December 29, 2010

News You (Individuals) Can Use (and that we may use to serve our clients better)

1. Employees get a 2% raise with their first 2011 payroll checks. The Tax Relief Act of 2010 reduces the employee-share of the FICA tax by 2%

2. Provisions set to expire on December 31, 2010, related to sales tax, educator, tuition, contributions, mortgage insurance premiums, and student loan interest deductions, and some related to the Earned Income and Child Tax Credits were extended by the Tax Relief Act. An energy credit for individuals was also reinstated, but at a lower rate.

3. Updated mileage rate deductions for 2011: business-51 cents/mile; charitable-14 cents/mile; moving and medical-19 cents/mile.

4. While it received a lot of negative press, the Health Care Reform Act of 2010 contained provisions that may benefit individuals including tax credits and increased benefits for employees' adult children.

5. The Small Business Jobs Act of 2010 increased some business write-offs and created additional Roth Account conversion opportunities for individuals.

Review of Year-End Charitable Giving Reports by Churches

Questions:

What do we do with post-dated checks or checks that arrive in the offering box in January with a December date on them? If a contribution is postmarked by the 31st of December, I assume we are required to include that figure in our 2010 tally? Is there anything else we should know about the reporting of contributions?

Answers:

Make sure to check collection boxes, if any, prior to the close of the year. Checks that are received by the church prior to January 1 are included as 2010 contributions as long as the funds are available to the charity. A post-dated check (after December 31) must be posted as 2011, even if a 2010 date is recorded on it, since it cannot yet be deposited. Checks received via US Mail postmarked by December 31 should be recorded for 2010.

Make sure to provide date and amount for any individual contributions greater than $250. A simple total for the year is appropriate unless additional notation is necessary to list these larger amounts. Many churches simply give a list of all contributions for the year no matter the amount. Then they provide a total as well.

Finally, provide a statement that no goods or services other than intangible religious benefits were provided in return for the contributions. IRS Publication 1771 is helpful in addressing many charitable giving questions. A link is provided below.

December 15, 2010

Deductible Travel Expenses for Volunteers

Question:
You have covered in several previous posts the question of whether contributions made in support of mission trips are deductible. Here's a question with a slightly different slant.

If a congregation member, who is a member of a mission team and travels with that team, purchases supplies, food, or other “goods” for the trip and those supplies are used directly and immediately for the purpose of the trip (in other words, they do not run those contributions through the church), will that person be able to deduct those as contributions, assuming they have supporting documentation? Will they have to get some kind of statement from the church in support of those contributions? Would they claim these on Schedule A, assuming they itemize?

Answer:

IRS Publication 526 offers some good help to answer this question.
"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."

The Publication has a good section on travel expenses, plus a table of Volunteer's Q&A. It includes a summary of deductible travel expenses. "These include 1) Air, rail, and bus transportation, 2) Out-of-pocket expenses for your car, 3) Taxi fares or other costs of transportation between the airport or station and your hotel, 4) Lodging costs, and 5) The cost of meals. Because these travel expenses are not business-related, they are not subject to the same limits as business related expenses."

So in answer to the questions above, "yes," with proper documentation the costs for volunteers' travel expenses can be deductible.

In the event of an audit, the taxpayer may need proof from the church that volunteers were involved in a charitable activity that involved paying their own costs in giving services (to use Publication 526 language). Absent an audit, such proof is not necessary.

Volunteers' costs are deducted along with other contributions on Form 1040, Schedule A.

December 08, 2010

Health Reimbursement Arrangements for Pastors With No Taxable Compensation

Question:

Three pastors of a congregation receive a housing allowance and no actual wage. Can a Health Reimbursement Arrangement be made available to a pastor who's only compensation is a housing allowance?

Answer:

A minister whose compensation is designated 100% as housing allowance is still considered an employee eligible for all statutory fringe benefits that other workers enjoy.

Question:

It is understood that HRAs cannot be taken through voluntary salary reductions. May a church have an agreement with a pastor that he receives a monthly HRA that, if unused, is designated as a housing allowance instead?

Answer:

Since an HRA must be 100% funded by employer contributions, it is not considered taxable compensation. The plan may be established to permit unused amounts to roll over into a subsequent year. However, to distribute amounts contrary to the design of HRAs places the whole arrangement in non-compliance. IRS Publication 969 makes this quite clear:

"If any distribution is, or can be, made for other than the reimbursement of qualified medical expenses, any distribution (including reimbursement of qualified medical expenses) made in the current tax year is included in gross income. For example, if an unused reimbursement is payable to you in cash at the end of the year, or upon termination of your employment, any distribution from the HRA is included in your income. This also applies if any unused amount upon your death is payable in cash to your beneficiary or estate, or if the HRA provides an option for you to transfer any unused reimbursement at the end of the year to a retirement plan."

December 06, 2010

When the Church Finances Get Too Much for Volunteers

Question:

A New York City church has been handling all its church finances through volunteers, but the work is getting overwhelming. It is considering hiring an outside firm/person to handle all church finances- reimbursements, writing checks, payroll, bookkeeping. Is this a good idea? What is a reasonable price?

Answer:

The bookkeeping function for volunteers has always been, in my opinion, the most time-demanding volunteer responsibility in most churches. When most churches reach a point of advanced time and expertise requirements they seek to hire help rather than to continue using volunteers.

Of course, some functions cannot nor should be "farmed out." The confidentiality and security required for offering counts and deposits typically means that volunteers will continue performing these duties. Maintenance of donor records often stays under the watchful eye of church members. Of course, processes to approve invoices for payment and to set compensation arrangements must be overseen by the church leadership, as does creation of the church budget. So church member expertise is still much needed.

