December 18, 2009

Missions Trip Income (long-term but less than one year)

Question:

A couple plans to move overseas to work with a mission organization on temporary assignment (less than one year). The church managing their support intends to issue Form 1099-MISC reporting their earnings.

How do they report the income for tax purposes? Do they owe federal and state income taxes and self-employment (SE) taxes? Can they deduct business expenses (such as computer, camera, etc. used for the mission trip)?

They believe that they will be out of the US for a long enough period to qualify for Foreign Earned Income Exclusion.

Answer:

There are many facts and circumstances that must be considered in this case, but many of the rules to interpret their implications are covered in IRS Publication 463. Questions to be answered include the following:

1. What is the couple's "tax home"?
2. Is the assignment temporary or indefinite?
3. Is the trip primarily for "business" or personal reasons?

If the couples' support is only enough to cover travel costs, then the support is nontaxable. Any additional costs they incur for ministry purposes may be eligible for deduction as a charitable contribution.

On the other, as may be the case here, support is expected to exceed these costs and to augment their living expenses while serving on the missions trip. They should read the above Publication and point their preparer to consider their unique facts and circumstances.

December 16, 2009

SE tax on Housing Allowance as Well as Salary

Question:

Is it true, when a minister files his yearly taxes, he pays Social Security & Medicare taxes on his salary dollars as well as his housing allowance?

Answer:

You are correct. As a combined 15.3 percent tax, called self-employment (SE) tax, ministers calculate the tax on Schedule SE and include the tax payment along with their Form 1040 filing.

Some are not aware that the amount subject to the tax ("SE income") can be reduced by unreimbursed employee business expenses (Form 2106). Also, elective deferrals to a IRC 403(b) reduce SE income. Qualifying employee health benefits are also exempt.

Deductions for Uncompensated Minister

Question:

An unpaid, ordained minister works with his local church pastor. He participates in several ministerial duties. His main out of pocket expense is transportation to and from these duties. He also purchases reference books and software. He receives no income from the church nor does he receive mileage reimbursement.

Does he have a choice in deducting for the best tax result--either claiming a charitable contribution on Schedule A for his miles driven in performing volunteer duties, or claiming a miscellaneous deduction on Schedule A via Form 2106 (at a more generous IRS standard mileage rate available for employee business expenses)?

Answer:

Since he is not an employee he cannot claim employee business expenses. He must use the appropriate charitable rate.

However, all is not bad news. A minister employee cannot deduct mileage from his home to his church office (it is considered personal commuting). However, volunteers can deduct mileage from home to the church and to any other destination to perform charitable activities. Of course, if the sole purpose of the trip to church is to attend services this is considered personal, not charitable, use of one's vehicle. But the minister, in the above case, appears to be performing substantial ministry activity as a volunteer.

His out-of-pocket expenses for consumable materials are also charitable contributions.

December 15, 2009

Ministry Compensation Other than from a Church

Question:

An itinerant minister serves as a workplace chaplain (as the sole proprietor for a religious organization he has established), compensated by the businesses he serves. Instead of compensating him directly, some businesses contribute to an established tax-exempt ministry which, in turn, compensates him. He also speaks at civic and Christian organization gatherings and is provided a stipend. He's trying to follow the example of "circuit riding preachers."

Without obtaining Internal Revenue Code 501(c)(3) status from the IRS for his sole proprietor religious organization can he claim ministerial tax benefits for earnings received from his business clients?

Answer:

The only organizations that qualify as IRC 501(c)(3) organizations without formally filing for exempt status are churches and associations of churches (IRS Form 1023 instructions).

When the chaplain cited above receives compensation from a church for his ministerial services as a licensed or ordained minister, his income is considered as ministerial. Typically, I recommend that itinerants request housing allowance designations for an appropriate portion of their compensation at the time of receipt. Further, the ministry should first reimburse the minister fully for his specifically identified and documented travel and other expenses that he incurred to provide the services.

However, his payments received from for-profit business do not mirror the circuit riding preacher analogy cited above. The circuit riding preacher typically received compensation only from churches.

In order to qualify his religious organization as a IRC 501(c)(3) organization which, in turn, could compensate him as a minister, he will need to gain a corporate charter from his local state government, then file Form 1023 to gain recognition as a religious tax-exempt. Christian camps, schools, and other parachurch organizations typical follow this procedure.

Alternatively, he could bring his ministry (and all receipts) under the oversight of a church which was willing to partner with him in his unique ministry.

December 07, 2009

Annual Review of Church Christmas Gifts to Their Pastors (December 2009)

I’m getting the idea that every December will present another opportunity to review the tax law on Christmas gifts given to ministers. If you type “Christmas” in the above Search Window, you will find a number of postings on this topic. Here’s a review (much of it coming from my 12/15/08 post).

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 (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.

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 the gifts are taxable to him and deductible as charitable gifts by the donors.

A few additional comments from my 1/22/09 post:The rules I’ve stated above apply when an employer (the church congregation acting as a corporate body) takes a collection and gives it to its employee (the pastor). As a 501(c)(3) organization, a church is a qualified charitable organization. Gifts to it are tax-deductible. Compensation paid to an employee is taxable.

When I’m asked about this subject, all I need to hear is "the church solicits..." and I know we are addressing compensation issues, not gift issues. Making checks out to cash accomplishes nothing to defeat both the letter and spirit of the law.

November 27, 2009

Organizations That Can Ordain (or License)

Question:

A writer of Christian books wishes to enjoy the benefits of ministerial status. What organizations can ordain (or license) him to the gospel ministry? The minister plans to launch his ministry career from these books and would like to get a ministerial license through this ministry.

Answer:

The most frequent instance when a minister must provide proof of his status relates to the filing of Form 4361 applying for exemption from social security tax. The instructions to the form state the following:

"Enter the date you were ordained, commissioned, or licensed as a minister of a church...

