Key point. The Tax Cuts and Jobs Act of 2017 suspended from 2018 through 2025 a tax deduction for unreimbursed employee business expenses. It also suspended all other miscellaneous itemized deductions that were subject to the two-percent floor under prior law.
While no itemized deduction is allowed from 2018 through 2025 for unreimbursed employee business expenses, this case remains relevant for the following reasons: (1) calculating business expenses that are reimbursable under an accountable reimbursement arrangement (and the effectiveness and conveniences offered by one); (2) calculating the business expenses reported by self-employed persons on Schedule C (Form 1040); and (3) computing unreimbursed and nonaccountable reimbursed expenses incurred after 2025.
The Internal Revenue Service (IRS) disallowed a couple’s tax deduction of $36,510 for unreimbursed employee expenses for lack of receipts supporting those expenses, instead allowing a deduction of only $877.86.
A new job causes financial strain
A husband and wife lived in Oklahoma from the beginning of 2014 until August 2014. The husband was pastor of a church. His wife sold furniture at a store.
The husband’s role as pastor was not just religious and ministerial. He performed maintenance, tech work, and graphic design for the church.
He also traveled, whether for conferences and retreats, meetings with ministers at other churches, or to pick up large equipment the church needed, such as a soundboard or lighting rigs.
In July 2014, the husband began discussions with a Florida church about an executive youth pastor position. On July 15 he traveled to Florida for an interview. His wife joined him to interview for a teaching position with the church’s school. The couple were offered the positions, and they moved to Florida the next month.
But the move to Florida proved to be a financial strain.
Out-of-pocket costs, lower pay
Because the Florida church is in a rural area, everything is spread far apart.
Therefore, the pastor logged tens of thousands of miles for meetings, hospital visits, and other pastoral duties. He paid for this out of pocket and was not reimbursed (i.e., the expenses were unreimbursed employee business expenses).
In addition, the wife took a significant pay decrease to accept the teaching position at the church’s school.
She paid for her own chalk, pencils, paper, notebooks, markers, classroom decorations, and other common supplies.
She also bought basic classroom supplies for many low-income students, and rewards for good behavior.
None of these purchases were reimbursed by the school.
The wife’s mother moved to Florida when the couple did, but struggled to find employment. In August 2015 she moved into the couple’s extra bedroom. To make room, they moved records, documents and office supplies from the bedroom to the garage.
The financial stress and family issues persisted. The couple’s first child had been born in early 2016, and they expended much of their savings.
Return to Florida
By early 2016, the couple decided to leave Florida. They requested a few months to transition, but the Florida church granted only three weeks.
The husband reached out to his former church in Oklahoma, and was offered a position there. In the ensuing weeks, the couple rushed to find a new place to live, sold their home in Florida, and returned to Oklahoma.
At the time, the couple had the funds available to rent only one moving truck. They took what they could carry back with them to Oklahoma, but the wife’s mother had to put some items from the garage into storage in Florida with the intent of returning in a few months to retrieve them. In doing so, the couple inadvertently moved the boxes containing their business and tax records into the storage unit.
By August 2017 the wife’s mother had stopped paying for the storage unit, and the unit had been repossessed.
Tax return and examination
The couple timely filed their 2014 joint income tax return. They reported total income of $68,899 and claimed above-the-line deductions of $250 for educator expenses and $4,950 for moving expenses, resulting in adjusted gross income of $63,699. They claimed itemized deductions totaling $50,116 and exemptions totaling $7,900 for taxable income of $5,683.
On Schedule A, the couple reported (before application of the two-percent floor) unreimbursed employee expenses totaling $37,460 and tax preparation fees of $75. The couple’s unreimbursed employee expenses consisted of $950 of excess educator expenses related to the wife’s employment at the Florida church school, and $36,510 related to the husband’s employment as a minister.
The husband’s expenses were calculated on Form 2106, Employee Business Expenses, as follows:
|Unreimbursed employee business expenses
|Travel expenses while away from home overnight
|50% of meals and entertainment
|Other business expenses
The couple reported business use of two vehicles. For vehicle 1, a 2003 Dodge truck, they reported 34,000 business miles. For vehicle 2, a 2009 Nissan Altima, they reported 22,000 business miles. They multiplied the claimed 56,000 total business miles driven by the then-standard mileage rate of 56 cents to arrive at the vehicle expense of $31,360.
The IRS selected their return for examination in 2017, and it was during the examination that the husband discovered that his records were lost. He was unable to provide the IRS with the requested documentation but attempted to reconstruct his mileage log from memory.
The IRS determined that the couple was not entitled to the deductions for unreimbursed employee expenses or tax preparation fees and issued a notice of deficiency. The couple appealed to the United States Tax Court.
Heightened substantiation requirements
The Court noted that section 274 of the tax code prescribes stricter substantiation requirements for travel expenses, meals, and lodging away from home, and expenses with respect to the business use of a car.
So, “even if such an expense would be otherwise deductible, section 274 may still preclude a deduction if the taxpayer does not present sufficient substantiation.”
To meet the heightened substantiation requirements, taxpayers must substantiate by adequate records “(1) the amount of the expense, (2) the time and place of the expense, (3) the business purpose of the expense or use, and (4) the business relationship.”
To substantiate car expenses through adequate records, taxpayers must maintain a contemporaneous log, trip sheet, or similar record, as well as corroborating documentary evidence, that together establish each required element of the expense.
