Background. In March the IRS released amended regulations addressing the substantiation of business expenses under an employer’s expense reimbursement arrangement. The amended regulations contain a number of provisions that will affect the way churches reimburse business expenses. It is important for church treasurers to be familiar with the new rules. This article will summarize the amended regulations, and illustrate them with several examples.
Receipts. For many years the income tax regulations required that taxpayers substantiate the amount of any business expense of $25 or more with a receipt. In 1995 the IRS announced that it was increasing this “receipt threshold” to $75. The amended regulations make official the action taken by the IRS in 1995.
Key point. The $75 receipt requirement applies both to the deductibility of a business expense, and to the substantiation of a business expense under an employer’s accountable expense reimbursement arrangement.
Example. A church has adopted an accountable business expense reimbursement arrangement for its two pastors and three staff members. This means that the church only reimburses those employee business expenses that are properly substantiated. In order to properly substantiate a business expense of $75 or more, an employee must produce a receipt.
Example. Rev. G is not reimbursed for business expenses that he incurs. In order to claim a business expense deduction on his tax return he will need to produce a receipt for each separate expense of $75 or more.
Retaining documentary evidence. The income tax regulations specify that a reimbursement arrangement will not satisfy the requirements of an accountable arrangement
to the extent that the employer … does not require an adequate accounting from its employees or does not maintain such substantiation. To the extent an employer fails to maintain adequate accounting procedures he will thereby obligate his employees to separately substantiate their expense account information.
According to this regulation, churches and other employers are required to keep the receipts and other records submitted by employees to substantiate their business expenses under an accountable expense reimbursement arrangement. In a 1963 ruling, the IRS observed that it was “studying the problems presented to employers regarding warehousing and retention of documentary evidence.” It promised to “issue a ruling on this matter in the near future.” For more than 30 years employers have waited for the promised ruling, and the expected relief from the requirement that they retain records and receipts submitted by employees to substantiate their business expenses under an accountable arrangement.
The amended income tax regulations address this issue directly—in response to numerous comments the IRS has received to provide employers with relief from the records retention requirement. Federal agencies and private employers alike asked the IRS to provide relief from the administrative burden and cost of storing large quantities of paper receipts. Some employers asked the IRS to adopt a rule allowing employers to dispose of documentary evidence after an employee has made an adequate accounting—or return the documentary evidence to the employee for retention. Other employers asked the IRS to consider modifying the rules for accountable expense reimbursement arrangements to permit employees to substantiate their business expenses by submitting an expense voucher or summary without any receipts of documentary evidence.
The IRS responded to these concerns in the following two ways:
- It noted that with the increase in the receipt requirement to business expenses of $75 or more “the necessity for storing large quantities of paper records is significantly reduced.”
- It amended the above-quoted regulation that in the past has required employers to retain records and receipts submitted by employees to substantiate their expenses under an accountable arrangement. The new, amended regulation provides:
The [IRS] Commissioner may, in his discretion, prescribe rules under which an employee may make an adequate accounting to his employer by submitting an account book, log, diary, etc., alone, without submitting documentary evidence.
This language is very important. It is saying that the IRS can issue new rules modifying the substantiation requirements for an adequate accounting by an employee to an employer under an accountable arrangement. The IRS explained this amendment as follows:
Under the amendment, the [IRS] could publish rules defining the circumstances (including the use of specified internal controls) under which an employee may make an adequate accounting to his employer by submitting an expense account alone, without the necessity of submitting documentary evidence (such as receipts). This change is expected to reduce the recordkeeping burden for employers and employees.
Key point. Why may the IRS issue rules allowing expense accounts (without supporting receipts or documentary evidence) to substantiate business expenses under an accountable arrangement? To relieve employers of the burden and cost of maintaining receipts and other documentary evidence supporting an employee’s business expenses.
Key point. The IRS has not yet issued rules permitting employees to substantiate business expenses under an accountable arrangement by submitting an expense account without any supporting receipts or documentary evidence. As soon as these rules are published, we will be addressing them in this newsletter. Until they are issued, churches should continue to rely on the old rules.
Key point. The IRS has warned that any relaxation in the substantiation requirements for accountable plans will not affect the deductibility of unreimbursed business expenses (or expenses reimbursed under a nonaccountable arrangement).
The importance of this proposed change cannot be overstated. In the future, churches may be able to maintain an accountable business expense reimbursement arrangement by having employees submit an expense account or summary without any supporting receipts or other documentary evidence. This is a major development that we will be following closely.
Example. A church reimburses its pastor’s business expenses upon receipt of an account book or log, without any receipts of other supporting documentary evidence. For 1996, the church reimbursed $4,000 of business expenses under this arrangement. Under present law, this arrangement is nonaccountable since it does not provide receipts for expenses of $75 or more. This means that the church should have reported the $4,000 as income on the pastor’s W-2 for 1996. However, under the amended income tax regulations, the IRS may relax the requirements for an accountable plan. Depending on what (if anything) the IRS announces later this year, the church may be able to treat its reimbursement arrangement as accountable—meaning that reimbursed expenses would not be reported as income on the pastor’s W-2. If the IRS does relax the rules for accountable plans, it likely will do so only if certain conditions are satisfied.
