Taxes for Foreign Missionaries: The Accountable Plan

I get emails —

I appreciate your blog and, in addition to all the great Bible study stuff you’ve got on there, your financial advice to ministers is so helpful. (Your commentary on opting out of Social Security is spot on and something my wife and I just recently had to learn for ourselves after being told it was a matter of stewardship. After reading the opt-out ourselves, though, it became very apparent that that was the wrong point of view altogether.)

We are really feeling overwhelmed with all this overseas tax stuff, mostly because it seems like many people have different understandings of the law. Right now our current confusion has to do with the missionary’s work fund while overseas. I understand the accountable plan setup, and I understand the 1099 setup as well. However, we have a minster/missionary tax professional (that’s the only thing his office of 30 plus years works with) tell us something that doesn’t seem to align with it. I am writing to ask if you have already posted on this subject and if you could link to that article (I didn’t have a positive search experience on your site, and was only able to stumble across certain things.) If not, maybe you could point me in the right direction, because even the internet seems to be void of clear documentation of what we need to do.

So, in as brief a story I can make it, here it is:

Our tax professional tells us that we need to have two separate accounts, one for work fund and one for our income. My understanding is (though he is out of town at the very moment so I can’t discuss this further with him for a few days) that he says all money given to us by churches and individuals for our one-time expenses (travel, shipping, etc.) will go directly into that account and won’t be taxable. However, this will not be an accountable plan setup with our sending congregation, so we will simply be 1099 workers. And it is my understanding that if I file a 1099, then all money I receive is taxable until I prove that I used it otherwise. The thing is, we have collected about $20,000 one-time needs for this trip in 2010, but won’t be leaving the country until January of 2011. So, as a 1099 filer, I think I understand that I need to pay the taxes on the $20,000, but will, in effect, get that money “back” when I deduct it off my 2011 filing.

That is how I currently understand the law, but I have this tax guy telling me that the money put in a separate account and only used for work fund expenses will not need to be reported whatsoever.

Sorry this is so long, but I wanted to explain it as I understood. So again, if you could point me the right direction with all of this, I would greatly appreciate it.

Thanks again for your blog.

For readers unfamiliar with the “accountable plan” concept, let me review how it works. The IRS advises —

A plan under which an employee or volunteer is reimbursed for expenses or receives an allowance to cover expenses is an accountable plan only if:

• There is a business connection for the expenses;
• The employee/volunteer adequately accounts for these expenses within a reasonable period of time; and
• The employee/volunteer returns any amounts of excess expenses within a reasonable period of time.

If these conditions are not met, the plan is a nonaccountable plan.  For more information, see Chapter 11 in Publication 535.

The substantiated and deductible business expenses under an accountable plan may be excluded from an employee’s or officer’s gross income and are not subject to income tax withholding and employment taxes.  Moreover, accountable plan payments need not be reported on Form W-2.  Amounts paid under a nonaccountable plan are included in the employee’s or officer’s gross income, reported on Form W-2, and subject to all applicable employment taxes.

If an expense allowance or reimbursement arrangement partially an accountable plan and partially a nonaccountable plan, the arrangement is treated as two separate arrangements.  One part is an accountable plan and the other as a nonaccountable plan.

Now, there are two cases where this makes a truly huge difference.

1. For an employee (W-2 income), expenses paid by the employee in performing his or her job may be deductible, but only as an itemized deduction, and there are severe limits on deductibility. In fact, most people get no benefit at all from employee expenses, because they take the standard deduction instead. And itemized deductions aren’t allowed against the alternative minimum tax, and many missionaries will have large enough work funds to trigger this problem.

2. For an independent contractor (1099 income), you avoid timing problems as described by the reader. If you receive work funds in 2010 and spend them in 2011, they are indeed inmcome in 2010 and not deductible until 2011 (unless you have an accountable plan), but a missionary might not have enough taxable income to take advantage of the deduction once he’s in the field due to various exclusions he’ll qualify for.

Moreover, the income and expenses that flow through an accountable plan, properly handled, don’t show up on the missionary’s tax return, because the IRS trusts the employer not to reimburse expenses that aren’t legitimate. They are therefore much less likely to be subject to audit — but because an accountable plan forces excellent record keeping by the missionary, audit should be of no concern.

So what’s an accountable plan? Well, it’s what most employers do naturally. Most employers aren’t going to write you a check for expenses on faith. They require receipts. If they advance funds, they’ll insist on documentation of how you spent the money or else will cut your pay check. The rules are laid out in Publication 535 beginning on page 40. They’re pretty common sense — except for churches. It’s not that churches don’t have common sense; it’s that they leave it outside the front door for some reason.

Here’s the rule. If you are a sponsoring church and provide a working fund for a missionary (or reimburse expenses for a preacher or other employee!) — whether from your own church’s money or from other donors — you are responsible to handle the money as the Lord’s own money. It’s being donated to the church and for the mission — not the missionary. You are responsible for getting this right. It’s your job.

That means you set up separate accounts for the working fund and for missionary pay. The missionary gets the pay on time as scheduled — and a 1099 at year end. The working fund is held by the church and spent based on proper documentation. You can give the missionary a credit card or advances against the fund, but if you do, you must require concurrent accounting — including third-party receipts. Most businesses require the accounting to be within 30 days. The IRS says you can give the missionary a “reasonable” time. Don’t let it languish.

The credit card bill doesn’t count as a “receipt.” As fiduciaries (stewards) for Jesus, treat this money as carefully as you’d treat your own.

Now, we all at times are unable to document an expenditure. Receipts get lost. I’ve done it. Everyone’s done it. Be reasonable.

But if the missionary habitually fails to document expenses, stop advancing money, cut off the credit card, and require the missionary to spend his or her own money and then seek reimbursement.

Or eliminate the working fund, add the full amount to his or her support, and issue a 1099 for the full amount — and don’t accept checks earmarked for a working fund. The missionary could deduct whatever expenses he or she can document. Just don’t create a non-accountable working fund and fail to treat it as income. Don’t engage in tax fraud.

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