The problem. According to our annual surveys of church financial practices, we know that most churches by now have adopted "accountable" expense reimbursement arrangements. This means that they reimburse business expenses incurred by their pastor, and perhaps lay employees, which are adequately substantiated ("accounted for") in a timely manner. A question that often arises is who owns property purchased by a pastor or lay employee if the purchase price is reimbursed by the church under an accountable arrangement? The pastor (or lay employee)? The church? What difference does it make? Church treasurers should be able to answer these questions.
Let's illustrate the practical significance of this subject with a few examples.
Example 1. First Church adopted an accountable expense reimbursement arrangement several years ago. It reimburses those expenses incurred by any of its employees that are adequately substantiated. To substantiate an expense, an employee must submit proof of its amount, date, location, and business purpose. Receipts are required for any expense of $75 or more. Substantiation of each expense must be completed within a month of the date the expense was incurred. Such an arrangement qualifies as an accountable expense reimbursement arrangement. Assume that Pastor D purchased a personal computer for $2,000 in 1998 that he uses entirely for work-related duties (sermon preparation, research, and communicating with church members and other ministers). In 1999, one year after purchasing the computer, Pastor D accepts a position at Second Church. A few days before moving, the treasurer at First Church asks Pastor D about the computer. Will he be leaving it, or taking it with him? Pastor D is unsure who should keep it, and so is the church treasurer.
Example 2. Pastor B has served as pastor of First Church for 20 years. Over that time, he has purchased several books and commentaries for a professional library that he maintains in his church office. Many of the books were purchased in the past few years. The church has reimbursed Pastor B for the purchase of all of these books. The reimbursements have amounted to $3,000. Pastor B accepts a position at Second Church. As his last day at First Church approaches, he begins to wonder about his library. Should he leave it for his successor at First Church? After all, the church paid for it. Or, should he pack it up and take it with him? He asks the church treasurer for her opinion, but she is unsure. They agree to let the pastor take the library with him. This decision is based on the fact that a pastor's library is a matter of personal preference, and that Pastor B's library may be of little if any use to his successor. Further, they assume that the next pastor probably will be bringing his own library with him from his previous church. An accountant who attends First Church learns that Pastor B will be taking the library with him. The accountant questions the legality of this arrangement. The church board addresses this issue, but does not know how to resolve it. They want to let Pastor B take the library with him, but they do not how to explain such a decision to the accountant.
Example 3. Same facts as example 2, except that Pastor B is retiring.
Example 4. Pastor T is the youth pastor and resident "computer expert" at his church. During the three years he is employed by the church, he purchases several CDs and software programs to assist in the performance of his duties. The church reimbursed him for all of these purchases, which amounted to nearly $1,500. Pastor T accepts a position at another church. A question arises as to the ownership of the CDs and computer programs.
How church treasurers should respond. Unfortunately, the tax code and regulations do not address the question of who owns property purchased by an employee if the purchase price is reimbursed by the employer under an accountable reimbursement arrangement. And no guidance has been provided by the IRS or the courts.
So what should church treasurers do? Here are our suggestions:
The general rule
In general, when an employer reimburses an employee for the cost of property purchased by the employee for business use, it is the employer rather than the employee that is the legal owner of the property. After all, property purchased by an employee cannot be reimbursed under an accountable arrangement unless the employee substantiates the cost and business purpose of the property. In other words, it must be clear that the property will be used solely for the business purposes of the employer. Under these circumstances, there is little doubt as a matter of law that the employer is the legal owner of the property. It paid for it, and the accountable nature of the reimbursement arrangement ensures that it will be used by the employee within the course of his or her employment on behalf of the employer.
Key point. In many states, a "resulting trust" arises by operation of law in favor of the person who purchases property in the name of another. The law presumes that it ordinarily is not the intention of a person paying for property to make a gift to the one receiving title.
Example 5. A court ruled that a home purchased by a church for its pastor was subject to a "purchase money resulting trust" in favor of the church and therefore the home could not be considered in a property settlement following the pastor's divorce. The court ruled that when property is purchased by one person, but title is vested in another, the person holding title does so subject to a "purchase money resulting trust" in favor of the person who paid for the property. Cayten v. Cayten, 659 N.E.2d 805 (Ohio App. 1995).
A possible exception
In many cases, the value of property diminishes rapidly, and in a sense is "used up" within a period of months or a few years. As a result, the question of "ownership" of the property when the employee leaves his or her job has little relevance, since the value is so minimal.
Example 6. A pastor purchases a small dictation machine for $49 in 1995. The church treasurer reimburses her for the cost of the machine under the church's accountable reimbursement arrangement. When she leaves the church in 1999, the value of the machine is negligible. The "value" of the machine has been "used up" over its useful life. The church in essence has received full value for the purchase, and it would be pointless to insist that the machine remain with the church.
Example 7. Pastor G purchases a "state of the art" computer in 1992 at a cost of $2,500. First Church reimbursed the full purchase price, since the pastor used the computer exclusively for church-related work. The computer is an IBM compatible 20 megahertz "286" model, with 1 RAM of memory and a hard disk storage space of 200 megabytes. It has no modem and no CD drive. Pastor G accepts a position at Second Church in 1999. He is still using the same computer, and a question arises as to the ownership of the machine. While the computer may have been "state of the art" in 1992, it is essentially worthless in 1999. Like the dictation equipment described in example 6, the church has received full value for its purchase of the computer, and it would be pointless to insist that the computer remain with First Church.
