December 28, 2011

403(b) Plan Rollovers to IRAs

Question:

From my 403(b) retirement plan can I rollover an amount to a Traditional IRA, then roll that over to a Roth IRA to avoid paying self employment taxes?

Answer:

First, timely rollovers from an Internal Revenue Code section 403(b) plan to a Traditional IRA are non-taxable both for income and self-employment (SE) tax purposes. In fact, distributions from qualified retirement plans are not subject to SE tax. Income tax can be postponed by rolling over 403(b) distributions to a Traditional IRA. But subsequent distributions from a Traditional IRA rolled over to a Roth are not tax-free.

However, there may be reason to avoid rolling over a lump-sum distribution from a 403(b) plan into a Traditinal IRA. Please reference the following posting and others within this blog related to housing allowance designations.

http://ministrycpa.blogspot.com/2008/02/ministers-retirement-distributions.html

December 02, 2011

Housing Allowance for Extra Mortgage Principal Payments

Question:

Can a pastor pay extra on his mortgage principal and use it to count toward his housing allowance?

Answer:

Yes, but.

A minister who receives a housing allowance may exclude the allowance from gross income to the extent it is used to pay expenses in providing a home. The IRS lists only food and servants as prohibitions to allowance housing expenses. If a minister owns a home, the amount excluded from the minister’s gross income as a housing allowance is limited to the least of the following: (a) the amount actually used to provide a home, (b) the amount officially designated as a housing allowance, or c) the fair rental value of the home (IRS Publication 1828; Clergy Housing Allowance Clarification Act of 2002; IRS Regulation Section 1.107-1).

Because of the third limitation listed here, many ministers gain little or no benefit by accelerating their mortgage payments. For example, an additional $5,000 principal payment adds to the amount actually used to provide a home. But it does not increase a minister's fair rental value of his home.

November 21, 2011

"Volunteer" Pastor Receives a Gift from His Congregation

Question:

A church led by a "volunteer" pastor wishes to give him a monetary gift for Christmas. Will the church need to issue a Form 1099-MISC? Is the answer different depending on the amount?

Answer:

The payment will be considered as compensation for services rendered--the church is acting corporately in compensating a minister who serves it. However, there are some options.

First, the amount can be designated (prior to payment) as housing allowance. This removes the federal income tax consequence to the extent of his actual housing expenses (and the fair rental value of his home).

Second, while the compensation is subject to the 15.3 percent self-employment (SE) tax, to the extent the minister has unreimbursed ministry expenses, he can reduce his SE income. If his net self-employment income is less than $400, he will owe no SE tax.

With so little income, it is unlikely that the IRS would classify him as a Form W-2 employee. Therefore, if the non-housing allowance portion of the payment is $600 or more, Form 1099-MISC should be issued. The minister is responsible to report the income correctly regardless of the church's obligation to issue a statement of earnings.

November 06, 2011

Church Donor Designations to Foreign Ministries

Question:

Some members and non-members of a church direct funds to a ministry overseas, partly because they want to get a tax deduction by giving it through the church versus giving to the overseas ministry directly. The church has elected to include the foreign ministry in its missions budget, albeit with a much smaller amount than what is being designated by other people. Does this pose any problems that the church should be aware of?

Answer:

With the church as the organization overseeing the support of the overseas work (it obviously endorses it by virtue of its own giving), it's almost certainly better to contribute in this manner than by individual donors trying to make wire transfers (I suppose) to a foreign ministry.

In my experience, the typical concern the church must have is that it does not become a conduit for the otherwise non-charitable obligations of individuals who are not really donors.

Let me illustrate. Imagine that a parent is obligated to pay on the college loans of a child who because of his or her mission activity has little income to pay the loans. By "donating" to the church the parent gets a tax deduction. Yes, the income is taxable to the child, but if he or she is a low-income (or, more likely, a high deduction) taxpayer then the "gift" may produce little or no tax to the child. The church has unwittingly become a conduit for the parent's otherwise personal obligation. That's why I believe it is important that churches carefully monitor excessive contributions to funds that benefit their family members.

November 05, 2011

Example of Independent Contractor vs. Employee Decision

Question:

A church's janitor is paid a fixed sum each month. He works without direction (although direction could be given) and on his own schedule (within limits, of course). The church provides supplies. Is he an employee or contractor?

The same individual also does the church's lawn care for which he is paid each time that he performs the service. He provides his own equipment. The schedule for the service is "when it needs it" and as such is not necessarily regular, especially in the winter. Is he an employee or a contractor?

Answer:

Each church's situation is unique. That's why the general guidelines and links that I provided in my September 21, 2011, blog posting can be helpful.

Church Employee or Independent Contractor

Minister as a Volunteer--No Housing Allowance Benefit

Question:

A pastor works a full time job and thus does not take a salary from the church. Since he owns his own home, can he take a tax deduction for housing allowance and travel expenses from his ministry even though his income is actually from another job?

Answer:

Unfortunately, a housing allowance is only based on a designation of compensation paid by the church. No housing allowance is permitted in his case. Essentially, the minister is a volunteer. This does mean that his mileage on behalf of the church is deductible as an itemized deduction (at the charitable rate) and his out-of-pocket costs as a volunteer may be written off (Schedule A).

October 24, 2011

Tax-deductible Support of Missionary by Personal Friends

Question:

A church has a member preparing to go to the mission field. Before she leaves she is required to be debt-free, including college loans of $35,000. If friends give money to the church with the understanding that the funds may be used for the purpose of repayment, are the gifts deductible since they are given to the church?

Answer:

It is a very common experience that missionaries supported by a church have friends in the congregation. These contributions are tax-deductible as long as the church has established a fund and communicated its interest to support the missionary's endeavors. Typically, a church will forward these funds to the missionary's mission agency since it provides oversight in his or her financial matters. Churches that issue this compensation directly to the missionary must comply with the reporting requirements of the Internal Revenue Code--using Form W-9 to obtain the missionary's name, address, and identifying number and using Form 1099-MISC to report the taxable earnings. Yes, regardless of the use of the funds they are considered taxable support to the missionary.

