December 20, 2008

Church's Issuing Form 1099-MISC to Missionaries

Question:

In the case of giving cash donations to a missionary who has applied for and received an Internal Revenue Code 501(c)(3) determination letter as a tax-exempt organization, what is the amount that can be given before it becomes a Form 1099-MISC issue? What about those who do not have a 501(c)(3) organization but are members of a known missionary organization?

Answer:

Payments to non-employee individuals for services rendered in excess of $600 per year are reportable on Form 1099-MISC (see instructions for the Form at www.irs.gov). Since a 501(c)(3) tax-exempt organization is not a "non-employee individual," no Form 1099-MISC requirement applies. The payments are considered to be made by one tax-exempt organization to another.

If the church wishes to receive confirmation of a missionary's statement about the organization, it can request a copy of its determination letter (a common practice for many 501(c)(3) charities). Perhaps just as effective is to simple send the missionary IRS Form W-9 -- Request for Taxpayer Identification Number and Certification. If the missionary is not an individual, but, rather, employed by a 501(c)(3) organization, he or she can check a box labeled "exempt payee."

If the missionary is not associated with a missions board or other tax-exempt charity, then Form W-9 will facilitate collection of the necessary information to issue Form 1099-MISC. Missionaries affiliated with a missions board are considered employees of their agencies and receive Form W-2 from them.

Benevolence Policies

Question:

What are the tax code rules applicable to a church giving financial help to families it deems necessary for benevolence? Does it matter whether any assistance is paid indirectly on the beneficiaries' behalf (i.e. rent, utilities, grocery gift card) versus directly in the form of cash?

Answer:

IRS Publication 525 stipulates that gifts received for which no services were provided are not taxable income. Hence, no Form 1099-MISC requirement applies.

If the gift was received in exchange for goods or services, it is taxable. This includes all gifts received by employees from their employers with only minor exceptions for non-cash gifts such as the Thanksgiving turkey (see also IRS Pub. 525). The value of taxable gifts must be reported to employees on Form W-2.

A few cautions:

1. Benevolent gifts to families of employees must be treated with extreme care. The "safe" route is to include the gift on Form W-2. However, if there is a demonstrated need (e.g. a child's medical bill) by a family with one member employed by the church, and the church follows the same procedure with that family as it would with any other family, then it may not be taxable. I recommend careful documentation of the situation.

2. Avoid becoming a "conduit" for re-characterizing a donor's payment of a personal obligation as a contribution to the benevolent fund. For example, while the church may offer scholarships to send children to a Christian camp it should not accept a family member's contribution with the designation that it be forwarded to one of his or her own family. My suggestion when confronted with this potentially disingenuous (or well-intentioned) contribution is to respond as follows: "We'd be happy to assist you in maintaining your anonymity with regard to your gift to [your granddaughter] but, of course, we cannot provide you a receipt for tax deduction purposes."

More on Health Insurance and Section 125 Plans

Question:

This is a follow-up on the posting of December 16 regarding health insurance:

Must a health insurance policy be held by the organization in order to qualify health insurance premium payroll deductions for tax-free treatment under a Section 125 cafeteria plan? or can the employee hold the policy?

Also, must the employer pay at least a portion of the premium, or can the full amount be withheld through payroll deduction?

Answer:

I'll give this question "my best shot" -- employee benefit plans are not my forte. Further, there may be some insurance industry regulations or requirements of individual insurance firms that can affect this issue (e.g., I believe that Golden Rule Insurance here in Wisconsin does not permit a church to own (or even reimburse premiums) the policy).

Having said this, I do not believe that the Code stipulates the owner of the insurance plan nor requires partial payment by the employer. However, before a church and its pastor jumps into such as arrangement, its leadership is well-advised to clearly understand and communicate the specific requirements of Section 125 -- especially its use-or-lose-it component.

December 16, 2008

Minister's W-2 Form

Question:

If a minister gets a W-2, does the minister have to fill out the SE form for salaries paid in Box 1 of the W-2?

Answer:

This question was reproduced here verbatim from a recent Comment I received. Let me address a few items of clarification relative to the posting.

1. Churches are required to prepare Form W-2 for their pastors' compensation. Form 1099-Misc may be used to report non-employee compensation (e.g., the snow-plowing service), but not for the pastor.

2. The general formula I use to report a minister's self-employment income on Form 1040, Schedule SE is as follows:
Form W-2, Box 1 amount + Housing allowance (and fair rental value of parsonage, if applicable) - Unreimbursed Employee Business Expenses (from Form 2106).

Health Insurance Premiums Withheld

Question:

In your blog post on September 12, you say that health insurance premiums paid are “not reported as taxable income.” If the amount for the pastor’s health insurance is paid by payroll deduction, does that decrease the amount of taxable income? What benefit could there be to a pastor to have his health insurance paid by payroll deduction? What way is most appropriate to handle this if the church will not assume the payments?

Answer:

According to Table 2-1 of 2009 IRS Publication 15-B, health benefits paid by the employer are tax-free. When an employer wishes to offer employees a choice between receiving taxable and nontaxable benefits, a Internal Revenue Code section 125 plan must be established if benefits such as health insurance are to avoid taxation. In the question posed above, the pastor is offered the choice between receiving his full salary or having a health insurance premium withheld. In order to avoid inclusion of his full salary in Box 1 of his Form W-2, a Section 125 must be established. Of course, the best arrangement for him is to have his employer agreed to paying the premium as a benefit. He loses the flexibility to receive that amount as cash, but enjoys tax-free status, and the church most likely assumes more responsibility for premium increases.

External Audits of Churches

Question:

If a church wants to have its books externally audited, are there CPAs out there who understand church accounting who could perform a church audit?