It's good to ask potential part-time employees or bookkeeping service providers whether they have experience in accounting for churches, particularly payroll functions since there are significant differences between churches and business enterprises. Often, experienced people are not available so a new hire must be expected to do some research to learn about ministerial compensation. As many have discovered in this blog, there are some tips along the way here, but a good general resource may be helpful. Type "tax" in the search window of Christianbook.com and you will find helpful resources by B.J. Worth and Dan Busby. Check out Churchlawandtax.com as well.

Further, the new employee or self-employed bookkeeper may not be familiar with the church's method of financial reporting--typically, an "Other Comprehensive Basis of Accounting." The individual must have a solid understanding of accounting in order to avoid attempting to convert the ministry to his or her own limited sphere of experience in for-profit business accounting.

As to reasonable pricing, each geographic area has its standard of living that a church must consider. Volunteers who have performed financial services in the past may be able to suggest the amount of time it will take to fulfill the work. Then, local wages rates must be considered. Typically, independent firms must charge more but will have their own computer systems and will have access to greater expertise. These all are matters that must be considered.

November 15, 2010

Church-established Fund for Families Adopting Orphans

Question:

A church plans to establish an adoption fund as part of an orphans/widows ministry. Church members may contribute tax-deductible donations to the fund. The church leadership understands that IRS rules related to benevolence prohibit designation by donors to specific individuals. Rather, benevolent funds must be controlled by the church and distributed to recipient families identified by the church as a whole.

Will donations given for adopting families identified by the church be tax deductible for donors and non-taxable to recipients? Will the same answers hold true for adopting families who are both members and employees of the church?

Answer:

As long as the church as a whole exercises control over the process for identifying the recipients of benevolent funds, as long as the disbursements are not disguised compensation to employees, I believe that the donations will be tax-deductible and recipients will not be taxed.

It should be noted that Qualified Adoption Expenses for the federal Adoption Credit must be reduced by amounts "paid or reimbursed by your employer or any other person or organization" (instructions to Form 8839).

Church Sales of Music Tapes

Question 1:

A church choir produces and sells a Christmas CD, the proceeds offsetting the cost of making the CD and contributing to its music ministry budget. Will the sales be subject to sales tax?

Answer 1:

Sales taxes are collected by most states, so the law must be considered for the location of each church. Since I'm in Wisconsin, I'll share its law.

According to the State of Wisconsin, Department of Revenue, Publication 206, churches may make such sales without collecting and submitting sales tax to the state authorities if the Occasional Sales Rules apply. In Wisconsin, as long as the church does not otherwise hold a Seller's Permit and, as noted above, the sales receipts are not event admission fees, then the church will not be subject to sales tax collection and payment if it satisfies Wisconsin's definition of "not engaged in a trade or business." Only if a church makes sales of greater than $25,000 in a calendar year and makes sales on more than 20 days will it be considered "engaged in a trade or business" in Wisconsin.

It is important that each church study its local law.

Question 2:

Will these sales be subject to federal unrelated business income tax?

Answer 2:

According to IRS Publication 598, "unrelated business income is the income from a trade or business regularly carried on by an exempt organization and not substantially related to the performance by the organization of its exempt purpose or function, except that the organization uses the profits derived from this activity" (my emphases).

The Publication continues, "business activities of an exempt organization ordinarily are considered regularly carried on if they show a frequency and continuity, and are pursued in a manner similar to comparable commercial activities of nonexempt organizations."

Further, "a business activity is not substantially related to an organization's exempt purpose if it does not contribute importantly to accomplishing that purpose (other than through the production of funds). Whether an activity contributes importantly depends in each case on the facts involved."

Each church must weigh its own situation, but the occasional production and sale of church music (not "regularly carried on") for the legitimate purpose of putting church music in the hands (and hearts) of people ("substantially related to an organization's exempt purpose") could very well present a defensible position for not classifying the above "profits" as unrelated business income.

November 14, 2010

Church as Mission Agency

Question:

Our church is acting as the mission agency for an individual sent from the church. We will receive funds and clearly indicate that the church has complete authority over the funds in order to protect their tax-deductibility. My understanding is that in order for the church to send the money on to the missionary, we can do one of the following:
1. Pay the missionary reimbursements for allowable business expenses requiring documentation; other support sent to the missionary will be taxable as self-employed ministry income.
2. Make the missionary an employee of the church, paying the individual through payroll and therefore take taxes out of the support before paying the missionary.
3. Pay the missionary without requiring documentation as a self-employed individual and issue Form 1099-MISC.

Are any/all of these correct ways to handle this?

Answer:

Knowledge of complex tax laws provides one of many reasons that mission agencies are most often more prepared than a local church to serve a missionary and his or her sending churches. Nevertheless, churches do commonly attempt to provide this help so I will attempt to outline the options.

It is my experience that most well-established mission agencies classify their missionaries as employees. Mission agencies do provide considerable oversight (control as the Internal Revenue Code defines it). Missionaries often find that supporting churches welcome this oversight in order to aid the missionary in his or her ministry and to practice good stewardship over their own resources.

Whether taxes are withheld from these employees depends on their status as ministers or non-ministers. Just as a minister of a church is, by law, exempt from withholding and responsible for his own self-employment and income tax, so too is a missionary who is a licensed or ordained minister of the gospel. If the individual sent by the church is not a minister (e.g. a school teacher, office worker, or medical provider), then, as any other employee of the church, FICA taxes and federal and state income taxes are withheld.

As employees, the missionaries may document business expenses to the church for tax-free reimbursement. As long as substantiation requirements are met, these amounts will not be reportable as taxable income on Form W-2. Also, as employees, these missionaries are eligible for many of the same employee benefits that are discussed throughout this blog.

