpose, then that portion of the church’s reimbursement of the travel expenses of the minister and spouse attributable to the spouse’s travel represents taxable income to the minister.

This is not simply a matter of splitting the combined expenses in half. Rather, the amount to add to the minister’s taxable income is the actual amount of additional travel expenses attributable to the spouse’s travel. For example, if the minister and spouse drive their car to a church convention, the travel expenses allocable to the spouse would include any additional hotel room charge based on double occupancy as well as the spouse’s meals. If the couple flies to their destination, the spouse’s airfare would be included.

Examples

The application of section 274(m)(3) and the IRS regulations are illustrated by the following examples.

Example:
Pastor B is the senior minister of a church and is a member of the church’s governing board by virtue of his position. He attends a church convention in another city. He is accompanied by his spouse, who was selected by the church as an official delegate. The spouse is not an employee of the church. The spouse attends business meetings with her husband and votes on matters addressed at the convention. Pastor B’s travel expenses were $800 (transportation, lodging, and meals), and travel expenses attributable to his spouse were an additional $400. The church reimburses fully those travel expenses of both Pastor B and his spouse that are adequately substantiated under an accountable arrangement.

Since the spouse’s presence on the trip serves a legitimate business purpose and her travel expenses were reimbursed under an accountable arrangement, the church’s reimbursement of her travel expenses does not represent taxable income to either her or Pastor B.

Example:
Same facts as the previous example, except that the church issues a cash advance of $1,500 to Pastor B for all the travel expenses he and his spouse incur while attending the church convention. No substantiation of actual business expenses is required. The IRS regulations do not apply to this situation, since the church is not reimbursing the spouse’s travel expenses under an accountable arrangement. Accordingly, the full amount of the church’s travel reimbursement represents taxable income and must be included on Pastor B’s Form W-2 (or 1099-NEC). No itemized deduction is allowed in 2018 through 2025 for unreimbursed (or nonaccountable reimbursed) employee business expenses, so these expenses are not deductible if Pastor B is an employee for federal income tax purposes. However, Pastor B’s expenses would be deductible as a business expense on Schedule C (Form 1040) if he is self-employed; if the church reimburses these expenses under an accountable plan, the reimbursements are not taxable income to Pastor B, so there are no expenses to deduct. The spouse’s travel expenses ($400) are not deductible.

Example:
Same facts as the first example, except that Pastor B and his spouse must pay their own expenses in attending the church convention. Pastor B will not be able to deduct his travel expenses ($800) as an itemized deduction on Schedule A, since the itemized deduction for employee business expenses was suspended by Congress for tax years 2018 through 2025. There is no deduction for the spouse’s expenses.

Example:
Same facts as the first example, except that Pastor B’s spouse is a church employee. Since the spouse is an employee of the church and her presence on the trip serves a legitimate business purpose, her travel expenses ($400) are a legitimate business expense. Since the church reimbursed her expenses under an accountable arrangement, the reimbursement is not taxable income (it is not reported on her Form W-2), and there is no deduction to claim. As a church employee engaged in legitimate business travel, the treatment of the spouse is identical to that of Pastor B.

Example:
Same facts as the first example, except that Pastor B’s spouse does not attend the convention as an official delegate of the church. She has no official duties at the convention and does not attend or participate in business sessions. She spends most of her time with friends and relatives who are at the convention. Since the spouse’s presence on the trip does not serve a legitimate business purpose, the IRS regulations do not apply. As a result, her travel expenses reimbursed by the church ($400) represent taxable income to Pastor B. If the $400 is not reported as taxable income on the pastor’s Form W-2 or Form 1040 for the year in which the reimbursement occurred, this omission will expose the pastor not only to the risk of back taxes and interest but also (if he is a “disqualified person,” meaning an officer or director or a relative of an officer or director) to substantial excise taxes since the IRS views this as an automatic excess benefit transaction unless the benefit was reported as taxable income by the church or pastor in the year it was provided. Church board members who authorized the transaction are exposed to excise taxes of up to 10 percent of the amount of the excess benefit. This topic is addressed under “Intermediate sanctions” on page .

Example:
Pastor C is an executive officer of a religious denomination. One of Pastor C’s functions is to attend church conferences and conventions and to speak at local churches. Pastor C’s spouse goes along on many of these trips. The denominational agency expects the spouse to accompany Pastor C on these trips, although the spouse performs no business function or purpose. The agency reimburses the travel expenses of both Pastor C and Pastor C’s spouse under an accountable arrangement (only those expenses that are adequately substantiated are reimbursed). The spouse is not an employee of the agency. Since the spouse is not an employee of the agency, the spouse’s travel expenses are not a business expense and cannot be deducted. However, it is possible that the agency’s reimbursements of the spouse’s expenses would not be included in Pastor C’s income—if the spouse’s presence on Pastor C’s trips serves a legitimate business purpose.

While the likelihood that the spouse satisfies this condition is remote under these facts, it is possible. A few courts have suggested that a spouse’s presence on a business trip can serve a business purpose if (1) the employee’s spouse is an executive officer; (2) the employer has a “long-standing practice of defraying the travel expenses” of the employee’s spouse; (3) one of the business objectives of the employee’s travel is to “promote the public image” of the employing institution, and this task reasonably required the presence of the employee’s spouse on at least some occasions; (4) the spouse’s presence is necessary to assist the employee in “developing and renewing personal contacts”; and (5) it is customary for the spouse to accompany the employee on some activities, and the spouse’s absence would materially diminish the image that the employee was seeking to project of the employer. See, e.g., United States v. Disney, 413 F.2d 783 (9th Cir. 1969); Bank of Stockton v. Commissioner, 36 T.C.M. 114 (1977).

There is little doubt that the IRS would challenge the business purpose of the spouse’s travel under these facts. Reliance on proposed tax regulation 1.132-5(t) (explained above) to avoid recognizing the agency’s reimbursement of the spouse’s expenses as taxable income to the minister would be a highly aggressive position that should not be pursued without the advice of a tax professional.

Note that treating the spouse’s travel expenses as business expenses may expose Pastor C and members of the denomination’s governing board to intermediate sanctions if the IRS determines that the spouse’s presence on the trips served no legitimate business purpose. In such a case the denomination’s reimbursement of the spouse’s expenses constitutes the reimbursement of personal expenses. And since these reimbursements were not reported as taxable income during the year they were paid (because the denomination assumed they were accountable reimbursements of business expenses), the reimbursements constitute an automatic excess benefit exposing Pastor C and members of the denomination’s governing board to intermediate sanctions. This topic is covered fully under “Intermediate sanctions” on page .

Example:
Same facts as the previous example, except that the spouse is a featured speaker at one or more special events held during the convention. Such responsibilities make it more likely that the denomination’s reimbursement of the spouse’s travel expenses will be a nontaxable working condition fringe benefit since the “business purpose” test is more likely satisfied. This assumes that the spouse’s travel expenses are reimbursed under an accountable arrangement. If the denomination reimburses the spouse’s expenses without adequate substantiation or more than 60 days after incurring the travel expenses, then the reimbursements will represent taxable income for Pastor C and must be added to his Form W-2.

Charitable contributions

As noted in Chapter 8, unreimbursed expenses incurred while performing donated labor for a church may constitute a deductible charitable contribution. The income tax regulations specify:

Unreimbursed expenditures made incident to the rendition of services to an organization contributions to which are deductible may constitute a deductible contribution. For example, the cost of a uniform without general utility which is required to be worn in performing donated services is deductible. Similarly, out-of-pocket transportation expenses necessarily incurred in performing donated services are deductible. Reasonable expenditures for meals and lodging necessarily incurred while away from home in the course of performing donated services are also deductible. Treas. Reg. 1.170A-1(g).

Another way for travel expenses of a spouse to be nontaxable under the IRS regulations would be if the spouse performed meaningful church-related business activities. Under these circumstances, the spouse’s unreimbursed travel expenses could be claimed as a charitable contribution deduction. Consider the following examples:

Example:
A denomination’s bylaws permit churches to send lay delegates to annual denominational meetings. These lay delegates, along with ordained ministers, comprise the eligible voters. Pastor G is an ordained minister who attends an annual meeting in another city. Pastor G’s church selected his spouse to accompany him as an official delegate. Pastor G’s spouse attends all business meetings and exercises her voting privileges. The travel expenses of Pastor G’s spouse are not reimbursed by the church.

Pastor G’s spouse can deduct her travel expenses as a charitable contribution. This conclusion is supported by the following language in IRS Publication 526 (Charitable Contributions): “You cannot deduct your travel expenses in attending a church convention if you go only as a member of your church rather than as a chosen representative.” Further, “if a qualified organization selects you to attend a convention as its representative, you can deduct your unreimbursed expenses for travel, including reasonable amounts for meals and lodging, while away from home overnight for the convention.” Alternatively, the church’s reimbursement of the spouse’s expenses may represent a nontaxable working condition fringe benefit under the IRS regulations.

Example:
Same facts as the previous example, except that the church does not select Pastor G’s spouse to attend the meeting as a church delegate. The spouse’s unreimbursed expenses are not deductible as a charitable contribution. IRS Publication 526 states: “You can’t deduct your travel expenses in attending a church convention if you go only as a member of your church rather than as a chosen representative. You can, however, deduct unreimbursed expenses that are directly connected with giving services for your church during the convention.”

Example:
Same facts as the previous example, except that after arriving at the location of the meeting, Pastor G’s spouse visits a religious music publisher to consider music for the church. Her unreimbursed expenses in making this side trip can be claimed as a charitable contribution. However, this does not convert her expenses incurred in traveling to the meeting site to a deductible business expense. This conclusion is supported by the following language in IRS Publication 526: “You can, however, deduct unreimbursed expenses that are directly connected with giving services for your church during the convention.”

Example:
Pastor H is invited to speak at a church in a different city. His spouse accompanies him on the trip but performs no specific duties on behalf of the church. The unreimbursed travel expenses of Pastor H’s spouse are not deductible as a charitable contribution.

Example:
Same facts as the previous example, except that Pastor H’s spouse is asked to speak to a Sunday-school class and sing a solo during the worship service at which her husband speaks. Her travel expenses are not reimbursed by either church. While not certain, it is possible that the spouse’s activities during the trip represent sufficient charitable activity for her unreimbursed travel expenses to be deductible as a charitable contribution. If the church reimburses these expenses, then the expenses would not be deductible as a charitable contribution, but as noted above, the reimbursements may be nontaxable if they meet the requirements of a working condition fringe benefit.

For more information on claiming a charitable contribution deduction for expenses incurred during charitable travel (and substantiation requirements), see “Introduction” on page  and “Three important principles” on page .

Section 274 of the Internal Revenue Code was amended by the Tax Cuts and Jobs Act (2017). As amended, section 274 generally disallows a deduction for expenses with respect to entertainment, amusement, or recreation. However, the Act does not specifically address the deductibility of expenses for business meals, and this has led to considerable confusion.

The IRS issued a notice in 2018 clarifying that taxpayers may deduct 50 percent of an otherwise allowable business meal expense if

Note that this clarification does not benefit employees whose business expenses are not reimbursed by their employer, since such expenses remain nondeductible after 2017 and through 2025.

You may deduct the cost of business gifts on Schedule C (Form 1040) if self-employed. However, you cannot deduct more than $25 for business gifts you give, directly or indirectly, to any one individual during your tax year. Such gifts would include gifts made by a minister to church staff or board members. If you and your spouse both give gifts, both of you are treated as one taxpayer.

Incidental costs, such as costs for engraving on jewelry or for packaging, insuring, and mailing, are generally not included in determining the cost of a gift for purposes of the $25 limit. A cost is incidental only if it does not add substantial value to the gift. For example, the cost of gift-wrapping is an incidental cost. However, the purchase of an ornamental basket for packaging fruit is not an incidental cost if the value of the basket is substantial compared to the value of the fruit.

The following items are not considered gifts as regards the $25 limit:

Example: The Tax Court ruled that $2,300 in expenses incurred by a minister in one year to pay for plants, flowers, and other gifts to members and staff were nondeductible personal expenses rather than deductible business expenses. The court observed: “[The minister] testified that the gifts stemmed from a desire to foster goodwill among his parishioners and staff; however, [he has] not provided sufficient evidence to prove that these expenses were not personal. We find that [the minister] failed to prove that the gifts were not personal expenses; therefore, [he is] not entitled to deductions for these amounts.” Shelley v. Commissioner, T.C. Memo. 1994-432 (1994).

General educational expenses

General education expenses include expenses you have for education, such as tuition, books, supplies, correspondence courses, and certain travel and transportation expenses. These items can be reimbursed by an employer under an accountable plan or deducted by a self-employed person on Schedule C (Form 1040), even though the education may lead to a degree, if the education

However, these expenses are not reimbursable under an accountable plan or deductible by a self-employed person, even if one or both of the above-mentioned requirements are met, if the education

Once you have met the minimum educational requirements for your job, your employer or the law may require you to get more education. This additional education is qualifying work-related education if all three of the following requirements are met:

When you get more education than your employer or the law requires, the additional education can be qualifying work-related education only if it maintains or improves skills required in your present work.

Education during temporary absence

If you stop working for a year or less in order to get education to maintain or improve skills needed in your present work and then return to the same general type of work, your absence is considered temporary. Education that you get during a temporary absence is qualifying work-related education if it maintains or improves skills needed in your present work.

Education during indefinite absence

If you stop work for more than a year, your absence from your job is considered indefinite. Education during an indefinite absence, even if it maintains or improves skills needed in the work from which you are absent, is considered to qualify you for a new trade or business. Therefore, it is not qualifying work-related education.

Deductible expenses

The following education expenses can be reimbursed by an employer under an accountable plan (not reported as taxable income to the employee) or deducted as a business expense on Schedule C (Form 1040) by a self-employed person:

Nondeductible expenses

You cannot deduct personal or capital expenses. For example, you cannot deduct the dollar value of vacation time or annual leave you take to attend classes. This amount is a personal expense.

Transportation expenses

If your education qualifies, your local transportation expenses for going directly from work to school can be reimbursed by an employer under an accountable plan (not reported as taxable income to the employee) or deducted as a business expense on Schedule C (Form 1040) by a self-employed person. If you are regularly employed and go to school on a temporary basis, you can also deduct the costs of returning from school to home. You go to school on a temporary basis if your attendance at school is realistically expected to last one year or less and does, indeed, last one year or less; or you initially believed that your attendance at school would last one year or less, but at a later date your attendance is reasonably expected to last more than one year (your attendance is temporary up to the date you determine it will last more than one year.) If you are in either situation, your attendance is not temporary if facts and circumstances indicate otherwise.

If you are regularly employed and go directly from home to school on a temporary basis, the round-trip costs of transportation between your home and school can be reimbursed by an employer under an accountable plan (not reported as taxable income to the employee) or deducted as a business expense on Schedule C (Form 1040) by a self-employed person. This is true regardless of the location of the school, the distance traveled, or whether you attend school on nonworkdays. Transportation expenses include the actual costs of bus, subway, cab, or other fares, as well as the costs of using your car. Transportation expenses do not include amounts spent for travel, meals, or lodging while you are away from home overnight. Local transportation expenses can be computed using either actual expenses or the standard mileage rate. You may not deduct the cost of local transportation between your home and school on a nonworking day (this expense is a personal commuting expense).

Examples

Example:
A minister who is not a college graduate can claim as education expenses the costs of obtaining a college degree if the degree will not qualify him for a new trade or business. Glasgow v. Commissioner, 31 T.C.M. 310 (1972).

Example:
Pastor B, a minister of music, enrolled in several music courses at a local college. Expenses associated with such courses were not deductible education expenses, since the courses qualified the minister for a new trade or business of being a public school or junior college instructor. Burt v. Commissioner, 40 T.C.M. 1164 (1980).

Example:
J is a 25-year-old seminary student. She is not employed while attending school and has never previously served as a minister of a church. Her educational expenses are not deductible, since they (1) are not related to a current job, (2) are required in order to meet the minimum educational requirements to qualify her in her “trade or business,” and (3) are part of a program of study that will lead to qualifying her in a new trade or business.

Example:
A minister who serves a local church without compensation cannot deduct the cost of his educational expenses, since an uncompensated minister is not engaged in trade or business. IRS Letter Ruling 9431024.

Example:
The Tax Court ruled that a minister could not deduct the cost of courses he took at a local university to complete his undergraduate degree, even though he took the courses to enhance his ministerial skills. The minister enrolled in various courses at a local university (including Introduction to Counseling, Internship in Ministry Practice, Death and Dying as a Life Cycle, Modern Social Problems, The Family, Community, Ethics in Human Services, Symphonic Choir, Basic Writing, and Writing Strategies). These courses were not required for him to continue as a local pastor. He later earned a bachelor’s degree in human services. On his tax return he claimed a deduction of $9,698 for “continuing education.” The amount claimed represented tuition, books, and course-related fees incurred for the courses taken at the university.

The IRS disallowed the deduction, and the minister appealed. The Tax Court agreed that the educational expenses were not deductible. It acknowledged that education expenses are deductible as business expenses if the education “maintains or improves skills required by the taxpayer in his employment or meets the express requirements of an employer imposed as a condition for the taxpayer’s continued employment.” However, education expenses are not deductible if they are “made by an individual for education which is part of a program of study being pursued by him which will lead to qualifying him in a new trade or business.” This is so even if the courses meet the express requirements of the employer.

