MinistryCPA - Corey A. Pfaffe, CPA, LLC

Are Unincorporate Churches Treated Differently?

2012-02-06T19:42:00.000-08:00

Question:

A church has opted to not incorporate with its State nor file for Internal Revenue Code section 501(c)(3) tax exempt status, having adopted the stance that churches are already tax-exempt according to IRS tax codes and publications.

May such a church give occasional "gifts" to individuals (who perform ministerial services) within the church from money that was given to the church by donors who write their contributions off as tax-deductible and the recipients of these gifts not be required to report the receipts as taxable income?

Answer:

Regardless, whether a church incorporates, files for formal recognition as a tax-exempt, or utilizes many States' statutes that recognize the exempt nature of unincorporated churches, gifts to individuals who perform ministerial services represent taxable compensation to them.

In ignorance, some churches fail to file proper documents with the IRS (typically Form W-2, but in some circumstances, Form 1099-MISC). Of course, ministers should report taxable income as such even though the payer fails in its duty to disclose the taxable compensation.

Exceptions to these reporting requirements relate to the distribution of funds for non-compensatory purposes (e.g., benevolence, ministry-related expense reimbursements).

Examples When No Form 1099-MISC is Required

2012-02-06T19:24:00.000-08:00

Question 1:

If an individual is given money (more than $600) as benevolence is a Form 1099-MISC required?

Answer 1:

No Form 1099-MISC is required. In order to receive benevolent gifts no services are required in exchange.

Question 2:

When a member of the church receives financial support for a mission trip that exceeds $600 should a Form 1099-MISC be issued?

Answer 2:

No Form 1099-MISC is required as long as the funds are spend for travel and other costs directly associated with the individuals voluntary ministry-related activities. I recommend that the church maintain documentation of these costs.

If the gifts exceed actual costs, the church should expect excess funds to be returned by the volunteer. Otherwise, it may appear the the individual was not a volunteer and, instead, was being compensated for providing taxable services. In this case, Form 1099-MISC should be issued for the portion of compensation in excess of qualifying ministry-related expenses.

Form 4361--What Taxes are Made Exempt?

2012-01-07T16:52:00.000-08:00

Question:

If a minister is "tax exempt" by being approved on the IRS tax form 4361, does that mean he doesn't pay Federal, State or Social Security?

Answer:

No, Form 4361 only exempts a minister's self-employment income from SE tax normally reported and calculated on Schedule SE, Form 1040.

403(b) Plan Rollovers to IRAs

2011-12-28T09:54:00.000-08:00

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

Housing Allowance for Extra Mortgage Principal Payments

2011-12-02T19:09:00.000-08:00

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.

"Volunteer" Pastor Receives a Gift from His Congregation

2011-11-21T16:32:00.000-08:00

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.

Church Donor Designations to Foreign Ministries

2011-11-06T17:32:00.000-08:00

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.

Example of Independent Contractor vs. Employee Decision

2011-11-05T12:02:00.000-07:00

Question:

A church's person who cleans the church is paid a fixed sum each month. He works without direction (although direct 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.
http://ministrycpa.blogspot.com/2011/09/church-employee-or-independent.html

Minister as a Volunteer--No Housing Allowance Benefit

2011-11-05T08:26:00.000-07:00

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).

Tax-deductible Support of Missionary by Personal Friends

2011-10-24T19:41:00.000-07:00

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 who 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.

"Benevolent" Gifts to Volunteers

2011-10-10T16:41:00.000-07:00

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 they do it 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."

Expenses for Wife Attending Conference with Minister

2011-09-22T18:06:00.000-07:00

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

2011-09-22T17:45:00.000-07:00

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.

Sabbatical Expense Reimbursements--Authoritative Sources

2011-09-21T06:59:00.000-07:00

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:
http://www.irs.gov/pub/irs-pdf/p463.pdf

Minister with Other "Business" Income

2011-09-21T06:46:00.000-07:00

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

2011-09-21T06:33:00.000-07:00

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: http://www.irs.gov/pub/irs-pdf/fss8.pdf

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.

Retired Minister Housing Allowance SE Tax Free?

2011-09-09T17:33:00.000-07:00

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.

Pastor Compensation NOT for Services Performed

2011-08-18T14:44:00.000-07:00

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.

IRS Statute of Limitations for Prior Year Return Errors

2011-07-27T13:24:00.000-07:00

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

2011-07-27T13:01:00.000-07:00

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:
http://ministrycpa.blogspot.com/2009/04/church-worker-employee-or-independent.html

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

2011-07-27T06:55:00.000-07:00

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."

Educational Assistance by Churches for Their Missionaries

2011-07-22T07:21:00.000-07:00

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 began 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

2011-07-22T05:23:00.000-07:00

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.

Unrelated Business Income Tax on Gift of Corporate Stock

2011-07-21T12:34:00.000-07:00

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.

Bookkeeping Entries for Roofing Bid Received

2011-07-16T12:23:00.000-07:00

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.

Church Planting--Mother/Daughter Contributions

2011-05-14T19:13:00.000-07:00

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.

Small Business Health Care Tax Credit

2011-05-09T15:01:00.000-07:00

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: http://www.irs.gov/instructions/i8941/ar01.html.