As for the self-employment route, if it's easily and cheaper for the local church to provide no accountability as to how the funds are spent and the church simply wishes to act as a conduit for other churches' (and its own) support, then Form 1099-MISC can be issued for the full amount of the support. The church could set up a reimbursement and documentation arrangement but as a self-employed minister there will be virtually no difference in his taxable income. Further, he is not eligible for many employee benefits described in the Internal Revenue Code (e.g., 403(b) plans, HRAs, employee insurance plans).

November 05, 2010

Non-GAAP Accounting Question: Capital Assets

Question:

If a church has recorded the acquisition costs for capital assets but chooses not to depreciate (thereby, not being in compliance with FASB 93) how do these capital assets get removed from the books at time of disposal or replacement?

Answer:

While two wrongs don't make a right, I suppose the ministry here would be required to make a general journal entry reducing capital assets and recording a gain or loss depending on the cash proceeds received, if any.

I recommend that churches that do not need to follow Generally Accepted Accounting Principles use a modified cash basis in which capital asset acquisitions are recorded at the time of purchase as disbursements on a Statement of Receipts and Disbursements. Note that I do not call it an income statement or a statement of activities since it is not consistent with the use of GAAP.

Further, checks written for mortgage payments (both principal and interest) are recorded as disbursements. Only current assets and current liabilities are recorded on the Balance Sheet. Additional disclosures to the ministry should be made regarding the status of long-term debt (e.g., report the beginning mortgage balance, principal payments applied, and ending balance).

While use of the modified cash basis as described here is not GAAP, at least most non-accountants associated with these ministries can understand the budgeting process used in these cases since it very closely relates to "cash in and cash out."

October 21, 2010

Prizes Given at Charitable Events

Question:

A church hosted an event primarily for religious purposes, but required guests to purchase a ticket or receive one from someone who had purchased a ticket for them. Several prizes were given away that were either purchased by the church or donated to it. Is the church responsible to issue a Form 1099-MISC with the fair market value of the prize in Box 3 at the end of this year?

Answer:

If a prize winner receives a non-cash item with a fair market value greater than $600, then Form 1099-MISC must be issued to the winner for its full value. Perhaps the most widely accepted authority for this requirement is simply the IRS instructions to Form 1099-MISC (link below).

Form 1099-MISC Instructions

October 20, 2010

Payments to a Foreign Minister

Question:

What are the reporting requirements for a minister who is not a U.S. citizen, but performs services in the US? Does sending his earnings to his foreign location make any difference?

Answer:

Depending on several factors, it is likely that this minister is classified either as a resident or nonresident alien. His income is reportable on Form W-2 if he was an employee while in the U.S. or on Form 1099-MISC if he was an independent contractor. Sending the money overseas does not avoid the reporting requirements.

IRS Publication 519--U.S. Tax Guide for Aliens--may be helpful both to the ministry and to the minister. The ministry may also wish to explore Form 1042 and instructions--Annual Withholding Tax Return for U.S. Source Income of Foreign Persons. Also, Tax Topic 851 may be helpful (link provided here).

Topic 851

Probably the easiest way for a local church without foreign tax knowledge to deal with this issue is to advance the funds to the minister's (or to his U.S. sponsor's) U.S. missions agency and let it use its expertise to apply the law.

October 18, 2010

Form 990 for Church "Subordinate Organizations"

Question:

A qualifying church is not required to file an annual informational return (Form 990). Would this change if the church owns a single member LLC? Assume that unrelated business income tax (UBIT) is not as issue.

Answer:

Great question and a new one on me! But it seems that its qualification under the church and its exemption falls under the Group Exemptions provisions of the Internal Revenue Code. Specifically, whether the LLC is a "subordinate organization" will likely determine its inclusion under the church's filing waiver. IRS Publication 4573 (link below) seeks to define the qualifications and may be helpful.

IRS Pub 4573

As the inquirer points out, the UBIT matter is important. Churches earning unrelated business income must file Form 990-T and pay income tax on any profits.

September 30, 2010

Should Churches Apply for Tax-Exempt Status?

Question:

Should a church apply for Internal Revenue Code 501(c)(3) status? What are the benefits or disadvantages of applying for such status when it is already treated as exempt from income tax?

Answer:

IRS Publication 1828 helps to answer these questions.

One quote:

"Churches that meet the requirements of IRC section 501(c)(3) are automatically considered tax exempt and are not required to apply for and obtain recognition of tax-exempt status from the IRS. Although there is no requirement to do so, many churches seek recognition of tax-exempt status from the IRS because such recognition assures church leaders, members, and contributors that the church is recognized as exempt and qualifies for related tax benefits. For example, contributors to a church that has been recognized as tax exempt would know that their contributions generally are tax-deductible."

A few BIG disadvantages:

The application Form 1023 is 30 pages long and requires a fee. Also, the IRS estimates that it will take in excess of 189 hours for "recordkeeping, learning about the law, preparing the form, and copying, assembling, and sending the form to the IRS."

Receipt of Benevolent Gift Versus Refund of Contribution

Question:

If a church gave a member a benevolent gift during a time of need should that church then record the gift on the member's giving statement as a negative against which all of that member's future (or past) donations are subtracted?

Answer:

No, the receipt of a benevolent gift is non-taxable nor does it reduce one's charitable giving deduction. This offers another good reason to properly document the nature of benevolent gifts to assure that they are not mistaken for refunds of previous contributions.

September 23, 2010

Director of Christian Education: Is He a Minister?

Question:

A church hires a Director of Christian Education. Does he qualify for the same tax-status as a pastor (e.g., housing allowance, exempt from income tax withholding, eligible for Form 4361 election)?