Answer:

Church financial statements prepared in accordance with Generally Accepted Accounting Principles follow the FASB 117. Just as other tax-exempt organizations, this requires classification of the church's Net Assets (the amount by which Assets exceed Liabilities) in three funds: Unrestricted, Temporarily Restricted, and Permanently Restricted.

Unless the statements are to be prepared using an Other Comprehensive Basis of Accounting (OCBOA), most CPAs will likely require preparation of the audited financial statements following FASB 117. Most CPA firms, I believe, are fully capable of providing this service.

My experience tells me that many churches have not adequately accounted for the activities of these three funds. For this reason and others, most churches will find an external audit to be cost prohibitive. I do not provide these services, but a quote receive by a small congregation in Wisconsin within the past five years placed the annual cost at $12,000.

Accordingly, many churches have adopted internal audit policies.

December 15, 2008

Christmas Gifts to a Minister

This is probably a good time to review the tax law on Christmas gifts given to ministers. For more details, you can check out my blog entries on November 23 and January 31, 2008.

IRS Publication 525 directly addresses what it calls holiday gifts. "If your employer gives you a turkey, ham, or other item of nominal value at Christmas or other holidays, do not include the value of the gift in your income. However, if your employer gives you cash, a gift certificate, or a similar item that you easily can exchange for cash, you include the value of that gift as extra salary or wages regardless of the amount involved."

At Christmas time, generous lay people often seek opportunities to give to those who have ministered to them during the year. Great idea! Gifts between individuals are neither taxable to the recipient, nor deductible to the donor.

The challenge comes when the entire congregation as the minister's employer (IRS Topic 417 and Publication 517) decides to take a collection and give him a Christmas bonus. This is viewed as an action by the minister's employer to compensate its employee--it's taxable. Of course, church revenues are almost entirely from the tax-deductible, charitable contributions of its members and guests. To rephrase my last sentence from the previous paragraph: Gifts between employers and employees are taxable to the recipient and deductible to the payer. Of course, a tax-exempt church "payer" is not concerned about receiving a tax deduction, but its contributors are.

I suppose that a church's lay leaders could remind its members: "Now we're getting close to Christmas. Don't forget to add our minister to your Christmas list. You can catch him in his office or here's his home address." But as soon as the congregation acts in concert as his employer ... well, refer to the previous paragraph.

November 24, 2008

Designated Contributions Held in Trust

Question:

A congregation is raising money for building improvements, receiving gifts designated for that sole purpose. Is it necessary to hold those gifts in a separate bank account or is it permissible to hold the funds in the church's general checking or savings account and otherwise account for it in its records?

Answer:

Churches typically receive both general and designated gifts. A third category of gifts--called Permanently Restricted by accountants--is rarely received by churches.

It is not required that these funds be segregated from other cash accounts as long as proper accounting is maintained. Many churches have multiple designated accounts. Maintaining separate bank accounts for each is rarely necessary or even advisable.

If general and designated funds are commingled, the church may wish to establish a reasonable method for allocating any interest or other earnings to unexpended designated fund balances.

Extreme care must be taken to avoid using designated gifts for purchases other than those specified by donors. Some ministries have shown very poor stewardship by overspending their general funds and, effectively, borrowing from designated gift funds with little hope of restoring the cash accounts to their proper level. This obviously discourages donors but may also draw attention from State authorities if a donor files a grievance.

November 23, 2008

Gifts to Church Employees

Question:

Can a congregation give gifts to its employees on a tax-free basis?

Answer:

Yes and no...

The Rest of the Story:

Internal Revenue Code Section 102(c)(1) prohibits the exclusion "from gross income any amount transferred by or for an employer to, or for the benefit of, an employee." However, IRC Section 132(e) offers an exception for "de minimis fringe" amounts, defined as "any property or service the value of which is (after taking into account the frequency with which similar fringes are provided by the employer to the employer's employees) so small as to make accounting for it unreasonable or administratively impracticable."

A Reveune Ruling by the IRS clarified this for holiday gifts: Gifts of minimal value that are provided by an employer to its employees may be excluded from the employees' incomes if the gifts have little value and are not readily convertible into cash. "The value of a turkey, ham, or other item of merchandise of similar nominal value, distributed by an employer to an employee at Christmas, or a comparable holiday, as part of a general distribution to employees engaged in the business of the employer as a means of promoting their good will, does not constitute wages" (Rev. Rul 59-58).

November 05, 2008

Retired Minister-Taxable Income

Question:

A retiring minister receives a severance package from the church, and the congregation collects a love offering as additional financial assistance. Are the payments taxable?

Answer:

Yes, the income will be characterized in the same manner as his standard compensation during his tenure as a minister. This is also true of deferred compensation plans under which the minister continues to receive support for a period of time after retirement. He should consider requesting that an appropriate portion be designated as housing allowance. Alternatively, he may wish to request withholding ("elective deferral") into a 403(b) retirement plan.

Question:

Several members pay out-of-pocket costs to provide home repairs on his house. Are their payments for these materials tax deductible as contributions? Are the payments for lumber, etc. taxable to the minister?

Answer:

Since the costs paid and benefits received are related to a personal act between a benevolent donor and a donee and not related to an employer-employee relationship, the amounts are not considered compensation for the minister's services. They are neither deductible by the members, nor taxable to the minister.

Question:

The church congregation announces the establishment of an effort to collect contributions in order to fund home repairs to the retiring minister's home. The monies once collected are used to pay for lumber and other materials. Are the contributions deductible by the members and taxable to the minister?