"Attach a copy of the certificate (or, if you did not receive one, a letter from the governing body of your church) that establishes your status ...

"[E]nter the legal name, address, and employer identification number of the denomination that ordained, commissioned, or licensed you ...

"You must be able to show that the body that ordained, commissioned, or licensed you ... is exempt from federal income tax under section 501(a) as a religious organization described in section 501(c)(3). You must also be able to show that the body is a church (or convention or association of churches) described in section 170(b)(1)(A)(i).

"[Y]ou can attach a copy of the exemption letter issued to the organization by the IRS. If that is not available, you can attach a letter signed by an individual authorized to act for the organization stating that the organization meets both of the above requirements."

While denominational polity differs, as a member of an independent Baptist church, I believe (from a theological standpoint) that only a local assembly of believers in Jesus Christ can recognize the call to the gospel ministry upon a qualified member of the church. The IRS readily accepts this type of recognition as well. Other churches may certainly have different methods for ordination or licensure but I cannot attest to their defensibility before the IRS.

Partially Retired Minister Compensation

Question:

A minister is partially retired and receiving Social Security benefits that will be limited by the Social Security Administration (SSA) if his earnings exceed the SSA's thresholds. at age 62. Can the church continue to employ him and compensate him appropriately without exceeding the threshold? The church did investigate a deferred compensation arrangement called a "rabbi trust" but found it to be overly complex.

Answer:

According to the SSA website:

"If you are under full retirement age for the entire year, we deduct $1 from your benefit payments for every $2 you earn above the annual limit. For 2009 and 2010, that limit is $14,160.

"In the year you reach full retirement age, we deduct $1 in benefits for every $3 you earn above a different limit, but we only count earnings before the month you reach your full retirement age. If you will reach full retirement age in 2009 or 2010, the limit on your earnings for the months before full retirement age is $37,680.

"When we figure out how much to deduct from your benefits, we count only the wages you make from your job or your net profit if you're self-employed. We include bonuses, commissions and vacation pay. We don't count pensions, annuities, investment income, interest, veterans or other government or military retirement benefits.".

For most ministers, the amount reported on Schedule SE to Form 1040 will be the amount compared to these limits. This amount includes cash compensation plus housing allowance, but does not include the following:
  • professional expense reimbursements from an accountable plan
  • health care benefits
  • other non-taxable fringe benefits (e.g., employer matching of 403(b) plan contributions)
In addition, elective deferrals to a 403(b) plan by a minister are excluded from SE income
(IRS Revenue Rulings 68-395 and 78-6). Also, please search other postings in this blog.

November 23, 2009

Unspent Professional Reimbursement Plan Advances

Question:

A pastor writes, "Every year I break my package down how I want (base salary, housing, and a professional reimbursement). Can I carry over my excess unspent professional reimbursement or excess expenses into the following year?

Answer:

IRS Publication 15 spells out the rules for accountable plans--required conditions for employees to receive non-taxable employer advances for business expenses:

"To be an accountable plan, your reimbursement or allowance arrangement must require your employees to meet all three of the following rules.

1. "They must have paid or incurred deductible expenses while performing services as your employees. The reimbursement or advance must be paid for the expense and must not be an amount that would have otherwise been paid by the employee.

2. "They must substantiate these expenses to you within a reasonable period of time.

3. "They must return any amounts in excess of substantiated expenses within a reasonable period of time."

Publication 15 goes on, "Amounts paid under an accountable plan are not wages and are not subject to the withholding and payment of income ... taxes.

"If the expenses covered by this arrangement are not substantiated (or amounts in excess of substantiated expenses are not returned within a reasonable period of time), the amount paid under the arrangement in excess of the substantiated expenses is treated as paid under a nonaccountable plan. This amount is subject to the withholding and payment of income ... taxes for the first payroll period following the end of the reasonable period of time.

"A reasonable period of time depends on the facts and circumstances. Generally, it is considered reasonable if your employees receive their advance within 30 days of the time that they incur the expenses, adequately account for the expenses within 60 days after the expenses were paid or incurred, and return any amounts in excess of expenses within 120 days after the expenses were paid or incurred. Also, it is considered reasonable if you give your employees a periodic statement (at least quarterly) that asks them to either return or adequately account for outstanding amounts and they do so within 120 days."

APPLICATION TO MINISTERS AND CHURCHES: Can expenses or reimbursements be carried over from one year to the next? Well, I suppose they can. For example, at each month-end a church advances its pastor $100 for his professional expenses ($1,200 per year). The pastor uses this money in January, documents it to the church in February, and returns any excess advance in April. This seems to meet the requirements.

The PROBLEM with the question posed above relates to who is funding the professional expense reimbursement plan. These plans are designed (and permitted by the Internal Revenue Code) to use an employer's funds to reimburse employees for their job expenses. When an employee manipulates his own pay (with the cooperation of his employer) on an annual basis to gain tax-free treatment of the reimbursements, then the types of scenarios address here can arise. After all, it's the minister's money that may need to be returned to the church when this was certainly never the intent. Professional expense reimbursement plans do not work like 403(b) plans with annual elective deferrals or cafeteria plans with employee elections.

My SUGGESTION: When a minister first begins employment with the local church, the initial compensation package may allocate an appropriate portion to the church's budget for professional expenses. The minister and congregation will want to estimate on the low side since excess funds must remain with the church (or be reimbursed back to it). In subsequent years, the church should first increase this budget to more closely align with the minister's actual expenses. After this budget is set, it may consider any raise in taxable compensation or other employee benefits. This process removes the very awkward situation described above.