Deductions Against Missionary SE Income

2011-03-25T18:25:00.000-07:00

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.

Church Withholding of FICA Taxes

2011-03-21T12:17:00.000-07:00

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

2011-03-21T09:48:00.000-07:00

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

2011-03-21T09:39:00.000-07:00

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.

Year-end Tax Forms to Summer Interns

2011-03-07T13:23:00.000-08:00

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?

2011-03-07T04:32:00.000-08:00

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.

Taxable Support of Foreign Missionary or Benevolence?

2011-02-27T12:33:00.000-08:00

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

2011-02-27T12:22:00.000-08:00

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

2011-02-27T11:46:00.000-08:00

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.

Form W-2 Example

2011-02-21T20:01:00.001-08:00

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).

Housing Allowance Erroneously Reported on Form 1099-MISC

2011-02-14T18:04:00.000-08:00

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.

http://ministrycpa.blogspot.com/2011/01/definition-of-minister.html

Depreciation Entries for Churches

2011-02-14T15:52:00.000-08:00

Question:

We have a church valued at $351,000.00 which includes land of $120,000.00. How long should we depreciate the church for 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.

Charity Refuses to Provide Year-End Giving Statement

2011-02-09T18:36:00.000-08:00

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

2011-02-09T14:47:00.000-08:00

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

2011-02-09T14:18:00.000-08:00

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.

Parachurch Ministries Under the Authority of a Church

2011-02-07T19:05:00.000-08:00

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.

Reconstructed Church Financial Statements for Bank Financing

2011-02-02T10:24:00.000-08:00

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

2011-02-02T10:07:00.000-08:00

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.

Single Member Limited Liability Company (SMLLC) Start-up Questions

2011-02-02T08:30:00.000-08:00

Questions:

Can you tell me the pros and cons of a SMLCC choosing a taxation option as either a Sole Proprietorship or a Corporation? In a SMLCC, does the member receive a salary from the company? How should the bank accounts be set up?

Answers:

State law generally governs Limited Liability Companies (both single and multiple member). Generally, a SMLLC is taxed as a sole proprietorship. In my opinion, if a start-up business owner understands and desire the arrangements a corporation offers, then s/he should incorporate rather than attempting to operate an LLC as a corporation. One's attorney should be consulted relative to a particular State's rules.

A SMLLC sole proprietor does not receive a salary with tax withholdings, etc. S/he is taxed as a sole proprietor who takes owner draws during the year, but reports the full net business income on Schedule C of Form 1040 on his or her annual tax return.

The SMLLC must apply for a federal Employer Identification Number (link below) which will typically be needed to open the company bank accounts.
http://www.irs.gov/pub/irs-pdf/fss4.pdf

Ministers Employed in Parachurch Organizations Who Do Not Perform Sacerdotal Duties

2011-01-30T10:58:00.000-08:00

Question:

Does a member of a mission organization, who has been commissioned, qualify for the ministerial housing allowance even though not performing sacerdotal duties?

Answer:

It depends, but here's the general guideline from Treas. Reg. § 1.107-1(a): "examples of specific services considered duties of a minister."

-- Performance of sacerdotal functions;
-- Conduct of religious worship;
-- Administration and maintenance of religious organizations and their integral agencies;
-- Performance of teaching and administrative duties at theological seminaries.

Publication 517 further helps to define ministers in parachurch organizations. I'll provide the entire section to give readers some context.

"Most services you perform as a minister, priest, rabbi, etc., are qualified services. These services include:

-- Performing sacerdotal functions,
-- Conducting religious worship, and
-- Controlling, conducting, and maintaining religious organizations (including the religious boards, societies, and other integral agencies of such organizations) that are under the authority of a religious body that is a church or denomination.

"You are considered to control, conduct, and maintain a religious organization if you direct, manage, or promote the organization's activities.

"A religious organization is under the authority of a religious body that is a church or denomination if it is organized for and dedicated to carrying out the principles of a faith according to the requirements governing the creation of institutions of the faith.

"Services for nonreligious organizations. Your services for a nonreligious organization are qualified services if the services are assigned or designated by your church. Assigned or designated services qualify even if they do not involve performing sacerdotal functions or conducting religious worship.

"If your services are not assigned or designated by your church, they are qualified services only if they involve performing sacerdotal functions or conducting religious worship."

Payments to Widow of Former Pastor

2011-01-29T13:20:00.000-08:00

Question 1:

A church's pastor passed away in 2010. In recognition of his years of past service, the church continued his salary payable to his wife for a short time. Does a Form 1099-MISC need to be issued for that amount?

Answer 1:

The compensation is reportable in the same manner as was the former pastor's -- typically on Form W-2. However, the widow is not eligible for a non-taxable housing allowance designation (Revenue Ruling 72-249).

Question 2:

The church also had agreed to pay health care expenses for the former pastor's wife for an indefinite period. Does that amount need to be reported as well?

Answer 2:

"Contributions by an employer to a health and accident plan, which was adopted during the employee’s employment and continues to provide benefits to the spouse and dependents after the employee’s death, are excludable from gross income under section 106 of the Code" (Revenue Ruling 82-196).