The church's endorsement is very important. The church cannot simply become the conduit for otherwise personal gifts. The missionary must be one whom the church congregation believes is worthy of the support of its members financially and is pursuing a Christian work that it can endorse.

Friends and family who give money directly to the missionary apart from the church's endorsement of the missionary's ministry will not receive a tax deduction, nor are these gifts taxable to the missionary friend receiving them.

October 10, 2011

"Benevolent" Gifts to Volunteers

Question:

At times, a church gives out monetary "thank you" gifts to volunteers regularly involved with ministry. It has considered this to be a "benevolence." Since there is a "service" done, though with no monetary reward in mind, is this still benevolence, or should this be considered a Form 1099-MISC item? Also, if this is done on a regular basis, would this now be considered more of an employer/employee item?

Answer:

These gifts should be considered taxable income. If the "volunteers" are independent contractors, then Form 1099-MISC should be issued to each individual paid $600 or more. Employees should be issued Form W-2 with applicable withholdings.

IRS Publication 3079--Tax Exempt Organizations and Gaming--addresses some of these issues with an example. While I personally am opposed to gaming activities, the IRS position on volunteers can be seen by reviewing portions of the publication.

"Example: ABC Organization operates a private school and sponsors [fundraisers] to raise revenue for the school. Parents who work at the [fundraising] session are given a tuition reduction of $50 for each week they work. This reduction of tuition is compensation to the parents; they are not working as “volunteers.”

"Compensation may also include non-monetary benefits such as free drinks or food if such items are more than a mere gratuity and are intended to be compensation for the workers’ services. On the other hand, a worker who receives merely insignificant monetary or non-monetary benefits is considered a volunteer, not a compensated worker. Determining whether a benefit is insignificant requires consideration not only of the value of the benefit but also:
• The quantity and quality of the work performed;
• The cost to the organization of providing the benefit; and
• The connection between the benefit received and the performance of services."

September 22, 2011

Expenses for Wife Attending Conference with Minister

Question:

Is it allowable for a minister to use funds from his professional expense reimbursement plan to pay for the registration of his wife at a Christian conference?

Can the minister and his wife be classified as a “ministry team” and therefore allow such an expense?

Answer:

IRS Publication 463 indicates that an employer cannot deduct payments (or reimbursements, including those through an accountable plan) for a spouse accompanying an employee "on a business trip or to a business convention," unless that spouse is also 1) its employee, 2) has a bona fide business purpose for the travel, and 3) would otherwise be allowed to deduct the travel expenses."

These rules also apply to tax-exempt employers (e.g. churches) even though they are unconcerned about losing deductions since they pay no income tax in the first place (Federal Tax Regulation 1.132-5 (t)(2).

However, this does not necessary give the whole picture. Internal Revenue Bulletin No. 1996-26, Regulation 1.132-5(t)(1), and the IRS's own "Executive Compensation - Fringe Benefits Audit Techniques Guide (02-2005)" (available on the IRS website) provide that "the amount will be excludable [as taxable income to the employee/minister] as a working condition fringe if it can be shown that [the] spouse’s presence has a bona fide business purpose and if the employee satisfies the substantiation requirements under § 274(d) (i.e., business purpose, date and amount of expense documented on a timely basis).

The bona fide business purpose must be clearly established. Publication 463 states: "A bona fide business purpose exists if you can prove a real business purpose for the individual's presence. Incidental services, such as typing notes or assisting in entertaining customers, are not enough to make the expenses deductible." Of course, this determination is subjective. But there certainly are numerous cases where the wife's presence serves a real business purpose.

Accountant's New Church Checklist

There are a lot of church planting websites with ideas and services offered to church planters. But what list might an accountant provide for a new church to consider?

Initial Budget

Prepare a budget forecasting both outside support and initial giving by the families expected to charter the new church. Determine the pastoral compensation level that the new congregation can realistically provide. Project costs for meeting facilities (secure a lease). Use church planting resources to develop proper strategies for initial communication and outreach; project the costs to implement the strategies and adjust based on the realities of financial resources.

Organization

Establish a constitution and by-laws. Incorporate with counsel of an attorney familiar with laws for tax-exempt organizations in the state.

Pastor Compensation

Work with the pastor to establish a wise compensation and benefits package. Consider establishing a professional expense reimbursement plan, either using an “advances” or a “reimbursement” arrangement. Determine health insurance and medical care benefits, including the possible use of a major medical policy combined with a Health Reimbursement Arrangement (HRA). Consider retirement funding, typically either contributing to his Internal Revenue Code 403(b) plan or providing funds for the pastor to fund his own Roth or traditional IRA. Designate a portion of cash compensation as a housing allowance. Determine remaining cash compensation. Determine whether the pastor desires to elect optional income tax withholding, especially if he has a large amount of Self-Employment tax to pay (tax law does not permit churches to withhold and match the 7.65% FICA tax that most U.S. employees are subject to). Assign responsibility for government reporting including quarterly (Form 941), if necessary, and annual employment filings (Forms W-2, 944, 1099-MISC and state, if necessary).

Financial Procedures
Adopt a process for establishing the church budget (projecting revenues, compensation planning and communication, categorizing expenses by activity or functional, establishing a contingency fund). Establish policies and procedures for 1) offering counts, 2) disbursements / purchasing, 3) bookkeeping (fund accounting for general and designed gifts), 4) missions and other special funding methods, 5) financial reporting (determine frequency, recipients, and contents — balance sheet (modified cash basis of accounting), statement of receipts and disbursements (modified cash basis of accounting), and other schedules (e.g. mortgage schedule, designated funds activity), 6) internal auditing, 7) maintenance of donor records (Answer: who will record donations? what software, if any, will be used? what reports will be provided to donors?), 8) benevolence, and 9) records retention (church minutes, financial documents). Determine qualifications for church volunteers who oversee bookkeeping records. Purchase and implement accounting software; establish chart of accounts consistent with church budget determinations.