Answer:

An examination of IRS rulings and court case findings offers some fairly consistent guidance here, but there may be rare exceptions. Generally, the situation described here should result in charitable donation classification by the church with tax-deductible reporting made to its members and taxable income reportable to the minister on Form W-2.

Some limited evidence can be found for treating the payments out of the church's benevolence fund in support of a retired minister who has remained an active church member as non-taxable gifts, just as they would be treated for any non-employee receiving assistance from the church. In the case of a retired minister, it will be necessary to justify (if called upon to do so) that no services were rendered by the minister in exchange for the benevolent act of the congregation. It may be necessary to demonstrate by virtue of the passage of time (it's difficult to be more specific than this) that the payments were not associated with his employment.

October 27, 2008

Form W-2 Reporting for Roth Contributions in a 403(b) plan

Question:

How does a church report designated Roth contributions on its pastor's Form W-2?

Answer:

According to the IRS instructions for 2008 Form W-2, Roth contributions withheld from the pastor's pay do not reduce Box 1--Wages, tips, other compensation. The amount of the contributions should be recorded in Box 12, using code BB. Also, the Retirement Plan option in Box 13 should be checked.

October 16, 2008

Minister's Exemption from Self-Employment Tax

Question:

If a minister has acquired tax exempt status on Oct. 15, 2008, but has pastored since being ordained in 2006, is he refunded his social security and medicare taxes paid during that time?

Answer:

If a minister wishes to pursue exemption from self-employment (SE) tax--social security and medicare taxes--he must apply no later than the due date of his tax return for the second year in which has self-employment income greater than $400 any portion of which is attributable to his employment as a minister (source: instructions for IRS Form 4361).

Form 4361 requires the applicant to indicate these first two years. Publication 517 describes the process for amending earlier years' returns in order to receive a refund of previously paid SE tax. Generally, you have three years after the due date of any return to file for a refund of overpaid tax.

Answering the above question specifically, if 2006 and 2007 were the two years listed on Form 4361 and the IRS granted final approval of the application on October 15, 2008, then the minister has until April 15, 2010, to apply for a refund of SE tax related to his ministerial income in 2006. He will have until 4/15/11 to seek a refund for his 2007 overpayment.

September 27, 2008

403(b) Plan Documents

Question:

A ministry writes: "Having received notification from the investment company that we must comply with the new IRS regulations for our employer-sponsored 403(b) plan, we must write the plan. Do you have any advice on how to get the plan written easily?"

Answer:

Unfortunately, I don't have an easy answer for this one. The churches and Christian organizations that I've worked with have relied on the support provided by financial services firms (e.g., TIAA-CREF), some of which are getting out of the 403(b) market. My recommendation is that churches and Christian organizations with 403(b) plans work with the investment firm receiving the employees' elective deferrals and employer's matching contributions to assure that the January 1, 2009, deadline for establishing written 403(b) plans is met. If your investment company (yes, the one that's been charging your employees commissions on their monthly contributions) is placing the onus on your ministry for the written plan and unable to assist you, then I would guess that your organization has been operating with scant plan documents already. It may be time to change investment firms.

September 24, 2008

Roth IRAs

Question:

Do I pay tax when I invest in Roth IRAs?

Answer:

Since annual contributions to Roth IRAs are not tax deductible, the minister who invests in them uses funds available to him from income on which he first paid federal income tax. It sounds a little awkward to say that one pays tax when investing in Roth IRAs, so I prefer to explain it the way I do here.

September 12, 2008

Pastor's Salary Breakdown

Question:

A layperson writes: "My pastor's salary is broken down as follows: Wages, Insurance, Education, Housing, Utilities, Social Security Offset. Is every category taxable income on his W-2 Form?"

Answer:

This is a good review question. I'll try to answer concisely without oversimplification.
Wages -- Form W-2, Box 1
Insurance -- Health insurance premiums paid: Not reported as taxable income (additional rules apply to other insurance benefits such as disability and life)
Education -- Continuing professional education reimbursements: Not reported as taxable income (additional rules apply to other education benefits such as payments for dependent(s) and payments for employees' basic entry-level training)
Housing -- Reporting on Form W-2 not required, but I highly recommend it as a memo item in Box 14 (this apprises the pastor of the amount he must document in order to enjoy full income tax-free status and of the amount that he may need to report on Form 1040, Schedule SE as self-employment income)
Utilities -- Treated identically as housing
Social Security Offset -- Payments to the pastor in lieu of his self-employed status under which the church incurs no obligation to match a FICA withholding amount (unlike non-ministerial employees) are taxable income reported on Form W-2, Box 1

September 03, 2008

Church Matching Contributions to 403(b)

Question:

A church matches and contributes a portion of church staff members' salary to a 403(b) plan with an investment firm. Instead of using the 403(b) plan, can the employee direct the church contribution money to an investment option/plan of his or her own? Would there be a problem in changing the church policy to allow staff members to direct their retirement funds where they want to?

Answer:

The church administration will need to consult its plan documents presumably filed by investment firm. Normally the church as employer must, however, be consistent in its application of plan provisions among all employees. Accordingly, it is not likely that your plan document (nor Section 403(b) of the Internal Revenue Code) will permit this “cash or deferral” choice with the church’s matching portion.

August 13, 2008

Designated Contributions

Question:

If I make a contribution to my church and make a note on the envelope that it is for Vacation Bible School, I was told it is not a tax deductible contribution. Is this true and why?

Answer:

Generally, contributions to support the general ministries and programs of the church are tax deductible. If the church VBS program requires a fee for materials or other costs, then payment of such a fee for oneself or an identified individual beneficiary will not be deductible. These contributions fall under the quid pro quo rules of the Internal Revenue Code (i.e., the donor received goods or services in exchange for the contribution). Unless these conditions apply, the gift should be deductible.