Year-End Charitable Giving Statements

2011-01-29T10:34:00.000-08:00

Question 1:

Is there a required date by which contribution statements should to sent to church constituents?

Answer 1:

There is no mandatory date for distribution of contributions statements. However, IRS Publication 1771 states, "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." If the church fails to provide this statement within a reasonable time, then donors should request it.

Question 2:

Is it inappropriate to list only a total amount given for the calendar year or must there will a statement with a record of each offering given?

Answer 2:

Please see my December 29, 2010, posting linked below:
http://ministrycpa.blogspot.com/2010/12/review-of-year-end-charitable-giving.html

Definition of a Minister

2011-01-29T10:19:00.000-08:00

Question:

A man serving in the capacity as pastor is not yet ordained, but serving "on trial" and will come up for ordination in 2011. He received a small amount of compensation in 2010 (but greater than $600), all of which the church designated by formal action as housing allowance. Though he is not yet ordained can he have a housing allowance or will everything he received in 2010 be reported on a Form 1099-MISC?

Answer:

A minister is not required to be ordained to qualify as a minister. As long as he fits the definition of a minister he is eligible for a housing allowance and other ministerial tax provisions. This includes the potential that 100% of his compensation may be designated as a housing allowance. When the pastor files his tax return, he must then apply the three-part test for a housing allowance to determine his exclusion. This test is discussed in other postings to this blog.

The Internal Revenue Service's "Minister Audit Technique Guide" states the following.

"Treas. Reg. § 1.1402(c)-5(b)(2) provides that service performed by a minister in the exercise of the ministry includes:

Ministration of sacerdotal functions;
Conduct of religious worship;
Control, conduct, and maintenance of religious organizations (including the religious boards, societies, and other integral agencies of such organizations), under the authority of a religious body constituting a church or denomination.

"Treas. Reg. § 1.1402(c)-5(b)(2) also provides that whether service performed by a minister constitutes conduct of religious worship or ministration of sacerdotal functions depends on the tenets and practices of the particular religious body constituting the church or denomination."

I generally recommend that churches consider licensing their pastors recognizing their call to the gospel minister in situations where they are preparing for lifelong ministry but are not yet ordained.

In the case when 100% of the compensation was properly designated by the church as non-taxable housing, no Form W-2 or Form 1099-MISC is required. However, I recommend that the church provide the pastor a letter communicating the amount to him so that he can properly fulfill his responsibility to apply the three-part test. Further, the housing allowance is only exempt from income taxes. He will need to consider his self-employment tax obligation for these earnings.

Debits and Credits for Designated Gifts

2011-01-23T19:48:00.000-08:00

Question:

A church is setting up Quickbooks for its accounting, but it personnel have little experience with fund accounting. What are the entries for the receipt and disbursement of designated gifts and the opening balances?

Answer:

I recommend that most churches that do not need to present financial statements in accordance with Generally Accepted Accounting Principles observe the following steps. Even those churches that do report using GAAP can employ these methods, but must make some adjustments when preparing their financial statements.

What I will demonstrate relates to what most churches call "designated gifts" (CPAs call these Temporarily Restricted gifts). These are gifts that donors contribute with the intention that the church will spend the funds as they direct. Most churches do not receive "endowment gifts" in which donors prohibit the expenditure of the core gift (CPAs call these Permanently Restricted gifts). Only earnings on the subsequent investments made with the gift money may be spent and then only for the purpose stipulated by the donor.

I will illustrate assuming a church is using QuickBooks to record transactions in a designated fund called Missions.

Opening Balances entered into QuickBooks:

1. In the Chart of Accounts, establish a new account entitled Designated Funds. Categorize it as an Equity Account. This account will be a title account to which no transactions are ever recorded. Enter no opening balance.
2. In the Chart of Accounts, establish a new account entitled Missions. Categorize it as an Equity Account. In the Sub-Account window select Designated Funds. Enter the missions fund opening balance. As a new QuickBooks "Company" is established with opening balances carried over from the church's existing accounting system, QuickBooks posts a balancing entry to an account called Opening Balance Equity. In most cases, once all opening balances are entered, a General Journal entry should be made to zero out this balance and reclassify it to a new equity account called General Fund Balance.

Now, the Designated Funds: Mission account should be reflected on the church's Balance Sheet which may be printed from the Reports Menu.

Next, two sample entries.

Receipt of funds designated by a donor to missions:

$x,xxx Debit Cash account (typically, a deposit to the checking account)
$x,xxx Credit Designated Funds: Missions account

Expenditure of funds from gifts previously designated by donors to missions:

$x,xxx Debit Designated Funds: Missions account
$x,xxx Credit Cash account (typically, a check written against the checking account)

Form 1099-MISC for Missions Trips

2011-01-23T19:30:00.000-08:00

Questions:

Should a church issue a Form 1099-MISC in the following situations?

1. Church member takes a short term mission trip. Money is raised by asking for donations to the church. The church writes checks to the person for more than $600. No accounting of expenses is required of the member.
2. Same as above, but church reimburses expenses for the trip based on an accounting provided to the church (essentially an expense report).
3. Are the answers different if the trip is not actually sponsored by the church but done by a church member through another organization?