November 19, 2009

Homebuyer Credit Update-Straight from the IRS

First-Time Homebuyer Credit

From the IRS, November 17, 2009:

"New legislation, the Worker, Homeownership and Business Assistance Act of 2009, which was signed into law on Nov. 6, 2009, extends and expands the first-time homebuyer credit allowed by previous Acts. The new law:

-- Extends deadlines for purchasing and closing on a home.
-- Authorizes the credit for long-time homeowners buying a replacement principal residence.
-- Raises the income limitations for homeowners claiming the credit.
"Under the new law, an eligible taxpayer must buy, or enter into a binding contract to buy, a principal residence on or before April 30, 2010 and close on the home by June 30, 2010. For qualifying purchases in 2010, taxpayers have the option of claiming the credit on either their 2009 or 2010 return.

"For the first time, long-time homeowners who buy a replacement principal residence may also claim a homebuyer credit of up to $6,500 (up to $3,250 for a married individual filing separately). They must have lived in the same principal residence for any five-consecutive year period during the eight-year period that ended on the date the replacement home is purchased.

"People with higher incomes can now qualify for the credit. The new law raises the income limits for homes purchased after Nov. 6, 2009. The credit phases out for individual taxpayers with modified adjusted gross income (MAGI) between $125,000 and $145,000 or between $225,000 and $245,000 for joint filers. The existing MAGI phase-outs of $75,000 to $95,000 or $150,000 to $170,000 for joint filers still apply to purchases on or before Nov. 6, 2009."

Some amplification:

1. The up-to-$8,000 credit for first time homebuyers set to expire November 30, 2009, has been extended. A "buyer must have a contract in place before May 1, 2010, and the deal must close before July 1, 2010" ("The Lowdown on Home-Buyer Tax Credits," By Laura Saunders, The Wall Street Journal, 11/12/09).

2. "Taxpayers who have lived in one residence for five consecutive years of the past eight can now qualify for a tax credit of as much as 10% of the purchase price, up to a maximum $6,500, of a new principal residence" (Saunders).

Check out the sources I've listed for much more information.

November 08, 2009

Retirement Contributions to Reduce SE Tax

Question:

A church compensates its minister who does not request optional income tax withholding. Then, it issues Form 1099-MISC (non-employee compensation form).

He deposits the maximum allowable contribution to a Roth IRA. Can he also establish a tax deductible Simplified Employee Pension (SEP) retirement account which is eligible for a higher maximum contribution?

Answer:

My January 27, 2008, blog posting, Ministers’ Retirement Options, reviews some of the alternatives available to ministers.

In the question above, I recommend that the church consider filing Form W-2 (employee compensation form). Unless the minister is an itinerant preacher, it is likely that he should be properly classified as an employee. This means that the church could establish a 403(b) plan and the minister could make elective deferrals to reduce both his income and SE tax. Unlike 403(b) plan contributions, Roth contributions reduce neither Form 1040 taxable income nor Schedule SE self-employment income.

Further, the contribution limits for 403(b) plans are significantly higher than those for Roth IRAs.

November 05, 2009

Discriminatory HRAs for Churches

Question:

If a church establishes a Health Reimbursement Arrangement (HRA), can it define the plan to include only its ministerial staff and not its other full-time employees?

Answer:

Several resources are valuable in this determination:
  • IRS Publication 969
  • IRS Publication 15-B, Chapters 1 and 2
  • Internal Revenue Code (IRC) Section 105 (available at Cornell Law)
IRC Section 105 describes nondiscriminatory requirements for HRA and other accident and health benefit plans. Plans may be able to exclude five classes of employees. Three are generally applicable to churches (Section 105(h)(3)(B)):
  • employees who have not completed 3 years of service
  • employees who have not attained age 25
  • part-time or seasonal employees
Section 105(h)(4) states that "a self-insured medical reimbursement plan [and HRA] does not meet the [nondiscriminatory] requirements ... unless all benefits provided for participants who are highly compensated individuals are provided for all other participants" (other than those cited in the above bullet list).

So the definition of highly compensated individuals becomes all important. You should read Section 105 for yourself, but as I read it, for most churches, these individuals include the five highest paid employees or the highest paid 25 percent of all employees, if that number is more than five.

The consequence of providing HRA benefits on a discriminatory basis? Generally, full taxability of any benefits. Again, Section 105 has a small "out" for taxability of part of the benefits that will not likely help most churches.

November 03, 2009

Opt Out of Social Security Denied

Question:

A minister filed IRS Form 4361 but never received written confirmation of its acceptance. Later, the IRS audited his return and assessed the unpaid self-employment tax. What can he do now?

Answer:

According to the Minister Audit Technique Guide, a guide prepared by the IRS for its auditors but available to the public through the above link,

"To determine if a minister is exempt from self-employment tax, request that he or she furnish a copy of the approved Form 4361 if it is not attached to the return. If the taxpayer cannot provide a copy, order a transcript for the year under examination. The ADP and IDRS Information handbook shows where the ministers' self-employment exemption codes are located on the transcripts and what the codes mean. Transcripts will not show exemption status prior to 1988.

"If the transcript does not show a MIN SE indicator and the taxpayer still claims that he or she is exempt from self-employment tax, the Taxpayer Relations Branch at the Service Center where the Form 4361 was filed can research this information and provide the taxpayer with a copy. The Social Security Administration in Baltimore also can provide the information on exemption for an individual."

The normal procedure for filing Form 4361 is (abridged):
1. minister files Form 4361 in triplicate (several attachments are also required)
2. the IRS communicates with the minister for written confirmation of his conscientious objection (other information may also be requested)
3. an IRS representative returns a signed original to the minister
4. the minister runs a photocopy and gives one to his tax preparer :^)

Since it is now likely that his two-year window of opportunity to opt out is expired, absent this proof (i.e., an IRS-signed Form 4361), the minister has few options other than to pursue the advice above.

