August 22, 2013

Private Inurement: Review and Application

Question:

The secretary of a small church, who handles the checkbook, often purchases supplies for the pastor's personal use and pays his expenses along with those for the church. He enjoys the convenience, and the deacons approve of this arrangement. Does this need to be reported as compensation? Are there any other tax consequences to be aware of?

Answer:

In regard to the first question, yes, this would be reportable compensation. Payments in cash or in kind (instead of cash) on behalf of an employee are taxable. However, this situation presents issues for a tax-exempt organization in the area of "private inurement." According to IRS Code Section 501(c)(3), "No part of the net earnings of a section 501(c)(3) organization may inure to the benefit of any private shareholder or individual." Essentially, private inurement describes a situation in which a tax-exempt organization deviates from its exempt purpose through the enrichment of an individual or group. This condition may give the IRS cause to revoke the organizations's tax-exempt status. 

Private inurement involves at least two ares of concern for a tax-exempt organization that appears to be benefiting one individual to the detriment of the fulfillment of its charitable purpose. 1) Excessive compensation, violating the guideline that "none of an exempt organization's income or assets may disproportionately benefit a person or company that is closely related to the organization" (Ron Blue and Co., Tax Exemption is a Privilegeand 2) private benefit, a more subjective situation in which the ministry gives the appearance that it is benefiting one individual to the detriment of its charitable purpose. According to Ron Blue and Co., "personal expenses paid by the entity" are viewed by the IRS as private inurement. 

Though the IRS may never investigate or uncover this issue, the church, and any other organization, should be very careful to maintain its testimony by obeying all applicable laws. Romans 13 speaks to this issue, as does I Thessalonians 5:22: "Abstain from all appearance of evil." 

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