Insurance

Determine need and pursue quotes for liability, auto (if necessary), workers' compensation (employee and subcontractors), and professional liability (counseling).

Miscellaneous
Pursue sales tax exemption certificate from the state government. Discuss philosophy of church leadership regarding use of debt for church capital expenditures.

September 21, 2011

Sabbatical Expense Reimbursements--Authoritative Sources

Question:

Your blog posts on February 18, 2010, and January 12, 2011, (accessible by typing "sabbatical" in your search window) offer the only specific statements along these lines that I can find, anywhere. I would like to have as much authority behind me as possible. Can you please refer me to something from IRS or others that provide the authority for your statements?

Answer:

Both blog postings reference IRS Publication 463. Chapter 1 of the 2010 edition offers on only 6-7 pages of content a good initial read. Chapter 6 includes roughly 4 pages on reimbursements under Accountable and Nonaccountable Plan rules.

The Publication defines travel expenses that qualify and offers extensive examples. Further, its section on accountable plan rules offers direction to churches wishing to set up arrangements that establish reasonable reimbursement plans.

Here's a link to the Publication in .pdf format:

IRS Publication 463

Minister with Other "Business" Income

Question:

A minister creates a DVD depicting his experiences as a missionary. He sells the tapes and uses all of the proceeds to make additional copies of the DVD and to have it translated into several languages. He uses none of the DVD proceeds for personal expenses.

Does he need to report the DVD proceeds and how does he treat the DVD costs?

Answer:

The minister will need to file Schedule C along with his personal tax return. The sales represent revenues and the DVD costs represent deductible expenses. Typically, a minister will retain an outside firm to duplicate the DVDs, buying in bulk in order to save money. These purchases of DVDs are subject to inventory rules that the minister's tax preparer will need to apply.

Church Employee or Independent Contractor

Question:

My question concerns a church's categorizing of church employees as independent contractors to avoid paying taxes and workers compensation insurance. Can you shed some light on this?

Answer:

The IRS makes available Form SS-8 to aid in the determination of employee versus independent contractor status. I've provided a link here: IRS Form SS-8

Further, the IRS provides the following guidance:

"In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered.

"Facts that provide evidence of the degree of control and independence fall into three categories:

"Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?

"Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)

"Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

"Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.

"The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination."

I provide one more bit of advice. When it is appropriate to classify an individual providing services to the church as an independent contractor, the church should require proof of business insurance (a "binder") from the contractor. Churches should consult their business insurance agent when contractors do not have insurance in order to determine whether the church's workers' compensation insurance extends to them.

September 09, 2011

Retired Minister Housing Allowance SE Tax Free?

Question:

The IRS Minister Audit Technique Guide says, "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" (http://www.irs.gov/businesses/small/article/0,,id=210018,00.html). How does the IRS define "retired" in this sense?

Answer:
IRS Publication 517 also refers to the self-employment tax-free status of post-retirement allowances designated as housing, but does a slightly better job explaining the conditions. Both sources relate to IRS Revenue Ruling 58-359 (yes, from the year 1958!).


If retirement were defined as the-time-I-start-collecting-social-security-retirement-benefits, then many pastors would be elated to stop paying the 15.3 percent SE tax since they often continue ministering to congregations on at least a part-time basis well after reaching typical retirement age.

Unfortunately, this is not the case. A church that allows its pastor to continue living in its parsonage as consideration of his past services, or establishes a plan to provide an ongoing "retirement allowance" in cash designated as housing allowance may do so without the minister being required to pay SE tax. The key is the "past services" stipulation. Retirement is therefore defined as the condition when the pastor is no longer providing services to the congregation. Just because the minister has scaled back to part-time and begun receiving monthly social security checks does not eliminate the SE tax.

On the other hand, ministers whose churches do provide a parsonage or cash "retirement allowance" designated as housing will enjoy the SE-tax free status. Of course, many churches are not in the financial position to do so.

A minister who is able to defer a substantial portion of his compensation into a Internal Revenue Code 403(b) plan can benefit from the SE tax-saving strategy enabled by Revenue Ruling 78-6 (search for other entries in this blog).

If he is older than age 59 1/2, he can take simultaneous retirement distributions from the 403(b) plan without IRS penalty to replace his cash in-flow lost to the large elective deferrals into the plan. These distributions are subject to income tax, but not to SE tax.

He should select his retirement investments wisely, however, since many mutual funds charge fees on these contributions and distributions. Some have found some money market mutual funds effective for these purposes.

August 18, 2011

Pastor Compensation NOT for Services Performed

Question:

A pastor terminated his position with a church and moved to serve a new church started in another state. The pastor's former church/employer is going to send support to this pastor through the end of the year, even though he is no longer employed by them and will not be providing any services to them. Can the income be reported in Box 3 of Form 1099-MISC as Other Income thus avoiding self-employment taxes? Alternatively, should the church continue to report the support as pastoral W-2 wages and designate it as housing allowance?

Answer:
Box 3 of Form 1099-MISC is reserved for Other Income--"prizes and awards that are not for services performed." Regardless whether a minister's compensation is considered wages as an employee or non-employee compensation as a self-employed individual, for purposes of self-employment tax he is considered as self-employed. Accordingly, he must file Schedule SE and pay SE tax (unless he has been recognized by the IRS as exempt by virtue of filing Form 4361).

As a minister engaged in providing religious services, his earnings are considered earned income regardless of their source. For example, a foreign missionary performing services overseas yet supported by a U.S. congregation is subject to SE tax even though the payer (the U.S. church) received no direct services.

However, whether classified as an employee of a local church or as a non-employee independent contractor the compensating church or organization may designate (at the minister's request) all or a portion of his compensation as housing allowance. Of course, the minister must comply with the provisions of the the Clergy Housing Allowance Clarification Act of 2002 which is explained fully in other entries within this blog.