Whether the education qualifies a taxpayer for a new trade or business depends upon the “tasks and activities which he was qualified to perform before the education and those which he is qualified to perform afterwards.” The court noted that it had “repeatedly disallowed education expenses where the education qualified the taxpayer to perform significantly different tasks and activities. Further, the taxpayer’s subjective purpose in pursuing the education is irrelevant, and the question of deductibility is not satisfied by a showing that the taxpayer did not in fact carry on or did not intend to carry on a new trade or business.” The court agreed that the courses the minister took qualified him for a new trade or business and that the expenses of a college education are almost always nondeductible personal expenses.

The court concluded, “We conclude that the courses, which ultimately led to his bachelor’s degree, qualified him in a new trade or business. The courses provided him with a background in a variety of social issues that could have prepared him for employment with several public agencies and private nonprofit organizations outside of the ministry. Whether or not he remains in the ministry is irrelevant; what is important under the regulations is that the degree ‘will lead’ him to qualify for a new trade or business.” The court noted that it is “all but impossible” for taxpayers to establish that a bachelor’s degree program does not qualify them for a new trade or business. Warren v. Commissioner, T.C. Memo. 2003-175 (2003).

Employer-provided educational assistance

Some educational expenses paid by your employer may be excluded from your income. See “Employer-provided educational assistance” on page .

Additional tax benefits for education

Congress has created several tax breaks for education, including

The first two options are addressed in this text. The others are addressed fully in IRS Publication 970 (accessible on the IRS website, IRS.gov).

No itemized deduction is allowed after 2017 for unreimbursed (or nonaccountable reimbursed) employee business expenses, so these expenses are not deductible by employees. However, if certain conditions are met, the cost of books and subscriptions can be reimbursed by an employer under an accountable plan (not reported as taxable income to the employee) or deducted as a business expense on Schedule C (Form 1040) by a self-employed person.

The income tax regulations specify that “a professional . . . ​may claim as deductions the cost of . . . ​subscriptions to professional journals [and] amounts currently paid for books . . . ​the useful life of which is short.” Treas. Reg. 1.162-6.

The cost of a subscription will be deductible by self-employed workers or reimbursed by employers under an accountable plan if it is related to the conduct of a minister’s trade or business. Professional clergy journals (such as Church Law & Tax Report) and specialized clergy periodicals clearly satisfy this test. News magazines may also qualify if a minister can demonstrate that the information contained in such periodicals is related to his or her ministry (e.g., sources of illustrations for sermons). The cost of a general circulation daily newspaper is not deductible.

The cost of any book that you purchase for use in ministry and that has a useful life (not the same as its physical life) of less than one year is deductible by self-employed workers and can be reimbursed by employers under an accountable plan. This includes the cost of a book that you purchase and read but have no intention of using again.

Books and subscriptions include commentaries or theological dictionaries and encyclopedias that are acquired for extended reference. These are reimbursable under an accountable plan or deductible by self-employed workers in the year of purchase using the section 179 deduction (see “Depreciation and section 179 deductions” on page ). Most ministers prefer to deduct the entire cost of reference books in the year of purchase using the section 179 deduction. Alternatively, ministers can allocate the purchase price of reference books to their useful life by means of annual depreciation deductions. The depreciation deduction is computed using the Modified Accelerated Cost Recovery System (MACRS) method. See IRS Publication 946 for details.

Property must be used more than 50 percent for business purposes to be eligible for a section 179 deduction or to use the MACRS method of computing depreciation. You must indicate on IRS Form 4562 that you have elected to claim the section 179 deduction in the year of acquisition. Form 4562 is submitted with your Form 1040.

Religious books generally are used exclusively in a minister’s work, so no allocation is required between business and personal use.

Example:
Pastor S claimed deductions for the costs of publications used in his ministry. He claimed that he was reimbursed by the church for amounts he spent on business publications in excess of $1,600. He presented canceled checks and a summary of some of the publication expenses for each of the years in issue. The IRS disallowed the deductions in full, arguing that the evidence failed to establish that the publications were related to his business. The Tax Court disagreed, concluding that “based on [Pastor S’s] testimony and notations made on the checks, we conclude that [he] has established that the expenses were related to his ministry and that he has substantiated the claimed deduction in each of the years in issue.” Shelley v. Commissioner, T.C. Memo. 1994-432 (1994).

Example:
An ordained minister wrote several manuscripts on religion and other subjects but only submitted one for publication (it was not accepted). The minister claimed a deduction of $8,000 for depreciation on his professional library of 6,400 books (with an alleged purchase price of $160,000), plus an additional $1,320 for depreciation on various office equipment, such as desks, bookcases, filing cabinets, furniture, and computers. He insisted that he was engaged in the trade or business of writing, so he was entitled to deduct the depreciation on his library and home office equipment.

The IRS denied any deduction for the minister’s library, and the Tax Court agreed. It observed that for the minister to be able to deduct writing expenses, “he must prove that profit was the primary or dominant purpose for engaging in the activity.” The court referred to the income tax regulation’s list of factors to consider in deciding whether a taxpayer is engaged in an activity with a profit objective:

(1) the manner in which the taxpayer carried on the activity; (2) the expertise of the taxpayer or his advisers; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that the assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer’s history of income or loss with respect to the activity; (7) the amount of occasional profits that are earned; (8) the financial status of the taxpayer; and (9) whether elements of personal pleasure or recreation are involved. No single factor is controlling, and we do not reach our decision by merely counting the factors that support each party’s position. Treas. Reg. 1.183-2(b).

The court concluded that the minister’s writing activity was not motivated by profit according to these considerations, and as a result, he could not deduct depreciation expenses associated with this activity: “[He] did not carry on this activity in a businesslike manner, as he did not maintain any books and records. Moreover [he] submitted only one manuscript for publication and earned no income from his writing activity. In addition, he did not demonstrate that he changed his operation to improve profitability, had a business plan, or investigated the basic factors that affect profitability.” Nauman v. Commissioner, T.C. Memo. 1998-217.

Example:
The Tax Court denied a pastor’s deduction for books because it was unclear whether this expense was business related or personal. Bernstine v. Commissioner, T.C. Summ. Op. 2013-19.

Many church employees are provided with a church-owned computer that they use in the performance of their duties. Others own a computer that they use for both personal and business purposes. The tax rules associated with both scenarios are summarized below.

Church-owned computer

Some employees use an employer-provided computer for personal reasons, and this personal use constitutes a taxable fringe benefit that must be valued and reported on their Form W-2. If the personal use is minimal or infrequent, it may qualify as a nontaxable de minimis fringe benefit (see “De minimis (minimal) fringe benefits” on page ). If the personal use is significant, then it must be valued and reported as taxable income. The IRS has not clarified how this is done other than to say it depends on the facts and circumstances of each case. Many employers follow one of the following two rules:

Neither of these options has ever been officially recognized by the IRS or the courts in the context of the personal use of a church-owned computer.

Personally owned computer

No itemized deduction is allowed after 2017 for unreimbursed (or nonaccountable reimbursed) employee business expenses, so these expenses are not deductible by employees. However, if certain conditions are met, some or all of the cost of a personal computer used on the job can be reimbursed by an employer under an accountable plan (not reported as taxable income to the employee) or deducted as a business expense on Schedule C (Form 1040) by a self-employed person. However, note that personal computers are “listed property” and, as such, are subject to strict substantiation requirements regarding business use.

If you are self-employed, then you can claim a section 179 deduction if you use your personal computer more than 50 percent of the time during the year in your work. This means you can deduct the entire cost in the year of purchase. However, this assumes that you can substantiate your “business use percentage” (the percentage of total use that consists of business use). Your section 179 deduction is limited to the percentage of business use of the computer.

You compute your section 179 deduction on Form 4562. Section 4562 requires the following information regarding personal computers: (1) date first placed in service as a business asset, (2) business use percentage for the year, (3) cost, and (4) evidence to support the business use claimed. Your evidence supporting the business use of the computer must be in writing.

If you cannot prove your business use percentage, or if your business use percentage is less than 50 percent of total use, then you may not expense the cost in the year of purchase by claiming a section 179 deduction. Instead, you must depreciate the computer using the straight-line method over the five-year recovery period (i.e., the annual depreciation expense is the cost of the computer divided by five years). Using your computer to keep track of your personal investments does not count in determining whether you satisfy the “50-percent business use” test. On the other hand, if you meet the 50-percent business use test without considering use of the computer for investments, you may include your use of the computer for investments in computing your deduction.

Example:
The Tax Court ruled that a minister was not entitled to a tax deduction for the purchase of a computer that he used in his ministry. It noted that the tax code imposes strict substantiation requirements on the business use of any property designated as “listed property” and that personal computers are included in this definition. The court concluded: “The taxpayer’s testimony described the purchase of video equipment and tapes for preparing, editing, and duplicating video tapes for [his] ministry. He claimed that he bought such equipment in 2001 but also testified that he could not remember honestly. This testimony is insufficient to satisfy the strict substantiation requirement applicable to computers as listed property.” Vigil v. Commissioner, T.C. Summary Opinion 2008-6 (2008).

Example:
The Tax Court ruled that an employee could not claim any deduction for the business use of her personal computer, since she failed to maintain any records demonstrating the percentage of total use that was for business purposes. Kelly v. Commissioner, T.C. Memo. 1997-185.

Example:
A taxpayer purchased a personal computer and deducted the entire cost as a business expense in the year of purchase. The IRS audited the taxpayer and disallowed the deduction. It pointed out that the taxpayer failed to make any section 179 election in the year the computer was purchased, so he could not deduct the full cost of the computer in that year. The Tax Court agreed. It noted that section 179 of the tax code permits a taxpayer to deduct the entire cost of many kinds of business equipment in the year of purchase—but only if a section 179 election is made on the taxpayer’s tax return. This is done on Form 4562, the depreciation schedule that accompanies Form 1040. If this election is not made, then a taxpayer has no choice but to claim annual depreciation deductions over the useful life of the computer or other business equipment. Fors v. Commissioner, T.C. Memo. 1998-158 (1998).

Example:
A taxpayer claimed a business expense deduction for his personal computer equipment. The IRS denied the deduction, and the taxpayer appealed. The Tax Court noted that any computer or peripheral equipment is “listed property” that is subject to stricter substantiation rules. Among other things, the taxpayer must demonstrate that business use exceeds 50 percent. The court concluded: “Based on his testimony and the evidence introduced at trial, petitioner failed to establish the percentage of business use for the computer and peripheral equipment. Rather, at trial petitioner merely asserted ‘these are office expenses’ and then proceeded to name each item purchased and the amount purportedly incurred for it. Furthermore, even if petitioner had established the business-use percentage for such items, he failed to satisfy all of the stringent substantiation requirements.” Whalley v. Commissioner, 72 T.C.M. 1422 (1996).

Example:
A school adopted a rule requiring teachers to switch from written report cards and evaluations to a computerized format. The school had eight computers that were available for faculty and student use. One teacher purchased a $3,233 personal computer and deducted the entire cost on her tax return as a section 179 deduction. The teacher claimed that due to the insufficient number of computers available at her school for faculty to use in preparing their reports, and the confidentiality and security problems that existed at the school, it was necessary for her to purchase a computer to properly perform the duties of her employment. She also claimed that without her own computer she would be unable to timely prepare her reports and evaluations, and for these reasons she argued that the computer was required as a condition of employment.

The Tax Court denied the deduction. It noted that the computer was “listed property,” and as such the teacher could not claim a section 179 deduction for the full cost unless her use of the computer was for the convenience of the employer and was required as a condition of her employment. The court noted that the purchase of the computer was not required as a condition of her employment:

Although a computer was needed [by the teacher] to file her reports and evaluations, the school had computers which could be used for this purpose. Furthermore, we note that there were several teachers who did not own personal computers and, nonetheless, they were able to file timely reports and evaluations. . . . ​In short, it is amply clear on this record that a personal computer was not required for the proper performance by school teachers of their employment duties. Although it may have been more convenient for [the teacher] to use her own personal computer, we must, as the statute requires, focus on the convenience of the employer and not the convenience of the employee. Moreover, the record shows that . . . ​the school continually purchased additional computers available for faculty and student use. Consequently, it is evident that the ‘convenience of employer’ requirement is not satisfied since [the teacher’s] purchase of a personal computer did not spare her employer the cost of providing her with suitable equipment with which to engage in her job responsibilities. Bryant v. Commissioner, 66 T.C.M. 1594 (1993).

Example:
The IRS denied a pastor’s deduction of the cost of two computers (a laptop and desktop), and the Tax Court agreed. It noted that computers are treated as “listed property” under the tax code, which triggers more rigorous substantiation requirements that the pastor failed to meet. His claim that he only used the computers for business purposes was not adequate substantiation. Burden v. Commissioner, T.C. Summary Opinion 2019-11.

Cable TV and Internet expenses

Example The IRS denied the pastor’s $450 deduction for Internet service. While he reasoned that he used the Internet for work, he offered no testimony or other evidence from which the IRS could estimate his usage for work apart from his usage for personal purposes. The court concluded: “As with his cell phone expense, we will allow no deduction for Internet expense.” Burden v. Commissioner, T.C. Summary Opinion 2019-11.

Example:
A minister’s deduction for Internet expenses was disallowed by the IRS because she “did not provide . . . ​a reasonable evidentiary basis for estimating the portion of time that the Internet at her personal residence was used for business purposes.” The Tax Court noted that Internet expenses “have been characterized as utility expenses rather than expenses related to the use of listed property (such as computer equipment),” meaning that the strict substantiation requirements described in section 274(d) of the tax code do not apply. Instead, taxpayers can use the Cohan rule to estimate business expenses. Under this rule, if a taxpayer establishes that an expense is deductible but is unable to substantiate the precise amount, the court may estimate the amount, “bearing heavily against the taxpayer whose inexactitude is of his or her own making.” Cohan v. Commissioner, 39 F.2d 540 (2nd Cir. 1930). Therefore, pursuant to the Cohan rule, the amount of deductible Internet expenses can be estimated by a court, provided, however, that the court has a reasonable basis for making an estimate of the amount of the expense related to business use.”

The taxpayer claimed that she used the Internet at home for business purposes. But the court concluded that she “did not provide . . . ​a reasonable evidentiary basis for estimating the portion of time that the Internet at her personal residence was used for business purposes. Accordingly, we hold that she is not entitled to a deduction . . . ​for any portion of her home Internet expenses.” Barnes v. Commissioner, T.C. Memo, 2016-212.

The costs of clothing and laundry expenses are deductible as a business expense on Schedule C (Form 1040) if the clothing (1) is of a type specifically required as a condition of employment, (2) is not adaptable to general or continued usage to the extent that it could take the place of ordinary clothing, and (3) is not so worn. In addition, if you are an employee and your employer reimburses these expenses under an accountable plan, the reimbursements are not taxable income to you, so there are no expenses to deduct.

Example:
A church pays a monthly clothing allowance to its minister. The Tax Court concluded that these amounts represented taxable income and were not deductible. The court observed that the tax law “provides a comprehensive definition of gross income” and that this term “includes income realized in any form, whether in money, property, or services.” Accordingly, “income may be realized in the form of clothing as well as in cash.” In rejecting any deduction for the cost of the taxpayer’s clothing, the court noted that “the cost of acquisition and maintenance of uniforms is deductible generally if (1) the clothing is of a type specifically required as a condition of employment, (2) it is not adaptable to general usage as ordinary clothing, and (3) it is not so worn. There is no indication in this record that the amount of the clothing allowance is for uniforms or special clothing.” Kalms v. Commissioner, T.C. Memo 1992-394.

Example:
Pastor S claimed laundry and dry cleaning deductions of more than $300 per year. To support the deductions, he presented canceled checks on which he had made notations. The IRS disallowed these deductions in full. The Tax Court mostly agreed:

Example:
A pastor claimed a deduction of $4,900 for robes and dry cleaning. He insisted that he was required to wear business suits that he would not otherwise have worn because of the nature of his employment. The Tax Court disallowed this deduction. It concluded, “[E]ven if this were correct, the cost of clothing is only deductible if the clothing is of a type specifically required as a condition of employment and is not adaptable as ordinary clothing. This rule also applies to the maintenance of such clothing. There is no indication in the record that the amounts disallowed were for clothing that could not be worn in an ordinary way.” Swaringer v. Commissioner, T.C. Summary Opinion 2001-37 (2001).

Example:
The Tax Court disallowed a pastor’s deduction for uniform and dry cleaning expenses, noting that “he must show that the clothing was required and that it was not suitable for general personal use. There is no way for the Court to decide from the record whether the clothing purchased or dry cleaned was for specialized clergy uniforms. We accordingly hold that he has not shown entitlement to these deductions.” Bernstine v. Commissioner, T.C. Summ. Op. 2013-19.

No itemized deduction is allowed after 2017 for unreimbursed (or nonaccountable reimbursed) employee business expenses, so these expenses are not deductible by employees. However, if certain conditions are met, home office expenses can be reimbursed by an employer under an accountable plan (not reported as taxable income to the employee) or deducted as a business expense on Schedule C (Form 1040) by a self-employed person.

Many ministers maintain an office in their home. For some ministers, their “home office” is simply a desk or table in a corner of a bedroom. For others, it is a separate room that is used either regularly or exclusively for business purposes. Can any of the expenses associated with such offices be classified as a business expense?