Follow-up to July 26 Posting re: Retirement Distributions as Housing Allowance

Question:

If a minister is retired, he would have no congregation, so who would his "designated appointee" be to declare the appropriate dollars as housing allowance?

Answer:

I recommend that the minister contact the local church under which he retired to request the housing designation. Obviously, this is a good thing to take care of prior to retirement but can still be accomplished. I suppose that an earlier congregation under which he (and perhaps the church itself) made 403(b) contributions would work as well. Recall, IRA distributions do not appear to qualify since they are not considered employer plans.

Minister's Use of Church Vehicle

This posting is a follow-up to August 10th regarding gifts of cars to ministers.

If the church owns a vehicle and allows the minister to use it for personal use, then it's generally best to have the church pay 100% of all expenses (including fuel) and to consider personal use as additional taxable compensation. In accordance with Internal Revenue Code Section 61(a)(1), vehicles used primary for business purposes, but occasionally for personal purposes by employees qualify for use of the standard mileage rate for taxation. For example, the minister records 1,500 miles of business use in August 2008, but 200 of personal use. Under the current $.585 standard mileage rate, $117.00 should be added to the minister's taxable earnings for August.

2008 IRS Publication 15-B provides a succinct explanation on page 20. A link is provided here:
IRS Publication 15-B

August 10, 2008

Gifts to Ministers

Question:

The church gave its pastor a car during an appreciation service. The fair market value of the car was not included in income on Form W-2. Is this an issue?

Answer:

In accordance with Internal Revenue Regulation Section 1.61-2(d)(2)(i) (reproduced in part below), there is virtually no condition under which an employee may receive a gift from an employer and it not be considered taxable compensation. Further, in the case of a minister, it's also subject to Self-Employment tax.
  • "...if property is transferred by an employer to an employee ... as compensation for services, for an amount less than its fair market value, then regardless of whether the transfer is in the form of a sale or exchange, the difference between the amount paid for the property and the amount of its fair market value at the time of the transfer is compensation and shall be included in the gross income of the employee."
Solution:

Absent more information regarding the specific situation, I'll provide an answer that "fits" in almost all situations. The church will need to prepare a corrected Form W-2c. The minister will need to amend his original return. In this difficult circumstance, the church may wish to aid its minister in paying the tax--wonderful, but any financial assistance will be taxable in the year received by the minister.

Follow-up Question:

What about cash gifts given directly to a pastor (not by the church) versus those collected by the church and then distributed? Are they taxable?

Follow-up Answer:

Gifts given by an individual to another individual (not in exchange for services rendered) are not taxable income to the recipient, nor itemized deductions for the donor.

Housing Allowance Clarifications

Question:

If a minister doesn't want to keep records, can he simply accept the fair market rental value (plus actual cost of utilities)?

Answer:

Unfortunately, the Clergy Housing Allowance Clarification Act of 2002 clearly says, "No." 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 (plus utilities). I've found that the fair rental value is rarely the lowest amount, except when the minister's home undergoes considerable remodeling costs or a large mortgage prepayment is made.

But... what happens when a minister pays off his home mortgage? Can he simply claim the fair market rental value? Again, unfortunately, "no." I know it sounds weird, but prepayments on a minister's home may be counterproductive, taxwise.

Follow-up Question:

How does one determine the fair market rental value?

Follow-up Answer:

The IRS will expect the minister to do his homework on this one. Local advertised comparable home rental rates may help. Ministers have also called upon knowledgeable realtors. Ask for the realtor's response in writing so that documentation is available in case of an audit. Most realtors' estimates will fall in a range and will not include the fact that the home is furnished--an obvious increase in value to any potential renter.

July 31, 2008

Books for Financially Troubled Christians

Looking for a good resource to help a fellow believer rechart his or her financial course? Need some guidance yourself?

This summer, I read what appears to me to be each of three ministries' best single book resource for Christians' personal financial management. Here's the author, title, and website link to each along with my brief assessment of its strengths and weaknesses or best applications (in alphabetical order by author):

Ron Blue, Master Your Money (2004), http://www.ronblue.com/
Blue’s Financial Planning Process offers steps to rise from one’s current status to achieve long-term goals. It's a comprehensive, biblically based plan for Christians at all financial levels. Some may find its terms and detailed schedules overwhelming. He doesn't offer as many nuts-and-bolts of balancing one's budget, but, as a CPA, it's probably my favorite of the three. Website: Points to resources available at Amazon.com; personal financial recovery is not its major focus.

Howard Dayton, Your Money Map (2006), http://www.crown.org/
Crown and Larry Burkett's Christian Financial Concepts merged in 2000, three years before cancer took Burkett home. Many were blessed (including the Pfaffe's) by his ministry initiated in 1976. Dayton's Money Map depicts seven Destinations on his "journey to true financial freedom." Before explaining Destination 1 beginning on page 107, the book offers a broad array of topics that present biblical truth on giving, honesty, work ethic and other basics--good material for group Bible study, I believe. The meat for the reader looking to dig out of crisis provides easy-to-read, easy-to-accept, general teaching for the "journey." Ideal target for this book: the believer looking for Bible-rich teaching on personal finance and help to better manage his resources, avoiding the mistakes of his or her past. Website: Resource-rich; opportunities to learn more without breaking out your debit card.

Dave Ramsey, The Total Money Makeover (2007), http://www.daveramsey.com/
Ramsey's book offers an in-your-face challenge to reverse your finanical downward spiral--just what we often need. Yet, through his frequent testimonials by Christians who have been "madeover" he offers encouraging hope to his readers. His book is narrowly and specifically focused on taking what he calls Baby Steps to get out of debt and become financially fit. His motto: "If you live like no one else, later you can live like no one else." It's not a biblical apologetic for doing so, but he does draw his readers' attention to Scriptural applications. I like his approach to dispelling common myths of personal finance. Ideal target for this book: the believer or unbeliever looking for direct, motivating teaching for recovery from near or real financial ruin. Website: Flashy; opportunities to buy more help.