Answer:

The IRS Minister Audit Technique Guide helps to answer this question. I'll edit out some of the technical citations, but readers should follow the link for more details:

"To qualify for the special tax provisions available to ministers, an individual must be a 'minister' and must perform services 'in the exercise of his ministry.'

"[Tax rules] require that an individual be a 'duly ordained, commissioned, or licensed minister of a church.'

"[Tax rules] provide that service performed by a minister in the exercise of the ministry includes: Ministration of sacerdotal functions; Conduct of religious worship ...

"[Tax rules] also provide that whether service performed by a minister constitutes conduct of religious worship or ministration of sacerdotal functions depends on the tenets and practices of the particular religious body constituting the church or denomination."

Readers really need to read the entire section of the Guide on "Who Qualifies for Special Tax Treatment as a Minister." But I'll offer just one more quote that may apply to the specific question posed in the Blog entry:

"The Tax Court held in Lawrence v. Commissioner, 50 T.C. 494, 499-500 (1968), that a 'minister of education' in a Baptist church was not a 'duly ordained, commissioned, or licensed' minister."

Church Meals Free of Charge

Question:

Can a church provide meals (or other food such as pizza parties for youth) to its members using funds that come from the regular Sunday morning offering?

Answer:

Presumably we're talking here about occasional church fellowships. Yes, it's okay, as long as it's not disguised compensation for a church employee (e.g. paying for employees' family meals and entertainment on the church tab). I suggest that the budget plan for such expenditures though. Furthermore, it may be a sensitive matter to some who believe it is inappropriate to spend God's money to "feed the flock."

Interest-Free Loan to Church Employee

Question:

A church gives its pastor a loan to be used to pay down his home mortgage. The condition will be that he will not pay anything back until or unless he leaves the church or sells the home. At that time he would pay the money back without any interest. How this would be treated by the IRS for tax purposes?

Answer:

IRS Publication 15-A answers this one pretty well:

"In general, if an employer lends an employee more than $10,000 at an interest rate less than the current applicable federal rate (AFR), the difference between the interest paid and the interest that would be paid under the AFR is considered additional compensation to the employee. This rule applies to a loan of $10,000 or less if one of its principal purposes is the avoidance of federal tax.

"This additional compensation to the employee is [reported as] compensation on Form W-2 (or Form 1099-MISC for an independent contractor). The AFR is established monthly and published by the IRS each month in the Internal Revenue Bulletin."

September 11, 2010

Rental of a Church Parsonage to a Non-minister

Question:

A church owns a parsonage, but the pastor does not use it as he own his own home. The church rents the parsonage to a tenant other than a minister or employee of the church. Will the church be responsible for paying income tax on these monies as Unrelated Business Income (filing a Form 990-T) even if the money is used to carry on the business of the church?

Answer:

Whether the money is used for church purposes is irrelevant. IRS Publication 598 states:

"If an exempt organization regularly carries on a trade or business not substantially related to its exempt purpose, except that it provides funds to carry out that purpose, the organization is subject to tax on its income from that unrelated trade or business."

Fortunately, in the case of rental income from real property, such income is "excluded in computing unrelated business taxable income" (Publication 598 (rev. March 2012), Chapter 4).

However, a second concern not addressed in the question must be raised: Will the parsonage lose its status as excluded from the real estate tax rolls of the local government? I have worked with two churches in similar situations in two different states. My recommendation has been to communicate openly with the local authorities (typically an Assessor) as to the church's intentions. In both cases, because the use was temporary (in one case) and rented to a missionary of the church during his furlough (in the other case) the Assessor did not believe its use violated the statutory exclusion from real estate taxes for church property.

September 06, 2010

Missions Trip Contributions and Expenditures--a Good Plan!

Question

We would like to send our pastor on a missions trip, asking our congregation to participate in giving toward this trip. We have a separate Missions Fund to which donors can contribute. They would be instructed to make any checks payable to the church designated to this Fund.

All approved expenses for the trip will be reimbursed through this Fund. We have an Accountable Reimbursement policy in place.

Can the donors include these gifts as charitable contributions? Will the reimbursements for expenses be non-taxable to our pastor?

Answer

Well designed plan! The contributions will be tax-deductible to donors and the reimbursements for properly documented ordinary and necessary ministry travel expenses will be non-taxable to your pastor.

Refund of Contributions

Question:

"Does a church need to distribute Form 1099 to donors that receive refunds of donations to a building fund. The building will no longer be built, and the church has sent notice that the money in the building fund can either be applied to the debt of the church or returned to the donor. Since these were designated donations, I don’t believe they would have been deductible in the first place, but the church has no way of knowing how individual taxpayers handled this."

Answer:

First, designated donations to a building fund are typically deductible. A refund will, then, have tax ramifications that each donor's tax professional will need to address. However, the church has no requirement to issue Form 1099.

Richard R. Hammar in his 4/23/2009 post on Church Finance Update (Bottom-Line Training: Refunds of Charitable Contributions; What do we do if a member wants to take back their contribution?) provides an excellent treatment of this subject. I cannot improve upon it.

Also, Hammar provides free e-mail newsletters that reader will find well done and useful.

September 05, 2010

"Benevolent Loans", an Oxymoron?

Question:

A reader asks a follow-up question to my detailed posting on July 15, 2010, regarding churches offering non-interest bearing loans to their pastors.

Employee Loan by Church to Pastor

Do the same rules apply for a zero-interest loan to a church member (not an employee)? Does the difference between the applicable federal rate and 0% need to be reported on a Form 1099-MISC or other form?