Eligibility for a home office deduction

If you are self-employed, you may be able to deduct certain expenses for the part of your home that you use for business.

To deduct expenses for business use of the home, you must use part of your home as one of the following:

Note the following additional considerations:

IRS audit guidelines for ministers

The IRS has published audit guidelines for its agents to follow when auditing ministers. The guidelines provide IRS agents with the following information regarding the business use of a home:

In order for a home to qualify as a principal place of business . . . ​the functions performed and the time spent at each location where the trade or business is conducted are the primary considerations and must be compared to determine the relative importance of each.

The church often provides an office on the premises for the minister, so the necessity of an office in the home should be questioned closely. Furthermore, since the total cost to provide the home is used in computing the exempt housing allowance, home office deductions for taxes, insurance, mortgage interest, etc. would be duplications. (Note that itemized deductions are allowable for mortgage interest and taxes.)

Examples

Example:
Pastor H had an office at the church (his principal place of work) and an office in his home, where he prepared sermons and performed other ministerial duties. The Tax Court ruled that he could not deduct the costs of daily round trips by car between his home and church. The transportation was commuting. Hamblen v. Commissioner, 78 T.C. 53 (1981).

Example:
A minister claimed a deduction for a home office based on the fact that approximately 18 percent of his home was used for a home office. Accordingly, the minister claimed a deduction for 18 percent of the maintenance and repair expenses incurred with respect to his home. The Tax Court denied any home office deduction. It noted that to deduct home office expenses, a taxpayer must prove that a specific portion of his residence was used exclusively for business. However, in this case, the court concluded that the minister’s “testimony makes clear that the office was used both as an office and as a guest room. Thus, his office fails the exclusive use test. Accordingly, we find that the minister cannot claim deductions attributable to a home office.” Shelley v. Commissioner, T.C. Memo. 1994-432 (1994).

Example:
A minister claimed that he used 20 percent of his home as a home office associated with his counseling ministry. The minister did all of his counseling in another office and used the office in his home (consisting of two rooms) to store his books and office equipment and to prepare for counseling sessions. He did not meet with or counsel clients at his home office but rather used his other office for that purpose. He claimed that he maintained his counseling books and accounting materials at the home office because the presence of these items in the other office would have “intimidated the clients.” The Tax Court concluded that the minister could not claim a business expense deduction for any portion of the expenses associated with his home office. Hairston v. Commissioner, T.C. Memo. Dec. 51,025(M) (1995).

Example:
A pastor claimed a deduction in the amount of $8,546 for the business use of his home office. He lived in a 1,200 square foot residence with one room dedicated exclusively for use related to his work as a pastor. The dedicated room equaled one-third of the total space in the residence, and so he computed his deduction by taking one-third of his total expenses for insurance, rent, and utilities. The pastor spent most of his time in his home office and much less time at the office the church provided, where he met with members of the congregation. The Tax Court noted that while in general, no deduction is allowed for use of a personal residence, the tax code “provides for an exception when an allocable portion of the residence is used exclusively on a regular basis as a principal place of business for a trade or business of the taxpayer.” The tax code also allows a home office deduction “where a home office is used as a place of business to meet with customers in the normal course of a trade or business.” While the pastor “met with members of his congregation at the office the church provided, his home office was the focal point of his activity involving all other individuals with whom he was involved with in his trade or business.”

The court concluded: “Because the pastor’s trade or business is not limited to serving the church and because most of his business activity was conducted at his home office, we hold that he qualifies for the exception and is entitled to a home office deduction of $8,546.” Bernstine v. Commissioner, T.C. Summ. Op. 2013-19.

Housing allowance and the home office deduction

Does a housing allowance preclude a home office deduction? In 1964 the Tax Court ruled that section 265 of the tax code (which denies a deduction for any expense allocable to tax-exempt income) prevented a minister from deducting his unreimbursed transportation expenses to the extent they were allocable to his tax-exempt housing allowance. To illustrate, assume that a minister receives compensation of $50,000, of which $10,000 is an excludable housing allowance, and incurs unreimbursed business expenses of $1,500. Since one-fifth of the minister’s compensation is tax-exempt, he should not be permitted to deduct one-fifth of his business expenses, since they are allocable to tax-exempt income and their deduction would amount to a double deduction. As a result, the minister can deduct only $1,200 of his unreimbursed business expenses. Deason v. Commissioner, 41 T.C. 465 (1964).

This principle is commonly thought to apply to the home office expenses of a minister, meaning that ministers who claim a housing allowance or parsonage exclusion are not entitled to the home office deduction. This is the view taken by the IRS in its audit guidelines for ministers.

A possible exception

Some ministers are not able to claim all their home expenses in computing their housing allowance exclusion. To illustrate, some churches designate an allowance that is less than actual expenses. Other churches fail to designate an allowance at all. In these cases, a partial home office deduction (in some cases, a full deduction) may be permissible under the Deason ruling. Since neither the IRS nor any court has addressed or endorsed this position, it should not be adopted without the advice of a tax professional.

The moving expense deduction is addressed under “Moving Expenses” on page .

Basic telephone service

No itemized deduction is allowed after 2017 for unreimbursed (or nonaccountable reimbursed) employee business expenses, so these expenses are not deductible by employees. However, if certain conditions are met, these expenses are deductible as a business expense on Schedule C (Form 1040) if you are self-employed. For both self-employed workers and employees, if your employer reimburses these expenses under an accountable plan, the reimbursements are not taxable income to you, so there are no expenses to deduct.

You cannot deduct the cost of basic local telephone service (including any taxes) for the first telephone line you have in your home, even if you have an office in your home. However, charges for business long-distance phone calls on that line, as well as the cost of a second line into your home used exclusively for business, are business expenses.

Example:
A minister used his home phone to speak with members of his congregation or to deal with other church-related matters. He did not have a separate telephone line for business calls. He claimed a business deduction of 75 percent of his total telephone expenses (including both local and long-distance charges) on his federal tax returns for three years. The IRS audited the minister and disallowed all of the deductions, but the Tax Court ruled in the minister’s favor. The court observed:

No deduction is allowed for a taxpayer’s telephone expenses if the primary purpose of the telephone is personal rather than business. . . . ​The minister presented canceled checks paid to the telephone company and testified that approximately 75 percent of all local and long-distance calls received at home were related to his business. He did not maintain a separate business telephone line. Due to the nature of his business and the hours devoted to his duties, we believe his approximation of the business use of his home phone. We hold that he has met his burden of proof as to the claimed telephone expenses and is entitled to the deductions claimed.

Note that this case was decided before the tax law was changed to deny any deduction for basic local telephone service for the first telephone line into a home. However, even under the new rule, the minister’s deduction for 75 percent of his long-distance calls would have been upheld. Shelley v. Commissioner, T.C. Memo. 1994-434).

Example:
A minister engaged in a counseling ministry from a downtown office and also maintained an office in his home. The minister claimed a business expense deduction for telephone expenses incurred at his downtown office and his home office. The IRS disallowed the portion of the telephone expenses attributable to the minister’s home office. The Tax Court disagreed with this conclusion, noting that the minister clearly “incurred some telephone expenses at home in the course of conducting his trade or business as a counselor” and that the deductibility of telephone expenses is not governed by the home office rules (the minister did not qualify for a home office deduction). The court further noted that the tax code disallows a deduction for “basic local telephone service with respect to the first telephone line” to any residence of the taxpayer, regardless of any business use of the telephone. The court added that “this section, however, does not apply in this case since [the minister has] not claimed local telephone service expenses.” Hairston v. Commissioner, T.C. Memo. Dec. 51,025(M) (1995).

Example:
The Tax Court denied a $2,000 deduction for a pastor’s home telephone expenses. It concluded:

Cell phones

In 2011 the IRS provided guidance to employers on two important issues: (1) personal use by employees of employer-provided cell phones and (2) reimbursement by an employer of an employee’s business use of his or her own cell phone. IRS Notice 2011-72. The IRS guidance is summarized below.

Personal use of employer-provided cell phones

The value of an employer-provided cell phone, provided primarily for noncompensatory business reasons, is excludable from an employee’s income as a “working condition fringe benefit.” Personal use of an employer-provided cell phone, provided primarily for noncompensatory business reasons, is excludable from an employee’s income as a de minimis fringe benefit.

An employer provides a cell phone primarily for noncompensatory business purposes if there are substantial business reasons for providing the cell phone. Examples of substantial business reasons include the employer’s

You cannot exclude from an employee’s wages the value of a cell phone provided to promote the goodwill of an employee, to attract a prospective employee, or as a means of providing additional compensation to an employee.

Employer reimbursement of business use of employees’
cell phones

IRS Notice 2011-72 only addresses the tax treatment of employees’ personal use of employer-provided cell phones. It does not address employer reimbursements of employees’ use of their personal cell phones for business purposes. In interim “audit guidance” provided to its agents, the IRS made the following observations:

Notice 2011-72 does not address the treatment of reimbursements received by employees from employers for the business use of an employee’s personal cell phone. In cases where employers, for substantial noncompensatory business reasons, require employees to maintain and use their personal cell phones for business purposes and reimburse the employees for the business use of their personal cell phones, examiners should analyze reimbursements of employees’ cell phone expenses in a manner that is similar to the approach described in Notice 2011-72. Specifically, in cases where employers have substantial business reasons, other than providing compensation to the employees, for requiring the employees’ use of personal cell phones in connection with the employer’s trade or business and reimbursing them for their use, examiners should not necessarily assert that the employer’s reimbursement of expenses incurred by employees after December 31, 2009, results in additional income or wages to the employee.

However, the employee must maintain the type of cell phone coverage that is reasonably related to the needs of the employer’s business, and the reimbursement must be reasonably calculated so as not to exceed expenses the employee actually incurred in maintaining the cell phone. Additionally, the reimbursement for business use of the employee’s personal cell phone must not be a substitute for a portion of the employee’s regular wages. Arrangements that replace a portion of an employee’s previous wages with a reimbursement for business use of the employee’s personal cell phone and arrangements that allow for the reimbursement of unusual or excessive expenses should be examined more closely. IR-2011-93.

The IRS has noted that

Example:
A pastor claimed a deduction of $1,400 for cell phone expenses. The IRS denied this deduction, and the Tax Court agreed: “While [the pastor] testified that he used the phone in his work to make and receive calls from his congregants, he offered no evidence that he was required by his employer to have a cell phone, that he would not have had a cell phone independent of any business use of it by him, or of how much he used his phone for business purposes and how much he used it for personal purposes.”

The court concluded:

The Tax Cuts and Jobs Act of 2017 provides that no deduction is allowed with respect to membership dues in any club organized for business, pleasure, recreation, or other social purposes. This provision expires at the end of 2025 unless extended by Congress.

Most ministers support their church with regular contributions. Some also make voluntary or mandatory payments to a denominational agency. Must this financial support be treated as a charitable contribution? Or is it possible to treat it as professional dues? This question was addressed directly in an unpublished “small” Tax Court decision in 1992. That case is explored below.

Forbes v. Commissioner, T.C. Sum. Op. 1992-167 (unpublished)

A local church adopted a “tithing policy” requiring every employee to pay a tithe of 10 percent of total compensation back to the church. The church strictly enforces the tithing policy. Tithing records are maintained on a computer and are periodically examined for all employees. Employees found to be delinquent in their tithes are required to become current. The church has dismissed several employees for failing to comply with the tithing requirement.

The church views its tithing policy as both moral and managerial. From a moral standpoint, the church believes that “a church member whose wages are paid from the tithes of the parishioners, but refuses to participate in the support of the ministry, is dishonest and hypocritical.” From a management standpoint, the church believes that an employee who disagrees with its basic tenets and is unwilling to comply with its policies is not fulfilling his or her employment commitment.

One of the church’s ministers received $24,600 in wages from the church in one year, which consisted of salary, housing allowance, and miscellaneous amounts received for services performed at weddings, funerals, and other occasions. She paid a tithe of $2,460 back to the church, as required by the tithing policy. In computing her self-employment (Social Security) taxes for the year, she deducted this tithe as a “business expense.”

The IRS audited the minister’s tax return and claimed that she could only claim her tithe as a charitable contribution deduction and not as a business expense. As a result, the IRS concluded that it was improper for the minister to deduct the tithe in computing her Social Security taxes. While taxpayers can deduct business expenses in computing self-employment taxes, they cannot deduct charitable contributions. The minister appealed the IRS ruling to the Tax Court, claiming that her tithe was a business expense that she was entitled to deduct in computing her self-employment taxes.

The Tax Court concluded that the minister’s tithes to the church represented a business or professional expense rather than a charitable contribution under the facts of this case. As a result, the minister properly deducted her tithes in computing her Social Security taxes. The court observed:

Under consideration of the record in this case, we agree with [the minister]. Tithing is required by [the church] as a matter of employment policy, and [the minister] must annually tithe 10 percent of the income she receives as a result of her position as a minister. Since [the church’s] tithing policy is rigorously enforced, [the minister’s] employment is, in a very real sense, dependent upon her willingness to give. The fact that she is tithing to a charitable organization to which she belongs and to which she might tithe 10 percent anyway is of little consequence given the facts in this case. Accordingly . . . ​we hold that [the minister] is entitled to compute her net earnings from self-employment by reducing her gross income from self-employment by the $2,460 she paid to [the church] during the year in issue as a tithe.

Federal tax law permits taxpayers to deduct business and professional expenses, which are defined as “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” The court concluded that the minister’s tithes satisfied this definition and accordingly could be deducted as a business expense. It is significant that the IRS conceded that the minister’s tithes could be deducted as a business or professional expense except for a provision in federal law preventing taxpayers from claiming a business expense deduction for an item that could be claimed as a charitable contribution. The IRS claimed that this provision prevented the minister from deducting her tithes as a business expense—since she could have claimed them as a charitable contribution. Not so, said the court. It concluded that “payments made as an integral part of a taxpayer’s trade or business” are deductible as business or professional expenses even if “the recipient of the payment is a charitable organization.” That is, the critical question to ask is whether a payment satisfies the definition of a business expense. Is it an ordinary and necessary expense paid or incurred in carrying on a trade or business? If so, it is deductible as a business expense even though it may be possible to characterize it as a charitable contribution.

Further, the court suggested that it would be unrealistic to treat the minister’s tithe to the church as a voluntary charitable contribution, since in no sense was it a voluntary transfer of funds to the church. Rather, it was a mandatory payment, and as such it could not be characterized as a charitable contribution.

Conclusions

Note the following additional considerations about this controversial decision:

This case suggests that in some cases, mandatory contributions made by ministers and lay employees to a church can be treated as business expenses.

However, since no itemized deduction is allowed after 2017 for unreimbursed (or nonaccountable reimbursed) employee business expenses, the relevance of this expense is limited to computing the business expenses reported by self-employed persons on Schedule C (Form 1040).

What is the practical effect of this result? Most importantly, it suggests that ministers may be able to deduct such contributions as a business expense in computing their self-employment (Social Security) tax on Schedule SE (of Form 1040). If the payments to the church are reported as charitable contributions by a minister, they are not deductible in computing self-employment taxes. Remember, ministers are self-employed for Social Security purposes with respect to their ministerial income.

Mandatory contributions may be reimbursable.

Many churches reimburse their minister’s business expenses. If mandatory contributions to the church are considered to be business expenses, can a church reimburse them? This is a difficult question that the Tax Court’s ruling did not address. Logically, if mandatory contributions are considered to be business expenses, they can be reimbursed under either an accountable or nonaccountable business expense reimbursement arrangement. However, neither the IRS nor any court has directly addressed this issue. This does not mean that the reimbursement of mandatory contributions would be wrong or illegal. It simply means that there is no direct precedent to support such a position, so it represents an aggressive position.

Churches that elect to reimburse these expenses should understand that the reimbursements cannot be funded under an accountable arrangement by reducing the minister’s compensation (a salary reduction plan).

To be treated as a business expense, contributions must be mandatory.

For contributions to a church to be treated by ministers and lay employees as a business expense rather than a charitable contribution, they must be “mandatory” under the Tax Court’s rigid definition. Note the following elements that were mentioned by the court:

Example:
Pastor K would like to reduce the amount of Social Security taxes he pays. He decides to deduct the contributions he makes to his church as a business expense in computing his self-employment taxes. He claims that if he does not set an example to his congregation by making contributions to the church, he may be asked to resign. The church has never adopted a formal tithing policy and has never dismissed (or even suggested dismissing) a minister for inadequate contributions. These contributions are not mandatory and are not deductible (for income tax or Social Security tax purposes) as a business expense.

The IRS conceded that mandatory contributions could be treated as business expenses.

Note that the IRS conceded that the minister’s tithes could be deducted as a business or professional expense except for a provision in federal law preventing taxpayers from claiming a business expense deduction for an item that could be claimed as a charitable contribution. Since the Tax Court concluded that this provision did not apply, the contributions were deductible as a business expense.

Mandatory denominational support may be a business expense.

Some denominations require ministers to make contributions for their support. If these contributions are mandatory, they can be treated as business expenses and deducted in computing self-employment taxes according to the Tax Court’s decision. Once again, it is important to emphasize that the contributions must be mandatory. For example, the denomination’s governing documents specify that ministers can lose their ordained status for failure to pay the required support.

Decisions in a “small” Tax Court case are not legal precedent.

