A pastor’s sabbatical is a time of refreshment and rejuvenation is common, but a sabbatical comes with tax implications.
While churches desire a sabbatical to be both beneficial to the pastors and a blessing, when it comes to taxes, many common practices surrounding sabbaticals create unanticipated adverse consequences for both churches and pastors. Several questions commonly arise from the practice of sabbatical programs offered by churches.
If a church wants to provide a month-long sabbatical to all full-time, credentialed pastors, can the church continue to pay a pastor’s regular salary during the sabbatical?
A sabbatical is generally a vacation and can be offered at will by the church. A sabbatical can be considered “paid” time off and compensation related to the time off is fully taxable. However, the extent of paid time off should be reasonable considering the pastor’s tenure with the church. For example, the IRS could consider granting an extended sabbatical a form of unreasonable compensation, if the pastor has only worked at the church for a few years.
If a church provides its pastor a sabbatical and agrees to cover the cost of a special trip providing a time of renewal with the pastor’s family, are the related expenses taxable to the pastor?
Yes, the payment of personal travel expenses is taxable to the pastor. While a church may see the benefit of a time of renewal, this purpose is not recognized as a business purpose by the Internal Revenue Code (IRC) and a pastor cannot convert personal expenses into business expenses.
Our pastors are expected to study and pray for the future vision of the church during their sabbatical. Does this required activity allow the related expenses to be business expenses?
An expectation of spiritual development may appear to have a business purpose for a church, but it does not turn travel that is inherently personal in nature into a business trip. There must be a business purpose for the travel for it to be considered business travel. Since activities involving personal spiritual development and prayer don’t require a destination, the IRS doesn’t agree that traveling to another destination is required to accomplish these purposes.
Our pastor believes visiting various historical sites provides a better education or understanding of biblical events, places, and people and is planning on spending part of the sabbatical in the Holy Land. Can the church cover the expenses, tax-free, related to this trip?
IRC Section 274(m) disallows a deduction for any travel expenses where the travel itself is a form of education. While the “deduction” is not in question, amounts disallowed under IRC Section 274 generally fail the definition of business expenses allowed under IRC Section 162. These rules apply to trips where a taxpayer is not completing a specific course of study or attending a specific educational event, but rather the trips simply provide a greater knowledge and understanding of an area that will enhance the traveler’s abilities. In cases when pastors may determine their own itinerary, the trip is considered a personal trip and not a business trip.
Are there times when the church can pay sabbatical expenses without creating taxable income to the pastor?
For a church to pay sabbatical expenses tax-free, the trip expenses must rise to the level of a business expense as allowed by IRC Section 162 and Section 274. The IRC requires the predominant or primary purpose for travel to be the conduct of a business activity. Emphasis on the “predominant” or “primary” is an important attribute. Where the predominant purpose for the trip is personal in nature, integrating a small amount of a business activity does not translate the entire trip into a business trip.
For example, during a sabbatical a pastor and his family go to California for two weeks. During the trip, the pastor attends a conference for two days. Since the majority of the days are spent on personal activities, the trip is not considered as “primarily” taken for business. Likewise, travel expenses, such as airfare, are not considered business expenses in this scenario. The church may only pay for the conference fee and any of the related travel expenses on a tax-free basis, i.e., the cost of the hotel during the conference and any meals on conference days.
How are any taxable expenses reported?
Personal expenses covered by the church represent additional taxable compensation and must follow the compensation rules:
- Payment of the expenses must be approved by the appropriate board or committee.
- Payment of the expenses must not cause a pastor’s compensation to exceed reasonable compensation for services provided to the church.
- Payment of the expense must be included in Box 1 of the pastor’s Form W-2.
Should the church be concerned about excess benefit transactions and intermediate sanctions under IRC Section 4958?
If the pastor taking the sabbatical is considered a disqualified person under IRC Section 4958, the church must be concerned about excess benefit transactions. There are two common ways excess benefit transactions are created from sabbaticals:
- If the payment of personal expenses results in excess or unreasonable compensation, the amount of unreasonable compensation is an excess benefit; or
- If the payment of expenses is not approved by the proper board or committee as additional compensation, and it is not included on the pastor’s Form W-2 as compensation, then it is considered an automatic excess benefit transaction even if the expenses would not have created unreasonable compensation if properly approved and reported.
What are the consequences of excess benefit transactions (EBT)?
The assessment of intermediate sanctions and the required repayment of the expenses to the church are the consequences of the EBT. Sanctions include an initial sanction of 25 percent of the EBT with a potential additional assessment of 200 percent if the expenses are not repaid to the church in a timely manner. Additionally, any individual who agreed with the transaction, for example a finance committee member or a board member or other executive officer, may be assessed a sanction of 10 percent of the EBT. In rare cases, and generally only when EBTs are extensive, a church’s tax-exempt status may be revoked (although the law does provide that the church’s tax-exempt status may be revoked at the existence of one EBT). In cases where an EBT could exist, the church should never pay for the expenses initially—thus avoiding any future potential sanctions or complications.
If a church is going to create a sabbatical policy for its pastors, the church should clearly state the expenses it will and will not cover during the sabbatical and what expectations it has of pastors during a sabbatical.
If a church is providing for personal expenses, a policy should clearly indicate the expenses to be included in taxable income. Not only does this create clear expectations between a church and its pastors, this allows both planning for the payment of expenses and planning for any related tax consequences. And, while we have addressed pastoral sabbaticals, in general, the rules apply to any staff member when working with a sabbatical.