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.