Surviving an IRS Audit
by Richard R. Hammar
January 1, 1996
Recently the Internal Revenue Service issued "audit guidelines" for ministers' tax returns. Here are attorney and accountant Richard Hammar's conclusions of the risks and benefits of the new guidelines.
Is a minister an employee or self-employed?
The guidelines inform agents that most ministers are employees for income-tax reporting purposes, and that this is "the first issue that must be determined." The guidelines do not say that all ministers are employees but "are generally considered employees." Self-employed status will be the exception, however, and any minister reporting income taxes as self-employed must expect to have his or her status challenged if audited.
Who is a "minister"?
Happily, the guidelines apply a flexible definition of the term "minister." It is more likely that associate pastors, and clergy employed by seminaries and parachurch ministries, will be considered "ministers" for federal tax purposes. There is less risk of an auditor challenging ministerial status.
What is considered "income"?
The guidelines urge agents to look for several kinds of taxable income that may not have been reported, including:
- "Special gifts." It is more likely that ministers will be asked if they received gifts during the year (for example, on a birthday, an anniversary, Christmas, or retirement). In most cases such gifts are taxable—especially if funded through offerings collected during church services from donors who receive charitable giving credit for their contributions.
- Business expense reimbursements. Many ministers are reimbursed for business expenses under a "nonaccountable" reimbursement arrangement. For example, your church pays a monthly car allowance to staff members, without requiring substantiation. Or your church reimburses business expenses without requiring receipts for expenses of $75 or more, with the date, place, and business purpose of each expense. Or your church reimburses business expenses once each year, rather than within a "reasonable time" (generally 60 days or less). Or your church provides travel advances and requires no accounting for the use of these funds.
First, all such nonaccountable reimbursements must be reported as taxable income to the minister (on a W-2 or 1099). Second, ministers can deduct such expenses only as miscellaneous itemized deductions on Schedule A. (Ministers who cannot use Schedule A lose any deduction for their nonaccountable business expenses, even though they must report all of their church's reimbursements as taxable income.)
If you have a nonaccountable reimbursement arrangement, immediately convert it to an accountable arrangement.
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