October 28, 2009

Retired Minister Continued Support from His Congregation

Question:

Our pastor is retiring from our assembly in 2010. He will be remaining with our congregation as a member and will have no further duties or responsibilities with our church. He has been our shepherd for many years. If the church were to supplement his social security income with a monthly "benevolence" check would this qualify as non-taxable benevolence? 

Answer:

Rare exceptions to the taxability of gifts to employees (current or former) have been made by the IRS (Private Letter Rulings, I believe; but I am going on memory right now) in cases of former ministers with medical or other needs that typically merit benevolence. In the case here, it will likely appear to the IRS and other objective parties that the church is now aiding a former employee who received inadequate compensation during his tenure (at least inadequate in the sense that he did not accumulate funds for post-retirement living). This compensation, while appreciated by the minister, will be taxable.

However, the IRS Minister Audit Technique Guide published in April 2009 may provide some tax planning reminders (and IRS authority to back it up!).

"A retired minister may receive part of his or her pension benefits as a designated parsonage allowance based on past services. Trustees of a minister’s retirement plan may designate a portion of each pension distribution as a parsonage allowance excludible under IRC § 107. (Rev. Rul. 63-156, 1963-2 C.B. 79, and Rev. Rul. 75-22, 1975-1, C.B. 49) The “least of” rules should be applied to determine the amount excludible from gross income. (My commentary here: please see my September 18 blog posting for a summary of these rules.)

"The retired minister may exclude from his/her net earnings from self-employment the rental value of the parsonage or the parsonage allowance received after retirement. The entire amount of parsonage allowance received is excludible from net earnings from self employment, even if a portion of it is not excludible for income tax purposes. In addition, the retired minister may exclude from net earnings from self-employment any retirement benefits received from a church plan. Rev. Rul. 58-359, 1958-2 C.B. 422."

The church should consider cooperating with the retiring minister to designate these ongoing payments as housing allowance. It has the potential to reduce his tax bite significantly.

October 27, 2009

Benevolent Gift Rules Review

Question:

My church regularly gives financial help to individuals in need. Should the individual receiving financial help/charity from the church be issued any kind of Form 1099 from the church?

Answer:

IRS Publication 525 states that gifts to individuals not in the employ of the donor are non-taxable. This is true regardless whether the gifts are periodic or regular as long as no services are required (past, present or future) to receive the benevolence. I recommend that viewers of this blog type "Benevolence" in the above search window for much more on this subject.

Question:

Donations have been made to our church, and the donors requested that certain individuals then be given the same amount in charity from the church due to a perceived need (specifically, for people who have lost their jobs, but the specific individuals were named by the donors). The church told the donors that it would assume complete legal control over the donated funds, but the church has, in fact, been giving as much, or more, to the needy individuals as was donated by donors making such requests. Are these donations tax deductible as charitable donations for the donors?

Answer:

Generally, these type of gifts are deductible by the donor and non-taxable to the recipient. Again, type "Benevolence" in the above search window for much more on this subject.

Tax-exempt organizations that file Form 990 (most churches are excluded from this requirement) are familiar with IRS rules regarding donor advised funds. The Instructions to Schedule D of Form 990 define these funds:

"Generally a donor advised fund is a fund or account:
1. That is separately identified by reference to contributions of a donor or donors;
2. That is owned and controlled by a sponsoring organization; and
3. For which the donor or donor advisor has or reasonably expects to have advisory privileges in the distribution or investment of amounts held in the donor advised funds or accounts because of the donor's status as a donor" (Form 990 Schedule D Instructions).

The presence of this status does not deny tax-deductibility of donations but does merit the attention of the IRS since obvious abuse could occur. For this reason, in my blog entries I have persistently cautioned churches to be aware of potential abuses and to steer clear of them.

October 17, 2009

Missions Work: "Business" or "Hobby"

Question:

A missionary receives little support and uses a lot of her own funds to cover her expenses. Can the expenses paid out of her personal funds be deducted as a business expense on Schedule C as well? If so, she will always have a substantial loss, as she funds the majority of her work with her personal funds.

Answer:

Business expenses can be deducted even if they lead to a loss in a particular year. But if an activity is classified as a hobby (not as a business), expenses can only be deducted to the extent of income. In other words, a business loss on Schedule C cannot be created.

According to IRS Publication 535 and related instructions on its website,

"Generally, an activity qualifies as a business if it is carried on with the reasonable expectation of earning a profit.

"In order to make this determination, taxpayers should consider the following factors:
Does the time and effort put into the activity indicate an intention to make a profit?
Does the taxpayer depend on income from the activity?
If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business?
Has the taxpayer changed methods of operation to improve profitability?
Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?
Has the taxpayer made a profit in similar activities in the past?
Does the activity make a profit in some years?
Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?

"The IRS presumes that an activity is carried on for profit if it makes a profit during at least three of the last five tax years, including the current year."

In the question addressed above, my guess is that it is doubtful that her activity would be consider "for profit" unless it is only a rare year that income falls short of expenses. She should consider whether her excess expenses qualify for a charitable contribution deduction. For this determination, my posting earlier on this date may shed some light.

Travel Expenses for Ministry Trips

Question:

A family works with a ministry that serves orphans in several foreign countries. Many individuals and families travel to fulfill short-term missions projects each year. Parents typically bring their children who help with painting, cleaning, etc. There is no element of vacation associated with the trip. Can expenses for the family trip be deducted if paid directly by the family (airfare, etc) or does the ministry need to pay these expenses directly and be reimbursed in essence by the family to be deductible?

Answer:

IRS Publication 526 addresses "Out-of-Pocket Expenses in Giving Services" and travel costs.

First, let's consider four principles that the Publication highlights:

"Although you cannot deduct the value of your services given to a qualified organization, you may be able to deduct some amounts you pay in giving services to a qualified organization. The amounts must be 1) unreimbursed, 2) directly connected with the services, 3) expenses you had only because of the services you gave, and 4) not personal, living, or family expenses."