Standard Mileage Rates

...sorry that this is late, but the standard mileage rates changed July 1, 2008...

1/1-6/30/08 rates (the OLD rates)
Business miles--$.505 per mile
Charitable (volunteer) miles--$.14 per mile
Medical & moving miles--$.19 per mile

7/1-12/31/08 rates (the NEW rates)
Business miles--$.585 per mile
Charitable (volunteer) miles--$.14 per mile
Medical & moving miles--$.27 per mile

Source:
http://www.irs.gov/taxpros/article/0,,id=156624,00.html

July 30, 2008

Housing and Economic Recovery Act of 2008

President Bush sign HR 3221 today. I'll share a couple of quick excerpts that may be of interest to ministers who are considering a home purchase or already own a home.

First-time homebuyer credit. A credit against federal income tax equal to 10 percent of the purchase price (maximum credit of $8,000) for first-time homebuyers applies if the taxpayer "had no present ownership interest in a principle residence during the 3-year period" preceding the purchase. The purchase must be on or after April 9, 2008, and before April 1, 2009. Maybe now's the time for more churches to get out of the real estate business and sell their parsonages--something I've often advocated!

Married couples with more than $150,000 of income will lose the credit ratably as their income approaches $170,000, when it's eliminated entirely. On the other end of the income continuum, taxpayers with no tax will not receive a larger refund due to the credit. Apparently, it can only be used against income tax. And there's a recapture of the credit received if the home is resold within 15 years.

Real estate tax deduction for non-itemizers. Unless a pastor and his wife have more than $10,900 of itemized deductions in 2008, they cannot gain a benefit from their contributions, taxes, mortgage interest, and other personal write-offs. Beginning in 2008, they can take up to a $1,000 real estate tax deduction even if they cannot itemize.

More later, I'm sure...

July 26, 2008

Retirement Distributions as Housing Allowance

Question:

Daniel asks the following question that I've abridged:

On February 6 you posted a topic on Minister's retirement distributions designated as Housing allowance. Are you technically referring to a 403(b)9 plan? In such a plan, the Plan Administrator as an agent of a church body actually makes the distributions and I would assume be able to easily make such a designation before issuing a 1099-R. However, what about 403(b)7 or 403(b)1 plans where a custodial account plan sponsor (typically a mutual fund company) handles the distributions? Are retired ministers allowed to "correct" a 1099-R on their 1040s?

Answer:

In cases such as Daniel has addressed, the retired minister reports the full distribution on Line 16a (2007 Form 1040) and the taxable amount after allowable housing allowance on Line 16b. The minister must follow all other requirements of IRS Publication 1828, the Clergy Housing Allowance Clarification Act of 2002, and IRS Regulation Section 1.107-1.

The minister’s congregation or designated appointee(s) must prepare a valid statement designating the distributions as housing allowance.

July 25, 2008

Records Retention

Question:

A church treasurer in Wisconsin writes: "I've often wondered if I need to keep all the receipts on items purchased for the church? Here's an example. An individual purchases items for VBS, they turn in the receipt, and I reimburse them. Do I need to keep those receipts?"

Answer:

You should keep receipts like these for seven years—the statutory limit for most legal actions. In a worst case scenario, you’d be responsible to prove that each disbursement was for legitimate expenses of the ministry.

Many treasurers use a system such as the following:
1. Each paid invoice is clearly marked “PAID” along with its check number and date.
2. During the year, paid invoices are filed alphabetically by vendor or payee name. A church with a large volume of payments may set up 26 folders, each for a letter of the alphabet. If, for example, ABC Supply has a lot of paid receipts, then a 27th folder can be labeled and those documents filed in it, etc. A receipt for VBS items reimbursed to Maggie Petersen should include notation that she was the one being paid and then be filed in the “P” folder for her last name. (Some ministries create a separate form (“voucher”) to be attached to the receipt; the voucher includes bookkeeping account identification, budget authorization signatures and other information).
3. At the end of each fiscal year, the folders documenting payments are placed in a box with the fiscal year and a “Destroy Date” seven years later. The box from seven years earlier can also be discarded at that time.

July 06, 2008

Gifts to Ministers

Question:

If a minister receives a ‘gift’ from another church (not his home church), is it taxable compensation?

Example:

A church gives ‘gifts’ to a minister on his birthday, anniversary etc. Can it be treated as a nontaxable gift if that church writes a letter stating its intention to give?

Answer:

Internal Revenue Code section 102(c) clearly states that gifts given to employees by their employers are taxable compensation. The IRS has consistently applied this provision to self-employed (non-employee) individuals who provide services for an organization as well. Only the facts and circumstances surrounding a gift can determine whether IRC section 102(c) does or does not apply; a letter stating that a payment is a gift will not override the substance of a transaction.

Often churches will support a minister of another congregation that is unable to provide full support to its own minister. Similar to foreign missionaries supported by congregations, the IRS will imply that services were provided in exchange for the compensation. That support is taxable to the minister; a gift to that minister will have the same taxable character as the standard support.

Exception:

If the gift is benevolent in nature, then it will not be taxable since no services were provided for it. If the church has a benevolent fund for emergency needs of others and disburses funds to aid the minister of another church with his medical costs or to help his family recover from a sudden financial loss, then it will not be taxable just as it would not be taxable to a non-employee member of the congregation receiving similar funds. The facts and circumstances of each situation must be weighed to determine whether the "gift" is related to compensation for services or truly related to benevolent activity. A search of court cases related to the taxation of gifts to employees may produce the most fruitful examples to apply to specific situations.