Answers:

Assumptions:

The church member is serving as a volunteer and not an employee of the church.
The trip is for ministry purposes, not a disguised personal vacation.

If the church member had paid his or her own travel expenses, they would have been deductible as an out-of-pocket charitable contribution. Any reimbursements received simply reduce the amount of charitable deduction.

Form 1099-MISC is issued for amounts that payees receive as Miscellaneous Income. Since the disbursements were not in exchange for services rendered, they are not reportable on Form 1099-MISC.

Ministries expect volunteers to return any excess funds provided to them that are not needed to provide religious services. When an employee (not a volunteer) represents a ministry on a ministry trip, any excess disbursement to him or her will be considered taxable income. If no documentation is received from the employee, the entire amount should be treated as a non-accountable plan fully reportable on his or her annual Form W-2. The employee can then deduct the allowable expenses on Form 2106 as employee business expenses.

The sponsor (church or otherwise) should not effect the above answers.

Reimbursement of Minister's Expenses While on Sabbatical

2011-01-22T13:26:00.000-08:00

Question:

A church's minister is taking a trip while on sabbatical. The trip is a combination of sabbatical activities and vacation. The church has funds to pay for these expenses.

When the church reimburses the minister for sabbatical expenses, what are the tax implications? Are reimbursements reported to the IRS as ministerial income? Are taxes required to be withheld? Does the church have to decide the taxable status for each individual expense? What liability exposure might the treasurer of the church incur for errors?

Answer:

Employee business expenses reimbursed through an accountable plan are not taxable to the employee. They are not reportable on Form W-2, nor subject to withholding. Accountable plan rules do require the employer to receive and maintain documentation as to the business purpose, date and amount of reimbursements. Failure to comply with these rules may result in the filing of an erroneous Form W-2 – something that the preparer (the church treasurer) can be held responsible for by the IRS. IRS Publications 463 and 15 provide additional information.

Housing Allowance for U.S. Resident Supported for Itinerant Foreign Ministry

2011-01-22T13:00:00.000-08:00

Question:

A non-profit Christian organization supported a missionary who is not an ordained minister. He frequently traveled to a foreign country to serve the organization's charitable purposes. While there, the organization provided his temporary living expenses. He maintained a personal residence in the U.S. At the end of the year, he declared to the organization his housing expenses and requested that a portion of his support be, thus, treated as non-taxable.

On this basis, can the ministry exclude a portion of his support as a ministerial housing allowance?

Answer:

First, if the employee meets the definition of a minister, it is not necessary that he be ordained. Click on the following link for more information.
http://ministrycpa.blogspot.com/2009/08/irs-definition-of-minister.html

Second, a minister's primary residence qualifies for the housing allowance designation. Based on the information provided in the Question, the minister appears to meet this requirement.

Finally, the housing designation may not be made retroactively. This requirement appears to prohibit the income exclusion for compensation of past services. However, the minister and organization should establish a housing designation for future compensation.

Church Intern and Residency Programs

2011-01-22T12:24:00.000-08:00

Question 1:

A church is considering setting up an internship or residency program that would focus on young people in its community who are pursuing ministry as a vocation. The church general budget or missions fund may pay the individual a few hundred dollars per month, but the remainder of his full-time support would have to be raised from people both inside and outside the church.

How can the church appropriately accept funds from donors to support the individuals in this program while ensuring it avoids donor control issues?

Answer 1:

The church leaders demonstrate understanding of important tax rules when they address the donor control issue. Donors should not be permitted to use (control) the church as a conduit to satisfy non-charitable purposes. A common example of this type of control might be a parent or grandparent who wishes to pay a child's Christian camp fees or school tuition while gaining a tax deduction.

The situation described above is a common charitable activity of many churches. To receive tax-deductible gifts, the church must establish a fund to account for the gifts, thus avoiding co-mingling the funds with unrestricted gifts used for the church's general operations.

Just as important, via direct communication with donors or clearly communicated policy the church must maintain control over the funds. If a donor contributes to the fund knowing that a particular individual has been identified by the church as worthy of such a ministry, he or she should receive a receipt from the church establishing the deductibility of the gift. However, the donor must also understand that should the named individual withdraw participation, the church may identify other recipients who will fulfill the purpose of the charitable gifts.

Question 2:

Furthermore, what are the implications of having the church provide some support directly through payroll and the remainder coming from outside contributions?

Answer 2:

It is my experience that most churches in these situations exercise significant oversight and accountability in the ministries of interns. The intern should be classified as an employee of the church, not as independent contractor. Thus, the full amount of compensation (both church general funds and funds received from donors) is reportable on Form W-2. Independent contractor payments are reported, in full, on Form 1099-MISC.

For more information, type "control" or other appropriate search terms in the Search Window of this blog.

Form 1099 for Payments to Other Ministries

2011-01-03T17:49:00.000-08:00

Question:

A church supports various ministries. If a check is written to a ministry (a tax-exempt organization), does a church issue a Form 1099-MISC to that ministry. The church leaders understand that it is to issue Form 1099’s when it compensates individuals in a ministry.

The posted question concludes: "The only thing we can find is that in general we do not have to issue a Form 1099 to a corporation."

Answer:

One of the exceptions to required reporting of payments listed in the 2010 instructions for Form 1099-MISC is "payments to tax-exempt organizations." Therefore, payments to a ministry are not reportable.