Answer:

This answer may not be what some will expect, but here it goes:

Since the loan is not to an employee or independent contractor in exchange for services rendered, I must assume that the loan is disbursed as a benevolent activity of the church. Therefore, the foregone interest is essentially the "benevolent" act and, as such, is non-taxable (not reportable). HOWEVER, as a church member who has given this kind of "benevolence" a lot of thought, I strongly recommend that the above proposal to loan money to a member as a "benevolent" act be abandoned. I suggest that churches consider a policy along the lines of the following:

"[Church] has established a [benevolent fund] to meet the special financial needs of members. From time to time, those in need may ask for a loan rather than to receive a benevolent gift. The members of [Church] are not of a mind to do so when God has provided us the money (Proverb 3.27). We would much rather lend to the Lord by giving to others (Proverb 19.17)."

The following statement may be provided to benevolence recipients:

"Your brothers and sisters in Christ at [Church] earnestly rejoice to meet the needs of others. We trust that the gift God has provided will meet your immediate need at this time and will encourage your walk with the Him. We know that God loves a cheerful giver so we extend this help with absolutely no expectation of repayment.

"We do understand from the Apostle Paul’s instruction to the believers at Corinth, however, that you might desire to respond to God’s provision in some tangible way. Paul gave instructions to the church about the same kind of fund that provides for others’ needs at [Church].

"He said, 'For if there be first a willing mind, it is accepted according to that a man hath, and not according to that he hath not. For I mean not that other men be eased, and ye burdened: But by an equality, that now at this time your abundance may be a supply for their want, that their abundance also may be a supply for your want: that there may be equality: As it is written, He that had gathered much had nothing over; and he that had gathered little had no lack' (II Corinthians 8.12-15).

"If you at some time in the future wish to share in meeting others’ needs just as yours are now being met, we encourage you to give privately and confidentially to the [Church Benevolent Fund]."

Housing Designation of 403(b) Plan Retirement Distributions

Question 1:

An investment advisor "once heard regarding 403(b) plans that distributions from such plans could not qualify for the housing allowance." Later, he "came across several tax sources that say 403(b)(9) distributions may qualify for housing allowance [designation] (the "nine" apparently being the distinguishing characteristic)."

Can 403(b) distributions qualify for housing designation?

Answer 1:

Distributions from 403(b) plans qualify for housing designation. I point readers of this blog to my posting of October 28, 2009:

Retired Minister Continued Support from His Congregation

Question 2:

How does a 403(b)(9) differ from traditional 403(b) plans?

Answer 2:

Section 403(b)(1) describes TSAs (also known as 403(b) plans) as annuities (Tax-Sheltered Annuities). Section 403(b)(9)(a)(i) clarifies that “a retirement income account shall be treated as an annuity contract described in [section 403(b)]." Section 9 simply indicates that annuities are not the only form of permissible 403(b) plan investments.

August 25, 2010

Is Office Space Provided to a Missionary "In-kind" Compensation?

Question:

A church provides office space within its church to a local missionary who is raising his support. The church is one of the missionary's financial supporters. This office space is provided rent-free. The missionary is not an employee of the church, but does serve as a member within the church. Is the missionary responsible for any taxes in regards to this office space?

Answer:

The use is certainly consistent with the church's tax-exempt purposes and ministry emphases. Is is my opinion that the office space as described for use in his mission endeavor is non-taxable. Further, even if it did represent taxable income, the missionary would have an immediate and equal business deduction for rent.

Pastor in Transition to Missionary Receives Help from Former Congregation

Question 1:

Can a pastor who is leaving the church for a position as a full-time foreign missionary (the church will contribute missionary support as the sending church) receive retirement compensation for past services by declaration of the church? What would be the taxability of such an arrangement? Does it matter how long is is paid or whether it is in a lump sum or a monthly obligation?

Answer 1:

Probably the easiest way for the retirement contributions to be made as implied in this question is to have the church send support to the former pastor's account with his mission agency employer. Then the pastor may make elective deferrals into an Internal Revenue Code 403(b) plan. He can likely contribute in excess of $20,000 per year (IRS Publication 571 describes the limits).

Question 2:

Can the church continue to pay for health insurance as a tax-free fringe if the senior pastor is no longer an employee but simply a missionary from the church?

Answer 2:

Similar to my answer for Question 1, the pastor's mission agency employer can provide health coverage using funds supplied by supporting churches, including the pastor's former congregation.

Question 3:

Can the church compensate the outgoing pastor with severance pay before he goes to the field? Would that be taxable like his pastoral salary?

Answer 3:

Yes, the church can provide severance pay, but it will be taxable as any other compensation. To mitigate the tax costs, standard ministerial tax law benefits should be pursued (e.g., housing allowance designation, elective deferrals into IRC 403(b) retirement plan).

August 24, 2010

Missionary "Start-Up"

Background:

A new missionary endeavor has prompted a "missionary start-up" series of questions. His situation is very typical and may be helpful to rehearse with all viewers of this blog.

"The Lord has called me to be a missionary. At this time, I am still working and earning money in the United States. I not ordained at this time.

"After sharing my burden with our local church, a mission agency was created by our local church to help facilitate the funding for my family's’ mission needs. The only step that was taken to create the mission agency was to open an account at our church’s bank in the name of [the] Agency. We also opened a sub-account under the agency in my own personal name. [The church's agency] received a Tax ID number for this account. [Since 2009, contributions] have been accumulating in the two accounts.

"No money was taken or used from either account until August of [2010] when I took a survey trip. During my trip, I incurred expenses for taxi services, hotels, eating, obtaining a passport, and purchasing plane tickets. This money was taken from the sub-account in my personal name, most of which had been transferred from the “missions agency” account."

Question 1:

Were we required to report the income that was given in 2009 to the government in last years’ taxes?