May 22, 2008

New Church Checklist

Can you provide a checklist of items for a new church to consider?

Pastoral Compensation Issues:

1. Consider establishing a professional expense reimbursement plan, either using an “advances” or a “reimbursement” arrangement.
2. Determine health insurance and medical care benefits, including the possible use of a major medical policy combined with a Health Reimbursement Arrangement (HRA). Two key questions to resolve regarding an HRA—what annual amount? and will any unspent amounts carryover?
3. Consider retirement funding, typically using either a 403(b) plan to providing funds for the pastor to fund his own Roth or traditional IRA
4. Designate a portion of cash compensation as a housing allowance.
5. Determine cash compensation. It may not be wise to reduce this amount too low (by providing other benefits instead of cash compensation). Pastors need $11750-$17400 (2007 amounts) for maximum Earned Income Credit (EIC) with 2+ children or need $8350-$16000 (2007 amounts) for maximum EIC with 1 child.
6. Determine whether the pastor desires to elect optional income tax withholding, especially if he has a large amount of Self-Employment tax to pay (tax law does not permit churches to withhold and match the 7.65% FICA tax that most U.S. employees are subject to).
7. Assign responsibility for government reporting including quarterly (Form 941) and annual employment filings (W-2; Form 944).

Ministry Management Issues:

1. Adopt a process for establishing the church budget (a. project revenues, b. disclose compensation, c. categorize expenses by activity or functional, d. establish a contingency fund)
2. Establish policies and procedures (a. for offering counts, b. for disbursements / purchasing, c. for bookkeeping [1) Fund Accounting and donor designations, 2) missions and other special funding methods], d. for financial reporting [1) determine frequency, 2) determine recipients, 3) determine contents {a) balance sheet (modified cash basis of accounting), b) statement of receipts and disbursements (modified cash basis of accounting), c) other schedules: mortgage schedule; designated funds}])
3. Arrange purchase of insurance (a. liability, b. auto, c. workers' compensation (employee and subcontractors), d. professional liability (counseling))
4. Determine legal organization (tax-exempt status; sales tax exemption)
5. Establish policy for internal auditing
6. Adopt policy for maintenance of donor records (a. who will record donations, b. what software, if any, will be used)

March 26, 2008

Minister, But Not a Minister

Question:

Can a minister elect to be treated as a non-minister?

Answer:

In other words, while ministers are defined by the Internal Revenue Code as employees in every respect except for purposes of computing their 15.3% Self-Employment tax on Schedule SE (Form 1040), may a minister choose to have the church withhold the 7.65% FICA tax and then match the other half out of church money? The simple answer: "no."

Many churches, in recognition that they are saving 7.65% by not having to match their ministers’ FICA tax, choose to increase their pay by this amount and then immediately withhold it as federal income tax. That way, when the minister computes his full 15.3% SE tax, at least ½ is already paid in through withholding.

There may be good reason not to be treated as an employee even if the Internal Revenue Code allowed it. Before calculating one's SE tax a minister can reduce his reportable earnings by the excess of his employee business expenses over any reimbursement by the church. An employee cannot do this; he must pay FICA tax on his full earnings. Also, any contributions to 403(b) plans reduce a minister's SE reportable earnings. This provision is not available to employees. They must pay FICA on their full pay even though income taxable wages are reduced by 403(b) or 401(k) elective deferrals.

February 06, 2008

Minister's Retirement Distributions Designated as Housing Allowance

There's lots of IRS authority (or precedent) for a local church or a denominational body to designate a minister's retirement benefits as housing allowance:
1. Audit Guide: Ministers: Market Segment Specialization Program
2. Letter Rulings 7734028, 7939077, and 8344062
3. Revenue Rulings 62-117, 63-156, and 75-22

A church is considered to be the sponsor of a 403(b) (Tax Sheltered Annuity) plan that receives the elective deferral withholdings of and matching contributions for its pastor. Accordingly, distributions from these plans qualify for housing allowance designation by the church.

I find no evidence that funds in an IRA account, either originally contributed to it or rolled into it from a 403(b) plan, qualify for housing allowance designation by the church.

January 31, 2008

Taxation of Love Gifts to a Pastor

Question:

I received a love gift from the church for pastor's appreciation. In the past I have declared this as business income and paid self-employment tax on it. Is this correct?

Answer:

Yes, virtually all gifts from an employer are considered taxable in the same manner as an employee's standard compensation. The church should report this income along with the pastor's standard compensation in Box 1 on his Form W-2. However, if the church should omit the gift, you are still responsible to report it as both earnings for income tax purposes and for self-employment tax purposes. Generally, the only exception to the taxation of gifts by an employer to an employee relates to non-cash gifts of nominal value.

Per IRS Publication 525: Holiday gifts: If your employer gives you a turkey, ham, or other item of nominal value at Christmas or other holidays, do not include the value of the gift in your income. However, if your employer gives you cash, a gift certificate, or a similar item that you easily can exchange for cash, you include the value of that gift as extra salary or wages regardless of the amount involved.

January 27, 2008

Ministers’ Retirement Options

Your congregation wants to contribute to your retirement? Great! Now, how can/should you handle this?

First, let's discuss the options; then we'll consider how the church can get involved.
The best retirement plan option for each minister depends on his objectives and his current tax situation. The three most common retirement plan options used by ministers include:
(a) IRC 403(b) plans (also called Tax Sheltered Annuities (TSAs)),
(b) Traditional Individual Retirement Accounts (IRAs), and
(c) Roth IRAs.