Churches that pay rent, services, etc. to individuals who are not employees (they receive Form W-2) must file Form 1099-MISC.

Thanks for the Patient Protection and Affordable Care Act of 2010...
Regarding the last sentence in the above Question, beginning with payments in 2012, for-profit corporations that are paid by the church for rent, services, etc. must also receive Form 1099-MISC from it.

The penalties for non-filing and for failure to withhold Backup Withholding, when required, are steep and will increase in 2012.

IRS Filing by Church if No Taxable Compensation is Paid

2011-01-03T17:30:00.000-08:00

Question:

Does a church need to file an IRS form of any type if the church only pays professional reimbursement and housing allowance and not salary?

Answer:

Reporting of housing allowance to the IRS is not required. I recommend to churches that do pay taxable compensation to report the housing amount as a memo item in Box 14. This enables the minister to test whether any portion of the housing allowance is taxable. When no taxable compensation is provided I recommend that a church provide a report to its minister of the total housing allowance paid so that he may perform a similar test. However, that report is not submitted to the IRS. I have reproduced the three-part test below.

Professional reimbursements paid in an accountable plan are not reportable to the IRS. To review the requirements for an accountable plan, I suggest that viewers of this blog type "accountable plan" in the Search window.

Three-part housing allowance test:

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.
(Sources: IRS Publication 1828; Clergy Housing Allowance Clarification Act of 2002; IRS Regulation Section 1.107-1).

News You (Individuals) Can Use (and that we may use to serve our clients better)

2010-12-29T15:44:00.000-08:00

1. Employees get a 2% raise with their first 2011 payroll checks. The Tax Relief Act of 2010 reduces the employee-share of the FICA tax by 2%

2. Provisions set to expire on December 31, 2010, related to sales tax, educator, tuition, contributions, mortgage insurance premiums, and student loan interest deductions, and some related to the Earned Income and Child Tax Credits were extended by the Tax Relief Act. An energy credit for individuals was also reinstated, but at a lower rate.

3. Updated mileage rate deductions for 2011: business-51 cents/mile; charitable-14 cents/mile; moving and medical-19 cents/mile.

4. While it received a lot of negative press, the Health Care Reform Act of 2010 contained provisions that may benefit individuals including tax credits and increased benefits for employees' adult children.

5. The Small Business Jobs Act of 2010 increased some business write-offs and created additional Roth Account conversion opportunities for individuals.

Review of Year-End Charitable Giving Reports by Churches

2010-12-29T15:37:00.000-08:00

Questions:

What do we do with post-dated checks or checks that arrive in the offering box in January with a December date on them? If a contribution is postmarked by the 31st of December, I assume we are required to include that figure in our 2010 tally? Is there anything else we should know about the reporting of contributions?

Answers:

Make sure to check collection boxes, if any, prior to the close of the year. Checks that are received by the church prior to January 1 are included as 2010 contributions as long as the funds are available to the charity. A post-dated check (after December 31) must be posted as 2011 even if a 2010 date is recorded on it since it cannot yet be deposited. Checks received via US Mail postmarked by December 31 should be recorded as 2010.

Make sure to provide date and amount for any individual contributions greater than $250. A simple total for the year is appropriate unless additional notation is necessary to list these larger amounts. Many churches simply give a list of all contributions for the year no matter the amount. Then they provide a total as well.

Finally, provide a statement that no goods or services other than intangible religious benefits were provided in return for the contributions. IRS Publication 1771 is helpful in addressing many charitable giving questions. A link is provided below.

http://www.irs.gov/pub/irs-pdf/p1771.pdf

Deductible Travel Expenses for Volunteers

2010-12-15T19:14:00.000-08:00

Question:

You have covered in several previous posts the question of whether contributions made in support of mission trips are deductible. Here's a question with a slightly different slant.

If a congregation member, who is a member of a mission team and travels with that team, purchases supplies, food, or other “goods” for the trip and those supplies are used directly and immediately for the purpose of the trip (in other words, they do not run those contributions through the church), will that person be able to deduct those as contributions, assuming they have supporting documentation? Will they have to get some kind of statement from the church in support of those contributions? Would they claim these on Schedule A, assuming they itemize?

Answer:

IRS Publication 526 offers some good help to answer this question.

"Although you cannot deduct the value of your services given to a qualified organization, you may be able to deduct some amounts you pay in giving services to a qualified organization. The amounts must be 1) Unreimbursed, 2) Directly connected with the services, 3) Expenses you had only because of the services you gave, and 4) Not personal, living, or family expenses."

The Publication has a good section on travel expenses, plus a table of Volunteer's Q&A. It includes a summary of deductible travel expenses. "These include 1) Air, rail, and bus transportation, 2) Out-of-pocket expenses for your car, 3) Taxi fares or other costs of transportation between the airport or station and your hotel, 4) Lodging costs, and 5) The cost of meals. Because these travel expenses are not business-related, they are not subject to the same limits as business related expenses."

So in answer to the questions above, "yes," with proper documentation the costs for volunteers' travel expenses can be deductible.