July 27, 2011

IRS Statute of Limitations for Prior Year Return Errors

Question:

How many years can IRS chase after a minister who didn't report SE tax for the housing allowance?

Answer:

I'll let the IRS' own FAQ answer this one:

"Generally, the IRS can include returns filed within the last three years in an audit. Additional years can be added if a substantial error is identified. Generally, if a substantial error is identified, the IRS will not go back more than the last six years.
...
"More information related to extending a statute of limitations can be obtained in Publication 1035, Extending the Tax Assessment Period."

From Publication 1035:

"The statute of limitations for IRS to assess and collect any outstanding balances does not start until a return has been filed.In other words, there is no statute of limitations for assessing and collecting the tax if no return has been filed."

Love Gifts to Volunteer Pastor

Question:

A pastor is "volunteering" at a church. It's not ready to permanently hire him but wishes to "help him with his financial situation for $600 per month." Can the church classify the payments as "love gifts"? Will the church be subject to gift tax?

Answer:

Whether the pastor is an employee (receives Form W-2 from the church) or an independent contractor (receives Form 1099-MISC) is a matter of the facts and circumstances of his ministry at the church. The following link can be followed for a review of these factors as spelled out in a 2009 posting:

Church Worker: Employee or Independent Contractor

Love gifts are taxable income reportable on either Form W-2 or Form 1099-MISC depending on the minister's status. Gift tax is irrelevant since it relates to pre-inheritance distributions from an individual's taxable estate.

Whether he is treated as an employee or not may carry little difference in this temporary situation with a low amount of compensation. In either case, a licensed or ordained minister is responsible for his own self-employment (SE) and income tax. He is exempt from any tax withholdings. The church may consider designating all or a portion of his pay as housing allowance--generally this saves him income tax, but not SE tax. Other options may also be available and are discussed at length in entries to this blog.

July 1, 2011, Change in Standard Mileage Rate

According to IRS News Release IR-2011-69:

"The standard mileage rate for business miles increased to 55.5 cents a mile July 1. This is an increase of 4.5 cents from the 51 cent rate in effect for the first six months of 2011."

July 22, 2011

Educational Assistance by Churches for Their Missionaries

Question:

A church wishes to provide assistance/support for educational expenses of a member who is an international missionary. The missionary serves under a governing body ("mission agency") which raises support for its missionaries and provides all the proper tax documentation to the missionary.

The missionary already has his undergraduate degree, however, now is working on his master's. The church, through the advice of the governing body, has begun the initial stages of working on setting up a general educational assistance fund, along with proper documentation, oversight, and requirements for use of the fund.

Can this type of activity be structured in a way to where there would be no taxable income to the individual? Can the funds be used for educational expenses (tuition, books and fees) as well as travel expenses to the classes (lodging and air fare) as well as meals? Would a Form 1099-MISC need to be issued or can be this be looked at as some type of "accountable plan" in which the church is paying for the expenses and keeping track of such items as in accordance with the function and requirements of the fund? Church members would contribute to the designated fund and not specifically to the individual.

Answer:

IRS Publication 970, Chapters 11 and 12 (2010 version) offers a good overview of Employer-Provided Educational Assistance. Since the mission agency is considered the employer in most cases of missions support, it is important to work through it as donors seek to support advanced education.

Through 2012, employees whose employers help pay for their education costs through a qualified, nondiscriminatory educational assistance program may be able to exclude up to $5,250 per year. Otherwise, these payments are taxable, unless the reimbursement amounts can be treated as a qualified fringe benefit for work-related educational expenses. Since the mission agency is the employer and likely administers many missionaries' support, this is not likely the best alternative to the situation address above.

Publication 970 discusses qualifying work-related education: "Once you have met the minimum educational requirements for your job, your employer or the law may require you to get more education. This additional education is qualifying work-related education if all three of the following requirements are met.
1. It is required for you to keep your present salary, status, or job,
2. The requirement serves a business purpose of your employer, and
3. The education is not part of a program that will qualify you for a new trade or business."

The information included in the question seems to indicate all three may be met: the oversight body is advising the missionary's supporting churches to understand the need (a recommendation that would not be communicated to financial donors if it was not necessary to maintain his status), an undergraduate degree is the typical missionary minimum requirement but advanced education will enhance the ability of the missionary to accomplish mission agency objectives, and the program is not intended to prepare him for a new trade--only to help him better serve as a missionary. If the education is not required by the mission agency, but "it maintains or improves skills needed in your present work" (Pub. 970) it can also qualify for non-taxable treatment.

Of course, donors must support these additional costs incurred by the mission agency. Contributions designated for this purpose should be advanced to the mission agency. The mission agency should require documentation from the missionary much as it likely already does for other nontaxable ministry reimbursements of expenses.

Pub. 970 states that the "following education expenses can be deducted.
1. Tuition, books, supplies, lab fees, and similar items.
2. Certain transportation and travel costs (see the Publication for details).
3. Other education expenses, such as costs of research and typing when writing a paper as part of an educational program."

Mission Agency Basics--Getting Off on the Right Foot

Question 1:

A new nonprofit missions agency is being established and preparing to send its first missionary. Identical to established agencies, the missionaries will receive support from churches and individual donors who rely on the fiduciary and ministry accountability role of the agency. What is the responsibility of the nonprofit in withholding taxes for its missionaries?

Answer 1:

It's a delight to hear of the establishment of new mission agencies ready to contribute to the spread of the gospel. While there are many issues to tackle, let's review a couple that readers of this blog might expect to hear from a CPA.

1. Other than itinerant ministers, virtually all licensed or ordained ministers are classified as dual status. This means that they're employees in every respect, except for purposes of social security and Medicare tax obligations. For purposes of these two taxes, they are considered self-employed and responsible for their own tax determined on IRS Form 1040, Schedule SE. Because they are employees, the mission agency may establish employee benefits that independent contractors (self-employed) miss out on. Withholding is optional for these ministerial employees. The agency does not and cannot withhold and match the 7.65% FICA tax of most employees. However, at the election of its missionaries many agencies withhold federal and state income taxes to facilitate the timely payment of their taxes. Previous blog entries discuss a lot more about these issues so I encourage readers to use the Search window above to explore specifics.