Car expenses can be deducted at 14 cents per mile (2009 rate) for documented charitable miles.

Regarding travel expenses specifically, Publication 526 states:

"Generally, you can claim a charitable contribution deduction for travel expenses necessarily incurred while you are away from home performing services for a charitable organization only if there is no significant element of personal pleasure, recreation, or vacation in the travel. This applies whether you pay the expenses directly or indirectly. You are paying the expenses indirectly if you make a payment to the charitable organization and the organization pays for your travel expenses.

"The deduction for travel expenses will not be denied simply because you enjoy providing services to the charitable organization. Even if you enjoy the trip, you can take a charitable contribution deduction for your travel expenses if you are on duty in a genuine and substantial sense throughout the trip. However, if you have only nominal duties, or if for significant parts of the trip you do not have any duties, you cannot deduct your travel expenses."

The Publication lists the following expenses as deductible: "Air, rail, and bus transportation; out-of-pocket expenses for your car; taxi fares or other costs of transportation between the airport or station and your hotel; lodging costs; and the cost of meals."

Interpretation:

It seems to me that parents must carefully weigh all facts and circumstances to determine whether charitable deductions are appropriate for the expenses they incur on behalf of their children. The Publication does provide several examples of activities that the IRS believes qualify or do not qualify. If these tests can be passed, then a charitable deduction claimed on Schedule A (Form 1040) is appropriate. This is true regardless whether the payments were made directly by the taxpayer or indirectly through the charitable organization. Often, it is important for the organization to be involved in the disbursement of funds because it must provide stewardship over monies donated both by those traveling to serve and by those who contribute toward these expenses (often called "sponsors").

October 08, 2009

Itinerant Minister Housing Allowance Strategies

Question:

If an itinerant minister declared at the beginning of the year that the first x amount of dollars received would be considered his housing allowance, would that be an unreasonable interpretation of tax law concerning ministries?

Answer:

A housing allowance must be designated by action of the payer(s), not by declaration by the recipient, so I don’t believe the above strategy will work.

I recommend that a church providing an honorarium to an itinerant minister provide a written and signed breakdown of its remuneration including the portion designated as housing and any portion paid as reimbursement for properly documented travel or other costs. The minister may wish to provide guidance to the ministry as to the percentage and method for this statement.

Housing Allowance for Itinerant Ministers

Question:

An itinerant minister utilizes Schedule C to report his honoraria. No portion of this income to this point has been designated as housing allowance. As an itinerant minister, can he deduct all reasonable housing expenditures without having them designated by a church or other qualifying organization?

Answer:

The April 2009 Minister Audit Technique Guide published on the IRS website offers guidance here. The housing allowance must be officially designated before the compensation is received. While the Guide does not directly address the case of itinerant minister, it seems that an official designation of one's honorarium before it is disbursed to the minister will qualify. Accordingly, churches issuing Form 1099-MISC could properly exclude that portion from the Non-Employee Compensation box. I do recommend that such churches provide the itinerant minister a statement of the housing allowance paid to him as part of his honorarium since he must follow the Clergy Housing Allowance Clarification Act of 2002 in determining its income tax consequence. It remains subject to Self-Employment tax, in full.

A minister who erroneously claimed a housing allowance that was not officially designated must amend his return to correct the error.

Education Costs to Become a Minister

Question:

What advice can you give a newly ordained minister on the deductibility of expenses related to training materials, tuition, books and apartment rent incurred during the process of becoming a licensed minister?

Answer:

IRS Publication 529 communicates information regarding the deductibility of "Work-Related Education." These deductions are Miscellaneous Itemized Deductions on Schedule A. It says,

"You can deduct expenses you have for education, even if the education may lead to a degree, if the education meets at least one of the following two tests.
  • It maintains or improves skills required in your present work.
  • It is required by your employer or the law to keep your salary, status, or job, and the requirement serves a business purpose of your employer.
"You cannot deduct expenses you have for education, even though one or both of the preceding tests are met, if the education:
  • Is needed to meet the minimum educational requirements to qualify you in your trade or business, or
  • Is part of a program of study that will lead to qualifying you in a new trade or business."
Typically, ministers are not able to qualify their deductions for the bachelor's or master's degree that is expected for them to receive a call into the gospel ministry. However, ministers taking courses to fulfill one of the first two tests listed above may qualify. Publication 529 indicates which expenses qualify. Apartment rent is not deductible.

Of course, there are other tax benefits (education credits claimed on Form 8863) that aspiring ministers can enjoy.

October 07, 2009

Missionary Meal Expenses--Deductible?

Question:

"A missionary in Mozambique does not keep records of her actual meal expenses as she was told that there was a basic “formula” used in deducting food expenses. Can you provide any information regarding this “formula” for calculating food expenses?"

Answer:

First, most meals for missionaries are not deductible. According to IRS Publication 463, meals are only deductible when it is necessary for you to stop for substantial sleep or rest to properly perform your duties while traveling away from home on business. Business-related entertainment meals are also deductible. Since a missionary's home is his or her place of ministry in the foreign country, he or she is rarely traveling away from home on business. The exception may be short ministry-related trips within the country.

For these cases, Publication 463 describes a standard meal allowance. The IRS says, "If you use the standard meal allowance, you still must keep records to prove the time, place, and business purpose of your travel."

IRS Publication 463

The above link may be followed to find details for standard meal allowances in foreign countries (additional links are impeded in the Publication--page 6 in the February 4, 2009, printing). The Publication also provides details regarding partial days.

Private Inurement

Question:

A church houses a Bible school on its property that had been started at one time by a church employee as a for profit, sole-proprietorship. Church staff state that "the church is non-profit and the school is for profit." Does the church need to prepare tax returns each year for the school? Can it merge the school into the church after-the-fact so it won't be a sole proprietorship any more?

