Q: In the church, we often will take someone out for coffee or lunch—for pastoral- or church-related discussions. Is this no longer allowed with the business expense rules that resulted from the Tax Cuts and Jobs Act?
Tax reform should affect the way churches approach the reimbursement of entertainment expenses to pastors and staff members. If a church does not use an accountable reimbursement plan, the act prevents pastors or staff members from itemizing business expenses as deductions on schedule A.
Furthermore, pastors or staff members will have those reimbursements reported as compensation on their Form W-2 or 1040—and the amounts can be taken into account in computing automatic excess benefits (and any potential penalties, if they are triggered).
That’s why, as I have advocated for more than 30 years, churches should adopt an accountable reimbursement plan. Such a plan enables pastors and staff members to receive reimbursements without facing any tax consequences. But specific rules must be followed.
Only qualifying business expenses may be reimbursed under an accountable expense reimbursement plan. Entertainment expenses are a subset of business expenses. To qualify as a business expense, the expense must be the type of expense ordinarily incurred by churches when conducting their business. The expense must also be necessary to conduct the church’s business. Once these requirements are met, then the church must look at whether the expense qualifies as entertainment while conducting church business.
Entertainment expenses must meet the “directly related test” or “associated test.” “Directly related test” means that the entertainment expense was incurred at a business meeting where the primary purpose was to conduct church business, or the participants actually conducted church business during the entertainment. The “associated test” means the entertainment occurred immediately before or after a business meeting where substantive church business was discussed.
If a pastor takes a member out for coffee or lunch, as your question indicates, the expense is reimbursable under an accountable expense reimbursement plan if (1) the expense is ordinarily incurred to conduct church business and is a reasonable amount, (2) the expense is necessary to conduct church business, and (3) the primary purpose is to discuss church business or the expense was incurred after a more formal church meeting where church business was discussed. Pastoral- or church-related discussions are part of conducting church business.
From there, the pastor or staff member needs to meet the documentation requirements of an accountable reimbursement plan. This includes submitting expense reports containing receipts and details about the transactions within 60 days of when expenses are incurred. Without the documentation, however, the expense cannot be reimbursed under an accountable expense reimbursement plan.
I must again stress that tax reform no longer allows business expense deductions for schedule A. It again demonstrates why churches should incorporate an accountable reimbursement plan if they do not currently use one.