Example. Same facts as the previous example, except that the church only reimburses those business expenses for which the pastor submits adequate documentation substantiating the amount, date, place, and business purpose of each expense. The church also requires receipts to support any individual expense of $75 or more. The pastor must substantiate expenses not later than two months after they are incurred. This is an accountable arrangement under present law, meaning that the church’s reimbursements are not reported as income on the pastor’s W-2. However, under the amended income tax regulations, the IRS may relax the requirements for accountable plans. Depending on what (if anything) the IRS announces later this year, the church may be able to continue to treat its reimbursement arrangement as accountable while requiring less substantiation of expenses. If the IRS does relax the rules for accountable plans, it likely will do so only if certain conditions are satisfied.
Maintaining records in electronic form. Some employers urged the IRS to relieve their recordkeeping burden by permitting them to maintain records substantiating business expenses under an accountable arrangement in electronic form (on a computer). The new regulations do not address this issue. However, in commenting on the new regulations, the IRS noted that there is no requirement that records substantiating reimbursements of business expenses under an accountable arrangement be in paper or “hardcopy” form. It referred to a previous ruling in which it permitted retention of some records in electronic form.
Key point. Many church treasurers are unaware that some kinds of tax records can be kept in electronic form. Storing records electronically can result in a significant reduction in paperwork and storage facilities. Further, documents that are stored electronically often are far easier to access and research. There are several requirements that must be met in order to store records electronically. These include (1) documentation describing the electronic recordkeeping system; (2) specific documentation for retained files; (3) documentation of any change in the electronic recordkeeping system; (4) specific rules on how long such records must be kept, and where; (5) appropriate labeling of electronic records; and (6) periodic testing to identify data loss. These requirements will be addressed in a future issue of Church Treasurer Alert.
Credit card charges. Some employers asked the IRS to include a provision in the new regulations allowing employees to substantiate lodging expenses with a credit card statement alone. The IRS rejected this request. It noted that current law requires that documentary evidence of lodging must show separate amounts for charges such as lodging, meals, and telephone calls. The IRS concluded:
A credit card statement or record of charge, unlike a hotel bill, normally will not segregate lodging and other expenses, such as meals and entertainment … or personal expenses (such as personal phone calls or gift purchases) that may not be deducted. Therefore, such a credit card statement or record of charge alone will not constitute acceptable documentary evidence of a lodging expense …. The temporary regulations make no change to the current documentary evidence requirements for lodging expenses. Because of the large number of expenses that can be charged to hotel bills, and extensive variation from traveler to traveler in the types of expenses charged to hotel bills, any attempt to establish percentages for allocating hotel bills to lodging and other fully deductible business expenses, meals and entertainment, and personal expenses is considered impracticable.
Oral substantiation. Some employers asked the IRS to include a provision in the new regulations allowing employees to “orally”: substantiate the “business purpose” of their business expenses. The IRS responded by noting that “the current regulations do not preclude an initial oral substantiation of business purpose which is reduced to writing no later than the time of the employee’s final accounting to the employer.”
Employer verification procedures. Some employers asked the IRS to include a provision in the new regulations allowing employers to conduct a review of only a statistical sampling as opposed to 100 percent of employees’ expense vouchers. The IRS responded to this request as follows:
[Current regulations] state that an employee who makes an adequate accounting to his employer will not again be required to substantiate such expenses, unless the employer’s accounting procedures are not adequate or it cannot be determined that such procedures are adequate. The [IRS] will determine whether the employer’s accounting procedures are adequate by considering all the facts and circumstances, including the employer’s use of internal controls. The employer’s accounting procedures should include a requirement that an expense account be verified and approved by a reasonable person other than the person incurring the expense. To the extent the employer fails to maintain adequate accounting procedures, the [IRS] may require the employee to separately substantiate his expense account information.
[Current regulations] cite post-expenditure review of employees’ expense accounts as an internal control that should normally be employed. However, whether the employer’s post-expenditure review procedures are appropriate is a matter within the discretion of the [IRS], based on a review of all the facts and circumstances.
“De minimis” exception to substantiation requirements. Some employers asked the IRS to include a provision in the new regulations that would exempt employees who receive $1000 or less per year in reimbursed expenses from the need to substantiate the amount, date, and place of business expenses. Such a provision, these employers claimed, would reduce the paperwork burden imposed on employers that administer an accountable expense reimbursement arrangement. The IRS declined to adopt such an exception, noting that “in view of the other changes made by the temporary regulations that will lessen a taxpayer’s recordkeeping burden, such as the increase in the receipt threshold, the temporary regulations do not incorporate this suggestion.”
Increase in limit on deduction for gifts. Some employers asked the IRS to include a provision in the new regulations increasing the $25 limit on the deduction for business gifts to $75. The IRS refused to do so, noting simply that it had “no discretion to raise this statutory limit.”
Use of full federal per diem method to substantiate travel for deduction purposes. Some employers asked the IRS to include a provision in the new regulations allowing self-employed persons and unreimbursed employees to substantiate lodging expenses for deduction purposes by means of the “high-low” per diem method. The IRS declined to adopt this suggestion, noting that existing law “permits this substantiation method for employee reimbursements only” and that “this suggestion is outside the scope of this revision to the temporary regulations.”
When do the new rules take effect? The new rules were released in March of 1997, and apply to business expenses paid or incurred after September 30, 1995.
Need additional clarification? The new regulations were written by Donna Crisalli, Office of the IRS Assistant Chief Counsel (Income Tax & Accounting). For further information concerning the new regulations you can contact her at 1-202-622-4920.
This article originally appeared in Church Treasurer Alert, July 1997.
This content is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. "From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations." Due to the nature of the U.S. legal system, laws and regulations constantly change. The editors encourage readers to carefully search the site for all content related to the topic of interest and consult qualified local counsel to verify the status of specific statutes, laws, regulations, and precedential court holdings.