Answer:

There's a lot going on in these questions. As I try to be in all most posts, I'll try to be brief yet helpful. Some of the issues will undoubtedly require consultation with an attorney who knows state law applicable to the church.

Certainly, a church can have ministry related auxiliary activities such as a Bible school that will be tax exempt. But the church must be the "owner" of the venture.

For now, the church needs to very careful about having its property used by an employee to operate his own for-profit business, especially if he’s not paying a fair market value rent for its use. The Internal Revenue Code cautions tax-exempt organizations to avoid “private inurement” -- when an individual receives a personal, non-compensatory benefit from use of a tax-exempt organization’s assets.

On the other hand, if the school is truly a ministry owned by the church, then it may not actually be properly classified as “for profit.” While its receipts may exceed its disbursements in some years it will not likely incur a tax liability. Publication 598—Tax on Unrelated Business Income of Exempt Organizations—should be consulted.

October 01, 2009

Nonaccountable Plans for Missionaries

Question:

How should missionaries report their "working fund" as opposed to salary. Do they keep records themselves in case asked by the IRS? Are these funds reported by the supporting congregation/mission organization and then deducted as business expenses? Who is able to decide what constitutes a "working fund" expense as opposed to a salary item?

Answer:

Although I'm not familiar with the term "working fund" I believe it is a sum of money sent to the missionary for ministry use (not personal use) without documentation expectations. The IRS calls these arrangements "nonaccountable plans" (see IRS Publication 15 for a brief definition, including "accountable" plan rules).

The quick answer to the questions posted is that the full amount received into a missionary's nonaccountable working fund is treated the same as his standard support. If the mission agency is treating the missionary as an employee (the standard method), then these amounts should be included in Box 1 (taxable compensation) of Form W-2.

To my knowledge, most mission agencies provide a level of accountability for funds sent to missionaries which will satisfy the IRS requirements for accountable plans. These plans follow IRS rules as to what is reimbursable as a business expense. In my opinion, this is a much preferable arrangement--both from the perspective of the taxpaying minister and from my perspective as a donor to missionaries who is thankful for the role of mission agencies that serve both missionaries and the congregations that support them. (I hope I didn't get too "preachy" here!)

Minister Buys Business Vehicle with Church's Help

Great Question:

A church wishes to buy its pastor a new vehicle and has the cash to pay for it outright. Possible tax strategies:

1 – Church owns the vehicle and the pastor keeps log of business versus personal use; the value of his use is included on his Form W-2. Negative: this also keeps the insurance policy in the church’s name which somewhat exposes the church.

2 – Church pays for the vehicle and titles it to the pastor (15% federal income, 5.75% state income plus 15.3% self-employment (SE) taxes paid on the vehicle value; the taxes could be paid partially by the church by grossing up the pastor’s salary). Negative: all income coming into play in one year and the possibility of pushing the pastor into a higher bracket.

3 – Pastor owns the vehicle and finances it – church pays pastor additional paycheck each month grossed up for taxes and after deductions leaves enough net pay for making payment.

"Answer" (in quotes because my response will mainly be simple comments):

1 – This option also avoids the sales tax cost since it is purchased and owned by a tax-exempt entitity. This may only be advisible if the pastor has his own personal vehicle and limits personal use to his commute and other minor use.

2 – While costly, this option at least removes a church obligation for auto insurance and maintenance and gives the pastor total control over his vehicle. However, the church has used up its cash for this one time purchase and may not be able or interested in other tax-favored disbursements.

3 – I like this option the best, but suggest that the church consider funding a 33 or 50 percent down payment on the car in 2009 (subject to the taxes noted above in #2), then issuing a bonus on January 1, 2010 (and 2011 if three years are used) to permit rapid pay down of the debt by the pastor. Spreading out the disbursements may also save the church its current cash reserve in order to fund a professional expense reimbursement plan for the pastor's ministry miles. Even without this plan, the pastor can deduct his business use of the vehicle in the determination of his SE tax. However, unreimbursed business use of his vehicle offers significantly reduced benefits for federal income taxes (through the use of Form 2106 and Schedule A). Some state income tax formulas deny tax benefits entirely for unreimbursed employee business expenses.

Donor Records for Benevolent Gifts

Question:

A church maintains a benevolence fund to assist the needy in the church and community. Is the church required to keep a list of names of the donors (not recipients) of those funds?

Answer:

Identical to any other type of charitable contribution, in order for donors to receive a year-end statement of their giving benevolence fund records must also be kept. I recommend that these gifts be recorded in an identical manner as other contributions.

September 29, 2009

Ministerial Tax Status: Let Me Out!

Question:

An individual who has previously been employed by a church as a non-ministerial employee now has been added to the church staff as an ordained minister. He finds that his tax situation is worse now. How could this happen? Let me out!

Answer:

This question has a lot of variables. I'll try to get right to the point.

As a non-minister, his full compensation was subject both to federal and state income taxes and to FICA tax withholding of 7.65 percent. The church was required to pay the other 7.65 percent of his social security and Medicare tax. These withholdings were mandatory.

As a minister, he now qualifies for a housing allowance which is free of federal and state income taxes. However, he is now considered self-employed (SE) for purposes of his social security and Medicare tax obligations. He is responsible for the full 15.3 percent SE tax on his income including the housing allowance. According to the Internal Revenue Code, withholdings are optional for him, but without a substantial amount of federal income tax withholding (enough to cover both his actual federal income tax and his SE tax) he must file and pay quarterly estimated tax payments on his own. Otherwise, he may owe a substantial balance due on April 15th.