The Tax Court’s decision was a “small” Tax Court case, meaning it involved less than $50,000, and the taxpayer elected to pursue an expedited and simplified procedure authorized by section 7463 of the tax code. While small Tax Court cases are more quickly resolved, there is a trade-off: section 7463 specifies that “a decision entered in any case in which the proceedings are conducted under this section shall not be reviewed by any other court and shall not be treated as precedent for any other case.” In other words, the decision of the Tax Court was final, and it cannot be cited as precedent in other cases. Obviously, this greatly limits the impact of the case. The IRS is free to completely ignore the decision in other cases.

IRS audit guidelines for ministers

The IRS has published audit guidelines for its agents to follow when auditing ministers. The (revised) guidelines (2009) communicate the following information to agents regarding the tax treatment of ministers’ financial support to a church or denominational agency:

Ministers often pay a small annual renewal fee to maintain their credentials, which constitutes a deductible expense. However, ministers’ contributions to the church are not deductible as business expenses. They may argue that they are expected to donate generously to the church as part of their employment. This is not sufficient to convert charitable contributions to business expenses. The distinction is that charitable contributions are given to a qualifying organization (such as a church) for the furtherance of its charitable activities. Dues, on the other hand, are usually paid with the expectation that a financial benefit will result to the individual, as in a realtor’s multilist dues or an electrician’s union dues. A minister’s salary and benefits are not likely to directly depend on the donations made to the church. They may still be deducted as contributions on Schedule A but may not be used as a business expense to reduce self-employment tax.

You need to keep adequate records of business expenses for two reasons:

Three categories of business expenses

The kinds of records you need to substantiate a business expense depends on the type of business expense. The tax code divides business expenses into three categories for purposes of substantiation:

Local business transportation, overnight travel, entertainment, and gift expenses

Section 274(d) of the tax code states that no deduction for local business transportation, overnight business travel (including meals and lodging), business entertainment, or gift expenses will be allowed unless a taxpayer can substantiate the amount, date, place, and business purpose (and in the case of entertainment and gift expenses, the business relationship). You must be able to substantiate each item by adequate records or by sufficient evidence corroborating your own statement. A receipt is required for each expense of $75 or more.

Expenses associated with “listed property”

The tax code defines listed property to include automobiles and computers (and peripheral equipment) that are used for business purposes. In order to substantiate a business expense for the use of any of these items of listed property, a taxpayer must prove (1) the amount of the expense; (2) the business use percentage (the percentage of total use of the listed property for the year that consisted of business use); (3) the date of the expense; and (4) business purpose.

Other business expenses

For all other business expenses, you should be able to substantiate that such expenses were not only paid or incurred but also that they constitute ordinary and necessary business expenses. The income tax regulations provide the following information regarding the substantiation of this category of business expenses:

The tax code contemplates that taxpayers keep such records as will be sufficient to enable the [IRS] to correctly determine income tax liability. Accordingly, it is to the advantage of taxpayers who may be called upon to substantiate expense account information to maintain as adequate and detailed records of travel, transportation, entertainment, and similar business expenses as practical since the burden of proof is upon the taxpayer to show that such expenses were not only paid or incurred but also that they constitute ordinary and necessary business expenses. One method for substantiating expenses incurred by an employee in connection with his employment is through the preparation of a daily diary or record of expenditures, maintained in sufficient detail to enable him to readily identify the amount and nature of any expenditure, and the preservation of supporting documents, especially in connection with large or exceptional expenditures. Nevertheless, it is recognized that by reason of the nature of certain expenses or the circumstances under which they are incurred, it is often difficult for an employee to maintain detailed records or to preserve supporting documents for all his expenses. Detailed records of small expenditures incurred in traveling or for transportation, as for example, tips, will not be required.

Where records are incomplete or documentary proof is unavailable, it may be possible to establish the amount of the expenditures by approximations based upon reliable secondary sources of information and collateral evidence. For example, in connection with an item of traveling expense a taxpayer might establish that he was in a travel status a certain number of days but that it was impracticable for him to establish the details of all his various items of travel expense. In such a case rail fares or plane fares can usually be ascertained with exactness and automobile costs approximated on the basis of mileage covered. A reasonable approximation of meals and lodging might be based upon receipted hotel bills or upon average daily rates for such accommodations and meals prevailing in the particular community for comparable accommodations. Since detailed records of incidental items are not required, deductions for these items may be based upon a reasonable approximation. In cases where a taxpayer is called upon to substantiate expense account information, the burden is on the taxpayer to establish that the amounts claimed as a deduction are reasonably accurate and constitute ordinary and necessary business expenses paid or incurred by him in connection with his trade or business. In connection with the determination of factual matters of this type, due consideration will be given to the reasonableness of the stated expenditures for the claimed purposes in relation to the taxpayer’s circumstances (such as his income and the nature of his occupation), to the reliability and accuracy of records in connection with other items more readily lending themselves to detailed recordkeeping, and to all of the facts and circumstances in the particular case. Treas. Reg. 1.162-17.

Estimating business expenses

Employees who incur transportation, travel, entertainment, or gift expenses, or expenses associated with the purchase or use of listed property, in connection with their employment must substantiate each element of an expense or use as noted above. Estimating the amount of such expenses is strictly prohibited, even though it is clear that a taxpayer incurred some expenses. This limitation supersedes the “Cohan rule,” which allows taxpayers to estimate the amount of business expenses other than transportation, travel, entertainment or gift expenses, or expenses connected with listed property. Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930).

Adequate records

To maintain adequate records, you should keep the proof you need in an account book, diary, statement of expense, or similar record. You should also keep documentary evidence that, together with your record, will support each element of an expense.

Documentary evidence

You generally must have documentary evidence, such as receipts, canceled checks, or bills, to support your expenses. Documentary evidence is not needed if any of the following conditions apply: (1) You have meals or lodging expenses while traveling away from home for which you account to your employer under an accountable plan, and you use a per diem allowance method that includes meals or lodging. (2) Your expense, other than lodging, is less than $75. (3) You have a transportation expense for which a receipt is not readily available.

Documentary evidence ordinarily will be considered adequate if it shows the amount, date, place, and essential character of the expense. A canceled check, together with a bill from the payee, ordinarily establishes the cost. However, a canceled check by itself does not prove a business expense without other evidence to show that it was for a business purpose.

You do not have to record information in your account book or other record that duplicates information shown on a receipt as long as your records and receipts complement each other in an orderly manner.

You do not have to record amounts your employer pays directly for any ticket or other travel item. However, if you charge these items to your employer, through a credit card or otherwise, you must keep a record of the amounts you spend.

You should record the elements of an expense or of a business use at or near the time of the expense or use and support it with sufficient documentary evidence. A timely kept record has more value than a statement prepared later, when generally there is a lack of accurate recall. You do not need to write down the elements of every expense on the day of the expense. If you maintain a log on a weekly basis that accounts for use during the week, the log is considered a timely kept record. If you give your employer an expense account statement, it can also be considered a timely kept record. This is true if you copy it from your account book, diary, statement of expense, or similar record.

Proving business purpose

You must generally provide a written statement of the business purpose of an expense. However, the degree of proof varies according to the circumstances in each case. If the business purpose of an expense is clear from the surrounding circumstances, you do not need to give a written explanation.

Example:
A minister who frequently visits church members in a local hospital does not have to give a written explanation of the business purpose for traveling to that destination. He can satisfy the requirements by recording the length of the route once, the date of each trip at or near the time of the trips, and the total miles he drove the car during the tax year.

Confidential information

You do not need to put confidential information relating to an element of a deductible expense (such as the place, business purpose, or business relationship) in your account book, diary, or other record. However, you do have to record the information elsewhere at or near the time of the expense and have it available to fully prove that element of the expense.

If you do not have complete records to prove an element of an expense, then you must prove the element with: (1) your own written or oral statement containing specific information about the element, and (2) other supporting evidence that is sufficient to establish the element. If the element is the cost, time, place, or date of an expense, the supporting evidence must be either direct evidence or documentary evidence. Direct evidence can be written statements or the oral testimony of your guests or other witnesses, setting forth detailed information about the element. Documentary evidence can be receipts, paid bills, or similar evidence. If the element is either the business relationship of your guests or the business purpose of the amount spent, the supporting evidence can be circumstantial rather than direct.

Sampling

The income tax regulations specify: “[A] taxpayer may maintain an adequate record for portions of a taxable year and use that record to substantiate the business use of listed property for all or a portion of the taxable year if the taxpayer can demonstrate by other evidence that the periods for which an adequate record is maintained are representative of the use for the taxable year or a portion thereof.” Treas. Reg. 1.274-5T(c)(3)(ii)(A).

Example:
You keep adequate records during the first week of each month that show that 75 percent of the use of your car is for business. Invoices and bills show that your business use continues at the same rate in the later weeks of each month. Your weekly records are representative of the use of the car each month and are sufficient evidence to support the percentage of business use for the year.

Destroyed records

If you cannot produce a receipt for reasons beyond your control, you can prove a deduction by reconstructing your records or expenses. Reasons beyond your control include fire, flood, and other casualty.

Each separate payment is generally considered a separate expense that must be recorded separately in your records. You can make one daily entry in your record for reasonable categories of expenses. Examples are taxi fares, telephone calls, or other incidental travel costs. Meals should be in a separate category. You can include tips for meal-related services with the costs of the meals. Expenses of a similar nature occurring during the course of a single event are considered a single expense.

You must keep records as long as they may be needed for the administration of any provision of the tax code. Generally, this means you must keep records that support your deduction for three years from the date you file the income tax return on which the deduction is claimed. A return filed early is considered filed on the due date.

Employees who give their records and documentation to their employers and are reimbursed for their expenses generally do not have to keep copies of this information. However, you may have to prove your expenses if any of the following conditions apply: (1) you claim deductions for expenses that are more than reimbursements; (2) your expenses are reimbursed under a nonaccountable plan; or (3) your employer does not use adequate accounting procedures to verify expense accounts.

Most church employees incur out-of-pocket business expenses during the course of the year for transportation, travel, entertainment, education, books, and similar items. These expenses can be handled and reported in any one of three ways: (1) unreimbursed, (2) nonaccountable reimbursements, or (3) accountable reimbursements. These methods are summarized below.

CAUTION: The Tax Cuts and Jobs Act of 2017 suspended any itemized deduction for employees’ unreimbursed business expenses through 2025. These expenses can be reimbursed by an employer under an accountable arrangement or deducted on Schedule C (Form 1040) by persons who are self-employed under prevailing tests used by the IRS and the courts.

Many churches do not reimburse their employees’ business and professional expenses. Such employees have unreimbursed business expenses. Some churches reimburse employees’ business expenses only up to a specified amount. Such employees have unreimbursed expenses to the extent that they incur expenses in excess of what the church is willing to reimburse.

Church staff who are self-employed for federal income tax reporting purposes can deduct their unreimbursed business expenses directly on Schedule C regardless of whether they are able to itemize expenses on Schedule A.

Many churches reimburse some or all of their employees’ business expenses. Reimbursements may be either nonaccountable or accountable. A reimbursement arrangement is nonaccountable if it fails to meet any one or more of the four requirements for an accountable reimbursement plan described in the following section.

A common example of a nonaccountable reimbursement arrangement is a monthly car allowance. Many churches pay their minister a monthly allowance to cover business use of an automobile without requiring any substantiation of actual expenses or a return of the amount by which the allowance exceeds actual expenses. Such a reimbursement arrangement is called a nonaccountable reimbursement arrangement since the minister is not required to account for (substantiate) the actual amount, date, place, and business purpose of each reimbursed expense.

What are the tax consequences of a nonaccountable plan? That depends on whether a worker is an employee or self-employed for federal income tax reporting purposes.

Employees

For employees, the full amount of the church’s reimbursements must be reported as income on Forms W-2 and 1040. Furthermore, no itemized deduction is allowed after 2017 for nonaccountable reimbursed employee business expenses.

Self-employed

For church staff who are self-employed for federal income tax reporting purposes, the full amount of the church’s reimbursements must be reported by the church as income on Form 1099-NEC (and by the worker on Schedule C). The worker is then able to deduct expenses on Schedule C regardless of whether he or she can itemize expenses on Schedule A. This is seen by some to be an advantage of reporting income taxes as self-employed. However, because the IRS considers most workers (including ministers) to be employees for income tax reporting purposes, those who report their income taxes as self-employed should not assume that they are unaffected by the limitations on the deductibility of employee business expenses. In fact, this is one of the primary reasons the IRS targets self-employed workers. If it succeeds in reclassifying self-employed workers as employees, then their business expenses are shifted from Schedule C to Schedule A, where they no longer are deductible.

Church staff who are self-employed for income tax reporting purposes are not affected by the limitations on the deductibility of employee business expenses, since they can deduct all of their business expenses directly on Schedule C.

Examples of nonaccountable arrangements

Here are some common examples of nonaccountable reimbursement arrangements that should be avoided. If you currently have any of these arrangements, it is recommended that you consider switching to an accountable arrangement.

Example:
Pastor B serves as a senior minister of a church and reports his federal income taxes as an employee. The church expects Pastor B to pay business expenses out of his own salary, so it reimburses none of Pastor B’s business expenses. In other words, all of Pastor B’s business expenses are unreimbursed. For 2024, Pastor B had total church compensation of $35,000 and unreimbursed business expenses of $3,000. No itemized deduction is allowed after 2017 for unreimbursed (or nonaccountable reimbursed) employee business expenses, so these expenses are not deductible.

Example:
Pastor H receives a monthly car allowance of $300. Pastor H is not required to account for the use of any of these funds. This is an example of a nonaccountable reimbursement arrangement. The church is reimbursing business expenses (through a monthly car allowance) without requiring any accounting or substantiation. For employees, no itemized deduction is allowed after 2017 for unreimbursed (or nonaccountable reimbursed) employee business expenses, so these expenses are not deductible. Self-employed workers may continue to deduct their business expenses on Schedule C (Form 1040). See Chapter 2.

The adverse tax consequences associated with both unreimbursed and nonaccountable reimbursed business expenses can be eliminated if a church adopts an accountable expense reimbursement arrangement. This is one of the most important components of the compensation packages of ministers and lay church employees.

If a church adopts an accountable reimbursement arrangement, none of the church’s reimbursements appears on an employee’s Form W-2 (or 1040), and there are no expenses for the employee to deduct. The employee, in effect, accounts to the employer rather than to the IRS. This is the ideal way for churches to handle the business expenses of ministers and any other church worker.

To be an accountable plan, an employer’s reimbursement or allowance arrangement must comply with all four of the following rules:

Each of these requirements is explained in the following paragraphs.

Business connection

The tax regulations define the business connection requirement as follows: “An arrangement meets the [business connection requirement] if it provides . . . ​reimbursements only for business expenses that are allowable as [itemized deductions by the tax code] and are paid or incurred by the employee in connection with the performance of services as an employee of the employer.” Treas. Reg. 1.62-2(d).

Similarly, IRS Publication 463 (Travel, Entertainment, Gift, and Car Expenses) states: “Your expenses must have a business connection—that is, you must have paid or incurred deductible expenses while performing services as an employee of your employer.”

In summary, the business connection requirement means that an employer only reimburses business expenses that would have been deductible as itemized expenses under prior law. 

Churches occasionally reimburse ministers for nonbusiness expenses. Such reimbursements, though they require an accounting, ordinarily must be included in the minister’s wages for income tax reporting purposes, and they are not deductible by the minister. Such “personal, living, or family expenses” are not deductible, and the entire amount of a church’s reimbursement must be included on the minister’s Form W-2 and Form 1040.

Adequate accounting

You must adequately account to your employer for any business expense it reimburses. Following are the rules.

Adequate accounting—the general rule

Section 1.162-17 of the income tax regulations, which applies to all business and professional expenses other than listed property or transportation, travel, entertainment, and gift expenses, provides:

The employee [or self-employed person] need not report on his tax return (either itemized or in total amount) expenses . . . ​paid or incurred by him solely for the benefit of his employer for which he is required to account and does account to his employer and which are charged directly or indirectly to the employer (for example, through credit cards) or for which the employee is paid through advances, reimbursements, or otherwise, provided the total amount of such advances, reimbursements, and charges is equal to such expenses. In such a case the taxpayer need only state in his return that the total of amounts charged directly or indirectly to his employer through credit cards or otherwise and received from the employer as advances or reimbursements did not exceed the ordinary and necessary business expenses paid or incurred by the employee. . . . ​To “account” to his employer . . . ​means to submit an expense account or other required written statement to the employer showing the business nature and the amount of all the employee’s expenses (including those charged directly or indirectly to the employer through credit cards or otherwise) broken down into such broad categories as transportation, meals and lodging while away from home overnight, entertainment expenses, and other business expenses.

Adequate accounting—transportation, travel, entertainment, gift expenses, and “listed property”

The substantiation requirements for transportation, travel, entertainment, and gift expenses are set forth in section 1.274-5T(f) of the income tax regulations:

For purposes of computing tax liability, an employee [or self-employed person] need not report on his tax return business expenses for travel, transportation, entertainment, gifts, or with respect to listed property, paid or incurred by him solely for the benefit of his employer for which he is required to, and does, make an adequate accounting to his employer . . . ​and which are charged directly or indirectly to the employer (for example, through credit cards) or for which the employee is paid through advances, reimbursements, or otherwise, provided that the total amount of such advances, reimbursements, and charges is equal to such expenses. . . .

