A church provided its pastor with an office on the church campus, and a $12,000 per year housing allowance. The pastor rented a 1,200 square foot house in which he dedicated one room, approximately one-third of the house, for use as an additional pastor’s office. He purchased supplies, including computer software, computer accessories, books, pens, pencils, paper, and printer cartridges, for use in his home office. The church did not reimburse him for these supplies. He spent most of his professional time in his home office but met with parishioners only at the office the church provided.
(T)he 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.”
In addition, the pastor used his automobile to make hospital and sick visits and to organize community events. He also traveled throughout the state in connection with his position as vice president of the state church convention.
The church treated the pastor as an independent contractor for income tax reporting purposes, and issued him a Form 1099-MISC each year. On the basis of the independent nature of his relationship with the church, he reported his income and expenses on a Schedule C.
The pastor’s tax return for 2008 reported income of $89,000, and various deductions including “books,” supplies, bank fees, uniform and dry cleaning, professional dues, travel meals and entertainment, and a home office. The IRS denied the deductibility of several of these expenses, and the pastor appealed to the United States Tax Court.
The Court’s decision. In Bernstine v. Commissioner, T.C. Summ. Op. 2013-19, the Tax Court began its opinion by reviewing the rules for substantiating business expenses:
As a general rule, if the record provides sufficient evidence that the taxpayer has incurred a deductible expense, but the taxpayer is unable to fully substantiate the precise amount of the deduction, the Court may estimate the amount of the deductible expense and allow a deduction to that extent [the so-called “Cohan rule”]. Such estimates are to be made bearing heavily against the taxpayer whose inexactitude in substantiating the amount of the expense is of his own making. For the Court to estimate the amount of an expense, there must be some basis upon which an estimate may be made.
However, under [section 274 of the tax code] a taxpayer must satisfy strict substantiation requirements for certain kinds of expenses, such as those for travel, meals and entertainment, and “listed property” …. To deduct these expenses the taxpayer must maintain adequate records and documentary evidence to prove the amounts, times, places, and purposes of the expenses.
The Court assessed each expense. Ultimately, it was the pastor’s failure to substantiate expenses according to IRS requirements that led them to deny many of his deductions.
One item to note: The 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 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.”
Application. This case is instructive for several reasons. First, it provides an excellent review of the substantiation requirements for various business expenses. Note that while the “Cohan rule” can be used to estimate some business expenses, this is not possible for other expenses (including transportation, entertainment, travel) for which stricter substantiation requirements apply. In general, taxpayers must substantiate the amount, date, place, and business purpose of these expenses with adequate records including receipts for individual expenses of $75 or more.
Second, this case illustrates that according to the Tax Court, some ministers are self-employed for income tax reporting purposes. While this status is generally less desirable for tax purposes than reporting as an employee, it remains an option in appropriate cases.
Third, this case illustrates that while a deduction for home office expenses is often difficult to support, it is available in some cases. The Court concluded that the pastor’s self-employed status helped demonstrate his eligibility for a home office expense deduction. While he had an office at church where he met with parishioners (which ordinarily is fatal to a home office deduction for ministers reporting their income taxes as an employee), the fact that he was self-employed for income taxes supported his eligibility for a home office expense deduction since his other business activities were largely conducted at that location. n
To learn more about how to meet IRS requirements for deducting business expenses on clergy tax returns, see Chapter 7 of Richard Hammar’s annual Church & Clergy Tax Guide, available on ChurchLawAndTaxStore.com.