In the absence of adequate records, taxpayers must establish each required element by their own statement, whether written or oral, containing specific information in detail as to such element and by other corroborative evidence sufficient to establish such element.
The Court then addressed the deductibility of several unreimbursed employee business expenses:
The Court concluded that the couple had not satisfied the heightened substantiation requirements with respect to the claimed $31,360 deduction for vehicle expenses. The husband testified that his mileage log and other records from 2014 were lost, likely left in his mother-in-law’s storage unit in Florida and abandoned after she neglected to pay the rent on the unit following the family’s move back to Oklahoma in 2016.
The husband attempted to reconstruct his mileage from memory, including on his list only those trips for which he could recall the specific dates and other details. While the Court found the husband to be
forthright and believes he attempted to reconstruct his mileage in good faith, the reconstructed mileage log does not satisfy the requirements of section 274. It lacks sufficient specificity with respect to many of the trips …
Accordingly, the Court sustained the government’s disallowance of a vehicle expense deduction.
With respect to the claimed $2,800 travel expense deduction, the couple introduced into evidence copies of email receipts and itineraries from Priceline.com for a July 15 flight from Dallas to [Florida] for their job interviews for $748; a July 14 hotel stay in Dallas for $96.19; an August 1 hotel reservation for two rooms for the husband and a colleague in Columbus, Mississippi, for $156.26; a September 4 flight from Fort Lauderdale to Atlanta for $324.18; and a car rental in Atlanta from September 4 through September 7, for $83.49.
The Court was satisfied that:
the taxpayers have met the strict substantiation requirements with respect to the Dallas hotel stay, the husband’s flight from Dallas to [Florida], the flight from [Florida] to Atlanta, and the car rental. The information in the email receipts, along with the other evidence in the record, meets the requirements of section 274. The [wife’s] flight is not a deductible business expense, however, because expenses incurred in seeking or investigating a new trade or business are not deductible under [tax code] section 162(a) and there is insufficient information in the record to substantiate the business purpose of the Columbus trip or the portion, if any, that was paid by the husband himself. Accordingly, the Court holds that [the taxpayers] are entitled to a travel expense deduction of $877.86.
Meals and entertainment expenses.
The couple claimed a deduction of $750 (50 percent of $1,500) for meals and entertainment expenses, but provided no receipts or other evidence beyond general testimony in support of the claimed meals and entertainment expenses. The Court disallowed a deduction.
Other business expenses.
The couple claimed a deduction for other expenses of $1,600. These expenses included $1,000 for a used MacBook laptop, $200 for a used Nexus 7 tablet, and a used HTC One smartphone. The husband could not recall at trial whether the $1,600 figure included any other purchases.
The Court noted that section 280F(d)(4) of the tax code defines “listed property” to include any computer or peripheral equipment, including laptops and tablets. The laptop and the tablet “are thus subject to the heightened substantiation requirements of section 274.” But because the couple did not provide any evidence beyond their own testimony to back up the reported expenses, the Court denied a deduction for them.
Tax preparation fees.
Finally, the couple claimed, and the IRS disallowed, a deduction of $75 for tax preparation fees. The Tax Court agreed with the IRS that the couple “did not introduce any evidence or other substantiation in support of this amount beyond testimony that they generally used TurboTax to prepare their tax returns.”
What this means for churches
This case occurred before the Tax Cuts and Jobs Act of 2017, when unreimbursed employee business expenses were tax deductible as an itemized deduction on Schedule A (Form 2106) if a taxpayer had sufficient documentation to substantiate the deduction. In this case, a deduction was disallowed, because the taxpayers produced insufficient substantiation to qualify for a deduction of their unreimbursed employee business expenses.
As noted, the Tax Cuts and Jobs Act of 2017 suspended, from 2018 through 2025, a tax deduction for unreimbursed employee business expenses and all other miscellaneous itemized deductions that were subject to the two-percent floor under prior law.
However, this case is helpful in assisting self-employed church staff in computing the business expenses reported on Schedule C (Form 1040).
And, should the Tax Cuts and Jobs Act expire, this case will be helpful in assisting in assisting self-employed church staff in computing unreimbursed and nonaccountable reimbursed expenses after 2025.
The importance of accountable reimbursement plans
While no itemized deduction is allowed from 2018 through 2025 for unreimbursed employee business expenses, the suspension of an itemized deduction for unreimbursed employee business expenses (through 2025) does not affect the deductibility of business expenses reimbursed by an employer under an accountable reimbursement plan.
The Tax Cuts and Jobs Act of 2017 left intact a tax deduction for these expenses. The deductibility of business expenses reimbursed under an accountable plan is a primary reason for employers to maintain such a plan for the reimbursement of employee business expenses.
An accountable plan is one with the following four characteristics:
- only ordinary and necessary employee business expenses are reimbursed;
- no reimbursement is allowed without an adequate accounting of expenses within a reasonable period of time (not more than 60 days after an expense is incurred);
- 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
- an employer’s reimbursements must come out of the employer’s funds and not by reducing the employee’s salary.
Under an accountable plan, an employee reports to the church rather than to the IRS. The reimbursements are not reported as income to the employee, and the employee does not claim any deductions. In general, this is the best way for churches to handle employee business expenses. But it is especially needed now with the disallowance of itemized deductions for unreimbursed employee business expenses mandated by the Tax Cuts and Jobs Act of 2017.
Philips v. Commissioner, T.C. Sum. Op. (2023).