In the event of an audit, the taxpayer may need proof from the church that volunteers were involved in a charitable activity that involved paying their own costs in giving services (to use Publication 526 language). Absent an audit, such proof is not necessary.

Volunteers' costs are deducted along with other contributions on Form 1040, Schedule A.

Health Reimbursement Arrangements for Pastors With No Taxable Compensation

2010-12-08T19:16:00.000-08:00

Question:

Three pastors of a congregation receive a housing allowance and no actual wage. Can a Health Reimbursement Arrangement be made available to a pastor who's only compensation is a housing allowance?

Answer:

A minister whose compensation is designated 100% as housing allowance is still considered an employee eligible for all statutory fringe benefits that other workers enjoy.

Question:

It is understood that HRAs cannot be taken through voluntary salary reductions. May a church have an agreement with a pastor that he receives a monthly HRA that, if unused, is designated as a housing allowance instead?

Answer:

Since an HRA must be 100% funded by employer contributions, it is not considered taxable compensation. The plan may be established to permit unused amounts to roll over into a subsequent year. However, to distribute amounts contrary to the design of HRAs places the whole arrangement in non-compliance. Publication 969 makes this quite clear:

"If any distribution is, or can be, made for other than the reimbursement of qualified medical expenses, any distribution (including reimbursement of qualified medical expenses) made in the current tax year is included in gross income. For example, if an unused reimbursement is payable to you in cash at the end of the year, or upon termination of your employment, any distribution from the HRA is included in your income. This also applies if any unused amount upon your death is payable in cash to your beneficiary or estate, or if the HRA provides an option for you to transfer any unused reimbursement at the end of the year to a retirement plan."

When the Church Finances Get Too Much for Volunteers

2010-12-06T15:17:00.000-08:00

Question:

A New York City church has been handling all its church finances through volunteers but the work is getting overwhelming. It is considering hiring an outside firm/person to handle all church finances- reimbursements, writing checks, payroll, bookkeeping. Is this a good idea? What is a reasonable price?

Answer:

The bookkeeping function for volunteers has always been, in my opinion, the most time-demanding volunteer responsibility in most churches. When most churches reach a point of advanced time and expertise requirements they seek to hire help rather than to continue using volunteers.

Of course, some functions cannot nor should be "farmed out." The confidentiality and security required for offering counts and deposits typically means that volunteers will continue performing these duties. Maintenance of donor records often stays under the watchful eye of church members. Of course, processes to approve invoices for payment and to set compensation arrangements must be overseen by the church leadership, as does creation of the church budget. So church member expertise is still much needed.

It's good to ask potential part-time employees or bookkeeping service providers whether they have experience in accounting for churches, particularly payroll functions since there are significant differences between churches and business enterprises. Often experienced people are not available so a new hire must be expected to do some research to learn about ministerial compensation. As many have discovered in this blog, there are some tips along the way here, but a good general resource may be helpful. Type "tax" in the search window of http://www.christianbook.com/ and you will find helpful resources by B.J. Worth and Dan Busby. Check out http://churchlawtoday.com/ as well.

Further, the new employee or self-employed bookkeeper may not be familiar with the church's method of financial reporting--typically, an "Other Comprehensive Basis of Accounting." The individual must have a solid understanding of accounting in order to avoid attempting to convert the ministry to his or her own limited sphere of experience in for-profit business accounting.

As to reasonable pricing, each geographic area has its standard of living that a church must consider. Volunteers who have performed financial services in the past may be able to suggest the amount of time it will take to fulfill the work. Then, local wages rates must be considered. Typically, independent firms must charge more but will have their own computer systems and will have access to greater expertise. These all are matters that must be considered.

Church-established Fund for Families Adopting Orphans

2010-11-15T18:11:00.000-08:00

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

2010-11-15T17:14:00.000-08:00

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.

Church as Mission Agency

2010-11-14T13:51:00.000-08:00

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).

Non-GAAP Accounting Question: Capital Assets

2010-11-05T19:28:00.000-07:00

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."

Prizes Given at Charitable Events

2010-10-21T19:15:00.000-07:00

Question:

A church hosted an event primarily for religious purposes, but required guests to purchase a ticket or receive one from someone who had purchased a ticket for them. Several prizes were given away that were either purchased by the church or donated to it. Is the church responsible to issue a Form 1099-MISC with the fair market value of the prize in Box 3 at the end of this year?

Answer:

If a prize winner receives a non-cash item with a fair market value greater than $600, then Form 1099-MISC must be issued to the winner for its full value. Perhaps the most widely accepted authority for this requirement is simply the IRS instructions to Form 1099-MISC (link below).

http://www.irs.gov/pub/irs-pdf/i1099msc.pdf

Payments to a Foreign Minister

2010-10-20T16:25:00.000-07:00

Question:

What are the reporting requirements for a minister who is not a U.S. citizen, but performs services in the US? Does sending his earnings to his foreign location make any difference?

Answer:

Depending on several factors, it is likely that this minister is classified either as a resident or nonresident alien. His income is reportable on Form W-2 if he was an employee while in the U.S. or on Form 1099-MISC if he was an independent contractor. Sending the money overseas does not avoid the reporting requirements.