2. As the mission agency establishes its corporate status and Board of Directors, it should carefully study the requirements to gain recognition from the IRS as a tax-exempt organization. Most founders will need professional help with this process including the 28-page IRS Form 1023--Application for Recognition of Exemption.

Question 2:

Are grants considered taxable or nontaxable income for nonprofits?

Answer 2:

Grants are nontaxable to the recipient mission agency that has received a Determination Letter from the IRS as the result of its Form 1023 application. Further, granting agencies will likely expect confirmation that the mission agency has been granted tax-exempt status.

July 21, 2011

Unrelated Business Income Tax on Gift of Corporate Stock

Question 1:

Corporate stock was donated to a church. How are the gains on these stocks for a not-for-profit organization reported to the IRS?

Answer 1:

Section 511 of the Internal Revenue Code (IRC) imposes tax on tax-exempt organizations, including churches, that earn unrelated business income. Section 512 defines income and exclusions related to the unrelated business income tax (UBIT).

IRC Section 512(a)(1) General rule. "Except as otherwise provided in this subsection, the term 'unrelated business taxable income' means the gross income derived by any organization from any unrelated trade or business (as defined in section 513) regularly carried on by it, less the deductions allowed by this chapter which are directly connected with the carrying on of such trade or business."

According to IRC Section 512(b)(5) "stock [Commentary: this does not refer to corporate stock] in trade or other property of a kind which would properly be includible in inventory if on hand at the close of the taxable year, or property held primarily for sale to customers in the ordinary course of the trade or business" is subject to UBIT.

The section continues: "There shall also be excluded (my emphasis) all gains or losses recognized, in connection with the organization's investment activities, from the lapse or termination of options to buy or sell securities (as defined in section 1236(c)) or real property and all gains or losses from the forfeiture of good-faith deposits (that are consistent with established business practice) for the purchase, sale, or lease of real property in connection with the organization's investment activities."

Furthermore, IRC Section 512(b)(1) states: "There shall be excluded all dividends (my emphasis), interest, payments with respect to securities loans (as defined in subsection (a)(5)), amounts received or accrued as consideration for entering into agreements to make loans, and annuities, and all deductions directly connected with such income."

Question 2:

How will the broker record the tax-free status of the church organization?

Answer 2:

Typically, the broker will be required to record the church's federal identification number. This will facilitate issuance of Forms 1099-B and 1099-Div reporting the gross proceeds of corporate stock sales and dividends. Since the church is not required to file a return these forms will be for information purposes only and should not prompt an IRS inquiry.

July 16, 2011

Bookkeeping Entries for Roofing Bid Received

Question:

Help! My bookkeeping knowledge is limited to a semester of accounting at a local community college in the mid 1970's.

We contracted with a local roofer to make repairs to the church's roof. We have his estimate of how much it will cost and he's started working on it. My question is how do I enter the estimate into our financial software, Church Windows.

I imagine I need to create some sort of liability to show that we're involved in the work. But how do I enter the expense - do I create an expense acct labeled 'roof repairs in progress'? And then when we get the final bill, do I move the liability to an actual accounts payable acct with 'roof repairs' expense?

Answer:

No entry is required at the time of receiving the estimate or prior to receiving the roofer's invoice. Once the invoice is received you may enter it as an Account Payable. Your accounting program, Church Windows Software (http://churchwindows.com/), will record it as a liability and ask you for the expense account of your choice. Typically that account will be a building maintenance account of some sort.

When you use your software to pay the invoice, the check writing feature of the program will automatically create a journal entry to decrease accounts payable and decrease your checking account balance.

May 14, 2011

Church Planting--Mother/Daughter Contributions

Question:

Our church is a non-profit incorporation and we have founded an affiliated church. What is the status for donations made to the affiliation church?

Answer:

I'm guessing that the question relates to a church planting activity by one local church that has identified a geographic area needing a local church. The established congregation (the "mother" church) aids a group of people wishing to start a new church (the "daughter" church) similar to it.

Typically, the mother church provides financial oversight including paying initial ministerial salaries or renting facilities. Donations are collected by the daughter church, but managed by the mother church. Offerings are deposited into a mother church bank account, but accounted for as gifts designated to the new ministry. Contribution records and reports are managed by the mother church. Donors to the daughter church receive year-end giving statements from the mother church. Accordingly, the tax-deductible status of donations given to the mother church designated for the daughter church is secure.

Once the church plant is formally chartered as a new church (it establishes a constitution, recognizes members, applies for a federal employer identification number, opens bank accounts, adopts a budget, etc.), then the financial oversight and help is removed and the autonomous body becomes responsible for documenting and reporting its donations.

May 09, 2011

Small Business Health Care Tax Credit

Question:

We’ve heard that churches and tax-exempt organizations may qualify for the Small Business Health Care Tax Credit. Is this true?

Answer:

Yes, many churches and tax-exempt organizations qualify for the Health Care Tax Credit. If you can agree to all statements listed below, then your church (or other organization) is likely to qualify for the 2010 credit.

1. You paid at least 50% of your employee’s health insurance premiums.
2. You have fewer than 25 full-time equivalent employees during 2010 (you may have more than 25 employees if you have some part time employees).
3. You paid less than $50,000 in average annual wages—but don’t include your minister’s wages in the calculation.
4. You paid the following payroll taxes in 2010: Federal income taxes or Medicare taxes.

