Your church should establish an accountable reimbursement policy. Clergy are allowed to exclude all reimbursed expenses from their reportable income. The church reimbursement policy should include the following, but not limited to: office supplies, religious material, subscriptions and paperbacks, meals, entertainment, seminars, dues and memberships, library, educational expenses, camps, legal and professional services, gifts, auto, travel, etc. Any expenses incurred on behalf of the ministry to the church will qualify.
Nonaccountable Reimbursement Plans
A non-qualified/allowance plan is a reimbursement arrangement which does not require clergy to substantiate the expenses to the church and also give them the right to retain any amount in excess of the substantiated expenses. In this example, all the reimbursements would be reported as taxable income, which may increase the tax liability. These expenses could be treated as miscellaneous itemized deductions, which are subject to two-percent of adjusted gross income and may produce no tax benefit unless your itemized deductions exceed the standard deductions.
Accountable Reimbursement Plans
The new rules for qualified reimbursement arrangement plans would require that the reimbursements must not exceed the expenses incurred. All reimbursed expenses must be substantiated to the church with receipts or other documentation and all excess allowances must be returned to the church that are not used for ministry expenses.
In substantiating your expenses to the church, you must provide them receipts or documents indicating the amount, business use, number of business miles, time, date, business purpose and name.
A qualified reimbursement plan on a per diem or other fixed allowance basis that is similar in form to the allowance specified by the federal government is
a permissible arrangement providing that the expenses are substantiated.
All reimbursed ministry expenses under the qualifying reimbursement plan
are excludable from taxable income in full to the extent of the reimbursement. Failure to meet these new rules would required you to report your reimbursed expenses as taxable income.
Accountable reimbursement plans are one of the most misunderstood areas for church administrators.
Much documentation is required to substantiate expense reimbursements for employees taking ministry trips and can result in the church having to add such expenses to employee income and apply appropriate employment taxes to those amounts.
Internal Revenue Service Publication 463, Travel, Entertainment, Gift, and Car Expenses, defines qualified tax-free travel expenses as the ordinary and necessary expenses of traveling away from home for ministry, profession, or job.
However, churches must establish a travel and professional expense program using an accountable plan to maintain tax-free status of the amounts paid.
Accountable plans: three requirements
To be considered an accountable plan under federal tax provisions, a reimbursement or other employee expense allowance arrangement must comply with these requirements:
• Ministry connection—The reimbursements, advances, or allowances provided to employees under the plan must be for work-related expenses that would be deductible by the employee if claimed as a deductible ministry expense on the their personal return. Any advance payments must be reasonably related to ministry expenses that a worker is expected to incur.
• Substantiation—Employees must substantiate, within a reasonable period of time, the amount, time, use, and ministry purpose of the allowance or expense payment. In lieu of substantiation of actual expenses, churches can use IRS-approved per diems.
• Return of excess payments—The plan must require employees to return, within a reasonable period of time, any reimbursements or advances that exceed substantiated expenses, or, in the case of a per diem, payments for days not traveled. However, if an employee uses part of an advance payment that exceeds the amount that was incurred and substantiated to pay for other ministry expenses, the excess amount that was used need not be returned.
• Under the fixed date method, IRS will treat as timely: advance payments made no more than 30 days before an employee incurs ministry expenses; expenses that are substantiated within 60 days after they are incurred or paid; and excess payments that are returned to the church within 120 days after being incurred or paid.
• Using the periodic statement method, a church can issue periodic statements to employees, at least quarterly, regarding unsubstantiated expenses or unreturned excess payments, and the timeliness requirements will be satisfied if employees substantiate the expenses and refund any excess within 120 days of the statement.
Federal substantiation requirements
To be excluded from taxable wages, several different types of reimbursed costs incurred during ministry travel need to be documented based on the nature of the expense. A variety of options exist for substantiating certain costs, such as lodging and meals, where exact amounts need not be reported to qualify as tax-free, while others require a more direct-cost approach, such as airfare or other transportation amounts.
It is important that records be kept of all the expenses and any advances that are covered by a church. Employees can use a log, diary, notebook, or other written records to track expenses. Churches also need a system to implement an accountable plan that identifies costs and ensures appropriate substantiation exists on the amounts. If reimbursements for travel are made at the same time as regular wage payments, the reimbursement for expenses must be separately paid or separately identified, or the reimbursement will be considered taxable wages.
IRS has instructed its field examiners that travel-expense reimbursement plans that show a ‘‘pattern of abuse’’ should be declared nonaccountable and all reimbursements made under them considered taxable income to the employees.
Actual cost substantiation, reporting
Employee travel costs paid by churches can be tax free only if made under an accountable plan. Certain elements of these costs must be tracked and reported in exact amounts in order to keep the plan compliant. These costs include:
• amounts paid for air, train, or bus tickets, and other related expenses and surcharges
• amounts paid for taxis, airport limousines, or commuter busses;
• telephone charges while on ministry travel, including ministry communication by fax machine or other communications devices; and
• baggage and shipping of materials to the temporary work place.
Documentary evidence will be considered adequate to support an expenditure if it includes sufficient information to establish the amount, date, place, and the essential character of the expenditure. According to IRS Publication 535, Ministry Expenses, ‘‘evidence should include items such as receipts, along with either a statement of expenses, an account book, a day-planner, or similar record in which the employee entered each expense at or near the time the expense was incurred.’’
