July 22, 2012

The Deason Rule

Question:

A minister has been using tax preparation software for years. He is paid as a Form 1099-MISC, self-employed pastor. The program sent him to a worksheet which took his Schedule C business expenses and reduced them by a percentage of income attributed to housing allowance. He had never had that happen before. Is there some new regulation or provision in the tax code?
Answer:

What the minister is dealing with here is something called the Deason Rule, and it is based on a tax case going back to 1964. The rule applies to clergy who are able to take business expense deductions for unreimbursed business expenses. According to the IRS: “A minister may deduct ordinary and necessary business expenses. However, if a minister's compensation includes a parsonage or housing allowance which is exempt from income under IRC § 107, the prorated portion of the expenses allocable to the tax exempt income is not deductible, per IRC § 265, Deason v. Commissioner, 41 T.C. 465 (1964), Dalan v. Commissioner, T.C. Memo. 1988-106, and McFarland v. Commissioner , T.C. Memo. 1992-440.”

However, the pastor can avoid the Deason Rule by having the church set up an Accountable Plan for his professional clergy expenses. Under such an arrangement, the church establishes part of its minister’s compensation package for ministry expenses. The minister is reimbursed for those expenses. By doing this, the pastor will not have unreimbursed expenses that will be of limited tax benefit. Hint: This would be a good time to use this blog’s search window to find and review Accountable Plans.

The members of my Federal Taxation I class at Maranatha Baptist Bible College in Watertown, Wisconsin have taken on the challenge of study and research to answer posted questions. Mariya Bondarenko of Minnesota gets credit for this one.

Designated Gifts to Church on Behalf of Missionary

Questions:

A missionary is going to be serving with a recognized U.S. missions organization. His home church is willing to receive funds from donors and then disburse them to him. What is the best way for the missionary’s home church to do this?

Answer:

Once the church has communicated its endorsement of a missionary, it will naturally encourage donors to contribute to his support. The checks to support him need to be made payable to the church and accountable to its control. The church then will disburse the funds. It is strongly recommended that the church dispense the funds directly to the missionary’s mission agency. The agency will handle all tax related issues and the church will have no further reporting requirements.

The members of my Federal Taxation I class at Maranatha Baptist Bible College in Watertown, Wisconsin have taken on the challenge of study and research to answer posted questions. Mariya Bondarenko of Minnesota gets credit for this one.

Housing Allowance Designation of IRC 403(b) Distributions

Question:

Are Internal Revenue Code 403(b) distributions (to a minister over the age of 59 ½) that are designated as housing allowance in excess of housings costs subject to self-employment tax, or are they only subject to income tax as regular income?

Answer:

If a minister owns a home, the amount excluded from the minister’s gross income as a housing allowance is limited to the least of the following: (a) the amount actually used to provide a home, (b) the amount officially designated as a housing allowance, or c) the fair rental value of the home.

As with virtually all retirement plan distributions, no self-employment tax is due on 403(b) distributions.

The members of my Federal Taxation I class at Maranatha Baptist Bible College in Watertown, Wisconsin have taken on the challenge of study and research to answer posted questions. Mariya Bondarenko of Minnesota gets credit for this one.

Church as Facilitator of Pastor Contributions to a Traditional IRA Account

Question:

Is there any reason a church could not make deposits to an IRA account for its pastor? It is understood that any deposits would have to be reported as income on Form W-2, but other than that, is there any problem? Also, how much of a monthly contribution would be necessary for a 403(b) to be worth the trouble to set up?
Answer:

Usually it is the responsibility of the minister to make contributions to his IRA himself and take a deduction when he files his personal returns. However, there is no restriction to assist in payroll deductions for any purpose as long as they are handled correctly on Form W-2 (as is suggested in the Question). Many ministers do not use traditional IRA plans since Internal Revenue Code section 403(b) and Roth IRA plans are available. Self-employment tax is not assessed on contributions to Church Plans (IRS Revenue Rulings 68-395 and 78-6) which it is believed to include 403(b) plans.
It is our experience that most investment firms that sponsor 403(b) plans require minimum monthly contributions. Fees to establish and to contribute to these plans must be weighed against the tax benefits.

The members of my Federal Taxation I class at Maranatha Baptist Bible College in Watertown, Wisconsin have taken on the challenge of study and research to answer posted questions. Leslie Harrison of Michigan gets credit for this one.

Church Mileage Reimbursement of Volunteers


Question:
A church has an associate pastor who is unpaid. He drives 30 miles each direction from his home to the church, 2 to 3 times per week. It has been proposed that a “gift” from the church be made to reimburse his gasoline costs. It appears that any payment to him would be taxable. Is there any exception since he is unpaid for his services to the church, and not actually an employee? If not, can he claim his mileage at the charity rate since he is not a paid employee of the church, but involved in a charitable activity?

Answer:
Any money that the church gives the associate pastor is considered compensation because he is performing a service to the church. Employees can be reimbursed at $.555 (2012) for business miles, but not for commuting (the apparent case in this situation). If the pastor continues as a volunteer, he could claim his mileage at the $.14 per mile charitable rate (2012). Therefore, if he continues as a volunteer, the church could reimburse him up to $.14 per mile without tax consequences. Given an average of 2.5 trips per week, this equals $21 per week (truly a “token”)!

The members of my Federal Taxation I class at Maranatha Baptist Bible College in Watertown, Wisconsin have taken on the challenge of study and research to answer posted questions. Leslie Harrison of Michigan gets credit for this one.

Review of Car Allowance

Question:

A church approved a “car allowance” for one of its pastors. The pastor is considering a lease or new car purchase. What will be the effect of his options on his taxes?

Answer:

Any car allowance should be set up using an “accountable plan”, which must meet three requirements under the Internal Revenue Code Sec. 62(a)(2)(A): the reimbursements must have a business connection, must be substantiated on a timely basis using the mileage records kept by the employee, and must be returned to the employer to the extent they exceed actual expenses. Using an accountable plan allows the car allowance to be excluded from an employee’s income on his Form W-2. Mileage records should include the date, business purpose, and number of miles for each trip. The IRS sets maximum per mile rates (55.5 cents for 2012, according to IRS Notice 2012-1). If the actual miles multiplied by the IRS rate is less than the allowance, the pastor must return that amount to the church, otherwise the full allowance would be included in his income.

Readers of this post should search other blog entries regarding alternatives to “car allowances” – specifically, more flexible professional expense reimbursement plans. Also, leases can complicate the reimbursement arrangement, but that’s a topic of a future post!

The members of my Federal Taxation I class at Maranatha Baptist Bible College in Watertown, Wisconsin have taken on the challenge of study and research to answer posted questions. Kyle Krohn of Iowa gets credit for this one.