Q&A: Is Our Pastor’s Discretionary Account Considered Taxable Income?

Such discretionary funds are full of potential payroll and accounting pitfalls.

Our church has a discretionary account the minister can use for various purposes. No other staff may access this account. Our Board of Pensions guidelines state, “A minister’s taxable wages must include Discretionary Funds if the minister is allowed to distribute funds for his personal benefit; and if the minister has the authority to disburse funds directly to himself.”
This past year money contributed to the fund were included in the minister’s W-2. We are wondering if the following motion allows contributions to not be included in his W-2:

The Session establishes the Emergency Mission Fund and adopts the following standard: no pastor or employee of [the] Church has the authority to disburse any church funds to himself or herself. All disbursements, or reimbursements for disbursement, must be authorized by two other church officers not related to the pastor and must be for bona fide church uses and must be documented. No fund can be used for pastor’s personal benefit.

Using a discretionary fund by pastors is a long-accepted tradition by many churches, and each fund operates differently. However, this traditional form of providing expense funds to pastors is also one full of potential payroll tax and accounting pitfalls.

A discretionary fund within the total control of the pastor—which can be utilized by the pastor for personal expenses, has no oversight from the church, and and is outside the internal controls of the church’s regular accountable expense reimbursement plan—is considered additional taxable income to the pastor.

Under this structure, the discretionary fund creates a nonaccountable expense reimbursement plan requiring 100 percent of the funds be reported on the pastor’s Form W-2 as taxable income. While in the past, funds spent on valid business expenses could be deducted as unreimbursed employee business expenses (within certain limitations) on the pastor’s Form 1040, this deduction is suspended under current tax law through 2025.

For a discretionary fund to not be taxable income to the pastor, it must meet the qualifications of an accountable expense reimbursement plan including these requirements:

  • Personal expenses must be prohibited.
  • All valid expenses must be supported with the appropriate documentation in a timely manner as required by the rules governing accountable expense reimbursement plans.
  • The fund should be maintained through the church’s accounting system to ensure the expenses are properly recorded in the accounting records.
  • The pastor should be required to adhere to all rules, policies and procedures established by the church for its expenditures. For example, the church’s benevolence policy should not be avoided through the use of the fund.
  • Any excess funds remaining at the end of the year cannot be paid to the pastor.

Churches that operate these funds should review the procedures regarding the funds with competent tax counsel to determine that the church complies in all areas of payroll tax reporting and with the rules regarding documentation of exempt expenditures.

This information is current as of July 2021 and is not to be construed as legal advice.

Elaine L. Sommerville is licensed as a certified public accountant by the State of Texas. She has worked in public accounting since 1985.

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