Churches need to be concerned about the issue of inurement when they allow a minister or other employee to retain ownership and possession of property purchased by the church for church use. Churches are exempt from federal income taxes so long as they comply with a number of conditions set forth in section 501(c)(3) of the tax code. One of those conditions is that "no part of the net earnings [of the church or charity] inures to the benefit of any private shareholder or individual." What does this language mean? The IRS has provided the following clarification:
An organization's trustees, officers, members, founders, or contributors may not, by reason of their position, acquire any of its funds. They may, of course, receive reasonable compensation for goods or services or other expenditures in furtherance of exempt purposes. If funds are diverted from exempt purposes to private purposes, however, exemption is in jeopardy. The Code specifically forbids the inurement of earnings to the benefit of private shareholders or individuals …. The prohibition of inurement, in its simplest terms, means that a private shareholder or individual cannot pocket the organization's funds except as reasonable payment for goods or services." IRS Exempt Organizations Handbook section 381.1.
It is possible that prohibited inurement occurs when a church allows a minister or other employee to retain ownership and possession of property purchased with church funds for church use. However, in many cases the value of the property will be so minimal that inurement probably is not a problem. To avoid any question, especially if the property has some appreciable residual value, the church could "sell" the property to the employee, or it could determine the property's market value and add this to the employee's final W-2 or 1099 as additional compensation. In either case, the inurement problem would be avoided.
In deciding whether or not inurement has occurred, the relevant considerations will be as follows:
(1) the purchase price paid (or reimbursed) by the church
(2) the "useful life" of the property
(3) the date of purchase
(4) the residual value of the property at the time the pastor or lay employee is leaving his or her employment with the church
IRS regulations specify the useful life of several different kinds of property in order to allow taxpayers to compute depreciation deductions. These guidelines can be a helpful resource in deciding whether or not inurement has occurred.
Let's apply the inurement principle to the above examples.
Example 1. Inurement is a possibility according to the above criteria, since (1) the purchase price paid by the church was substantial; (2) a one-year old computer still has a remaining "useful life" (according to IRS regulations, the useful life of computer equipment is 5 years); (3) the computer was purchased one year ago; and (4) the residual value of a one-year old computer is still significant. To avoid jeopardizing the church's tax-exempt status as a result of prohibited inurement, the church has three options. First, it can ask Pastor D to return the computer. Second, it can let Pastor D keep the computer, but add the current value of the computer to Pastor D's W-2. The computer's current value can be obtained by calling local computer dealers, especially those dealing in used equipment. Third, the church can sell the computer to Pastor D for its current value.
Example 2. Inurement is a possibility according to the above criteria, since (1) the purchase price paid by the church was substantial; (2) some of the books still have a remaining "useful life" (according to IRS regulations, the useful life of books is 7 years); (3) while some of the books were purchased more than 7 years ago, many were purchased within the past 7 years; and (4) the residual value of books purchased within the past 7 years is still significant. To avoid jeopardizing the church's tax-exempt status as a result of prohibited inurement, the church has three options. First, it can ask Pastor B to return books purchased within the past 7 years. Books purchased prior to that time are beyond their "useful life," according to IRS regulations, and so their value is presumed to be insignificant. Second, it can let Pastor B keep the entire library, but add the current value of books purchased within the past 7 years to his W-2. The current value of these books can be obtained by calling a used book dealer. Third, the church can sell the books to Pastor B for their current value.
Example 3. See the analysis of example 2.
Example 4. Inurement is a possibility according to the above criteria, since (1) the purchase price paid by the church was substantial; (2) the CDs and software programs still have a remaining "useful life" (according to IRS regulations, the useful life of computer software is 36 months); (3) the CDs and software were purchased in the recent past (within the 36-month "useful life" specified by the IRS regulations); and (4) the residual value of the CDs and software is still significant. To avoid jeopardizing the church's tax-exempt status as a result of prohibited inurement, the church has three options. First, it can ask Pastor T to return the CDs and software. Second, it can let Pastor T keep the CDs and software, but add the current value of these items to his W-2. The current value of CDs and software can be obtained from a local computer dealer, especially one that deals with used products. Third, the church can sell the CDs and software to Pastor T for their current value.
Example 5. Not applicable.
Example 6. Inurement is not a possibility according to the above criteria, since (1) the purchase price paid by the church was minimal; and (2) the current residual value of a dictation machine that cost $49 four years ago is negligible. IRS regulations specify that the useful life of such equipment is 7 years, and so the machine still has a remaining useful life. However, the age and minimal cost of the machine outweigh the significance of any remaining useful life.
Example 7. Inurement is not a possibility according to the above criteria, even though the original cost was substantial, since (1) the computer has outlived its useful life (according to IRS regulations, the useful life of computer equipment is 5 years); (2) the computer was purchased 7 years ago, and is essentially obsolete; and (3) the residual value of a 6-year-old computer is minimal.
Key point. This article has focused on the ownership of property purchased by a pastor or lay employee, when the purchase price is later reimbursed by the church under an accountable business expense reimbursement arrangement. The same analysis will apply, of course, if the church reimburses the purchase price under a nonaccountable arrangement. This article addresses accountable arrangements since the vast majority (93%, according to our surveys) of churches that reimburse business expenses claim to be doing so under an accountable arrangement.