[A]n adequate accounting means the submission to the employer of an account book, diary, log, statement of expense, trip sheet, or similar record maintained by the employee in which the information as to each element of an expenditure or use [amount, time and place, business purpose, and business relationship] is recorded at or near the time of the expenditure or use, together with supporting documentary evidence, in a manner which conforms to all the “adequate records” requirements [described under “Recordkeeping” on page ]. An adequate accounting requires that the employee account for all amounts received from his employer during the taxable year as advances, reimbursements, or allowances (including those charged directly or indirectly to the employer through credit cards or otherwise) for travel, entertainment, gifts, and the use of listed property.

Listed property is defined by the tax code to include (i) any passenger automobile; (ii) any other property used as a means of transportation; (iii) any property of a type generally used for purposes of entertainment, recreation, or amusement; and (iv) any computer or peripheral equipment. IRC 280F(d)(4).

Section 1.274-5T(f) goes on to provide that “an employee who makes an adequate accounting to his employer . . . ​will not again be required to substantiate such expense account information,” except in the following cases: (1) an employee whose business expenses exceed the total of amounts charged to his employer and amounts received through advances, reimbursements, or otherwise and who claims a deduction on his return for such excess; or (2) employees in cases where it is determined that the accounting procedures used by the employer for the reporting and substantiation of expenses by such employees are not adequate, or where it cannot be determined that such procedures are adequate.

Key Points:

Credit cards

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.

When employees should account for their business expenses

The income tax regulations specify that under an accountable reimbursement arrangement, an employee’s accounting or substantiation of business expenses and the return of any excess reimbursements must occur within a “reasonable time.” The regulations state that “the determination of a reasonable period of time will depend on the facts and circumstances.” However, the regulations provide the following two “safe harbors” that will satisfy the reasonable time requirement:

Fixed date method. Under the fixed date method, business expenses will be deemed substantiated within a reasonable amount of time if done within 60 days after the expenses are paid or incurred, and excess reimbursements will be deemed to have been returned to the employer within a reasonable amount of time if done within 120 days after the expenses are paid or incurred.

Periodic statement method. Under the periodic statement method, an employer gives employees a periodic statement (not less often than quarterly) setting forth the amount by which the employer’s reimbursements exceed the amount of business expenses substantiated by the employee and requesting the employee to either substantiate the difference or return it within 120 days of the statement. Expenses that are substantiated or returned during the 120-day period satisfy the reasonable time requirement.

Tax withholding

Business expense reimbursements or allowances paid to employees must be included on the employees’ Forms W-2, and income taxes and Social Security and Medicare taxes must be withheld—unless the reimbursements are paid under an accountable reimbursement plan. But the withholding requirements will not apply to ministers, who are exempt from tax withholding (unless they have elected voluntary withholding).

How churches pay for expense reimbursements

A church can fund an accountable reimbursement plan in a variety of ways. First, it can agree to reimburse all substantiated business expenses without limitation. Second, it can agree to reimburse substantiated expenses up to a fixed limit (e.g., $4,000 per year). Any business expenses incurred by the minister in excess of this amount would be unreimbursed. Third, some churches reimburse employee business expenses through “salary reductions.” This practice has been repudiated by the IRS. Salary reduction arrangements are fully addressed later in this chapter.

Employee records and receipts

Regulation 1.274-5T(f) (quoted above) specifies that a reimbursement arrangement will not satisfy the requirements of an accountable arrangement “to the extent that the employer . . . ​does not require an adequate accounting from its employees or does not maintain such substantiation. To the extent an employer fails to maintain adequate accounting procedures he will thereby obligate his employees to separately substantiate their expense account information.”

Making a nonaccountable arrangement accountable

An employee cannot make a nonaccountable arrangement accountable. The regulations specify that “if a payor provides a nonaccountable plan, an employee who receives payments under the plan cannot compel the payor to treat the payments as paid under an accountable plan by voluntarily substantiating the expenses and returning any excess to the payor.” Treas. Reg. 1.62-2(c)(3)(i).

Independent contractors

The income tax regulations permit independent contractors (i.e., self-employed persons) to be reimbursed for their business expenses; such reimbursements need not be reported as income to the extent that the self-employed individual properly accounts to his or her client or customer for each expense that is reimbursed.

Generally, the substantiation and accounting requirements described above for employees apply to self-employed persons as well. Since self-employed ministers are permitted to deduct their business expenses (whether unreimbursed or reimbursed under a nonaccountable plan) directly on Schedule C regardless of whether they can itemize deductions on Schedule A, there is less need for a reimbursement policy. However, an accountable reimbursement plan for self-employed persons would have the following advantages: (1) it would reduce the likelihood of additional taxes if the self-employed individual is audited by the IRS and reclassified as an employee; and (2) it will reduce audit risk by permitting the individual to report to his or her church rather than to the IRS.

Ownership of property purchased by a church under an accountable expense reimbursement arrangement

A question that often arises is, who owns property purchased by a pastor or lay employee if the purchase price is reimbursed by the church under an accountable arrangement? Let’s illustrate the practical significance of this question with a few examples.

Example 1:
A church adopted an accountable expense reimbursement arrangement several years ago. It reimburses those expenses incurred by any of its employees who are adequately substantiated. To substantiate an expense, an employee must submit proof of its amount, date, location, and business purpose. Receipts are required for any expense of $75 or more. Substantiation of each expense must be completed within a month of the date the expense was incurred. Such an arrangement qualifies as an accountable expense reimbursement arrangement. Assume that Pastor D purchased a personal computer for $2,000 in 2024 that he uses entirely for work-related duties (sermon preparation, research, and communicating with church members and other ministers). In 2025, one year after purchasing the computer, Pastor D accepts a position at Second Church. A few days before moving, the church treasurer asks Pastor D about the computer. Will he be leaving it or taking it with him? Pastor D is unsure who should keep it, and so is the church treasurer.

Example 2:
Pastor B has served as pastor of First Church for 20 years. Over that time, he has purchased several books and commentaries for a professional library that he maintains in his church office. Many of the books were purchased in the past few years. The church has reimbursed Pastor B for the purchase of all these books. The reimbursements have amounted to $3,000. Pastor B accepts a position at Second Church. As his last day at First Church approaches, he begins to wonder about his library. Should he leave it for his successor at First Church? After all, the church paid for it. Or should he pack it up and take it with him? He asks the church treasurer for her opinion, but she is unsure. They agree to let the pastor take the library with him. This decision is based on the fact that a pastor’s library is a matter of personal preference, so Pastor B’s library may be of little, if any, use to his successor. Further, they assume that the next pastor probably will bring his own library with him from his previous church.

An accountant who attends First Church learns that Pastor B will be taking the library with him. The accountant questions the legality of this arrangement. The church board addresses this issue but does not know how to resolve it. They want to let Pastor B take the library with him, but they do not know how to explain such a decision to the accountant.

Example 3:
Pastor T is the youth pastor and resident “computer expert” at his church. During the three years he is employed by the church, he purchases several software programs to assist in the performance of his duties. The church reimbursed him for all of these purchases, which amounted to nearly $1,500. Pastor T accepts a position at another church. A question arises as to the ownership of the computer programs.

The tax code and regulations do not address the question of who owns property purchased by an employee if the purchase price is reimbursed by the employer under an accountable reimbursement arrangement. And no guidance has been provided by the IRS or the courts. So what should ministers and churches do? Here are some options:

The general rule. In general, when an employer reimburses an employee for the cost of property purchased by the employee for business use, it is the employer rather than the employee that is the legal owner of the property. After all, property purchased by an employee cannot be reimbursed under an accountable arrangement unless the employee substantiates the cost and business purpose of the property. In other words, it must be clear that the property will be used solely for the business purposes of the employer. Under these circumstances, there is little doubt as a matter of law that the employer is the legal owner of the property. The employer paid for it, and the accountable nature of the reimbursement arrangement ensures that it will be used by the employee within the course of his or her employment on behalf of the employer.

A possible exception. In many cases the value of property diminishes rapidly, and in a sense is “used up” within a period of months or a few years. As a result, the question of ownership of the property when the employee leaves his or her job has little relevance since the value is minimal.

Example 4
A pastor purchased a small dictation machine for $49 five years ago. The church treasurer reimbursed her for the cost of the machine under the church’s accountable reimbursement arrangement. When she leaves the church in 2025, the value of the machine is negligible. The “value” of the machine has been “used up” over its useful life. The church has realized the full value for the purchase, and it would be pointless to insist that the machine remain with the church.

Example 5
Pastor G purchased a “state of the art” computer in 2010 at a cost of $2,500. The church reimbursed the full purchase price since the pastor used the computer exclusively for church-related work. Pastor G accepts a position at Second Church in 2025. He is still using the same computer, and a question arises as to the ownership of the machine. While the computer may have been “state of the art” in 2010, it is worthless in 2025. Like the dictation equipment described in the previous example, the church has received full value for its purchase of the computer, and it would be pointless to insist that the computer remain with the church.

Inurement. Churches should be concerned about the issue of inurement when they allow a minister or other employee to retain ownership and possession of property purchased by the church for church use. Churches are exempt from federal income taxes so long as they comply with a number of conditions set forth in section 501(c)(3) of the tax code. One of those conditions is that “no part of the net earnings [of the church or charity] inures to the benefit of any private shareholder or individual.” What does this language mean? The IRS has provided the following clarification:

An organization’s trustees, officers, members, founders, or contributors may not, by reason of their position, acquire any of its funds. They may, of course, receive reasonable compensation for goods or services or other expenditures in furtherance of exempt purposes. If funds are diverted from exempt purposes to private purposes, however, exemption is in jeopardy. The Code specifically forbids the inurement of earnings to the benefit of private shareholders or individuals. . . . ​The prohibition of inurement, in its simplest terms, means that a private shareholder or individual cannot pocket the organization’s funds except as reasonable payment for goods or services. IRS Exempt Organizations Handbook section 381.1.

It is possible that prohibited inurement occurs when a church allows a minister or other employee to retain ownership and possession of property purchased with church funds for church use. However, in many cases the value of the property will be so minimal that inurement probably is not a problem. To avoid any question, especially if the property has some appreciable residual value, the church could “sell” the property to the employee, or it could determine the property’s market value and add that amount to the employee’s final Form W-2 or 1099-NEC as additional compensation. In either case, the inurement problem would be avoided.

In deciding whether inurement has occurred, the relevant considerations are as follows:

IRS regulations specify the useful life of several different kinds of property to allow taxpayers to compute depreciation deductions. These guidelines can be a helpful resource in deciding whether inurement has occurred.

Let’s apply the inurement principle to the above five examples.

Example 1:
Inurement is a possibility according to the above criteria since (1) the purchase price paid by the church was substantial; (2) a one-year-old computer still has a remaining “useful life” (according to IRS regulations, the useful life of computer equipment is five years); (3) the computer was purchased one year ago; and (4) the residual value of a one-year-old computer is still significant. To avoid jeopardizing the church’s tax-exempt status as a result of prohibited inurement, the church has three options. First, it can ask Pastor D to return the computer. Second, it can let Pastor D keep the computer but add the current value of the computer to Pastor D’s Form W-2. The computer’s current value can be obtained by calling local computer dealers, especially those dealing in used equipment. Third, the church can sell the computer to Pastor D for its current value.

Example 2:
Inurement is a possibility according to the above criteria since (1) the purchase price paid by the church was substantial; (2) some of the books still have a remaining “useful life” (according to IRS regulations, the useful life of books is seven years); (3) while some of the books were purchased more than seven years ago, many were purchased within the past seven years; and (4) the residual value of books purchased within the past seven years is still significant. To avoid jeopardizing the church’s tax-exempt status as a result of prohibited inurement, the church has three options. First, it can ask Pastor B to return books purchased within the past seven years. Books purchased prior to that time are beyond their “useful life,” according to IRS regulations, so their value is presumed to be insignificant. Second, it can let Pastor B keep the entire library but add the current value of books purchased within the past seven years to his Form W-2 as compensation. The current value of these books can be obtained by calling a used book dealer. Third, the church can sell the books to Pastor B for their current value.

Example 3:
Inurement is a possibility according to the above criteria since (1) the purchase price paid by the church was substantial; (2) the CDs and software programs still have a remaining “useful life” (according to IRS regulations, the useful life of computer software is 36 months); (3) the CDs and software were purchased in the recent past (within the 36-month useful life specified by the IRS regulations); and (4) the residual value of the CDs and software is still significant. To avoid jeopardizing the church’s tax-exempt status because of prohibited inurement, the church has three options. First, it can ask Pastor T to return the CDs and software. Second, it can let Pastor T keep the CDs and software but add the current value of these items to his Form W-2. The current value of CDs and software can be obtained from a local computer dealer, especially one that deals with used products. Third, the church can sell the CDs and software to Pastor T for their current value.

Example 4:
Inurement is not a possibility according to the above criteria, since (1) the purchase price paid by the church was minimal; and (2) the current residual value of a dictation machine that cost $49 five years ago is negligible. IRS regulations specify that the useful life of such equipment is seven years, and so the machine still has a remaining useful life. However, the age and minimal cost of the machine outweigh the significance of any remaining useful life.

Example 5:
Inurement is not a possibility according to the above criteria, even though the original cost was substantial, since (1) the computer has outlived its “useful life” (according to IRS regulations, the useful life of computer equipment is seven years); (2) the computer was purchased in 2010 and is now functionally obsolete; and (3) the residual value of a 2010 computer is negligible.

Returning excess reimbursements

Under an accountable plan, you are required to return any excess reimbursement or other expense allowance for your business expenses to your employer. Excess reimbursement means any amount for which you did not adequately account within a reasonable period. For example, if you received a travel advance and you did not spend all the money on business-related expenses, or you do not have proof of all your expenses, you have an excess reimbursement. You must return an excess reimbursement to your employer within a reasonable period of time. While the meaning of a reasonable period depends on the facts of each case, the IRS will always accept 120 days as a reasonable period.

The income tax regulations specify that if an employer establishes an accountable arrangement but an employee fails to return, within a reasonable period of time, any reimbursements in excess of substantiated expenses, “only the amounts paid under the arrangement that are not in excess of the substantiated expenses are treated as paid under an accountable plan.”

Using salary reductions to reimburse employee business expenses (the “reimbursement requirement”)

The income tax regulations caution that for an employer’s reimbursement arrangement to be accountable, it must meet a “reimbursement requirement” in addition to the three requirements summarized above (business connection, adequate accounting, and return of excess reimbursements).

The reimbursement requirement is described by the income tax regulations as follows: “If [an employer] arranges to pay an amount to an employee regardless of whether the employee incurs (or is reasonably expected to incur) business expenses . . . ​the arrangement does not satisfy [the reimbursement requirement] and all amounts paid under the arrangement are treated as paid under a nonaccountable plan.” Treas. Reg. 1.62-2(d)(3).

The IRS interprets this regulation to prohibit accountable reimbursement plans from reimbursing employee business expenses through salary reductions. Employers who agree to pay an employee a specified annual income and agree to reimburse the employee’s business expenses out of salary reductions have “arranged to pay an amount to an employee regardless of whether the employee incurs business expenses.”

In explaining this regulation, the IRS observed:

Example:
A church pays its senior pastor, Pastor G, an annual salary of $52,000 ($1,000 each week). The church also agreed that it would reimburse Pastor G’s substantiated business expenses through salary reductions. At the beginning of each month, Pastor G substantiates his business expenses for the previous month, and he is issued a paycheck for the first week of the next month consisting of both salary and expense reimbursement. Pastor G substantiated $400 of business expenses for January 2025 during the first week of February. The church issued Pastor G his customary check of $1,000 for the first week of February, but only $600 of this check represents taxable salary, while the remaining $400 represents reimbursement of Pastor G’s business expenses. The church only accumulates the $600 to Pastor G’s Form W-2 that it will issue at the end of the year.

Such arrangements are used by some churches. However, they are nonaccountable according to the regulation quoted above since Pastor G would receive his full salary of $52,000 if he chose not to incur any business expenses. As a result, the church would report the full salary of $52,000 as income on Pastor G’s Form W-2.

The above-quoted regulation (imposing the reimbursement requirement) effectively put an end to a common church practice that allowed many employees to enjoy the advantages of an accountable plan without any additional cost to the church. Regulation 1.62-2(d)(3), by imposing the reimbursement requirement, makes such arrangements nonaccountable. They are not illegal. They simply cannot be considered accountable. Even if they satisfy the first three requirements for an accountable reimbursement arrangement (described above), they do not meet the regulation’s reimbursement requirement. This is so for the following two reasons:

Example:
A church agreed to pay its youth minister, Pastor P, an annual salary for 2025 of $36,000 ($692 per week). In February of 2025, Pastor P accounts to the church treasurer for $300 of business and professional expenses that he incurred in the performance of his ministry in January 2025. Pastor P receives two checks for the first week in February—a check in the amount of $300, reimbursing him for the business and professional expenses he accounted for, and a paycheck in the amount of $392 (the balance of his weekly pay of $692). His weekly compensation remains $692, but $300 of this amount constitutes a business expense reimbursement. The same procedure is followed for every other month during the year.

Because of the income tax regulation discussed in this section, this arrangement constitutes a nonaccountable plan. As a result: (1) Pastor P’s Form W-2 for 2025 must include the full salary of $36,000; (2) Pastor P must report $36,000 as income on his Form 1040; and (3) if Pastor P reports his income taxes as an employee (or as self-employed but is reclassified as an employee by the IRS in an audit), he no longer can deduct business expenses as a miscellaneous itemized deduction on Schedule A (Form 1040). The key point is this—accountable reimbursement arrangements cannot fund business expense reimbursements out of an employee’s salary.