Eligible, tax-exempt small employers may claim the refundable credit by filing Form 990-T and Form 8941. For more information, see the Instructions for Form 8941: 

Form 8941 Instructions

March 25, 2011

Deductions Against Missionary SE Income

Question:

A missionary in Australia for several years receives donations from a U.S. church. He was not aware that these donations were being reported on a Form-1099, and also thought that he did not have to file a tax return since he wasn't "earning" income. He is now subject to several years of SE taxes based on the 1099s. What are some allowable deductions/expenses against this income? He paid his own housing, traveled to other countries such as Thailand and Indonesia doing mission work, returned to the U.S. to report to his home church and solicit donations, etc.

Answer:

He can deduct what are classified as business expenses against this income. He should use Schedule C of Form 1040 to report his income and deductions. Typical expenses for a missionary include 1) car expenses at the standard mileage rate both in Australia and in the U.S. during furlough trips to churches, 2) air travel to and from the U.S. and to other countries, 3) ministry supplies (e.g. books, literature, office supplies), 4) postage, 5) meals and lodging while away from his tax home overnight on business, and 6) other line items listed on Schedule C.

Housing expenses for his family in Australia are not classified as business expenses.

Based on the question, it appears that the missionary may not have had the benefit of a mission agency to advise him regarding these matters. I believe that this is one of the many benefits for both missionaries and churches to use these agencies.

March 21, 2011

Church Withholding of FICA Taxes

Question:

Businesses withhold and match 7.65% of employees' pay for their social security and Medicare taxes. Can a church pay an employee’s 7.65% or not?

Answer:

We must segregate ministerial and non-ministerial employees in this consideration. Churches must withhold and match FICA for non-ministerial employees unless they have filed Form 8274-Certification by Churches ... Electing Exemption From Employer Social Security and Medicare Taxes. Then the church employee is responsible to pay the full 15.3% himself or herself on Schedule SE, Section B, line 5a.

Churches may not withhold and match FICA for ministerial employees. I encourage churches to help their pastors with these costs but they cannot treat them as non-ministerial. It can actually hurt the pastor’s tax situation. Let me illustrate.

1. If a church wishes to “help” – a) calculate a 7.65% bonus to add to his pay by multiplying his cash compensation + housing allowance X 7.65%, b) then withhold an identical amount as federal income tax withholding. When he files his return and calculates his 15.3% self-employment tax (entered on Form 1040, line 56 from Schedule SE), he will have an extra large amount entered on line 61 as federal income tax withholding to offset his total SE + income tax. Of course, the “bonus” is also taxable income.

2. How can a church’s erroneous classification of its pastor as a non-ministerial employee “hurt”? – when a pastor calculates his 15.3% SE tax on Schedule SE, he can reduce the self-employment income amount by employee business expenses and 403(b) retirement contributions. This reduces his SE tax rather than having it withheld as FICA tax before these items are subtracted.

3. Further, by classifying a minister as a non-minister he becomes ineligible for a housing allowance and SE tax-reducing 403(b) contributions.

Numerous entries in this blog document these statements and examples.

Church Payment on Minister's Student Loan

Question:

A church collected a love offering for its youth minister and paid the full amount received directly on his student loans. The money never went directly to the minister but to the bank/lender. Is the love offering amount that was paid to the bank considered income and, therefore, taxable for the minister? If so, is that amount to be reported on Form W-2?

Answer:

This type of compensation does not enjoy a statutory classification as a non-taxable fringe benefit. It is taxable to the youth minister and reportable on Form W-2.

Hopefully, this action occurred early in 2011 so that the minister may consider tax planning alternatives to reduce his tax. He may also need to make estimated tax payments.

Reducing SE Tax -- Ministry Expenses

Question:

I have placed a number of miles on my vehicle and have purchased many items for my ministry (theology books, theology journals, etc.) that I was not reimbursed by the church for this year. Can I count these as a business expense in some way and lower my SE tax?

Answer:

Yes, in this case, a minister should prepare Form 2106 to determine the amount of deduction. Then the calculation for self-employment income on Schedule SE will be as follows:
ADD: Cash compensation from church
ADD: Housing allowance (or fair rental value of parsonage)
SUBTRACT: Form 2106 expenses

When carrying ministry expenses to Schedule A, ministers must be careful to reduce allowable Form 2106 expenses by a percentage determined by dividing their non-taxable compensation by their total compensation.

March 07, 2011

Year-end Tax Forms to Summer Interns

Question:

Should the church send a Form 1099-MISC to interns who worked for the summer?

Answer:

If the interns received more than $600, then Forms 1099-MISC must be issued. Apparently, the interns were treated as independent contractors. They will be subject to self-employment tax for social security and Medicare.

Most churches determine that interns are short-term employees subject to standard FICA tax withholding and matching by the church. In these cases, Forms W-2 are issued and the interns owe no additional social security or Medicare tax.

State Unemployment Tax Act Applied to Churches?

Question:

Does a church have to pay unemployment taxes for its Pastor, Youth Leader (not ordained), church secretary or custodian, all who are our church members? If we do not have to pay this tax, do I still need to register with the Dept of Workforce Development Division of Unemployment Insurance, or just ignore them?

Answer:

In Wisconsin, and perhaps all states (I cannot confirm this), churches are exempt from SUTA tax. Obviously, correspondence received from a state agency merits a response.

February 27, 2011

Taxable Support of Foreign Missionary or Benevolence?

Question:

A missionary is partially self-supporting and partially supported by donors. A church is considering giving him funds to help subsidize his daughter’s overseas schooling. Will this amount be reportable on Form 1099-MISC as taxable income or could it be considered a benevolence gift for which a Form 1099 would not be required? Would there be a difference if the church made checks out to him vs. making them out to his minor daughter who is receiving the schooling?

Answer:

The missionary is receiving the support targeted for his daughter's education due to his ministerial status. If the child been a needy individual within the church's congregation for which no services were rendered, then there would be no tax consequences. However, it appears that the support is in consideration of the missionary's overseas work. If the payments are directly to the missionary and not through his mission agency, then Form 1099-MISC should be issued. Making the payments directly to his daughter's school will not negate this requirement.