Ministers often select 403(b) plans when they want to maximize their eligible contributions, or to reduce their self-employment tax burden. For the year 2008, a minister may elect to have his employer withhold ("elective deferral") up to $15,500 of his compensation and contribute it, instead, to his 403(b) qualified investment account. Many ministers are eligible to increase this amount by another $5,000 to catch-up for earlier years' smaller deferrals (IRS Publication 571). In addition, unlike other retirement plan choices (Traditional and Roth IRAs, and for-profit company 401(k) plans), a minister is not subject to the 15.3 percent federal self-employment tax on amounts deferred into 403(b) accounts (IRS Revenue Rulings 68-395 and 78-6). This is also true of any amount that his employer contributes over-and-above the minister's own elective deferral.

The situations for which Traditional IRAs are the best choice for a minister's retirement plan are less frequent, especially since the establishment of Roth IRAs beginning with the 1998 tax year. For the year 2008, a minister and his wife may each contribute up to $5,000 to qualified IRA accounts; an additional $1,000 each may be contributed if they are 50 years of age (IRS Publication 590). A minister who has opted out of the social security system but is still looking for additional income tax deductions may find the Traditional IRA his best choice. These contributions can often be made even if the minister participates in a 403(b). However, he may not be able to deduct his full Traditional IRA contribution. For this reason and others, many ministers choose Roth IRA's instead of Traditional IRAs.

Roth IRAs enable ministers to make the same amount of contributions as do Traditional IRAs but without receiving an income tax deduction. For many ministers, especially those with young families and ample housing allowances, additional tax write-offs are not needed. Unlike Traditional IRAs, not only will future retirement (age 59½ or later) distributions of their current Roth IRA contributions be untaxed, the earnings distributed from the Roth IRA will not be taxed. Further, pre-retirement distributions may be made without penalty for:
(a) Medical expenses (and health insurance premiums for the unemployed).*
(b) Qualified higher education expenses.*
(c) New home purchase costs for taxpayers who have not owned a personal residence for at least two years ("first time homebuyers").
*Also available for some Traditional IRA distributions.


Now, how can the church get involved? The best way for a church to be assured that funds set aside for contribution to its minister's retirement are deposited into qualified accounts is to deliver its payments directly to the financial institution entrusted with the pastor's investments. Unless the church wishes to exceed the limits mentioned above (from $5,000/$6,000 for IRAs to $15,500/$20,500 for 403(b) plans) a check written by the church to the financial institution will work fine. Reporting on the pastor's Form W-2 at year-end will depend on the plan chosen. The options:
(a) IRC 403(b) plan—treat the payment as if it was additional compensation that was immediately elected by the pastor for withholding as an "elective deferral." The amount is excluded from his taxable income and reported in Box 12 (Code letter "E" is also entered). This amount can be increased by any additional amounts the minister elects to be withheld from his own cash compensation for deferral into the 403(b) plan.
(b) Traditional Individual Retirement Accounts (IRAs)—treat the payment as additional compensation reported as taxable income in Box 1. The pastor will take his IRA deduction on his personal return.
(c) Roth IRAs—treat the payment as additional compensation reported as taxable income in Box 1.

January 22, 2008

Free Credit Report

Question:

Where can I find a free credit report?

Answer:

Click here... https://www.annualcreditreport.com/cra/index.jsp

January 21, 2008

Designated Gifts Contributed to Individuals (more...)

A follow-up to yesterday's posting on designated gifts...

Donors can contribute non-cash gifts as well, including vehicles that may be used by the church. The Internal Revenue Code includes provisions regarding donations of vehicles that must be carefully followed.

If the church subsequently uses the vehicle for ministry purposes, all is well. However, if it is transfered to a church employee in lieu of cash compensation it represents taxable compensation at its fair market value. Unfortunately, the value will be taxable for both federal income tax and self-employment (social security) tax purposes.

The gift of a car to an individual is neither deductible by the donor nor taxable to the recipient.

Any business use that the donee makes of the car in 2008 is eligible for a business deduction at $.505 per mile. The only additional write-off available to the donee for business use is for tolls.

January 20, 2008

Individuals Paid for Services Provided to a Church

Any payments by a church to individuals for services rendered to the ministry represent taxable income to the recipients. If an individual is properly classified as an independent contractor (IRS Publication 15-A can help in this determination), then he or she must be issued Form 1099-MISC if his or her annual receipts paid by the church equals or exceeds $600. Each recipient properly classified as an employee must receive a Form W-2 by January 31 of the succeeding year. Church employees other than ministers are generally subject to social security and medicare tax withholding and employer matching; the exceptions to this requirement are rare. Churches are not subject to federal unemployment taxes.

Designated Gifts Contributed to Individuals

IRS Publication 526 prohibits contributions to individuals. "You cannot deduct contributions to specific individuals, including the following.
-- Contributions to individuals who are needy or worthy. This includes contributions to a qualified organization if you indicate that your contribution is for a specific person. But you can deduct a contribution that you give to a qualified organization that in turn helps needy or worthy individuals if you do not indicate that your contribution is for a specific person.
-- Expenses you paid for another person who provided services to a qualified organization. For Example. Your son does missionary work. You pay his expenses. You cannot claim a deduction for your son's unreimbursed expenses related to his contribution of services."

Unfortunately, IRS publications cannot address every scenario that might be presented. Here's one: A church member designates a contribution to a specific ministry or minister supported by the church. Generally, these contributions are permitted. In these cases, the individual eventually receiving the contribution is an employee or independent contractor of the church or Christian ministy (e.g. a foreign mission organization). As such, the payment represents taxable compensation. Common examples include special collections in support of a local church minister, and those in support of a missionary publicly acknowledged by the church as leading a ministry worthy of the congregation's prayer and financial support.