Salary “restructuring”

Can the regulation prohibiting the funding of business expenses under an accountable arrangement through salary reductions be avoided by proper drafting of an employee’s compensation package?

Example:
Assume that Pastor K and his church are discussing compensation for the next year and that the church board proposes to pay Pastor K $50,000. However, since it will require Pastor K to pay his own business expenses, the church board decides to pay Pastor K a salary of $46,000 and establish a separate church account for $4,000, out of which substantiated business expenses will be reimbursed. At the end of the year, any balance remaining in the reimbursement account would belong to the church, not Pastor K. It would not be distributed to Pastor K as a “bonus” or as additional compensation.

Since Pastor K has no right to any of the reimbursement account funds ($4,000) unless he adequately substantiates his business expenses, this arrangement should be permissible under the regulation. The church has not “agreed to pay an amount to an employee regardless of whether the employee incurs deductible business expenses.” But the IRS disagreed with this conclusion in a 1993 private letter ruling. IRS Letter Ruling 9325023. The ruling addressed the question of whether the following arrangement could be considered accountable:

Company X proposes to modify the district manager’s compensation arrangement to allow each district manager to elect on an annual basis and prior to the beginning of each calendar year to reduce the amount of gross commission payable to him for the upcoming calendar year. Under the arrangement, the district manager may elect to reduce his gross commissions by a percentage ranging from 0 to 40 percent. In exchange for the reduction in commissions, Company X will pay the district manager’s business expenses for the calendar year up to a maximum amount equal to the amount by which the district manager elected to reduce his commissions. Company X will pay only for expenses that satisfy the business connection and substantiation requirements of . . . ​the income tax regulations. If the expenses a district manager incurs in a calendar year are less than the amount by which the gross commissions were reduced, the excess amounts will be forfeited and may not be carried over and used for expenses incurred in the next calendar year.

The IRS began its ruling by noting that “a gratuitous assignment of income does not shift the burden of taxation and the donor is taxable when the income is received by the donee.” The IRS continued:

If a district manager of Company X elects to forgo future compensation under the reimbursement arrangement in consideration of Company X’s agreement to reimburse his business expenses up to an equivalent amount, the district manager is making an anticipatory assignment of future income to Company X for consideration (the reimbursements). Thus, when Company X reimburses a district manager, the district manager is treated as currently receiving the forgone compensation for which the reimbursement is a substitute. Accordingly, we conclude that when Company X reimburses a district manager for employee business expenses, the reimbursements will be includible in the district manager’s gross income in the taxable year when paid just as if the district manager had received the forgone compensation. We also conclude, as explained below, that the reimbursements are subject to employment taxes because they are not paid under an arrangement that is an accountable plan.

The IRS then quoted the following example that appears in the income tax regulations:

Employer S pays its engineers $200 a day. On those days that an engineer travels away from home on business for Employer S, Employer S designates $50 of the $200 as paid to reimburse the engineer’s travel expenses. Because Employer S would pay an engineer $200 a day regardless of whether the engineer was traveling away from home, the arrangement does not satisfy the reimbursement requirement of [the regulations]. Thus, no part of the $50 Employer S designated as a reimbursement is treated as paid under an accountable plan. Rather, all payments under the arrangement are treated as paid under a nonaccountable plan. Employer S must report the entire $200 as wages or other compensation on the employees’ Forms W-2 and must withhold and pay employment taxes on the entire $200 when paid.

The IRS noted that “the conclusion to be reached from this example is that an employer may not recharacterize a portion of an employee’s salary as being paid under a reimbursement arrangement or other expense allowance arrangement.” Further, the example illustrates that

in order to have an accountable plan . . . ​the code and regulations contemplate that the reimbursement or other expense allowance arrangement provided by an employer should be amounts paid to an employee in addition to salary. This conclusion is supported by the preamble to the final regulations published in the Federal Register on December 17, 1990, which provides that no part of an employee’s salary may be recharacterized as being paid under a reimbursement arrangement or other expense allowance arrangement. [Emphasis added.]

The IRS concluded that the reimbursement arrangement proposed by Company X would

Example:
The IRS released a private letter ruling in 1999 in which it concluded that appropriate salary restructuring arrangements could avoid the prohibition on the use of salary reduction arrangements to pay for business expense reimbursements under an accountable arrangement, so long as (1) the restructuring arrangement was done in advance of the year; (2) employees are reimbursed for employee business expenses that would be deductible as business expenses on their personal tax returns; (3) employees who do not request reimbursement under the plan receive no additional compensation; and (4) employees requesting reimbursement must account for reimbursed expenses within 45 days after the expense is incurred.

The IRS concluded that the company’s plan satisfied all the requirements for an accountable plan, and therefore: (1) reimbursements made to a consultant under the plan may be excluded from the consultant’s income as payments made under an accountable plan; and (2) reimbursements made to a consultant under the plan are not wages subject to employment taxes and are not reportable on the consultant’s Form W-2. IRS Letter Ruling 199916011.

IRS audit guidelines for ministers

The IRS has issued guidelines for its agents to follow when auditing ministers. The guidelines inform agents that if a church has a salary reduction arrangement that “reimburses” a minister for employee business expenses by reducing his or her salary, the arrangement will be treated as a nonaccountable plan. This is the result

The guidelines instruct IRS agents to be alert to salary reduction arrangements that are used to fund reimbursements under an “accountable” arrangement. According to the IRS, accountable plans cannot reimburse employee business expenses out of salary reductions. The important point is this—the guidelines are educating IRS agents as to this issue, so it is now far more likely that salary restructuring and salary reduction arrangements will be discovered and questioned in an audit.

Conclusions

Ministers, lay staff members, church treasurers, and church board members should be aware of the following points:

Example:
In December 2024 a church board addresses the compensation package for its minister for 2025. It decides to set aside $50,000 for the minister’s total compensation package consisting of a salary of $40,000 and a housing allowance of $10,000. During the same meeting, the board discusses the minister’s business expenses and agrees to create a business expense reimbursement account in the amount of $5,000 that it will use to pay for business expenses that the minister incurs and that are reimbursed by the church under an accountable reimbursement arrangement. This account is funded by the church and not by salary reduction.

This arrangement may not be a salary reduction or salary restructuring arrangement, since the board elected to create the expense reimbursement account independently from its consideration of the minister’s compensation. Further, the arrangement arguably meets all the requirements for an accountable reimbursement arrangement. It meets the reimbursement requirement (summarized above) because (1) the church will only distribute funds from the $5,000 business expense account as reimbursements of substantiated expenses, and (2) reimbursements are entirely separate from salary. As a result, business expenses the minister incurs in 2025 may be reimbursed by the church out of the expense reimbursement account if the requirements for an accountable reimbursement arrangement are met, and such reimbursements will not represent taxable income to the minister.

Whether the IRS and the courts would accept this reasoning remains to be seen. At best, it is an aggressive approach that should not be adopted without the advice of a tax professional.

Example:
In December 2024, a church board addresses the compensation package for its minister for 2025. It decides to set aside $55,000 for the minister’s total compensation package and adopts a resolution authorizing total compensation of $55,000, consisting of salary of $40,000, a housing allowance of $10,000, and reimbursement of business expenses up to $5,000. This arrangement clearly would be regarded as a salary restructuring arrangement by the IRS, meaning that any of the minister’s business expenses reimbursed by the church would not be accountable, and so the reimbursements would have to be reported as taxable income by the church.

There is very little difference, other than semantics, in these examples. However, the precise language used by the church board may determine the tax consequences.

Additional examples

The following examples illustrate the most important principles addressed under “Accountable reimbursed expenses” on page .

Example 1:
A church pays its pastor compensation of $50,000 this year. In addition, it reimburses business expenses incurred by the pastor during the year up to $5,000 if the pastor provides adequate substantiation of each expense within 30 days. This is an accountable reimbursement arrangement. Amounts reimbursed by the church are not reported on the pastor’s Form W-2 or by the pastor on Form 1040 (line 1).

Example 2:
Same facts as in Example 1, except that the church also reimburses some personal expenses of the pastor, such as the personal use of a car. The regulations specify that if an employer reimburses both business and personal expenses of an employee, the employer “is treated as maintaining two arrangements. The portion of the arrangement that provides payments for the deductible employee business expenses is treated as one arrangement that satisfies [the reimbursement requirement]. The portion of the arrangement that provides payments for the nondeductible employee expenses is treated as a second arrangement that does not satisfy [the reimbursement requirement] and all amounts paid under this second arrangement will be treated as paid under a nonaccountable plan.” As a result, the church does not accumulate business expense reimbursements on the pastor’s Form W-2, and the pastor does not report these reimbursements as taxable income on Form 1040 (line 1). However, the reimbursements of personal expenses are deemed nonaccountable. The church must report these reimbursements on the pastor’s Form W-2, and the pastor must include them as taxable income on Form 1040 (line 1).

Example 3:
Same facts as Example 1, except that the church accepts the pastor’s signed statement as to the amount of business expenses he incurs each month without any additional substantiation. This arrangement does not meet the substantiation requirement, so it is not accountable. Amounts reimbursed by the church are reported on the pastor’s Form W-2, and the pastor must include them as taxable income on Form 1040 (line 1). Note that Congress enacted legislation in 2017 that suspends for tax years 2018 through 2025 the itemized deduction on Schedule A (Form 1040) for unreimbursed (and nonaccountable reimbursed) employee business expenses.

Example 4:
A church provides a pastor with a monthly $400 car allowance. The church board is certain that the pastor incurs business expenses of at least this much each month and so does not require any additional substantiation. This arrangement does not meet the substantiation requirement, so it is not accountable. Amounts reimbursed by the church are reported on the pastor’s Form W-2, and the pastor must include them as taxable income on Form 1040 (line 1). Note that Congress enacted legislation in 2017 that suspends for tax years 2018 through 2025 the itemized deduction on Schedule A (Form 1040) for unreimbursed (and nonaccountable reimbursed) employee business expenses.

Example 5:
A church issues its senior pastor a cash advance of $1,500 to cover all expenses incurred by the pastor in attending a church convention. The pastor is not required to substantiate any of her expenses. The entire amount represents a nonaccountable reimbursement since the pastor is not required to substantiate expenses or return any excess reimbursement (in excess of substantiated expenses). The full amount of the cash advance must be reported by the church on the pastor’s Form W-2, and the pastor must report it as taxable income on Form 1040 (line 1). Note that Congress enacted legislation in 2017 that suspends for tax years 2018 through 2025 the itemized deduction on Schedule A (Form 1040) for unreimbursed (and nonaccountable reimbursed) employee business expenses.

Example 6:
Same facts as Example 5, except that the pastor substantiates $1,200 of business expenses but is allowed to keep the excess reimbursement ($300). The regulations specify that this arrangement is accountable up to the amount the pastor actually substantiates ($1,200), but it is considered nonaccountable with regard to the excess. As a result, the church must report the $300 excess on the pastor’s Form W-2, and the pastor must include this amount as taxable income on Form 1040 (line 1).

Example 7:
In December 2024, a church board agrees to pay its senior pastor a salary of $60,000 for 2025 ($1,154 per week). In addition, the church agrees to “reimburse” the pastor’s business expenses by reducing his salary. Each month, the pastor provides the church treasurer with the total amount of business expenses he incurred for the previous month. The pastor provides no substantiation other than his own statement. Some months the pastor orally informs the treasurer of the amount of expenses for the previous month, while in other months he provides the treasurer with a note showing the total expense amount. The treasurer then allocates the next weekly paycheck between salary and business expense “reimbursement.”

To illustrate, in the first week of September, the pastor informs the treasurer that he incurred business expenses of $400 in August. The church treasurer issues the pastor his customary check in the amount of $1,154 for the next week—but it is allocated between business expense reimbursement ($400) and salary (the balance of $754). Assume that the pastor incurs $5,000 of business expenses during 2025. The church treasurer issues the pastor a Form W-2 showing compensation of $55,000 (salary of $60,000 less the salary reductions that were allocated to substantiated business expenses).

This is incorrect. This arrangement does not meet the reimbursement requirement for two reasons: (1) The employer is not reimbursing the pastor’s expenses. A reimbursement assumes that the employer is paying for the employee’s business expenses out of its own funds. When an employer pays an employee for his or her business expenses through a salary reduction, it is the employee and not the employer who is paying for the expenses. Such an arrangement is not an employer reimbursement. (2) The arrangement also fails the reimbursement requirement because the church has agreed “to pay an amount to an employee regardless of whether the employee incurs (or is reasonably expected to incur) business expenses.” The church treasurer should have treated this arrangement as nonaccountable. The full amount of the salary reductions should have been reported on the pastor’s Form W-2, and the pastor should include this amount with taxable income on Form 1040 (line 1). Note that Congress enacted legislation in 2017 that suspends for tax years 2018 through 2025 the itemized deduction on Schedule A (Form 1040) for unreimbursed (and nonaccountable reimbursed) employee business expenses.

Example 8:
Same facts as Example 7, except that the church requires the pastor to adequately substantiate (amount, date, location, and business connection) each expense in order to be reimbursed for it through salary reduction. Even though this arrangement meets three of the requirements of an accountable plan (business connection, substantiation, and return of excess reimbursements), it is not accountable because it does not meet the reimbursement requirement for the same reasons mentioned in Example 7.

Sampling

You may maintain an adequate record for parts of a year and use that record to substantiate the amount of business expense for the entire year if you can demonstrate by other evidence that the periods for which an adequate record is kept are representative of your expenses throughout the entire year. The income tax regulations specify that “a taxpayer may maintain an adequate record for portions of a taxable year and use that record to substantiate the business use of listed property [such as a car] for all or a portion of the taxable year if the taxpayer can demonstrate by other evidence that the periods for which an adequate record is maintained are representative of the use for the taxable year or a portion thereof.” Treas. Reg. 1.274-5T(c)(3)(ii)(A).

Example:
Pastor M uses his car for local business transportation to visit members and make hospital calls. He and his family also use the car for personal purposes. Pastor M maintains adequate records during the first week of each month that show that 75 percent of the use of the car is for business. Invoices and bills show that business use of the car continued at the same rate during the later weeks of each month. Such weekly records are representative of the use of the car each month and are sufficient evidence to support the percentage of business use for the year. Treas. Reg. 1.274-5T(c)(3)(ii)(A).

Standard mileage rate

You can account to your employer for the amount of your car expenses by documenting the business nature of your monthly mileage (or any other accounting period) and then multiplying business miles by the standard mileage rate. Alternatively, you can account for all of your actual expenses in the manner described under “Business and Professional Expenses” on page . In Revenue Ruling 87-93 the IRS announced: “If an employer grants an allowance not exceeding [the standard mileage rate] to an employee for ordinary and necessary transportation expenses not involving travel away from home, such an arrangement will be considered to be an accounting to the employer. . . . ​However, an employer may grant an additional allowance for the parking fees and tolls attributable to the traveling and transportation expenses as separate items.” Note, however, that the Tax Cuts and Jobs Act of 2017 suspended any itemized deduction for employees’ unreimbursed business expenses through 2025. These expenses can be reimbursed by an employer under an accountable arrangement or deducted on Schedule C (Form 1040) by persons who are self-employed under prevailing tests used by the IRS and the courts.

Per diem rates

If your employer reimburses you for your expenses using a per diem or a car allowance, you can generally use the allowance as proof for the amount of your expenses. A per diem or car allowance satisfies the adequate accounting requirements for the amount of your expenses only if all the following conditions apply:

Use of the per diem rates is explained fully in IRS Publications 463 and 1542.

A sample accountable reimbursement policy is reproduced as Illustration 7-1. It may have to be modified to fit your circumstances. The reimbursement policy set forth in Illustration 7-1 can apply to either employees or self-employed workers. If you use it for a self-employed worker, the policy’s reference to “employees” should be changed. As noted previously (see Chapter 2), the reimbursement of business expenses is one of many factors to consider in deciding whether a particular worker is an employee, rather than a self-employed person, under the IRS 20-factor test (it suggests the individual is an employee).

The rules addressed in this section are illustrated in the following examples.

Accountable arrangements

Example:
Pastor G is the senior minister of a church. He is given a monthly allowance of $200 for business expenses. However, he is required to account for all business expenses incurred each month and is only given credit for those expenses that are sufficiently documented (as to amount, time and place, business purpose, and business relationship) by adequate records that would support a deduction on his income tax return. The proper reporting of this arrangement depends on whether Pastor G is required to return excess reimbursements to the church. If he is, and this requirement is stated in the church’s written reimbursement policy, and the excess reimbursements must be returned within 120 days of the associated expense, then this is an accountable arrangement, and the allowances are not reported on Pastor G’s Form W-2 or 1040.

Car allowances

Example:
Pastor H is given a monthly car allowance of $400 by her church and is not required to substantiate the business purpose or amount of any of her business expenses. This is a classic example of a nonaccountable reimbursement arrangement—the church is reimbursing business expenses without requiring the necessary substantiation. If Pastor H reports her income taxes as an employee (or as self-employed, but is reclassified as an employee by the IRS in an audit), the following reporting requirements apply: (1) the church must report all of the monthly allowances ($4,800) on Pastor H’s Form W-2; (2) Pastor H must report all of the monthly allowances ($4,800) as income on her Form 1040; and (3) Pastor H cannot deduct her actual expenses as a miscellaneous itemized deduction on Schedule A, since this deduction was suspended by Congress for tax years 2018 through 2025.

