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.

2 comments:

  1. Would the interest need to be reported each year on the W-2 or if we just learned this could we "catch up for past years".

    ReplyDelete
  2. The 2014 W-2 should only include the earnings of 2014; do not include past year's errors on this year's W-2.

    Here are two ways to handle the errors from the past:

    1) File corrected W-2's for the affected years.

    2) Inquire whether the pastor reported the in-kind benefit as taxable income and therefore, no under-reporting has occurred. If he also incorrectly omitted the income, preparation of amended returns are required.

    ReplyDelete