March 31, 2009

Gifts to Church School Teachers Paid as the Only Compensation

Question:

A Christian School affiliated with a church is very small and provides no salary to its teachers except $500 gifts at Christmas and at the end of the school year. Now that it's so late after the new year started, what reports should be filed in connection with these 2008 payments?

Answer:

It seems like a shame to have to do so after they earned so little income, but you should issue them Forms 1099-MISC for $1,000 of non-employee compensation each. Technically you were required to withhold the 7.65% FICA tax (and match this amount out of school funds) and then issue them Form W-2s, but it’s too late for that. I recommend that you consider reimbursing them for at least one-half of the self-employment tax that they will owe when they file their 2008 Form 1040s along with their attached Schedules C and SE.

More bad news...these reimbursements themselves are considered taxable income in 2009.

March 26, 2009

Deferred Compensation Plans

Question:

The sending church for a retiring missionary has for many years put money into an account that is set up as a missionary investment account (mutual funds in the church's name). It is now paying out a part of the money in the account directly to the retired missionary (i.e., not disbursed to the missionary's mission board and subsequently disbursed to the missionary). How should the church report these payments?

Answer:

Effectively, the church has established a deferred compensation plan. Whether a qualified or nonqualified plan, I make no judgment. The church should examine Internal Revenue Code section 457(b) plan requirements and Internal Revenue Bulletin (IRB) NO. 2007-19 regarding nonqualified plans.

Nevertheless, at this point in time, certainly the payments are taxable in the same character as the minister's previous compensation. It is, however, eligible for housing allowance designation. The church should issue Form 1099-MISC for the non-housing allowance portion (a designation cannot be made retroactively). Unless the minister has gained exempt status, the full amount (including housing allowance) is subject to Form 1040, Schedule SE self-employment tax.

Out-of-Pocket Contributions

Question:

What constitutes charities given in kind (not money)? When individuals make meals for those ill in their churches or meals for the hospital are they deductible as charitable contributions?

Answer:

Tax law prohibits deductions for contributions (direct and out-of-pocket) to individuals; a qualified charitable organization must be the recipient. However, Internal Revenue Service Bulletin (IRB) No. 1997-5 allows deductions for "volunteers who incurred unreimbursed out-of-pocket expenses while performing services for a charity to substantiate their contributions" particularly those "incurred incident to the rendition of services to a donee organization" (page 9).

I interpret IRB 1997-5 as follows. Taking a meal to a fellow church member at home or to an individual in a hospital is not deductible--a wonderful philanthropic activity, but not deductible. Also, churches organizing dinners for common sharing often ask members to "bring a plate to pass" -- not deductible. However, if a church or other 501 (c)(3) charity sponsors a meal(s) for needy individuals and a donor responds by providing food, thus incurring unreimbursed out-of-pocket costs, then a deduction is permitted.

According to IRB 1997-5 "to carry out the purposes of the statute, volunteers claiming a charitable contribution deduction for an unreimbursed expense of $250 or more are still required to obtain substantiation confirming the type of services they performed for the charity" (page 9). In others, if you give more than $250, request a letter from the organization acknowledging your participation.

See also 2008 Publication 26 entitled Charitable Contributions (pages 5 and 13). The Publication offers one example: "You can deduct reasonable unreimbursed out-of-pocket expenses you pay to allow underprivileged youth to attend athletic events, movies, or dinners. The youths must be selected by a charitable organization whose goal is to reduce junenile delinquency. Your own similar expenses in accompanying the youths are not deductible" (page 5). Presumably, the same rules apply to church donations to send needy youths to Bible camp.

March 23, 2009

Honoraria Paid to Ministers, Other Staff Members, and Church Members

Question:

Are payments by a church directly to members or staff for wedding services treated as compensation? It seems fairly certain that such payments are taxable. The payments are small ($50 to $150 per person). Should these payments be reported as compensation (Form W-2) for the employees and Form 1099-MISC for non-employees (issued only if they exceed $600 per year)?

Answer:

These payments are taxable and are properly reported as indicated within the second question. Similarly, honoraria that are paid to ministers directly by the benefiting party (weddings, funerals, etc.) are considered taxable compensation for services rendered.

March 21, 2009

SE Tax Trauma

Question:

Missionaries, as most ministers, are subject to both federal and state income taxes and self-employment tax.

Consider the following example. An independent missionary on deputation earns enough income (after deducting all allowable travel and ministry expenses) to owe $6,000 in self-employment (SE) tax on his support. Due to write-offs against his income taxable earnings (housing allowance, personal itemized deductions, personal exemptions for his family members, etc.) he not only owes no income tax, he receives $3,000 of credits that can gain him a refund check from the IRS even though he paid nothing in. Then comes his SE tax--ouch! Instead of receiving a refund, he must write the IRS a check for $3,000.

He asks, "Is there any legal way for me to file differently and avoid the Form 1040, Schedule SE tax?