100% Housing Allowance with Expenses

Question:

An ordained pastor receives part-time compensation from his church, designated 100% as housing. In order to pay SE tax on the housing allowance amount, where does he record this on his tax return?

He has a few expenses that he could deduct, but is hesitant to do so while showing no income. Should he deduct these expenses?

Answer:

Since 100% of his compensation was designated as housing, none of his expenses are deductible as business expenses on either Form 2106 or Schedule C. However, when calculating his SE tax, the deductions can be applied before entering his SE income on Form 1040, Schedule SE.

Continuing Payment of Wages to Surviving Spouse

Question:

A pastor recently died. His church desires to gift the amount of his salary to his spouse for a yet-to-be-determined amount of time. Is there any IRS limitations to the amount we can give? No services are provided by her.

Answer:

There are no limitations on the amounts, but they will be taxable as ordinary income. I tried to do some quick research to see if I could find an exception, but they only related to public safety officers and military personnel.

February 21, 2011

Form W-2 Example

Question:

The church pays me as a part-time pastor $1,000 a month. $500 of that was designated as "housing" in a business meeting. How should they report that?

Answer:

Assuming a full-year's compensation, $6,000 is reported in Box 1 of Form W-2 as taxable compensation. I recommend that the $6,000 paid as non-taxable housing allowance be reported in Box 14. This reports to you the amount that you must document for housing allowance purposes (see other blog entries for a review of these rules).

February 14, 2011

Housing Allowance Erroneously Reported on Form 1099-MISC

Question:

A minister received a Form 1099-MISC from a church. Most of the amount on the Form was designated as housing allowance (recorded in an official document by the church board when he began working for the church). He doesn't see a way to report this amount on his tax return, excluding it from federal income tax while paying the Social Security and Medicare (self-employment) taxes on it.

How should this be reported? Where does it go on the IRS tax forms?

Answer:

The church has filed an erroneous Form 1099-MISC. Housing allowance is not reportable as taxable income because it is exempt from income tax. The preparer should be apprised of this error and asked to file a corrected Form 1099-MISC. Near the end of the January 29, 2011, blog posting that I've linked below, I address the issue of housing allowance and Form 1099-MISC reporting-perhaps it will be helpful.

Definition of a Minister

Depreciation Entries for Churches

Question:

We have a church building valued at $351,000 which includes land of $120,000. How long should we depreciate the church, and will a parsonage be depreciated for the same period?

Answer:

This question brings up two important points.

1. Assuming that the church is best served by using an accrual basis of accounting in accordance with Generally Accepted Accounting Principles (GAAP), then the church property's value is not the basis for depreciation. Original cost is used. The estimated useful life that many organizations use for real property is 50 years. The same holds true for the parsonage.

2. In my opinion, many small churches are better served using the modified cash basis. Lay people and pastors alike have a better chance of understanding the reports. If external parties demand it, then GAAP may be necessary. Check out the New Downloads on my website, www.MinistryCPA.org. Select the presentation: Church and Christian Ministry Financial Management option. It's a MS--PowerPoint presentation that I've delivered in a few settings that explains my points in greater detail. As I propose the use of the modified cash basis by churches, no depreciation entries are required.

February 09, 2011

Charity Refuses to Provide Year-End Giving Statement

Question:

A person contributes to a charitable organization including individual contributions greater than $250. In spite of repeated efforts, the taxpayer cannot gain the cooperation of the charity to provide the statement. What can the donor do?

Answer:

According to IRS Publication 1771, the answer may be "nothing." Of course, the donor can stop making contributions.

The IRS:

"There are recordkeeping and substantiation rules imposed on donors of charitable contributions: 1) a donor must have a bank record or written communication from a charity for any monetary contribution before the donor can claim a charitable contribution on his/her federal income tax return; 2) a donor is responsible for obtaining a written acknowledgment from a charity for any single contribution of $250 or more before the donor can claim a charitable contribution on his/her federal income tax return (my emphases).

"An organization that does not acknowledge a contribution incurs no penalty; but, without a written acknowledgment, the donor cannot claim the tax deduction."

Housing on Church Property for Custodian

Question:

A house sits on a church's property. The church custodian was asked to move into the house. The custodian is now receiving his regular part-time wages in addition to “free” housing in exchange for additional on-call hours worked for security and such.

Is this considered additional income for the custodian?

Answer:

IRS Publication 15-B addresses this question:

"Lodging on Your Business Premises. You can exclude the value of lodging you furnish to an employee from the employee's wages if it meets the following tests: 1) it is furnished on your business premises, 2) it is furnished for your convenience, and 3) the employee must accept it as a condition of employment.

"The exclusion does not apply if you allow your employee to choose to receive additional pay instead of lodging.

"On your business premises. For this exclusion, your business premises is generally your employee's place of work.

"For your convenience. Whether or not you furnish lodging for your convenience as an employer depends on all the facts and circumstances. You furnish the lodging to your employee for your convenience if you do this for a substantial business reason other than to provide the employee with additional pay. This is true even if a law or an employment contract provides that the lodging is furnished as pay. However, a written statement that the lodging is furnished for your convenience is not sufficient.

"Condition of employment. Lodging meets this test if you require your employees to accept the lodging because they need to live on your business premises to be able to properly perform their duties. Examples include employees who must be available at all times and employees who could not perform their required duties without being furnished the lodging."

As the reader of this blog can see, the answer is "it depends."

If it is determined that the housing is not excludible, then it is reportable just as if it had been paid in cash, subject to all standard withholding and employer taxes. Determining a fair market rental value of the house for these purposes likely involves consulting local sources such as rental listings in the local newspaper or a realtor.

Bookkeeping for Expenses--Part Budget, Part Donation

Question:

A church bookkeeper uses Quickbooks. He asks: "How do I set up my Chart of Accounts in such a way that I can easily account for giving and spending?"

He offers the following example. The youth have a budget account for expenses of $500. The actual expenses for the youth was $1,500, but the youth raised $1,000 through donations. "So," he says, "in essence the youth ministry was on budget."