Answer 1:

No, as long as the church agency maintains complete control of the funds and their disbursement, you have no income until you are compensated for your personal services. In fact, to avoid potential confusion, if asked for my personal counsel I would likely advise you to close the personal sub-account under the church agency Tax ID. When the agency distributes personal living expense money to you, it should pay it to you for deposit into your own personal family account. At that point, these earnings must be reported to you and the IRS at year end on Form 1099-MISC or Form W-2 (depending on your employment or independent contractor status with the church agency).

Question 2:

How do we claim income in 2010?

Answer 2:

As you have described it so far, you have no taxable income in 2010. It appears that the monies disbursed to you were in reimbursement for business expenses, not for compensation of your personal services. The church agency should maintain copies of substantiation of your business expenses to document that all of the disbursements were business travel costs.

Question 3:

Does the fact that the church [has not pursued formal incorporation] mean that the church cannot consider me [its] employee, legally speaking?

Answer 3:

This should not make a difference. To my understanding and experience, virtually all state statutes recognize churches as corporations regardless of their formal status.

Commentary:

There are many other issues this new missionary will need to consider. A careful reading of past entries in this blog could probably be a good start. They include choices regarding ordination/licensure, employee vs. independent contractor status, financial management arrangements with the church agency, self-employment tax, and many other issues.
 

August 23, 2010

Taxability of In-kind Payments by Church for Intern

Question:

An intern at a church receives as part of his compensation a direct payment by the church to reduce his school debt. If the church pays off his loans will that be considered income for tax purposes?

Answer:

The loan payments will be taxable as standard wages. If he is or should be treated as a licensed minister then he will have no withholding. However, he will be obligated for both income and self-employment tax. A housing allowance could reduce his income tax to the extent he pays for his own housing. Of course, he could also consider "opting out."

If he is not a minister (not recognized by the church as called to the gospel Ministry and eligible to marry, bury and baptize) then both the cash and loan payments are subject to FICA withholding and matching by the church. His compensation will be classified as any other non-ministerial employee (e.g., administrative assistant, facilities manager). He would not qualify for a housing allowance since only ministers do.

Church Support of a Missionary with No Mission Agency

Question:

A church provides direct support to a missionary -- both through the church budget and from additional contributions received designated to his ministry. What reporting requirements does the church have?

Answer:

Since the church disburses directly to the missionary, it should issue Form 1099-MISC. If it wishes, the church can establish arrangements, for example, to reimburse documented business expenses and to designate a portion of the support toward housing. Absent these provisions, the entire amount should be reported annually on Form 1099-MISC.

August 19, 2010

Timing of Taxability of Missionary Support Handled by an Agency

Question:

A mission agency inquires as to the amount included on Form 1099-MISC filed each year. The office believes that the should be the total of all of the support that came in for the missionary during the year. Most of its missionaries zero out their accounts each month (i.e., what comes in to the agency's account each month goes out to the missionary immediately).


A missionary asks the agency to deposit a set amount each month into his/her personal account and to leave the rest in the hands of the agency. A clarification is needed as to whether the amount received by the agency or the amount disbursed to the missionary is the proper amount to record on Form 1099-MISC.

Answer:

The answer to this question relates to a tax concept called "constructive receipt." If a mission is simply acting as a clearing house for contributions and missionaries have unlimited and unsupervised access to funds held on their behalf, then all funds are taxable to the missionary as they are received by the mission. In these cases, all contributions received by the missionary are immediately reported as taxable income since he or she had unrestricted access to them. They were constructively received even if not deposited into a personal bank account.

However, to my understanding, most mission agencies take an active role in serving both the donors and the missionaries. Donors understand that such agencies receive contributions on the behalf of their missionaries and provide oversight in disbursements to them. Missionaries must submit budgets for their personal living expenses. They must document business expenses for appropriate reimbursement out of funds received by the agency from donors.

If donors designate contributions to special projects on a missionary's post, then the agency ensures compliance with the designation.

In these cases, a missionary is taxed only as he or she receives funds from the mission for personal living expenses.

Benevolent Fund Disbursements to Employees

Question:

An employee of a church was given a gift from the church benevolent fund to assist with curing a personal financial problem. Should the church withhold the taxes on this benevolence from the employee's pay check, or simply issue a W-2 to the employee, or do nothing?

Answer:

It is wise to be careful when distributing gifts to employees from the church's benevolent fund. As one might imagine, supplementing an employee's low pay with, presumably, non-taxable gifts from the benevolent fund could be tempting.

Nevertheless, most churches do distribute benevolent fund gifts to members and non-members in the community who have emergency financial needs. These funds have been collected from donors who wish to be generous with those in need; they are not motivated to disguise compensation. Accordingly, I believe that one-times gifts such as the one described above should be classified as benevolent gifts that are non-taxable and non-reportable on Form W-2 or any other form.

On the other hand, if a church congregation encourages benevolent fund contributes to help supplement an employee's low pay and, subsequently, disburses these funds to him/her, then these payments should be reported as taxable income to the employee.

July 22, 2010

Non-Taxable Life Insurance for the Pastor

Question:

May a church pay for variable universal life insurance for the pastor and his wife without showing it as income?

Answer:

Right "out of the horse's mouth" -- IRS Executive Compensation - Fringe Benefits Audit Techniques Guide (02-2005):

"Group term life insurance premiums paid to insure the lives of a spouse or dependent of an executive are included in the gross income of the executive (Treasury Regulation §1.61-21(b)(1)) . Employers attempt to classify such payments as a deminimis fringe benefit; however, the Government takes a very narrow view of this provision (PLR 200033011)."

IRS Publication 15-B, Employer's Tax Guide to Fringe Benefits, explains that only group, term life insurance policies may enjoy these benefits and then only the first $50,000 of death benefit.

Clearly, the above scenario strikes out in two respects: 1) it's not group term life insurance, and 2) the spouse is covered.

