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."