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.