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.