In an earlier article, I discussed the tax advantages of providing an expense account for ministers on a church staff. In essence, churches that pay for or reimburse a minister’s professional expenses, in areas such as mileage, materials, and hospitality, ensure that their ministers do not have to spend their own money to do the job they were hired by the church to do. As long as the church follows the IRS guidelines for providing an accountable reimbursement plan, nearly all expenses paid for by the church are not taxable income to the minister.
However, many churches decide against providing an expense account to their ministers, thinking it financially unwise for the church. The members of the church may believe that providing an expense account will be prohibitively expensive. Conversely, it may be based upon the church members’ misconception of a minister’s employment status. The church members may believe that since ministers are self-employed, there is no need to provide an expense account, because the minister can simply deduct their business expenses from their tax liability.
However, both of these reasons are misconceptions. First, it costs a church no additional money to provide an expense account if they will make the expense account part of the minister’s salary structure from the beginning. Second, remember that ministers employed by a church are only self-employed for Social Security and Medicare. For income taxes, ministers are employees of the church for which they work.
There are three strikes against a minister whose church fails to provide an expense account. These strikes come as a direct result of the minister’s status as an employee for income taxes. Unlike someone who is truly self-employed (for both income tax and Social Security), an employee may not deduct all of their unreimbursed expenses if they itemize deductions on their income tax return.
- Strike 1: Employees are limited by the 2% limit. According to IRS Publication 529, individual taxpayers who itemize their deductions are limited to the portion of those deductions which exceeds 2% of their adjusted gross income (AGI). If a minister’s AGI is $30,000, and his unreimbursed expenses total $4,000, the most he could deduct under this limit is $3,400 since he would have to reduce the $4,000 by 2% of $30,000, which is $600. In other words, the minister would be forced to pay $600 of his own money to do the job the church expects him to do, and he will have to pay taxes on that $600.
- Strike 2: The standard deduction may be a simpler avenue. For many taxpayers, taking the standard deduction may be simpler than itemizing. The standard deduction reduces the amount of income upon which one is taxed. The amount of the standard deduction is determined by a taxpayer’s filing status. For example, in 2017, the standard deduction for a married couple filing jointly is $12,700. There are many bi-vocational or smaller church ministers whose total wages are equal to or less than $12,700. When combined with the 2% limit, it may not benefit a minister to itemize deductions. This means that none of the money they spent doing their jobs will be deducted.
- Strike 3: The Deason Rule. Named after a 1964 court case, the Deason Rule interprets section 265 of the IRS Code in such a way that whatever percentage of a minister’s salary is designated by his church as a housing allowance directly correlates to the percentage of unreimbursed expenses that may be deducted from that minister’s taxes. For example, if a pastor has a $30,000 salary and a $10,000 housing allowance ($40,000 total), then his housing allowance comprises 25% of his total salary. Since the housing allowance is considered an exemption from income (not-taxable for income tax purposes), the minister would have to reduce any itemized expenses by 25% as well. Therefore, if this minister had $4,000 in unreimbursed expenses, he would have to reduce the amount he can deduct by 25% ($1,000). Additionally, the $3,000 remaining would be subject to the 2% rule mentioned above.
These three strikes carry with them some unfortunate results. Churches who fail to provide an expense account for their ministers demonstrate an expectation that their ministers should pay their own money to do the job they were hired to do. Additionally, their ministers are forced to pay unnecessary taxes.
Fortunately, these consequences can be avoided altogether by making an expense account an essential element in any minister’s salary structure. Doing so will ensure a lower tax liability and let the minister know the church is willing to provide the resources he needs to accomplish the work expected of him. That is a win-win in anyone’s book!