Cash allowances

Example:
A church provides its minister, Pastor M, with a cash advance of $1,500 to attend a church convention. Pastor M’s actual expenses in attending the convention were $1,200. He is not required to substantiate his expenses or return any excess reimbursement. This is a nonaccountable plan, meaning that the church must report the full $1,500 as income on Pastor M’s Form W-2, and Pastor M must report the $1,500 as income on his Form 1040.

Example:
Same facts as the previous example, except that Pastor M is required to substantiate his expenses within 60 days after the convention and return excess reimbursements to the church. However, he is not required to return excess reimbursements within 120 days. Pastor M substantiates $1,200 of expenses but fails to return the excess $300 within 120 days. According to the income tax regulations, only the $300 excess reimbursement is treated as paid under a nonaccountable plan, so only $300 (not $1,500) is reported as income on Pastor M’s Form W-2 and on his Form 1040.

Credit cards

Example:
Pastor G is the senior minister of his church. The church reimburses him for all his business expenses by means of a credit card (in the church’s name). Pastor G is not required to substantiate any expenses with adequate documentation but rather informs the treasurer at the end of each month of the expenses incurred during that month. If Pastor G received reimbursements of $4,000 in 2024, (1) the church would report the entire reimbursement amount ($4,000) as income on Pastor G’s Form W-2, and Pastor G would report it as income on his Form 1040; (2) Pastor G cannot deduct the nonaccountable reimbursed expenses as a miscellaneous itemized deduction on Schedule A. If the church’s reimbursements are not reported as taxable income in the year they are paid, they expose Pastor G to back taxes (plus penalties and interest) and intermediate sanctions in the form of substantial excise taxes if Pastor G is an officer or director. See “Intermediate sanctions” on page .

Example:
Pastor C has a church credit card that he uses for all church-related business expenses. Each month, Pastor C submits a statement of all charges to the church treasurer, along with supporting documentary evidence showing the amount, date, place, business relationship, and business nature of each expense. This is an accountable reimbursement plan. As a result, Pastor C need not report any of the charges as income, he need not deduct any expenses, and the church need not report any of the reimbursements as compensation on Pastor C’s Form W-2.

Mileage allowances

Example:
The IRS issued a ruling denying accountable status to an employer’s reimbursements of employee business expenses. The employer reimbursed certain employees’ business miles at a specified per diem (daily) rate or the standard mileage rate, whichever was greater. Odometer readings were not required on the employees’ claim forms. The integrity of the claim was the responsibility of the employee. The IRS ruled that these employees were not reimbursed under an accountable arrangement. As a result, all of the employer’s reimbursements of these expenses had to be reported as additional income on the employees’ Forms W-2. The IRS observed:

To meet the substantiation requirement . . . ​of the regulations for passenger automobiles, an arrangement must require the submission of information sufficient to [demonstrate the amount, date, and business purpose of each reimbursed expense]. The supervisor’s auto arrangement does not require the submission of mileage records and, thus, does not meet the applicable substantiation requirements. In addition, the automobile arrangement provides for reimbursements at the rate of the greater of [a daily rate] or the applicable cents-per-mile rate without requiring the return of amounts in excess of actual or deemed substantiated expenses. Accordingly, the supervisor’s auto arrangement does not meet the substantiation or return of excess requirements of . . . ​the regulations. Therefore, the supervisor’s auto arrangement is a nonaccountable plan. IRS Letter Ruling 9547001.

Nonaccountable arrangements

Example:
Assume that Pastor B’s church reimburses him for all of his business and professional expenses (by means of a credit card or cash reimbursements). However, Pastor B is not required to substantiate the business purpose or amount of any of these expenses. He simply informs the treasurer at the end of each month of the total expenses incurred during that month. Assume further that Pastor B is an employee for income tax reporting purposes.

If Pastor B received reimbursements of $4,000 in 2024, (1) the church would report the entire reimbursement amount ($4,000) as income on Pastor B’s Form W-2, and Pastor B would report them as income on his Form 1040; and (2) Pastor B cannot deduct the expenses as a miscellaneous itemized deduction on Schedule A (since this deduction was suspended by Congress for tax years 2018 through 2025). If a church’s reimbursements of an employee’s expenses under a nonaccountable plan are not reported as taxable income in the year the reimbursements are paid, they expose the employee to back taxes (plus penalties and interest) and intermediate sanctions in the form of substantial excise taxes if the employee is an officer or director (or a relative of one). See “Intermediate sanctions” on page .

Example:
Same facts as the previous example, except that Pastor B is self-employed for income tax reporting purposes. The proper way to report this arrangement would be as follows: (1) the church reports all of the reimbursements ($4,000) as income on Pastor B’s Form 1099-NEC; (2) Pastor B includes the total reimbursements ($4,000) as compensation on his Schedule C (Form 1040); and (3) Pastor B deducts his business expenses on Schedule C (Form 1040).

Example:
In 2024 Pastor W incurred $3,500 in church-related business expenses. He informed the church of this amount and received a full reimbursement. However, he did not document the business nature or amount of any of his expenses. The proper way to report this arrangement in 2024, assuming that Pastor W is an employee for income tax reporting purposes, is as follows: (1) the church reports all of the reimbursements ($3,500) as income on Pastor W’s Form W-2; (2) Pastor W includes the total allowances ($3,500) as salary on his Form 1040; and (3) Pastor W cannot deduct the expenses on Schedule A as a miscellaneous itemized deduction (since this deduction was suspended by Congress for tax years 2018 through 2025).

If a church’s reimbursements of an employee’s expenses under a nonaccountable plan are not reported as taxable income in the year the reimbursements are paid, they expose the employee to back taxes, plus penalties and interest, and intermediate sanctions in the form of substantial excise taxes if the employee is an officer or director (or relative of an officer or director). See “Intermediate sanctions” on page .

Example:
Pastor C brings all his 2024 business expense receipts and records to the church treasurer at the end of the year and adequately substantiates $4,150 of expenses. The church treasurer issues Pastor C a check for this amount. This is not an accountable reimbursement, since expenses are not substantiated within 60 days. Therefore, the church must report the $4,150 as income on Pastor C’s Form W-2. If Pastor C reports his income taxes as an employee (or as self-employed but is reclassified as an employee by the IRS), he cannot deduct his expenses as miscellaneous itemized deductions on Schedule A, since this deduction was suspended by Congress for tax years 2018 through 2025. If a church’s reimbursements of an employee’s expenses under a nonaccountable plan are not reported as taxable income in the year the reimbursements are paid, they expose the employee to back taxes (plus penalties and interest) and intermediate sanctions in the form of substantial excise taxes if the employee is an officer or director. See “Intermediate sanctions” on page .

Salary reduction arrangements

Example:
A church agreed to pay its part-time youth minister, Pastor P, an annual salary for 2025 of $26,000, payable in weekly checks of $500. On February 1, 2025, Pastor P accounts to the church treasurer for $300 of business and professional expenses that he incurred in the performance of his ministry in January 2025. Pastor P receives two checks for the first week in February—a check in the amount of $300, reimbursing him for the business and professional expenses he accounted for, and a paycheck in the amount of $200. His weekly compensation remains $500, but $300 of this amount constitutes a business expense reimbursement. The same procedure is followed for every other month during the year.

This arrangement is a nonaccountable plan. As a result, (1) Pastor P’s Form W-2 for 2025 must include the full salary of $26,000; (2) Pastor P must report $26,000 as income on his Form 1040; and (3) if Pastor P reports his income taxes as an employee (or as self-employed, but is reclassified as an employee by the IRS), he will not be able to deduct any nonaccountable reimbursements of employee business expenses, since this deduction was suspended by Congress for tax years 2018 through 2025. The key point is this: accountable reimbursement arrangements cannot fund business expense reimbursements out of an employee’s salary.

Unreimbursed expenses

Example:
In 2024 Pastor D incurred $3,500 in church-related business expenses. His church expected him to pay such expenses out of his salary and accordingly did not reimburse him for these expenses or pay him an allowance. Assuming that the IRS would regard Pastor D as an employee for income tax reporting purposes, he cannot deduct his business expenses as a miscellaneous expense on Schedule A, since this deduction was suspended by Congress for tax years 2018 through 2025. A better approach is the adoption of an accountable reimbursement plan that requires periodic accounting of reimbursed expenses by the minister, as described above. It costs the church nothing, yet it may result in significant tax savings to the minister.

Example:
A pastor claimed a deduction of $9,300 for car expenses. The IRS disallowed $8,000 of this amount. The pastor claimed that the deduction was based on the number of miles he drove in connection with the ministry. The court pointed out that to properly substantiate a deduction for the business use of a car, a taxpayer must have records to prove “the amount of the business use and total use of the automobile, the time of the use of the automobile, and the business purpose for the use. [Taxpayers] must maintain adequate records such as a log, diary, or trip sheet.”

The pastor’s records consisted of a document prepared by his secretary after the end of the year that contained headings as to the date of travel, the place of travel, the general purpose of the travel, and the mileage. But the court concluded that there were several “problems” with the information contained in this document: “It contains [the pastor’s] transportation to and from his residence and his place of business which represents personal commuting and not deductible expenses. It also contains a trip to Los Angeles, California, that the pastor admits was erroneous. There are trips listed for which the stated mileage is obviously wrong. Furthermore, the reasons stated for the travel lack any specificity. In short, we do not find that the pastor’s records satisfy the [substantiation] requirements.” The court noted that the pastor’s records stated that the reason for many of his trips was to attend a “conference” without any description of the nature of the conference. Swaringer v. Commissioner, T.C. Summary Opinion 2001-37 (2001).

Example:
A taxpayer claimed a deduction for the business use of her car in the amount of $4,300, which she computed by multiplying the standard mileage rate by the number of miles she drove her car for business during the year. The Tax Court noted that the tax code imposes “stringent substantiation requirements for claimed deductions relating to the use of a [car].” The information that must be substantiated to claim a deduction for the business use of a car includes the following: “(1) [t]he amount of the expenditure; (2) the mileage for each business use of the automobile and the total mileage for all use of the automobile during the taxable period; (3) the date of the business use; and (4) the business purpose of the use of the automobile.”

The taxpayer testified that she carried a calendar with her in her car and filled it out each day, recording any business activity she conducted. She further testified that she carried a “business miles log” on all of her business trips and made notes about these trips shortly after completing each trip.

The court conceded that the entries in the log and the notations on the calendar generally indicated the miles that were driven for business purposes. However, the court concluded that the taxpayer had failed to meet the substantiation requirements. It noted that she

Example:
The Tax Court denied a taxpayer’s $7,500 deduction for the business use of a car. The taxpayer had claimed a mileage expense deduction by multiplying the standard mileage rate by the miles he claimed he drove for business purposes. The court pointed out that use of the standard mileage rates “serves only to substantiate the amount of expenses and not the remaining elements of time and business purpose.” It noted that the taxpayer relied on a computer-printout “mileage log” with daily listings of business trips identified only by abbreviations under a column titled “client.”

The taxpayer insisted that all of the business miles listed on the mileage log were related to his employment. However, the court concluded that “nowhere does the record reveal the . . . ​business purpose of each trip recorded on the mileage log,” and as a result, it ruled that the taxpayer was not entitled to any deduction for the business use of his car because of his failure to comply with the substantiation requirements.

The court also referred to “irregularities” in the taxpayer’s mileage log. For example, “for those dates for which personal mileage is recorded, the mileage log invariably lists either 4, 5, or (more typically) 6 miles of personal travel for the day, for a total of 796 personal miles, compared with 25,096 total business miles recorded. Consulting our own experience, it seems improbable that the taxpayer’s daily personal use of his vehicle would be so rigidly fixed and limited, especially in light of the much larger number of business miles he recorded.” Tamms v. Commissioner, T.C. Memo. 2001-201.

In 1964 the Tax Court ruled that section 265 of the tax code (which denies a deduction for any expense allocable to tax-exempt income) prevented a minister from deducting his unreimbursed transportation expenses to the extent that they were allocable to his tax-exempt housing allowance. Deason v. Commissioner, 41 T.C. 465 (1964).

To illustrate, assume that a minister receives compensation of $30,000, of which $10,000 is a nontaxable housing allowance, and incurs unreimbursed business expenses of $1,500. Since one-third of the minister’s compensation is tax-exempt, he should not be permitted to deduct one-third of his business expenses, since they are allocable to tax-exempt income and their deduction would amount to a double deduction. This was the conclusion reached by the Tax Court in the Deason case. The Tax Court reaffirmed the Deason ruling in subsequent cases. See., e.g., Dalan v. Commissioner, T.C. Memo. 1988-106; McFarland v. Commissioner, T.C. Memo. 1992-440. 

The IRS has issued audit guidelines for its agents to follow when auditing ministers, and the guidelines instruct agents to apply the Deason allocation rule. The guidelines explain this rule as follows: “A minister may deduct ordinary and necessary business expenses. However, if a minister’s compensation includes a housing allowance which is exempt from income tax, then that portion of the expenses allocable to this tax-exempt income is not deductible. Before this allocation is made, the total amount of business expenses must be determined.”

Example:
A pastor was paid compensation of $78,000, consisting of a salary of $36,000 and a housing allowance of $42,000. He also received self-employment earnings of $21,000 for the performance of miscellaneous religious services (including weddings, funerals, and guest speaking). The pastor incurred business expenses of $25,000 that were not reimbursed by the church, including car expenses, books, office expenses, and business trips. The IRS audited the pastor’s tax return and claimed that his deduction for business expenses had to be reduced by the percentage of his total church income that consisted of a housing allowance.

On appeal, applying pre-2018 law, the Tax Court noted that section 265 of the tax code provides that “no deduction shall be allowed for any amount otherwise allowable as a deduction which is allocable to one or more classes of income wholly exempt from taxes.” The court noted that the pastor “received both nonexempt income and a tax-exempt parsonage allowance for his ministry work. The ministry expenses he attempts to deduct were incurred while he was earning both nonexempt income and a tax-exempt parsonage allowance. This is precisely the situation section 265 targets. . . . ​The parsonage allowance is a class of income wholly exempt from tax and section 265 expressly disallows a deduction to the extent that the expenses are directly or indirectly allocable to his nontaxable ministry income.” The court noted that since the pastor

failed to provide evidence that would allow the court to determine which of his ministry activities generated which expenses, the court will allocate the expenses on a pro rata basis. The court concludes that the pastor’s Schedule C ministry activities generated 22 percent of his total ministry income, and therefore allocates 22 percent of his ministry expenses to Schedule C, and the balance to Schedule A. Because 54 percent of his ministry salary was his parsonage allowance ($42,000/$78,000), 54 percent of his Schedule A deductions are rendered nondeductible because of section 265. The pastor may deduct (subject to the 2-percent floor) the balance as itemized miscellaneous deductions on Schedule A.

The court concluded that the reduced deduction for business expenses applied to both income taxes and self-employment taxes.

It has generally been assumed that the Deason rule does not apply to the computation of a minister’s self-employment taxes, since the housing allowance is not tax-exempt in computing self-employment taxes. This understanding is contained in the IRS audit guidelines for ministers. However, the court ignored this logic and applied the Deason rule to the pastor’s self-employment taxes. It observed, “In computing his net earnings from self-employment, a pastor must include all his earnings from his ministry, including his parsonage allowance, and may claim the deductions ‘allowed by chapter 1 of the tax code which are attributable to such trade or business.’ Because a portion of the pastor’s deductions is allocable to his parsonage allowance, and is disallowed as a deduction by section 265, it may not be deducted in computing his net earnings from self-employment.” Fortunately, this case is a “small case,” meaning it cannot be cited as precedent. Young v. Commissioner, T.C. Summary Opinion 2005-76.

The IRS audit guidelines for ministers explain the Deason rule as follows:

A minister may deduct ordinary and necessary business expenses. However, if a minister’s compensation includes a parsonage or housing allowance which is exempt from income under IRC § 107, the prorated portion of the expenses allocable to the tax exempt income is not deductible, per IRC § 265, Deason v. Commissioner, 41 T.C. 465 (1964), Dalan v. Commissioner, T.C. Memo. 1988-106, and McFarland v. Commissioner, T.C. Memo. 1992-440.

Before this allocation is made, the total amount of business expenses must be determined. Ministers are subject to the same substantiation requirements as other taxpayers.

How do ministers reduce their business expenses to properly reflect this rule? The guidelines provide IRS agents with the following procedure:

Once total business expenses have been determined, the nondeductible portion can be computed using the following formula.

Step 1

Divide the allowable housing allowance or fair rental value (FRV) of [the] parsonage by the total ministry income to get the nontaxable income percentage. Total ministry income includes salary, fees, expense allowances under nonaccountable plans plus the allowable housing allowance or FRV of the parsonage.

Step 2

Multiply the total business expenses times the nontaxable income percentage from step 1 to get the expenses allocable to nontaxable income which is not deductible.

The audit guidelines illustrate the Deason rule with the following two examples.