What strategies have ministers and churches pursued to manage this cost?
1. Many churches recognize that they are saving the 7.65 percent normally the responsibility of employers. Accordingly, they increase his pay by 7.65 percent, then immediately withhold an identical amount as federal income tax so that his tax bite is partially shared.
2. Some ministers choose to opt out of the social security system (Form 4361).
3. If he has children, it may be that his housing allowance reduces his taxable income to the point of qualifying for tax credits that he may not have otherwise earned.
4. Others utilize other tax saving strategies such as 403(b) plans, HRA plans, and professional expense reimbursement plans (all subjects of previous postings to this blog).

Parsonage as Only Compensation

Question:

A church is looking to bring on a youth minister but is unable to offer compensation other than living arrangements in a church home. The minister is not ordained. Can housing be offered as the sole compensation? Would the person need to be hired as a regular employee or as an independent contractor? How would the church and the youth minister report this?

Answer:

Regardless of the ordination, licensure or other formal recognition of the minister, he will qualify for ministerial status as long as he is providing what the IRS calls sacerdotal (ministerial) duties for a qualifying church. Licensure, at a minimum, certainly helps to establish (or document, if necessary) his call to the gospel ministry. Generally, an ordained minister performing solely non-ministerial duties does not qualify for clergy tax status.

While the minister in this case will most likely be properly classified as an employee, he will not be issued Form W-2 because he has received no taxable compensation. He will be responsible to report the fair rental value of the parsonage as self-employment income on Schedule SE. He will be able to reduce this amount by any unreimbursed employee business expenses he incurred.

September 27, 2009

Missionary Furlough: Deductible Travel Expenses

Question:

Most commonly, mission agencies treat their missionaries as Form W-2 employees (and, I believe, properly do so). They classify disbursements to them in categories such as cash compensation, housing allowance, and reimbursable employee business expenses.

The question has been asked, "Are there any IRS restrictions to consider in a mission agency's policy for the quantity of trips back to the home country? Because long-term missionaries are employees and eligible for accountable expense reimbursement arrangements, a common practice is to classify travel costs for furlough leave as reimbursable business expenses."

Answer:

This question is addressed by IRS Publication 463. The Publication asks the question, "What Travel Expenses Are Deductible?" then answers it:

"Once you have determined that you are traveling away from your tax home [the foreign mission location, in most cases], you can determine what travel expenses are deductible. You can deduct ordinary and necessary expenses you have when you travel away from home on business. The type of expense you can deduct depends on the facts and your circumstances.

"If a spouse, dependent, or other individual goes with you on a business trip, you generally cannot deduct his or her travel expenses. You can deduct the travel expenses of someone who goes with you if that person: (1) is your employee, (2) has a bona fide business purpose for the travel, and (3) would otherwise be allowed to deduct the travel expenses.

"If a business associate travels with you and meets the conditions in (2) and (3) above, you can deduct the travel expenses you have for that person. A business associate is someone with whom you could reasonably expect to actively conduct business. A business associate can be a current or prospective (likely to become) customer, client, supplier, employee, agent, partner, or professional advisor. A bona fide business purpose exists if you can prove a real business purpose for the individual's presence. Incidental services, such as typing notes or assisting in entertaining customers, are not enough to make the expenses deductible."

In the case of a missionary family, my experience is that both spouses are expected to represent the ministry of the family. Whether the children's presence is "ordinary and necessary" (using the IRS definition) must be determined based on the facts and circumstances of the situation.

There is no maximum number of trips that the IRS will permit. Rather, deductibility is determined based on the above criteria. A missionary returning to the US simply to "drop off" his college student at school seems to fall short of the criteria. At the opposite extreme, doing so during an extended furlough of reporting to churches should only deny deductibility for the excess expenses incurred related to the personal nature of the college trip (i.e., extra mileage, meals and lodging will not be deductible).

September 26, 2009

Designated Funds: Liability or Equity accounts?

Question:

A recent question came up on how certain designated funds should be reported on our balance sheet – we have funds like benevolence, scholarship, etc. – a previous treasurer changed these accounts from liability to equity and now we have another individual saying that these accounts must be liabilities; any recommendations on which way is correct?

Answer:

Unless the ministry is undergoing a certified audit or otherwise committed to strictly following Generally Accepted Accounting Principles (GAAP), I believe the classification is irrelevant. The key point is that the unspent balances will be carried over from one fiscal year to the next.

For us accountants:
Technically, the accounts are equity accounts in not-for-profit organizations following FASB 116,  which stipulates this treatment in order to comply with GAAP.

September 18, 2009

100% of Compensation Designated as Housing Allowance

Questions:

Are both full- and part-time pastors considered as employees who receive year-end earnings Form W-2? Can 100% of their pay be designated as housing?

Answers:

All church employees should receive Form W-2 regardless of their full- or part-time status. Form 1099-MISC is reserved for reporting independent contractor compensation only. Common examples of independent contractors compensated by church include janitorial services and guest speakers.

The housing allowance is limited to the lesser of three amounts: a) the amount actually used to provide a home, b) the amount designated by a minister's employer, c) the fair rental value plus actual cost of utilities. It may be that a minister expects a) and c) to exceed his full cash compensation, especially if he is part-time. Accordingly, a 100% designation may be appropriate.

Both full- and part-time ministers are eligible for the full list of allowable employee business expense deductions reportable on Form 2106. See the Form 2106 instructions for more information.

Payments to Former Pastor

Question:

A church sets up a fund to pay a former pastor's nursing home, housing and other expenses. He and his wife are current members of the church. Is the church required to issue him a Form 1099-MISC (or Form W-2)? Is there a limit as to how much he can receive?

Answer:

Situations such as this are common. Typically, the church has been unable to compensate the former minister as well as it would have wished and now intends to provide some current support to address this undercompensation. Such payments to the minister or on his behalf are taxable as compensation. The church can designate a portion to housing allowance and the minister may elect Internal Revenue Code section 403(b) elective deferrals which may reduce the tax bite.

