A pastor takes staff members out to lunch every Tuesday. Church business is always discussed, at least briefly, during these lunches. The church treasurer does not report the church's reimbursements as taxable income to the staff members because she believes that the lunches qualify as business expenses that can be reimbursed by the church under its accountable reimbursement arrangement.

Take the quiz first, then read the article for all the details.

1. A church has 3 pastors who for many years have gone out to lunch every Friday. Church business is almost always discussed at these lunches. The cost of these lunches is always charged to a church credit card, and the church treasurer has never reported the church's reimbursements as taxable income to the pastors by including it on their W-2 forms. The church is handling lunch expenses correctly.
   True or False
   
   
2. A church has one pastor and 3 staff members who for many years have gone out to lunch every Tuesday. Church business is almost always discussed at these lunches. The cost of these lunches is always charged to a church credit card. The amounts reimbursed by the church must be reported as taxable income to the employees.
   True or False
   
   
3. A pastor occasionally meets church members for lunch, and charges the cost of these lunches to the church credit card. The purpose of these lunches is for the pastor to become better acquainted with members, and to provide spiritual guidance as needed. These expenses qualify as an entertainment expense, and so they may be reimbursed by the church under its accountable reimbursement arrangement, and reimbursements will not constitute taxable income to the pastor.
   True or False
   
   
4. A pastor occasionally meets church members for lunch, and pays for the expenses himself. The pastor informs the church treasurer each month of the approximate amount he spent during the previous month on such lunches, and receives a reimbursement check. These checks need not be reported as taxable income to the pastor, since the lunches are for business purposes.
   True or False
   
   
5. A pastor takes the church staff out to lunch twice each year as a means of expressing appreciation for their hard work. The cost of these lunches is charged to the church credit card. These expenses represent a legitimate business expense, and as a result they can be reimbursed by the church under an accountable arrangement so long as they are adequately substantiated. As a result, the church treasurer would not report any of the reimbursements as taxable income.
   True or False
   
   

It is common for ministers and church staff members to go out to lunch together on work days. In many churches, it is a weekly ritual. Since church matters are discussed, many ministers assume that lunch expenses are a legitimate business expense. As such, they can be reimbursed by the church under an accountable arrangement without constituting taxable income; or, if the church does not reimburse these expenses, they can be claimed as a business deduction by ministers on their tax returns. The key question, then, is whether or not lunch expenses can be treated as a business expense for tax purposes. Here are the rules that apply:

Entertainment expenses
Local lunch expenses incurred by church employees qualify as a business expense, and can be reimbursed by a church under an accountable expenses reimbursement arrangement, only if they qualify as entertainment expenses. The requirements for substantiating entertainment expenses are strict. You must demonstrate that the expenses are either (1) directly related to the active conduct of your ministry, or (2) associated with the active conduct of your ministry and the entertainment occurred directly before or after a substantial business discussion.

In order to show that entertainment was directly related to the active conduct of your business, you ordinarily must be able to demonstrate that (1) you had more than a general expectation of deriving income or some other specific business benefit at some indefinite future time; (2) you did engage in business during the entertainment period; and (3) the main purpose of the entertainment was the transaction of business.

In order to show that entertainment was associated with the active conduct of your ministry, you must be able to demonstrate that you had a clear business purpose in incurring the expense, and that the meal or entertainment directly preceded or followed a substantial business discussion.

Frequent staff lunches
Frequent lunches with the same members of the church staff are much less likely to qualify as a business expense, even if church business is discussed. For example, if the same three church staff members go out to lunch every Friday, it is very unlikely that any of these lunches will qualify as a business expense. After all, these persons work in the same office, and presumably have considerable interaction during the week. A shared lunch under these circumstances does not constitute an ordinary and necessary business expense. In one case, the Tax Court ruled that employees who met for lunch one day each month were meeting too frequently for their lunch expenses to constitute business expenses.

Occasional lunches with non-staff members
Such lunches are more likely to qualify as entertainment expenses, and as a result the costs of these lunches can be reimbursed by the church under an accountable expense reimbursement arrangement. To illustrate, a lunch arranged by a pastor with a local architect to discuss new building plans would qualify as a business expense.

Occasional employee lunches
The Tax Court, in a decision addressing the deductibility of lunch expenses incurred by attorneys one day each month, conceded that "an occasional luncheon meeting with the staff to discuss the operation of the firm would be regarded as an ordinary and necessary expense," as would "a luncheon to mark an anniversary, retirement or other occasion for an employee" since such expenses "aid in building morale and loyalty and serve as an inducement for others to work more efficiently."

Lunch expenses while traveling
This lesson only addresses the reimbursement of local lunch expenses. Lunch expenses incurred while church employees are away from town on business travel are business related and can be reimbursed under an accountable arrangement.

Other requirements of an accountable arrangement
In order for your church to reimburse expenses under an accountable expense reimbursement arrangement, you must have adopted a reimbursement arrangement that meets certain requirements. See section E of this chapter. If any of these three requirements is not satisfied, the church's reimbursement of a lunch expense is nonaccountable, and the full amount of the reimbursement must be allocated to the employees' W-2 forms.

Unreimbursed expenses
This section addresses the tax consequences of a church's reimbursement of employee lunch expenses. In some cases, church employees pay for their own lunch expenses. Such "unreimbursed" expenses may be deducted as an employee business expense, but only if reimbursement from the church was not available. Further, church employees may deduct only 50% of business-related entertainment expenses, including meals. This 50% limitation is incorporated directly into the tax returns. Note however that the 50% limitation does not apply to expenses that are reimbursed by an employer under an accountable reimbursement plan. IRS Publication 463 states: "As an employee, you are not subject to the 50% limit if your employer reimburses you under an accountable plan and does not treat your reimbursement as wages." Publication 463 states that the self-employed persons also can avoid the 50% limitation through use of an accountable reimbursement arrangement.

Quiz answers: 1) F  2) T  3) T  4) F  5) T 

This article appeared in "Staff &Volunteer Training," October 15, 2005, at www.churchlawtoday.com.

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