A couple of suggestions that I offer in these unusual situations:
1. The payment to the designated minister or ministry should made by check or wire transfer directly to that individual or the organization sponsoring his or her Christian ministry. As such, either the church or the sponsoring organization will issue the appropriate IRS information return (typically a Form W-2 or Form 1099-Misc) to the recipient.
2. Be careful to avoid situations in which the substantial majority of the church's payment comes from a donor related to the recipient. Again, IRS Publication 526 denies contribution for which the donor receives or expects to receive a benefit--I would include in this category payments among related parties for whom they might otherwise feel obligated to support. I state this position as follows: "The church or charity must be careful not to become a conduit for recharacterizing otherwise nondeductible personal expenses into charitable contributions." Of course, the church may forward funds to any individual if the sole intent is to maintain the anonymity of a donor who will not be receiving a tax deductible receipt.
3. One final example that seems to come up a lot and, in my experience, receives a wide variety of treatment... My reading of the IRS rules and regulation would allow a tax deduction to donors for contributions to funds maintained by charitable organizations for the support of individuals pursuing missions and other trips designed to fulfill ministry purposes. To the extent that the funds are used for 1) travel, 2) meals and 3) lodging during the trip, they will not be taxable to the recipient. The organization should issue the appropriate information return when the payments exceed these actual costs. For recordkeeping sake, I recommend that the organization handle all disbursement of funds for these three qualifying uses.

I wish that I could be more specific, but there appears to be little other guidance provided by the IRS and court cases. I believe that I am advising in both the letter and spirit of the law.

January 17, 2008

Form W-2 and a Pastor's Auto Allowance

An auto allowance advanced by a church to its pastor is subject to very exacting accountable plan rules. See my explanation on my website at MinistryCPA.org under Minister and Ministry Tax, Top 10 Questions #4.

The church must receive timely evidence of the pastor's business mileage when it offers advances. Generally, I recommend that a church reimburse its pastor for business use of his personal automobile (at the current IRS rate) only after documentation is received.

Under accountable plan rules, when auto allowance advances exceed the allowable deduction (qualified miles times the current IRS rate) the pastor is required to refund the excess advance to the church. Otherwise, the arrangement is disqualified and the entire annual allowance should be included in Box 1 of the pastor's Form W-2.

Simply including the excess amount in Box 1 is not in compliance with provisions of the Internal Revenue Code.

Form W-2 and Medical Expense Reimbursments (now typically called HRAs)

Health Reimbursement Arrangements (HRAs) have become popular employee benefits for churches since Congress established them earlier this decade. Medical Expense Reimbursement Accounts were their common predecessor. Amounts paid to a pastor by a church under a properly established and managed HRA or Medical Expense Reimbursement Account are not reported on Form W-2.

Form W-2 and Retirement Payments Directly to a Pastor

Question:

Payments for a retirement account - the payments are part of a salary package and are made directly to our pastor. Are these listed on the W-2 and, if so, are they listed in Box 12 Code E or in Box 1 as salary?

Answer:

Generally, any payments directly to the pastor are considered taxable income included with his standard compensation in Box 1. Frequently, a church will provide in its budget for its pastor's retirement. The money is paid directly to him and he is responsible to follow up with an IRA contribution or other retirement savings plan. If he contributes the funds to a Traditional IRA account, then he can take a write-off on his personal return. Even if the church sends the contribution directly to the pastor's Traditional IRA investment account, the Form W-2 reporting is unaffected. Box 12, Code E is exclusively reserved for 403(b) (also called TSA) plan contributions. The amount withheld from the pastor's pay and contributed to his 403(b) is reported in Box 12 and does reduce the amount reported in Box 1.

January 13, 2008

Accident and Health Plans Provided for Church Employees

In accordance with Internal Revenue Code Section 105, amounts received by employees under employer accident and health plans are excluded from Gross Income. This rule is also communicated by the IRS in its Publication 15-B (2008), Employer's Tax Guide to Fringe Benefits. Relative to churches and Christian ministries, the typical lone exception to this rule applies when the employer has established a "self-insured medical reimbursement plan that favors highly compensated employees." These plans typically reimburse employees for medical expenses not covered by insurance. For a church with a pastor as its sole employee, these rules are not applicable. Publication 15-B provides concise, understandable explanations of these rules.

January 04, 2008

Church Benevolence Fund Disbursements

Question 1:

Can church benevolence funds be given to a non-profit entity on the behalf of a needy individual who is being treated by that entity?

Answer 1:

Yes, as long as the disbursement is not a private enrichment of that individual or entity (the IRS calls it "private inurement"). Care should be particularly exercised if the individual is a church employee.

Question 2:

Can church members or non-members give gifts to the benevolence fund designating an individual as the one to receive the donation?

Answer 2:

Generally, no. The church must be careful to avoid conditions in which it could become a conduit for recharacterizing personal gifts or payments as charitable contributions. My general advice has been that the church can offer to assist the donor of non-deductible gifts in maintaining his or her anonymity, but that it cannot provide a tax deductible receipt.

Having said this, I do believe it is acceptable for the church to announce its corporate decision to support a needy individual and to subsequently take up a collection. I believe that donors can be given deductible receipts in these cases. Care must be taken however, I believe, to avoid situations in which a substantial portion of the collection comes from a source(s) that are otherwise obligated to pay for the needy individual's costs (e.g., a family member donating a large sum to pay for another family member's medical costs).

Of course, members are encouraged to give deductible donations of any size to the benevolence fund as long as there truly are no strings attached.