Can an expense incurred in a prior year be covered in the following year? Our pastor used up his 2009 accountable expense money in October 2009, but still has reimbursable pastoral expenses he incurred in November and December. Can those expenses be paid from his 2010 accountable expense allowance, which begins in January (our church runs on a fiscal calendar year Jan-Dec)?
And conversely, can a portion of a reimbursable expense allowance for one year that is not entirely used up in the current calendar year be carried over to the next year by perhaps putting it in an Accounts Payable-Pastor Expense account to draw on in the following year? This would be used to cover expenses occurring in the new year, not left over from the prior year.
You really are asking two distinct questions: (1) Can the church reimburse expenses from a different tax year? (2) May the church reimburse expenses from a different year and treat the reimbursement as a tax-free payment to the pastor?
First, the church is free to reimburse (or not) as it determines that such action is in the best interest of the church. The church may choose to increase (or decrease) the pastoral expense budget line item at anytime during the tax year. It may also choose to do nothing. The church’s decision to reimburse an expense is a business decision that is entirely independent of the tax treatment of the payment.
To address your second question, if the expense reimbursement meets all the requirements of the church’s properly adopted accountable expense reimbursement plan, then the payments are not taxable or reportable to the IRS. If either the plan or the substantiation of any specific expense fails to meet the requirements of an accountable expense reimbursement plan, the payment is taxable and reportable to the IRS.
You first must determine whether the church has properly adopted and is following an accountable expense reimbursement plan.
Treas. Reg. section 1.62-2 defines an “accountable expense reimbursement plan” as a written plan that requires employees to substantiate adequately all expenses by providing a business connection with the employer, date, place, people involved and the dollar amount of the expense. The plan must also require that the employee timely return all funds advanced by employer if the employee does not adequately document expenses to cover the advance.
The employee must submit the required documentation and/or return excess advances within a “reasonable amount of time.” The regulation defines a reasonable amount of time as a facts and circumstances test. The regulation then creates a “safe harbor,” meaning the IRS will not challenge whether the plan meets the reasonable amount of time requirement. The safe harbor states that the employee must properly document to the employer expenses within 60 days of the date the expense was paid or incurred. The employee must return any excess advance within 120 days of the date the expense was paid or incurred.
A qualified accountable expense reimbursement plan may never allow an employee be paid (or retain if an advance is involved) any amounts that exceed the properly documented expenses.
Assuming the church’s written plan meets all of the above requirements, then the church’s governing body having jurisdiction over this matter must approve the plan. Generally, the Board of Directors (Vestry Board, Session, Elders, etc.) will have this responsibility, but the bylaws or Board may delegate this responsibility to a Finance or Personnel Committee. You should retain copies of the minutes to prove that the Board or Committee properly approved the plan.
Second, assuming the church has properly adopted an accountable expense reimbursement plan, you must examine whether the accountable expense reimbursement plan allows the church to reimburse the expense tax-free. Assuming the expenses meet the plan’s requirements, the reimbursement is tax-free.
If the expenses do not fit within the accountable expense reimbursement plan, the reimbursement payment is taxable.
Finally, assuming the church has properly adopted an accountable expense reimbursement plan and the expense meets all the plan’s requirements, then you must examine the documentation submitted by the pastor. If the documentation meets all the IRS requirements for expense reimbursement, then the church may treat the payment as tax-free. If the submitted documentation fails to meet the IRS requirements, the church should treat the payment as taxable.
Without having examined your expense reimbursement plan to determine whether it meets the accountable expense reimbursement plan requirements, or whether such documentation meets the IRS recordkeeping requirements, I am unable to provide a definitive answer to your question. For the remainder of this answer, I have assumed that your church has properly adopted a qualified accountable expense reimbursement plan and that the pastor has submitted the proper documentation to the meet the IRS recordkeeping requirements.
With the disclaimer that IRS may give you a different answer in an examination, it appears that your pastor’s request to reimburse 2009 expenses is too late for reimbursement under a qualified accountable expense reimbursement plan. His or her request is occurring more than 60 days after the expense was paid or occurred. However, facts and circumstances may exist that justifies the delay allowing for the tax-free reimbursement. Second, if you allowed the pastor to carryover any unused expense budget, then your church may not have a qualified accountable expense reimbursement plan. The IRS may argue that such a carryover violates the rule that amounts cannot be paid to the employee or retained by the employee over the amounts that were properly authorized. Since the pastor did not properly document expenses within the approved tax year or exceeded the authorized expense budget, such a policy is the equivalent of allowing him payment without properly documentation. As an alternative, the church may increase the budget for pastoral expenses at any time if it reasonably believes that the pastor will incur more expenses during the year than in previous years.
For more information on business expenses, see Chapter 7 of Richard Hammar’s annual Church & Clergy Tax Guide.