Answer:

Missionaries in the above situation should consider at least two matters.

First, travel and other business expenses incurred while on deputation reduce reportable SE earnings. Many mission agencies require their missionaries to submit regular reports documenting their financial activity. Not only is this good stewardship on behalf of the supporting churches and individual donors, it makes good tax sense for the missionary. The mission agencies then issue to their missionaries Form W-2 which include only the portion of their support that is taxable after excluding reimbursements sent to the missionary for tax-deductible expenses.

Second, a missionary may consider applying for exemption from SE tax by filing a timely Form 4361. See my answer to Question 9 in the link below to my website:

Top 10 Questions that Pastors ask Tax Preparers

One final "reality check." Paying the 15.3 percent SE tax is a burden and reality that most missionaries and ministers face. While non-ministers have the 7.65 percent FICA (social security and Medicare) tax withheld from their gross earnings and matched by their employers, ministers must pay "both halves" but can pay this tax on their net (after business expenses) earnings. Accordingly, missionaries are well advised to either make quarterly federal estimated tax payments or to request federal income tax withholding by their mission agencies.

March 19, 2009

Pastor Appreciation (Love) Gifts

Question:

A bi-vocational pastor works a full-time secular job, and also shepherds a small church. He receives no salary from the church. Once a year the church membership on its own initiative takes up a collection and provides it to the minister as a “pastor appreciation” gift. Does this gift represent taxable income?

Answer:

This situation mimics the case of itinerant ministers. To the extent that the minister has unreimbursed expenses it will be non-taxable (reportable as income less expenses on Form 1040, Schedule C). The individual here apparently holds himself out as a minister of the gospel and apparently is recognized as such by a grateful congregation that collected a pastor appreciation gift. This love offering is taxable to the extent it exceeds his business (ministry) expenses.

March 07, 2009

Foreign Missionary Expenses

Question:

What expenses can be deducted by a Form 1099-MISC foreign missionary in reducing his self-employment income. I would tend to take normal business type expenses. What about living expenses such as rent, utilities and possibly food?

Answer:

The missionary must attach Schedule C to his Form 1040 return and deduct the standard business expenses classified there. If any of his supporting churches designated a portion of his support as housing allowance, then his rent and utilities (but not food) can be used to justify the non-taxable status of his housing allowance. Any excess housing allowance must be reported as taxable income. Of course, unlike Schedule C business expenses, a properly documented housing allowance does not reduce the missionary's self-employment bill (calculated on Schedule SE to Form 1040).

Benevolence Fund Receipts and Disbursements

Question:

Several people in the community at large have been sending a church regular gifts for a disabled member of the church. None of the donors are close relatives and none of them are her employers (she doesn't "work" for them). The church has been disbursing the money to her monthly. No Form W-2 or 1099 has been issued and there isn't anything that she's expected to "do" as a result. Is the above inappropriate? Alternatively, will use of the funds to pay her bills instead of giving it to her directly eliminate any concerns?

Answer:

This appears to be a classic example of truly benevolent activity in the Scriptural sense--no motivations other than caring for a "widow (or disabled) indeed" (I Timothy 5.3). The church congregation has recognized a benevolent need, established a procedure to collect gifts, and controlled its disbursement in accordance with the congregation's directives. The form of the benevolent activities and the substance of the motivations for doing so are consistent. No one is compensating the needy person for services nor paying for benefits that they are otherwise obligated to provide. The situation described in the question appears appropriate. Payment of a recipient's bills never successfully disguises amounts that represent compensation for services. These are called "payment in kind." But it does not appear that that is what is occurring in the situation described here.

The same rules apply to other benevolent activities (for example, a church establishing a "wheelchair fund" designated to receive gifts to buy a wheelchair for a disabled teenager).

For more information, check out my December 20, 2008, posting entitled Benevolence Policies.

P.S. My January 20, 2009, Post may have created some confusion:

I said that non-deductible gifts "include 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."

The determination relates to control. If the church determines to provide benevolent assistance to a needy individual, then it is not the donor who is controlling its disbursement. He or she is simply responding to an invitation to give to a charitable cause. I understand the confusion that this can generate.

March 02, 2009

Missionary's W-2 From Sending Church When No Agency is Involved

Question:

A church sends a missionary acting as his mission agency. This role makes the church an employer subject to Form W-2 filing. A treasurer of such a church was told that a missionary's Form W-2 should only report the money given to him minus his on-field expenses. Alternatively, it seemed to him that the church should simply report what the missionary was given. Then he should report his deductions when he files his tax return. What should be done?

Answer:

The answers to questions 4 and 5 in the accompanying link discuss and illustrate the treasurer's situation. The bottom line? Without an accountable plan in place the full compensation should be reported in Box 1 of the Form W-2. With a properly administered accountable plan, the payments should be omitted.

For more, follow this link: Top 10 Questions Pastors Ask Tax Preparers