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.

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