. . . an important decision
By Dan Busby, President
Many clergy receive an auto allowance. Others are reimbursed for their church-related mileage. While the reimbursement approach is nearly always the most tax advantageous to clergy, it comes with a price—the price is recordkeeping!
Let's look at allowances first. Under this approach, churches give clergy, and perhaps other staff, a payment or allowance for using their personal vehicles for church purposes. But instead of the employees submitting a report for each trip, then being reimbursed, the church simply cuts a check, usually once a month, for a set amount to cover wear and tear and gas for the employee's vehicle. Using this concept, the church may consider it a more efficient to process periodic allowance payments and clergy may feel it is less burdensome by avoiding recordkeeping relating to the use of an auto.
What is sometimes not adequately considered are the tax ramifications of nonaccountable allowance payments. Payments to employees for travel and other necessary expenses under a nonaccountable plan are considered wages and are subject to income and social security tax if:
an employee is not required to or does not timely substantiate those expenses to the church with receipts or other documentation;
the church advances an amount to an employee for business expenses and that individual is not required to or does not return timely any amount he or she does not use for business expenses;
the church advances or pays an amount to the employee without regard for anticipated or incurred business expenses.
Now let's look at reimbursements. Under the IRS rules, a reimbursement or allowance arrangement is a system by which the church reimburses staff members' substantiated business expenses (which may include expense advances). How these payments are reported depends on whether there is an accountable or a nonaccountable plan.
For accountable plans, the reimbursement or allowance arrangement must require the church staff to meet all of the following rules:
The business-related expenses must have been paid or incurred while performing services as a church employee.
The employee must adequately account for the expenses within a reasonable period of time.
The employee must return any amounts advanced in excess of the expenses within a reasonable period of time.
A reasonable period of time depends on the facts and circumstances. Generally, it is considered reasonable if employees receive their advance within 30 days of the time that they incur the expenses, adequately account for the expenses within 60 days after the expenses were paid or incurred, and return any amounts in excess of expenses within 120 days after the expenses were paid or incurred.
Employees must demonstrate trips made by automobile are for business purposes by listing the nature of the trips and the actual mileage used. The reimbursement for business mileage must not exceed the current rate for the actual miles used to qualify for tax-free treatment.
It is not critical whether business mileage is documented in a monthly expense report or an actual mileage log. The IRS allows a lot of leeway on the type or nature of the report. As long as it is a written account of the nature of the trip, the report should be acceptable as substantiating the expense.
Let's use a few examples to apply these concepts:
Automobile advance/accountable plan—no taxable income. Pastor Smith received a $500 automobile allowance advance on April 1. On May 10, he submits his April auto log with adequate information to substantiate the church-related miles. Based on the current business mileage rate, the church reimburses him $598, less the $500 advance, or $98.
Since the $598 advance and reimbursement represents reimbursement for church-related miles, there is no tax reporting required by the church for April regarding the automobile advance and reimbursement. The payments for April are tax-free.
Automobile advance/accountable plan—some taxable income. Let's use the same facts as in the previous example except Pastor Smith is only reimbursed $475 for April miles. Since the $475 is less than the $500 advance, Pastor Smith must either return $25 ($500 minus $475) to the church within 120 days after the expenses were incurred or the church must add $25 to taxable income for the April advance less reimbursement.
No advance/reimbursement after miles is substantiated. In this example, the church reimburses Pastor Smith $550 for April miles upon the submission of substantiation of his church relates miles. No advances are made. This arrangement meets the accountable expense plan rules and is tax-free to Pastor Smith and the church has no federal reporting requirements related to the reimbursement.
Advance but no substantiation of any church-related miles. In this example, the church does not require any logs or receipts from the Pastor Smith for the $500 monthly automobile allowance payment. Since the church has chosen to follow a nonaccountable plan, the $500 represents taxable income for income and social security tax purposes. (If the $500 advance is made to a lay staff member and there is no substantiation, the $500 is subject to federal and state, where applicable, income tax withholding and FICA withholding.)
Summary. In the final analysis, it's not whether a church calls a payment an allowance or reimbursement—it's the substance of the transaction. Unless payments meet the accountable plan rules, they are always taxable for income and social security tax purposes.