For example, a hotel receipt is sufficient to support expenditures for ministry travel if it contains the name, location, date, and separate amounts for charges of lodging, meals, and telephone. On the other hand, a canceled check made payable to a named payee would not by itself support a ministry expenditure without other evidence showing that the check was used for a certain ministry purpose, IRS said.
Note that, under IRS regulations modified in 2000, employees are not required to produce documentation for most travel-related expenses that are less than $75. Costs for lodging, however, are excluded from the rule and must be documented regardless of the amount. Some churches maintain a policy of requiring documentation for incurred costs that are less than $75, but IRS does not require such documentation.
Options in substantiation
Unlike airfare tickets and the items listed above, other costs incurred during ministry travel do not require substantiation using exact amounts expended, but instead can conform to rates established by the federal government to meet tax-free treatment criteria. Recording and reporting exact amounts for these other costs remains an option under an accountable plan, but for administrative convenience, federal law and regulations allow for these different methods to meet the substantiation requirement for these common ministry travel costs:
• lodging/hotel expenditures;
• meals and incidentals; and
• vehicle use while on ministry travel.
For lodging and hotel expenses and meals and incidentals, a church can reimburse employees’ ministry travel expenses by means of a per diem allowance. Per diem, Latin for ‘‘per day,’’ is a sum of money calculated on a daily basis and may be paid in advance or after an expense is incurred.
For the use of a vehicle while on travel, churches have the option of applying in an accountable plan the standard mileage rate and calculating the expense per mile, as opposed to requiring substantiation of actual costs.
Per diem rates
Using per diem rates, paid at the applicable federal rate, the amounts of lodging, meals, and incidental expenses are deemed substantiated for purposes of avoiding taxability of expense reimbursements. Per diem rates can also be paid based on another flat rate or stated schedule that is reasonably calculated not to exceed ordinary and necessary ministry expenses.
The amount of expenses deemed substantiated by churches that pay per diem allowances in lieu of reimbursing employees for actual expenses for lodging, meals, and incidental expenses incurred for ministry-related travel is the lesser of the per diem allowance, or the amount computed at the federal per diem rate for the ‘‘locality of travel’’ for the period the employee is away from home. ‘‘Locality of travel’’ is where the employee stops to sleep or rest.
When using per diem rates as a method of substantiation, employees need only account for time, place, and ministry purpose of travel. Receipts for lodging and meals are not required under a per diem allowance, and employees whose actual expenses are less than their per diem are not required to refund the excess. Excess amounts advanced for days not actually traveled must be returned, however.
The per diem allowance must cover lodging, meals, and incidental expenses for travel away from home. Incidental expenses include laundry and dry cleaning, fees, and tips for services.
Churches choosing to apply per diem rates for travel expenses must include as wages amounts in excess of the federal rates used. IRS allows churches the following options to choose between types of per diem arrangements for substantiating lodging, meals, and incidental expenses:
• Regular federal per diem rate/per diem substantiation method.
• High-low substantiation method.
If the church uses the high-low method to set per diem rates for an employee, the church generally may not switch to the per diem method for that same employee for travel within during the same calendar year.
Churches also can provide employees with a per diem allowance only for meals and incidentals. This can occur only if the church pays the employee for actual expenses for lodging based on receipts submitted, the lodging is provided by the church either directly or through the provider, there is no reasonable belief that any lodging expenses were incurred by the employee, or the allowance is computed on a basis similar to that used in computing the employee’s wages, such as the number of hours worked or miles traveled.
The ‘‘standard meal allowance’’ method is an alternative to the actual cost method. It allows churches to set an amount for employee meals and incidental expenses, instead of keeping records of actual costs. The set amount varies depending on where and when employees travel. (Note that the standard meal allowance rates do not apply to travel in Alaska, Hawaii, or any other location outside the continental United States.)
Under these situations, the amount treated as an expense for food and beverages is the lesser of the per diem allowance; and the federal rate for meals and incidental expenses, or the ‘‘standard meal allowance.’’
Accounting for partial days
For meals taken on the partial days of travel to and from a destination, meal allowances need to be prorated (a reduced amount for each day) depending on the meals required while traveling. Churches can prorate by using one of two IRS-approved methods: three-quarters of the standard meal allowance can be claimed, or by using a method that can be consistently applied and that is in accordance with reasonable ministry practice.
Finally, IRS allows for an ‘‘incidental-expenses-only method,’’ where incidental expenses are limited generally to tips and other small expenses only if employees do not pay or incur any meal expenses. Employees cannot use this method on any day that the standard meal allowance is used. This method also is subject to the proration rules for partial days, according to IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses.
Adequate tracking required
Costs incurred when employees operate and maintain a car when traveling away from home on ministry can be tax-free. Churches have the option of substantiating costs using actual expenses with receipts, or combining the standard ministry mileage rate (with a record of miles traveled) with receipts for ministry related tolls and parking.
If employees rent a car while away on ministry, only the ministry-use portion of the expenses are tax free. If the rental car agreement includes the cost for gasoline, employees cannot also claim the standard mileage rate for ministry miles driven. Actual costs incurred, in addition to the cost of the rental, are necessary for full substantiation.