1. Inurement. One of the requirements for exemption from federal income tax is that none of a church’s funds or assets inures to the benefit of a private individual, other than as reasonable compensation for services. Inurement may occur in many ways, including excessive compensation, payment of excessive rent, and the payment of personal expenses of an officer that the church did not characterize as compensation at the time of payment. It is possible that your pastor’s use of a church credit card for his own personal needs and expenses constitutes inurement, especially if he fails to reimburse the church for all personal charges. This exposes the church to a loss of its tax-exempt status.
2. Excess benefit. The IRS deems any taxable fringe benefit provided to an officer or director of a tax-exempt charity (including a church), or a relative of such a person, to be an automatic excess benefit that may trigger substantial excise taxes (called “intermediate sanctions”) of up to 225 percent of the amount of the benefit, unless it was timely reported as taxable income by the charity. A nonaccountable expense reimbursement is an example of a taxable fringe benefit.
As a result, to the extent that a pastor uses a church credit card for some business expenses and fails to comply with the strict requirements for an accountable reimbursement arrangement, then those charges constitute nonaccountable reimbursements. If the church fails to report them as taxable income on the pastor’s W-2 form, then this amounts to a taxable fringe benefit that was not reported as taxable income, thereby exposing the pastor to intermediate sanctions assuming that he or she is an officer or director of the church. The penalty may be avoided if the pastor reports the benefit as taxable income, but this rarely happens if the church fails to do so.
3. Nonaccountable reimbursement. As noted above, a nonaccountable expense reimbursement represents taxable income to the employee. A reimbursement (including a charge to an employer’s credit card) is nonaccountable if it fails to meet all of the following requirements for an accountable plan: (1) only business expenses are reimbursed; (2) no reimbursement is allowed without an adequate accounting of expenses within a reasonable period of time (not more than 60 days after an expense in incurred); (3) any excess reimbursement or allowance must be returned to the employer within a reasonable period of time (not more than 120 days after an excess reimbursement is paid); and (4) an employer’s reimbursements must come out of the employer’s funds and not by reducing the employee’s salary.
The fact that the pastor fails to return to the church all credit card charges (“reimbursements”) over and above substantiated business expenses within 120 days renders them nonaccountable.
4. Risk management. The best practice would be for a church not to provide a credit card to employees who, for whatever reason, are unable to obtain a card on their own. Such an arrangement may constitute prohibited inurement of church funds to a private individual, even if all charges are properly reported as taxable income since the employee in effect is converting a church resource into a personal benefit.
In most cases, churches provide credit cards to employees as a convenient way to reimburse them for business expenses that they incur (travel, meals, church equipment, and so on). So long as a card is used primarily for business expenses, and the employee substantiates all charges on a timely basis under an accountable arrangement, reimbursing the church within 120 days for any incidental personal expenses, there are no problems.
To protect against abuses, church leaders should consider the following precautions:
- Be sure your church has implemented an accountable reimbursement policy that only reimburses credit card charges that are adequately substantiated within 60 days of each expense, and that requires the refund of any personal charges within 120 days.
- Be sure your church reports nonaccountable reimbursements (those not fully complying with the requirements of an accountable plan) as taxable income.
- Consider inserting “merchant category codes” on church-issued credit cards that prevent the cards from being used at specified locations or with designated vendors or facilities (i.e., ATM machines, salons, drug stores, clothing stores). Most employers, including churches, are not aware of this option.
- Impose low spending limits on each card.
- Adopt a written policy for the use of church credit cards that fully explains how they may be used, the limitations and conditions that apply, and potential tax consequences. The lack of such a policy often leads to abuse. Be sure that your policy applies to all employees who use church credit cards, including the senior pastor.
- Restrict the use of church credit cards to those employees with a legitimate need to charge purchases. Not all employees need access to a church credit card.
- Issue a separate church credit card to each approved employee, which makes it easier to account for individual employee’s charges and enforce purchase limits.