July 15, 2010

Employee Loan by Church to a Pastor

Question:

A church is considering providing a non-interest loan to a pastor for purposes of purchasing a home. What are the tax implications for the church should it choose to extend such a loan?

Answer:

There are non-tax considerations of the above arrangement that I will discuss later, but, first, the tax considerations.

According to IRS Publication 15-A:

"In general, if an employer lends an employee more than $10,000 at an interest rate less than the current applicable federal rate (AFR), the difference between the interest paid and the interest that would be paid under the AFR is considered additional compensation to the employee."

As of July 2010, the annualized AFR for long-term loans is 3.94% (Revenue Ruling 2018-18, Table 1). If a church gave an interest free loan, then the foregone interest would be reportable as taxable income to the pastor on Form W-2. If any portion of the loan principal is forgiven, that amount will also be taxable.

The IRS advises its auditors to review these situations carefully to assure that bona fide loans exist and that they are not "cleverly disguised" forms of additional compensation:

"Factors that are indicative of a bona fide loan are 1) existence of a promissory note, 2) cash payments according to a specified repayment schedule, 3) interest is charged, and 4) there is security for the loan.

"Loans to executives should be reviewed to determine if they are bona fide and to determine if the terms are being followed. Is there a written document detailing the terms of the loan, payment over a certain number of years or is payment on demand; is the interest rate at market or at a below market rate of interest; is the loan listed on the company’s balance sheet as a receivable? Are the terms of the loan being followed – payments are to be made monthly and the executive is not making payments, etc. (Source: IRS Executive Compensation - Fringe Benefits Audit Techniques Guide (02-2005))."

The non-tax considerations related to what the IRS calls "private inurement." A tax-exempt organization may risk its status if its resources are misdirected to benefit private individuals. It is not likely that a small loan (e.g. $20,000 for a pastor's down payment on a home) will be viewed as private inurement.

Love Offerings to Pastor Need Restructuring

Question:

A minister gets quite a bit of love offerings each week, usually cash. The minister then turns around and gives the majority of it to the church. What is your opinion of the treatment both from an income and deduction standpoint?

Answer:

As currently structured, the church must submit the minister a Form W-2 with the full amount of his weekly receipts recorded as taxable income in Box 1 of the form. This income is subject to both income tax and self-employment tax. The contributions should be reported by the church to the minister, as it would to all of its donors, consistent with IRS Publication 1771. He may, in turn, deduct these contributions on Schedule A.

It appears that the church finances could benefit from planning that most often takes place during observation of church budget processes. The budget should establish a salary and benefits package, including a housing allowance designation. This will likely reduce the pastor's weekly receipts, but also leave the church with more of the funds currently received as donations from the pastor.

Donation of Vehicle to Church, Used by Minister

Question:

A donor in a church donates a vehicle to the pastor for his personal use. The donors state that it is "his" van and want the van to stay with him in case he leaves. Church minutes record that the van was a gift and that the van would be gifted to the pastor after his employment ceases (as a benevolent gift). What are the tax effects of this transaction?

Answer:

There are several potential unanticipated pitfalls apparent in the above inquiry.

First, in order for the donor to receive a write-off as a charitable gift of the van it must be donated to the church. The van should have been titled in the church's name upon title transfer. The church and donor should be careful to follow instructions provided in IRS Publication 526. Publications 4302 and 4303 may also be helpful.

As an employee of the church, any personal use of the van will be subject to taxation. Publication 463 should be consulted by the church in preparation of the minister's Form W-2 to assure that the proper amount of income is reported.

Second, if at any time the vehicle is transferred by the church to its pastor, the value of the vehicle as of that date will be considered taxable income. The use of the word "benevolent" will not overcome the substance of the transaction that an employee of the church has been compensation with non-cash property.

A search of this blog will reveal additional information regarding "gifts" to church, including ministerial, employees.

"Exclusive Use Test" -- Business Use of Home Deduction by a Minister

Question:

How much can an overseas missionary deduct from income for SE tax purposes for business use of his home? Much of his ministry is one-on-one or else small group Bible studies and takes place in his home living room. Obviously this part of the house is not used exclusively for business purposes. Are you aware of any basis for claiming a larger office in home expense beyond what would be allowed under the "used exclusively" test?

Answer:

Directly quoted from IRS Topic 509:

"Where the exclusive use requirement applies, you cannot deduct business expenses for any part of your home that you use for both personal and business purposes. For example, if you are an attorney and use the den of your home to write legal briefs and also for personal purposes, you may not deduct any business-use-of-your-home expenses. Further, under the principal-place-of-business test, you must determine that your home is the principal place of your trade or business after considering where your most important activities are performed and most of your time is spent, in order to deduct expenses for the business use of your home."

Since the pastor cited above does not use his living room regularly and exclusive for business purposes, no portion is deductible as a business expense. Further, if he is provided an office by the ministry, then it is unlikely that he will satisfy the principal-place-of-business test--an additional stipulation for business-use-of-home deductions.

Switch to Roth IRA from 403(b) Church Retirement Plan

Question:

A church is currently contributing $6,000 per year to an Internal Revenue Code section 403(b) retirement plan for its pastor. He wants the church to stop putting that money into the 403(b) and start putting it into Roth IRAs for himself and his wife. Can the church pay for Roths for himself and his wife even if the wife is not an employee of the church? This benefits the pastor in that he sets aside tax-free income when he retires, but of course, he loses the tax deferment of the 403(b). Are there any other negatives for the pastor in making this move?