IRS Publication 519--U.S. Tax Guide for Aliens--may be helpful both to the ministry and to the minister. The ministry may also wish to explore Form 1042 and instructions--Annual Withholding Tax Return for U.S. Source Income of Foreign Persons. Also, Tax Topic 851 may be helpful (link provided here).

http://www.irs.gov/taxtopics/tc851.html

Probably the easiest way for a local church without foreign tax knowledge to deal with this issue is to advance the funds to the minister's (or to his U.S. sponsor's) U.S. missions agency and let it use its expertise to apply the law.

Form 990 for Church "Subordinate Organizations"

2010-10-18T13:20:00.000-07:00

Question:

A qualifying church is not required to file an annual informational return (Form 990). Would this change if the church owns a single member LLC? Assume that unrelated business income tax (UBIT) is not as issue.

Answer:

Great question and a new one on me! But it seems that its qualification under the church and its exemption falls under the Group Exemptions provisions of the Internal Revenue Code. Specifically, whether the LLC is a "subordinate organization" will likely determine its inclusion under the church's filing waiver. IRS Publication 4573 (link below) seeks to define the qualifications and may be helpful.
http://www.irs.gov/pub/irs-pdf/p4573.pdf

As the inquirer points out, the UBIT matter is important. Churches earning unrelated business income must file Form 990-T and pay income tax on any profits.

Should Churches Apply for Tax-Exempt Status?

2010-09-30T05:59:00.000-07:00

Question:

Should a church apply for Internal Revenue Code 501(c)(3) status? What are the benefits or disadvantages of applying for such status when it is already treated as exempt from income tax?
Answer:

IRS Publication 1828 helps to answer these questions. Hears a link:
http://www.irs.gov/pub/irs-pdf/p1828.pdf

One quote:

"Churches that meet the requirements of IRC section 501(c)(3) are automatically considered tax exempt and are not required to apply for and obtain recognition of tax-exempt status from the IRS. Although there is no requirement to do so, many churches seek recognition of tax-exempt status from the IRS because such recognition assures church leaders, members, and contributors that the church is recognized as exempt and qualifies for related tax benefits. For example, contributors to a church that has been recognized as tax exempt would know that their contributions generally are tax-deductible."

A few BIG disadvantages:

The application Form 1023 is 30 pages long and requires a fee. Also, the IRS estimates that it will take in excess of 189 hours for "recordkeeping, learning about the law, preparing the form, and copying, assembling, and sending the form to the IRS."

Receipt of Benevolent Gift Versus Refund of Contribution

2010-09-30T05:48:00.000-07:00

Question:

If a church gave a member a benevolent gift during a time of need should that church then record the gift on the member's giving statement as a negative against which all of that member's future (or past) donations are subtracted?

Answer:

No, the receipt of a benevolent gift is non-taxable nor does it reduce one's charitable giving deduction. This offers another good reason to properly document the nature of benevolent gifts to assure that they are not mistaken for refunds of previous contributions.

Director of Christian Education: Is He a Minister?

2010-09-23T18:26:00.000-07:00

Question:

A church hires a Director of Christian Education. Does he qualify for the same tax-status as a pastor (e.g., housing allowance, exempt from income tax withholding, eligible for Form 4361 election)?

Answer:

http://www.irs.gov/businesses/small/article/0,,id=210018,00.html
The IRS Minister Audit Technique Guide (link provide here) helps to answer this question. I'll edit out some of the technical citations, but readers should follow the link for more details:

"To qualify for the special tax provisions available to ministers, an individual must be a 'minister' and must perform services 'in the exercise of his ministry.'

"[Tax rules] require that an individual be a 'duly ordained, commissioned, or licensed minister of a church.'

"[Tax rules] provide that service performed by a minister in the exercise of the ministry includes: Ministration of sacerdotal functions; Conduct of religious worship ...

"[Tax rules] also provide that whether service performed by a minister constitutes conduct of religious worship or ministration of sacerdotal functions depends on the tenets and practices of the particular religious body constituting the church or denomination."

Readers really need to read the entire section of the Guide on "Who Qualifies for Special Tax Treatment as a Minister." But I'll offer just one more quote that may apply to the specific question posed in the Blog entry:

"The Tax Court held in Lawrence v. Commissioner, 50 T.C. 494, 499-500 (1968), that a 'minister of education' in a Baptist church was not a 'duly ordained, commissioned, or licensed' minister."

Church Meals Free of Charge

2010-09-23T18:19:00.000-07:00

Question:

Can a church provide meals (or other food such as pizza parties for youth) to its members using funds that come from the regular Sunday morning offering?

Answer:

Presumably we're talking here about occasional church fellowships. Yes, it's okay, as long as it's not disguised compensation for a church employee (e.g. paying for employees' family meals and entertainment on the church tab). I suggest that the budget plan for such expenditures though. Furthermore, it may be a sensitive matter to some who believe it is inappropriate to spend God's money to "feed the flock."

Interest-Free Loan to Church Employee

2010-09-23T18:10:00.000-07:00

Question:

A church gives its pastor a loan to be used to pay down his home mortgage. The condition will be that he will not pay anything back until or unless he leaves the church or sells the home. At that time he would pay the money back without any interest. How this would be treated by the IRS for tax purposes?

