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.