What do you recommend?

Answer:

I recommend that churches use Designated Fund accounts to record designated gifts and their matching disbursements. This provides good accounting for these gifts, plus it avoids posting income and expenses in the General Fund for which budget accounts have been established. Co-mingling these Funds can mess up budgeting and lose track of designated contributions. Here's the entries I'd recommend in the above example:

First --
$1,000 Debit to Cash/Checking to record the deposit of donations designated to the youth.
$1,000 Credit to Designated Funds: Youth (two new Equity accounts to set up with Youth as a sub-account of the Designated Funds account).

By the way, the account Designated Funds may also have other sub-accounts to account for other designated gifts categories and their subsequent disbursement (e.g., Benevolent Funds).

Second --
$1,000 Debit to Designated Funds: Youth to record the disbursement of funds for youth which were made out of designated gifts.
$500 Debit to the Youth expense account in the General Fund related to the church budget.
$1,500 Credit to Cash/Checking.

February 07, 2011

Parachurch Ministries Under the Authority of a Church

Question:

A church has a member who, on his own, founded a ministry. The ministry has not pursued recognition by the Internal Revenue Service as a tax-exempt organization under section 501(c)(3) of the Internal Revenue Code. Also, it is not a formally sponsored outreach program of the church.

The member has asked whether the church would act as a clearing house for designated donations towards his ministry. Most of the donations would come from non-attendees of the church. Checks would be made out to the church designated for the ministry. The founder would then use the donations to pay for the expenses associated with it. The over arching goal of the ministry is in harmony with the church's mission. Can the church issue tax-deductible receipts for these designated donations?

Answer:

This is a good question that has been answered, in principle, in several other entries in this blog. Type "conduit" in the above search window for more.

My advice has always been to churches and other tax-exempt organizations to avoid becoming conduits for donor contributions that are directed elsewhere. As the recipient, the church may be held responsible by donors and others for the appropriate disbursement of the funds (e.g. if the founder errs in his use of funds, the church could possibly bear the consequences).

If the ministry is truly one that the church leadership and membership supports and the founder is willing to come under the authority and oversight of the church as one of its ministries, then, by all means, receive donations and expend funds for its ministry using the standard receipt and disbursement procedures of the church (e.g., deposits into the church account, documentation of disbursements maintained by the church, fully integrating the ministry into the budgeting procedures of the church).

If the church and founder are not interested in these type of measures, then, in my opinion, the founder should pursue his independent status as a IRC 501(c)(3) organization.

February 02, 2011

Reconstructed Church Financial Statements for Bank Financing

Question:

A church owns real estate and has no mortgage. There are no records indicating the original cost of land or improvements (circa 1955). The church now plans to buy land and to build elsewhere. The bank wants financial statements as the church seeks a loan. How does the the treasurer value assets for which s/he has no costs? This includes not only the building and land, but most of the furnishings.

Answer:

The answer depends, in part, on the requirements placed on the church by the bank. If it insists on financial statements in accordance with Generally Accepted Accounting Principles (GAAP), then the treasurer has a lot of work ahead for him or her, and the bank is going to wait a while to receive its statements. Further, professional assistance may be required.

It might be that switching to GAAP reporting is long overdue for many large churches, but most small churches use non-GAAP cash or modified cash methods which work well for their congregations.

GAAP will require the church to inventory its assets (land, building, building additions, furnishings, and equipment), determine as best it can the original purchase dates and costs (not market value), and depreciate the assets using standard depreciation rules.

Of course, a 55 year-old building would likely be fully depreciated by 2011 and perhaps reflect a zero net book value on the Balance Sheet. Also, the original land, recorded at cost, will not reflect its current value. In the end, if the bank plans to use the old property as collateral or if the church plans to sell it to partially fund the new facilities, then appraised value may be the only relevant amount, not what the GAAP financial statements disclose.

Collateral is not the only determinant of the bank's willingness to grant credit to the church. Annual financial statements from the church that can demonstrate consistent cash flows sufficient to support the new debt will be very important. A strong General Fund Balance on the Balance Sheet generated by substantial cash balances (or other liquid assets) in excess of accounts payable and other non-mortgage debt is necessary. Further, evidence from the annual Profit and Loss statements of the church that its revenues consistently exceed its expenses, enough to absorb the additional new demands on the budget due to the mortgage payments, must be demonstrated.

It may very well be that the production of GAAP financial statements is less important to the bank than everything else I've discussed above. In this case, the typical church's current non-GAAP financial statements may be satisfactory. Church leaders should inquire of bank personnel whether the inventorying of assets and many other issues related to GAAP financial reporting is required.

Further, church leaders should carefully read any subsequent loan agreements with the bank to be fully informed of the bank's financial reporting requirements after the loan is secured.

Contributions to Foreign Churches

Question:

Do designated gifts towards foreign churches qualify as tax-deductible? The foreign church itself does not issue tax-deductible receipts. Moreover, some but not all of these foreign churches already receive some financial support from our church's missions budget.

Answer:

IRS Publication 526 addresses this issue as it informs individuals who make contributions to what it calls "Nonqualified Organizations" --

"You cannot deduct contributions to organizations that are not qualified to receive tax-deductible contributions, including ...

"Foreign organizations other than 1) A U.S. organization that transfers funds to a charitable foreign organization if the U.S. organization controls the use of the funds or if the foreign organization is only an administrative arm of the U.S. organization, or 2) certain Canadian, Israeli, or Mexican charitable organizations."

The Publication addresses item two in greater detail, for readers so inclined to pursue it.

Regarding item one, since the U.S. church (certainly a "qualified organization") is receiving the contributions and then forwarding them to the foreign organization, the members' designated gifts should be deductible. Most churches that I have served are very careful to provide considerable oversight in the use of the funds by foreign organizations. It becomes a matter of Christian stewardship. This is typically the "control" referenced in Publication 526.