There is no limit to the amount other than possible Social Security retirement limitations on those who have not reached full retirement age (between age 65 and 67 or so).

Another possible motivation for these payments produces an entirely different tax effect. Just as any member of a congregation may have needs addressed by the church's benevolent fund, a minister who is a current member may receive non-taxable benevolent gifts. Such gifts are not motivated by past undercompensation, but by compassion for the needs of members as funds are made available to cover them.

The IRS expects the church to determine the tax reporting (or absence of it) based on the full facts and circumstances of the case.

Housing Allowance and Form 1099-MISC Reporting

Question:

A church provides its minister a housing allowance, but for other purposes it believes that it must report the full amount of compensation (including the non-taxable housing allowance portion) on Form 1099-MISC (in order to demonstrate the full earnings of the minister). If the church reports his compensation, including the housing allowance, on Form 1099-MISC as taxable income, will he be able to deduct his housing expenses somewhere else on the Form 1040?

Answer:

This questions brings up a couple of issues. First, most ministers are properly classified as employees who receive Form W-2, not as independent contractors who receive Form 1099-MISC. On Form W-2, Box 1 for taxable compensation is reduced reflecting the church's designation of a portion of his pay as non-taxable. Then in Box 14, it typically reports as a memorandum item his additional non-taxable, housing allowance compensation. In the situation addressed in the question, this Form W-2 reporting may or may not adequately address the other uses the church must make of the Form 1099-MISC.

Alternatively, the minister will need to report the full Form 1099-MISC income on Schedule C where it will be fully taxable. The minister could then claim as a deduction on Line 21 of his Form 1040 as Other Income a negative amount for his allowable housing allowance. He should probably attach an explanation of the negative amount and be ready to answer correspondence from the IRS regarding the deduction.

Of course, the full amount of compensation (including the non-taxable housing allowance) is subject to self-employment tax on Schedule SE unless the minister has successfully applied for exempt status using Form 4361.

Two Residences for Housing Allowance Purposes?

Questions:

A minister temporarily commutes 100 miles from his principal residence to serve in a Christian ministry, also renting an apartment near the ministry while away from home. Can he claim a housing allowance on this second dwelling as well as his principal residence?

And what about the commute from home to the ministry--is it deductible? Can the ministry reimburse him on a tax-free basis?

Answers:

A housing allowance is available for only one principal residence. Plus, commuting from a minister's home to his place of business is non-deductible. Hence, reimbursements by a church for non-deductible expenses, while certainly appreciated, will be taxable income.

An exception may be important to consider. It relates to the Internal Revenue Code definition of Tax Home. Travel and lodging expenses while away from one's Tax Home for business purposes may be deductible (and reimbursements non-taxable). According to IRS Publication 463, "if you do not have a regular or a main place of business because of the nature of your work, then your tax home may be the place where you regularly live" (IRS Pub. 463, 2/4/2009, p. 3). It's important to carefully consider the "factors used to determine tax home" that are spelled out by the IRS. Some ministers who serve multiple ministries from one central location (their homes) may deduct mileage to travel to those ministries and lodging & meals while out-of-town, overnight to conduct their ministries. However, "itinerant" status ministers do not qualify for these deductions.

Ministers employed by a single ministry even if it requires significant travel and overnight lodging do not qualify for these deductions.

September 09, 2009

Minister Performing Services as an Independent "Business" Activity

Question:

Can a private pastoral counseling practice - including pastoral counseling, church consultation, and education - qualify for the housing tax deduction? The individual seeking ministerial status is not paid by his church; however, his ministry is affirmed as an extension of a church's ministry. Essentially, he operates a sole proprietorship earning income that supports his ministry at a church.

Answer:

IRS Publication 517 addresses this situation in its definition of a minister:

"Most services you perform as a minister, priest, rabbi, etc., are qualified services. These services include: performing sacerdotal functions, conducting religious worship, and
controlling, conducting, and maintaining religious organizations (including the religious boards, societies, and other integral agencies of such organizations) that are under the authority of a religious body that is a church or denomination."

Publication 517 also addresses services for nonreligious organizations:

"Your services for a nonreligious organization are qualified services if the services are assigned or designated by your church. Assigned or designated services qualify even if they do not involve performing sacerdotal functions or conducting religious worship. If your services are not assigned or designated by your church, they are qualified services only if they involve performing sacerdotal functions or conducting religious worship."

It seems that the individual described in the question may not qualify for ministerial status. If he and a Board of Directors establishes a qualified IRC 501(c)(3) organization "under the authority of a religious body that is a church or denomination" (see above), then that organization can designate a housing allowance. Alternatively, the church may recognize his contribution to its ministry and hire him as a counseling minister employed by the church. Of course, he loses the autonomy that he now enjoys as a sole proprietor.

Benevolent Fund Review

Question:

I have currently been made aware of a family in our church that has experienced some serious medical issues. One of our members would like to pay for these expenses. The only stipulation that I can find in the Internal Revenue Code is that the money cannot be given with a particular designation. Can the church receive these funds, give a tax-deductible receipt or acknowledgement to the donor, and disburse the funds to pay these medical expenses?

Answer:

Churches maintain ongoing Benevolent Funds to prepare to meet these type of needs. All members are generally encouraged to give monies to the fund to allow the church (through an authorization process observed by church officers) to respond.

The caution that I offer is that the church must avoid becoming a conduit for donors to convert their noncharitable obligations into tax deductible gifts. For example, if one family member "donates" a substantial portion of the benevolent monies given to another immediate family member (even stipulating that the funds may only be used to do so), then the church may find itself being "used" to convert his or her obligation to pay for family medical bills into a chartible contribution.

I recommend that churches communicate that gifts to their benevolent funds are disbursed solely at the discretion of the church. This does not mean that members cannot communicate needs of others that they have discovered and that they are willing to help meet.