Answer:

Since standard Roth IRA plans are not employer plans, the arrangement discussed above will be treated as if the church had given the $6,000 as additional compensation to the pastor and he subsequently invested the funds into Roth IRAs for he and his wife. The church will simply facilitate his personal investment choices. The $6,000 would be reported as taxable compensation in Box 1 of his Form W-2 and no longer excluded from tax (nor listed as an elective deferred in Box 12a).

For ministers who have not opted out of self-employment tax, they lose not only the reduction of taxable income enjoyed by contributors to 403(b) plans, they no longer may exclude the contribution from SE income on Schedule SE. In effect, the change costs these ministers 15.3 percent of their retirement plan contributions.

March 27, 2010

Office in Home Deduction for Pastors

Question:

A pastor receives a Form W-2 from the church reporting his compensation. The church cannot offer him an office at the church so he does most of his studies at home. Can he claim some of the home expenses for his church office? The pastor was told that he could do it if the church gave him a Form 1099 but not if he received a W-2.

Answer:

Employees (ones who receive Form W-2) are eligible to claim office-in-home deductions on Form 2106 if none is provided by their employers. Independent contractors who receive Form 1099-MISC from their customers may deduct an office-in-home using Form 8829.

Some churches erroneously issue Form 1099-MISC to their pastors but this does not prohibit legitimate office in home deductions. The office in home deduction may reduce his income tax by virtue of its inclusion as a miscellaneous itemized deduction (Schedule A); the calculation is determined on Form 2106 and transferred to Schedule A. (The use of a ministerial housing allowance will mandate reduction of this Schedule A amount.) Further, his self-employment income subject to SE tax on Schedule SE should be reduced by the Form 2106 unreimbursed employee business expenses, including his office in home deduction. This Schedule SE adjustment is not subject to the same partial loss of deduction experienced on Schedule A.

March 19, 2010

Reporting "Gifts" to Missionaries on Form 1099-MISC

Question:

A church gives money directly to a missionary in honor of 25 years of service in the field. The church issued a 1099-MISC and reported it in Box 7 (non-employee compensation). The missionary's tax preparer tells him that the church incorrectly reported it in box 7 and that it should have reported it in Box 3 (other income) since it was a gift, trying to avoid him having to pay self-employment tax on the monies.

When, if ever, should monies paid to missionaries be reported in box 3 rather than box 7?

Answer:

The church has filed the form correctly. The instructions to Form 1099-MISC leave little room for negotiation in this matter.

The Minister Audit Technique Guide produced by the IRS states:"There are numerous court cases that ruled the organized authorization of funds to be paid to a retired minister at or near the time of retirement were gifts and not compensation for past services. Rev. Rul. 55-422, 1955-1 C.B. 14, discusses the fact pattern of those cases which would render the payments as gifts and not compensation." Unless the minister qualifies in this sense, the income is reportable in Box 7. If the above situation does apply, then it should not be reported on Form 1099-MISC at all (or on any other form).

According to the Form 1099-MISC instructions, Box 3 might be used to report missionary payments if the following applies:

"Prizes and awards received in recognition of past accomplishments in religious, charitable, scientific, artistic, educational, literary, or civic fields are not reportable if:

The winners are chosen without action on their part,
The winners are not expected to perform future services, and
The payer transfers the prize or award to a charitable organization or governmental unit under a designation made by the recipient. See Rev. Proc. 87-54, 1987-2 C.B. 669."

March 09, 2010

Charitable Travel (Run it through the Church or Pay it Personally?)

Question:

A donor gave a large sum of money in 2009 to a church's designated fund for missions travel. It was announced that only a small portion of the fund (essentially the portion not received from the donor) was available to the general congregation and that the remainder was sequestered for the donor's 2010 missions travel. Does this procedure comply with the Internal Revenue Code?

Answer:

Publication 526 indicates that travel for charitable purposes is deductible in many cases. Below, I've reproduced a significant section from the Publication.

To me, the bigger issue is not whether the travel is deductible but whether the deduction is allowable in 2009 or 2010 and who must defend its appropriateness in light of the tax rules. Had the donor simply paid for his own expenses, then he would have done so, presumably, in 2010. Also, he personally would stand responsible before the IRS to substantiate his answers to the questions implied in Publication 526 (again, see below). By accepting and disbursing the contribution, the church has put itself in the position of needing to ascertain whether the travel qualifies for a deduction (and in which year it qualifies), a potentially sticky position to be put in when the donor and his tax advisors could handle this themselves.

Publication 526: "Travel. 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."

Temporary Versus Indefinite Assignment (travel deduction issues)

Question:

A missionary was sent by his home church in one state to another state two years ago to help start a church and other ministries. His church sends monthly support. Can he claim the rent and utilities for his rental house in the mission location as business (travel) expenses? He maintains a permanent residence back in the state of his home church. Also, if the housing qualifies as travel expense is there a limit to the amount he can claim, such as an amount equal to the ministry support received?

Answer:

Travel away from one's tax home is only deductible if it is on a temporary assignment. IRS Publication 463 discusses temporary versus indefinite assignments.

"If your assignment or job away from your main place of work is temporary, your tax home does not change. You are considered to be away from home for the whole period you are away from your main place of work. You can deduct your travel expenses if they otherwise qualify for deduction. Generally, a temporary assignment in a single location is one that is realistically expected to last (and does in fact last) for 1 year or less.

"However, if your assignment or job is indefinite, the location of the assignment or job becomes your new tax home and you cannot deduct your travel expenses while there. An assignment or job in a single location is considered indefinite if it is realistically expected to last for more than 1 year, whether or not it actually lasts for more than 1 year.

"If your assignment is indefinite, you must include in your income any amounts you receive from your employer for living expenses, even if they are called travel allowances and you account to your employer for them."

It seems apparent that a missionary in the situation posed in the question above certainly does not qualify for business travel deductions on his housing away from his original tax home.