Example:
F receives a salary of $36,000, an exempt housing allowance of $18,000 and an auto expense allowance of $6,000 for his services as an ordained minister. F incurs business expenses as follows: auto, $7,150; vestments, $350; dues, $120; publications and supplies, $300; totaling $7,920. His nondeductible expenses are computed as follows:

Step 1: $18,000 housing allowance/nontaxable income divided by $60,000 total ministry income ($36,000 salary, $18,000 housing, and $6,000 car allowance) equals 30 percent nontaxable income percentage.

Step 2: Total business expenses of $7,920 × 30 percent, the nontaxable income percentage, equals $2,376 in nondeductible expenses.

Total expenses of $7,920 less the nondeductible expenses of $2,376 equals the deductible expenses of $5,544.

F’s deductible expenses are reported as Schedule A miscellaneous deductions since his church considers him an employee and issues a W-2. These expenses, along with any other miscellaneous deductions, are subject to a further reduction of 2 percent of his adjusted gross income.

Example:
G received a salary of $12,000, a housing allowance of $9,000, and earned $3,000 for various speaking engagements, weddings, funerals, etc., all related to her ministry. She reports her salary as “wages” on page 1 of her Form 1040 and her fees on Schedule C. Because her actual housing costs ($6,000) were less than her housing allowance and the FRV of her home for the year, she must include $3,000 of her housing allowance as “other income” for income tax purposes. Her total business expenses are $4,500. The computation of deductible expenses is shown below:

Step 1: $6,000 (housing allowance actually exempt from income tax) divided by $24,000 total ministry income ($12,000 salary + $9,000 housing + $3,000 fees) equals 25 percent nontaxable income percentage.

Step 2: Total expenses of $4,500 × 25 percent, the nontaxable income percentage, equals $1,125 in nondeductible expenses. Total expenses of $4,500 less $1,125 equals $3,375 in deductible expenses.

Note that this $3,375 would further be allocable between Schedule A miscellaneous deductions (related to salary) and Schedule C (related to other fees).

However, this allocation will not change G’s self-employment tax, since all ministry income and ministry expenses are included in the computation, regardless of where they are reported on the return for income tax purposes. The allocation between Schedule A and Schedule C will also affect any AGI-dependent computations.

The impact of the Deason rule is mitigated in two ways:

What about ministers who live in church-owned parsonages? Are they affected by the Deason rule? The IRS Tax Guide for Churches and Religious Organizations states: “A minister who receives a parsonage or rental allowance excludes that amount from his income, and the portion of expenses allocable to the excludable amount is not deductible.” This statement indicates that the IRS will apply the Deason rule to ministers who live in church-owned parsonages.

Another ambiguity pertains to the proper manner of making the reduction in business and professional expenses called for by the Deason rule. IRS Publication 517 (Social Security and Other Information for Clergy and Other Religious Workers) presents a full-page example of a schedule that ministers can use to compute the reduction in their business expense deduction required by the Deason rule.

Ministers may have items of nontaxable income in addition to a housing allowance. Common examples include gifts, inheritances, life insurance proceeds, and interest on some government bonds. Must these items of nontaxable income be lumped together with a housing allowance in applying the Deason rule? In most cases the answer is no. In the Deason case, the Tax Court ruled that compensation earned by ministers in the exercise of their ministry cannot be used to pay business expenses incurred in earning this compensation. As a result, any business expense deduction must be reduced by the percentage of total compensation that is nontaxable because of the housing allowance. This principle does not apply to gifts, inheritances, life insurance proceeds, interest on government bonds, or most other forms of nontaxable income, since (unlike a housing allowance) they are not associated with services performed in the exercise of ministry. Therefore, business expenses incurred in the course of ministerial services need not be reduced by the percentage of a minister’s income that consists of such items.

An argument can be made that the Deason case makes no sense when applied to ministers. The IRS (and the Tax Court) are saying that ministers must reduce their business expenses by the percentage of their total compensation that consists of a tax-exempt housing allowance. But a housing allowance is tax-exempt, under section 107 of the tax code, only “to the extent used to rent or provide a home.” This being the case, it is impossible for one cent of a tax-exempt housing allowance to be used to pay for a minister’s business expenses. Business expenses are neither directly nor indirectly allocable to a minister’s tax-free housing allowance.

Many nonclergy taxpayers doubtless receive tax-exempt income and use that income to pay business expenses. There may be some logic in requiring such taxpayers to reduce their business expense deductions by the percentage of their total compensation that is tax-free. However, this logic does not apply in the case of a minister whose tax-exempt income is tax-exempt only if used exclusively for housing-related expenses rather than the payment of business expenses. Note, however, that both the IRS and the Tax Court have rejected this reasoning, and so it represents an aggressive position that should not be adopted without the advice of a tax professional.

If your itemized deductions exceed your standard deduction (see “Deductions: An Overview” on page ), you should report your itemized deductions on Schedule A (Form 1040). For 2024, itemized deductions include the following (with various limits and conditions):

Various conditions apply. Itemized deductions are explained fully in the instructions for Schedule A (Form 1040), which is available on the IRS website (IRS.gov).

Congress enacted legislation in 2017 that

However, the exclusion still applies for a member of the Armed Forces of the United States on active duty who moves under a military order to a permanent change of station. This change is effective for taxable years beginning after 2017 and before 2026.

A credit is a direct dollar-for-dollar reduction in your tax liability. It is much more valuable than deductions and exclusions, which merely reduce taxable income. Credits are reported on lines 1–14 of Form 1040 (Schedule 3), immediately after you compute your actual tax liability. For example, if your total tax liability amounted to $4,000 for 2024 and you have credits totaling $1,000, your tax liability is reduced to $3,000. The more common credits claimed by ministers are as follows.

The child and dependent care credit is a tax credit that may help you pay for the care of eligible children and other dependents (qualifying persons). The credit is calculated based on your income and a percentage of expenses that you incur for the care of qualifying persons to enable you to go to work, look for work, or attend school. See IRS Publication 503 for details.

Special rules for ministers

This credit is available only to persons who have earned income during the year. Earned income includes wages, salaries, other taxable employee compensation, and net earnings from self-employment. IRS Publication 503 states:

Form 4361. Whether or not you have an approved Form 4361, amounts you received for performing ministerial duties as an employee are earned income. This includes wages, salaries, tips, and other taxable employee compensation. However, amounts you received for ministerial duties, but not as an employee, don’t count as earned income. Examples include fees for performing marriages and honoraria for delivering speeches. Any amount you received for work that isn’t related to your ministerial duties is earned income. . . .

What isn’t earned income? Earned income doesn’t include:

A congressional committee report includes the following clarification in commenting on the child tax credit:

Earned income is defined as the sum of wages, salaries, tips, and other taxable employee compensation plus net self-employment earnings. Unlike the EITC, which also includes the preceding items in its definition of earned income, the additional child tax credit is based only on earned income to the extent it is included in computing taxable income. For example, some ministers’ parsonage allowances are considered self-employment income, and thus are considered earned income for purposes of computing the EITC, but the allowances are excluded from gross income for individual income tax purposes, and thus are not considered earned income for purposes of the additional child tax credit since the income is not included in taxable income.

Example:
A couple had a valid, approved Form 4029 exempting themselves from Social Security and Medicare taxes on the basis of their membership in a recognized religious group conscientiously opposed to accepting benefits of any private or public insurance (including Social Security and Medicare) that makes payments in the event of death, disability, old age, or retirement. The couple had nine children and claimed a refundable “additional child tax credit” based on the husband’s self-employment earnings from his carpentry business (the couple’s only source of income). The IRS denied this credit on the ground that the husband’s self-employment earnings were not “earned income” in calculating the additional child tax credit.

The court noted that section 24 of the tax code provides that the “additional child tax credit” is refundable and is equal to “15 percent of so much of the taxpayer’s earned income (within the meaning of section 32) which is taken into account in computing taxable income for the taxable year as exceeds [$3,000].” The court concluded that the couple was not eligible for the additional child tax credit because they had no earned income. The term earned income in section 32 is defined to include net earnings from self-employment. However, section 32 goes on to exclude from the definition of earned income any services by an individual who has filed a Form 4029 exempting himself from self-employment taxes as a result of his membership in a recognized religious group that is opposed on religious grounds to receiving benefits from any public or private insurance program, including Social Security, that makes payments on the basis of old age or sickness. Since the couple had a valid and approved Form 4029, the husband’s carpentry income was not “earned income,” and therefore they were not eligible for the additional child tax credit. Heilman v. Commissioner, T.C. Memo. 2011-210 (2011).

If you qualify for it, the earned income credit (EIC) reduces the tax you owe. Even if you do not owe tax, you can get a refund of the credit. Depending on your situation, the credit can be as high as $7,830 for 2024.

You cannot take the credit for 2024 if your earned income (or AGI, if greater) is more than

These limits are summarized in Table 7-4.

Housing allowances and the earned income credit

Should ministers treat a housing allowance (or annual rental value of a parsonage) as earned income when computing the earned income credit? If so, then earned income will be higher, making it more likely that a minister will not qualify for the earned income credit.

Section 32(c)(2)(A) of the tax code provides: “The term earned income means . . . ​wages, salaries, tips, and other employee compensation, but only if such amounts are includible in gross income for the taxable year, plus the amount of the taxpayer’s net earnings from self-employment for the taxable year (within the meaning of section 1402(a)).”

It is not clear if this language includes or excludes a minister’s housing allowance or the annual rental value of a parsonage within the definition of earned income for purposes of the earned income credit. Consider the following points.

Ministers who report income taxes as employees

Section 32(c)(2)(A) includes within the definition of earned income both employee compensation and net earnings from self-employment. A pastor’s salary obviously is included in earned income under this definition. But what about a housing allowance? Is it included because it constitutes net earnings from employment under code section 1402(a)? The answer is not clear. Pastors have a dual tax status. While most are employees for federal income tax purposes, they are self-employed for Social Security with respect to services performed in the exercise of ministry. IRC 3121(b)(8)(A). This means that most ministers have “employee compensation” from their ministry, but this same compensation also constitutes “net earnings from self-employment” for purposes of the self-employment tax.

Read literally, section 32 would require ministers who report their church salary as employees to “double report” their salary in computing their income for purposes of the earned income credit since their salary constitutes employee compensation and also is net earnings from self-employment within the meaning of section 1402(a). The instructions for line 27 (Form 1040) avoid this result for ministers who are not exempt from self-employment taxes.

Ministers who report their income taxes as self-employed

Section 32 only makes sense for those few ministers who report their church compensation as self-employment earnings in computing both income taxes and self-employment taxes. For these persons, there would be no double reporting of income in computing the earned income credit, and a housing allowance (or annual value of a parsonage) clearly would be included in the computation of earned income.

Ministers who are exempt from self-employment tax

About one-third of all ministers have exempted themselves from self-employment tax by filing a timely Form 4361 with the IRS. Such ministers do not report their church salary, housing allowance, or annual rental value of a parsonage as earnings from self-employment in computing their self-employment tax liability. As a result, while revised tax code section 32 would treat their church salary as earned income in computing the earned income credit, it would not treat a housing allowance or the annual rental value of a parsonage as earned income, since such amounts are not reported as net earnings from self-employment under section 1402(a). Is this what Congress intended? Ministers who have opted out of Social Security do not need to include their housing allowance (or annual rental value of a parsonage) in computing earned income for purposes of the earned income credit, but those who have not opted out of Social Security must do so?

Chaplains

The income tax regulations specify that service performed by a duly ordained, commissioned, or licensed minister “as an employee of the United States, a State, Territory, or possession of the United States, the District of Columbia, a foreign government, or a political subdivision of any of the foregoing” is not considered to be “in the exercise of his ministry” even though such service may involve the ministration of sacerdotal functions or the conduct of religious worship. Treas. Reg. § 1.1402(c)-5. This means that government-employed chaplains are not self-employed for Social Security purposes and have no “section 1402(a)” earnings. Thus, they would not include a housing allowance or the annual rental value of a parsonage as earned income for purposes of the earned income credit. Here we see another absurd result. Why should chaplains enjoy this advantageous rule, but not other ministers?

Conclusions

In summary, the problem is that ministers are always self-employed for Social Security with respect to their ministerial services, and so their entire church compensation constitutes net earnings from self-employment unless they filed a timely exemption application (Form 4361) that was approved by the IRS. Logically, then, housing allowances should be treated as earned income for those ministers who have not exempted themselves from self-employment taxes by filing Form 4361. On the other hand, ministers who have exempted themselves from self-employment taxes should not treat their housing allowance as earned income in computing the earned income credit.

As illogical as this result may seem, it is exactly what the IRS instructions for Form 1040 require (as illustrated below), and this position is confirmed in IRS Publication 596 (see below). The IRS national office is taking the position that there is nothing it can do to change a law enacted by Congress. So for now, whether a minister’s housing allowance (or annual rental value of a parsonage) is included within the definition of earned income for purposes of the earned income credit depends on whether the minister is exempt or not exempt from paying self-employment taxes.

Key Point: For further guidance with respect to this question, ministers should contact the IRS or their tax professional.

Example:
An ordained minister who qualified for the earned income credit was a part-time pastor of a church from which he received a salary of $2,400 and a housing and utility allowance of $600. During that year, the minister received directly from individuals fees totaling $500 for performing marriages, baptisms, and other personal services. The minister also received $2,000 of farming income. In an earlier year the minister had elected to be exempt from self-employment tax with respect to amounts received for services performed in the exercise of ministerial duties. This election was made by filing a Form 4361. As a result, the $2,400 of salary, the housing and utility allowance of $600, and the $500 of fees, all of which would otherwise be includible in net earnings from self-employment, were exempt from the self-employment tax. The $2,000 of income from farming was not exempt from self-employment tax. The gross income of $4,900 was also the minister’s AGI for the year.

The IRS ruled that in computing the minister’s earned income for purposes of the earned income credit, he should include the salary of $2,400 and the $600 housing and utility allowance. The $500 of fees received from individuals for performing marriages and other personal services was not received by the minister as an employee and thus is not earned income for purposes of the earned income credit. The $2,000 from farming is earned income because the election to be exempt from self-employment tax does not apply to services not performed in the exercise of the ministry. Revenue Ruling 79-78.

Computing the earned income credit for tax year 2024

The earned income credit is based on the amount of your earned income, so you must compute your earned income to determine the amount of your credit. The instructions for line 27 (Form 1040) will assist you in determining whether you are eligible for the earned income credit and, if so, the amount of the credit.

Computing the earned income credit is difficult, but here are some resources that can help:

Form 1040 instructions

See the instructions for line 27 of IRS Form 1040.

IRS Publication 596

This 39-page publication explains the earned income credit. The 2023 edition (the most recent available at the time of publication of this text) states, in general: “The rental value of a home or a housing allowance provided to a minister as part of the minister’s pay generally isn’t subject to income tax but is included in net earnings from self-employment. For that reason, it is included in earned income for the EIC” except for ministers who have opted out of self-employment taxes by filing a timely Form 4361 exemption application with the IRS.

With respect to ministers who have filed a timely Form 4361, Publication 596 states:

These excerpts from Publication 596 confirm that ministers who are employees for income tax reporting purposes and who have not exempted themselves from self-employment taxes by filing a timely Form 4361 with the IRS include their housing allowance or the fair rental value of a parsonage in computing earned income for purposes of the earned income credit.

But what about ministers who have exempted themselves from self-employment taxes by filing a timely Form 4361 with the IRS? Do they include a housing allowance or the rental value of a parsonage in computing their earned income for purposes of the earned income credit? As noted above, Publication 596 explicitly states, regarding ministers who have filed Form 4361, that “a nontaxable housing allowance or the nontaxable rental value of a home is not earned income.”

IRS Publication 517

IRS Publication 517 (Social Security and Other Information for Members of the Clergy and Religious Workers) contains the following information about the earned income tax credit:

Earned income. Earned income includes your:

To figure your earned income credit, see the Form 1040 instructions for line [27].

This language does nothing to clarify whether ministers include a housing allowance or rental value of a parsonage as earned income in computing the earned income credit.

IRS website

The IRS contains a section titled “Military and Clergy Rules for the Earned Income Tax Credit” that provide the following clarification:

If you are a clergy member or minister, you must:

Minister’s Housing

If the church provided housing to you as part of your minister’s pay, you should include the rental value of the home or housing allowance as part of your earned income from self-employment for the EITC.

The rental value of the home is the money the church would get if they charged you rent.

If you have an approved Form 4361 or Form 4029, you do not need to do this.

What Counts as Income for a Minister

You may file a request for your income to be exempt from Social Security taxes. These forms are:

Employee Minister Income

Even if you have an approved form to exempt your income from Social Security taxes, if you get income for working as a minister who is an employee, count it as earned income. This income includes:

To calculate your earned income, don’t subtract losses on Schedule C, C-EZ, or F from wages on line 7 of Form 1040.

Non-Employee Minister Income

If you get income for working as a minister who is not an employee, don’t count it as earned income. This income includes:

For more information about ministers and earned income, see Publication 596, Earned Income Credit.

If you qualify for the earned income credit on the basis of the rules summarized above, you need to compute the amount of your credit. The IRS will do so if you like (see the instructions for Form 1040).

Various tax benefits may be available to you if you are saving for or paying education costs for yourself or, in many cases, another student who is a member of your immediate family. Most benefits apply only to higher education. Listed below are benefits for which you may be eligible:

You generally cannot claim more than one of the benefits described in the list above for the same qualifying education expense. Each of these tax benefits is explained fully in IRS Publication 970 (Tax Benefits for Education), available on the IRS website (IRS.gov).