Answer:

IRS Publication 15-A answers this one pretty well:

"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. This rule applies to a loan of $10,000 or less if one of its principal purposes is the avoidance of federal tax.

"This additional compensation to the employee is [reported as] compensation on Form W-2 (or Form 1099-MISC for an independent contractor). The AFR is established monthly and published by the IRS each month in the Internal Revenue Bulletin."

Rental of a Church Parsonage to a Non-minister

2010-09-11T19:25:00.000-07:00

Question:

A church owns a parsonage, but the pastor does not use it as he own his own home. The church rents the parsonage to a tenant other than a minister or employee of the church. Will the church be responsible for paying income tax on these monies as Unrelated Business Income (filing a Form 990-T) even if the money is used to carry on the business of the church?

Answer:

Whether the money is used for church purposes is irrelevant. IRS Publication states:

"If an exempt organization regularly carries on a trade or business not substantially related to its exempt purpose, except that it provides funds to carry out that purpose, the organization is subject to tax on its income from that unrelated trade or business."

Fortunately, in the case of rental income from real property, such income is "excluded in computing unrelated business taxable income" (Publication 598 (rev. March 2010), Chapter 4).

However, a second concern not addressed in the question must be raised: Will the parsonage lose its status as excluded from the real estate tax rolls of the local government? I have worked with two churches in similar situations in two different states. My recommendation has been to communicate openly with the local authorities (typically an Assessor) as to the church's intentions. In both cases, because the use was temporary (in one case) and rented to a missionary of the church during his furlough (in the other case) the Assessor did not believe its use violated the statutory exclusion from real estate taxes for church property.

Missions Trip Contributions and Expenditures--a Good Plan!

2010-09-06T19:03:00.000-07:00

"Question" --

We would like to send our pastor on a missions trip, asking our congregation to participate in giving toward this trip. We have a separate Missions Fund to which donors can contribute. They would be instructed to make any checks payable to the church designated to this Fund.

All approved expenses for the trip will be reimbursed through this Fund. We have an Accountable Reimbursement policy in place.

Can the donors include these gifts as charitable contributions? Will the reimbursements for expenses be non-taxable to our pastor?

Answer --

Well designed plan! The contributions will be tax-deductible to donors and the reimbursements for properly documented ordinary and necessary ministry travel expenses will be non-taxable to your pastor.

Refund of Contributions

2010-09-06T18:30:00.000-07:00

Question:

"Does a church need to distribute Form 1099 to donors that receive refunds of donations to a building fund. The building will no longer be built, and the church has sent notice that the money in the building fund can either be applied to the debt of the church or returned to the donor. Since these were designated donations, I don’t believe they would have been deductible in the first place, but the church has no way of knowing how individual taxpayers handled this."

Answer:

First, designated donations to a building fund are typically deductible. A refund will, then, have tax ramifications that each donor's tax professional will need to address. However, the church has no requirement to issue Form 1099.

Richard R. Hammar in his 4/23/2009 post on Church Finance Update (Bottom-Line Training: Refunds of Charitable Contributions; What do we do if a member wants to take back their contribution?) provides an excellent treatment of this subject. I cannot improve upon it.

http://www.christianitytoday.com/yc/churchfinanceupdate/bottomline_090424.html?start=1

Also, Hammar provides free e-mail newsletters that reader will find well done and useful.

"Benevolent Loans", an Oxymoron?

2010-09-05T20:03:00.000-07:00

Question:

A reader asks a follow-up question to my detailed posting on July 15, 2010, regarding churches offering non-interest bearing loans to their pastors.

http://ministrycpa.blogspot.com/2010/07/employee-loan-by-church-to-pastor.html

Do the same rules apply for a zero-interest loan to a church member (not an employee)? Does the difference between the applicable federal rate and 0% need to be reported on a Form 1099-MISC or other form?

Answer:

This answer may not be what some will expect, but here it goes:

Since the loan is not to an employee or independent contractor in exchange for services rendered, I must assume that the loan is disbursed as a benevolent activity of the church. Therefore, the foregone interest is essentially the "benevolent" act and, as such, is non-taxable (not reportable). HOWEVER, as a church member who has given this kind of "benevolence" a lot of thought, I strongly recommend that the above proposal to loan money to a member as a "benevolent" act be abandoned. I suggest that churches consider a policy along the lines of the following:

"[Church] has established a [benevolent fund] to meet the special financial needs of members. From time to time, those in need may ask for a loan rather than to receive a benevolent gift. The members of [Church] are not of a mind to do so when God has provided us the money (Proverb 3.27). We would much rather lend to the Lord by giving to others (Proverb 19.17)."

The following statement may be provided to benevolence recipients:

"Your brothers and sisters in Christ at [Church] earnestly rejoice to meet the needs of others. We trust that the gift God has provided will meet your immediate need at this time and will encourage your walk with the Him. We know that God loves a cheerful giver so we extend this help with absolutely no expectation of repayment.

"We do understand from the Apostle Paul’s instruction to the believers at Corinth, however, that you might desire to respond to God’s provision in some tangible way. Paul gave instructions to the church about the same kind of fund that provides for others’ needs at [Church].

"He said, 'For if there be first a willing mind, it is accepted according to that a man hath, and not according to that he hath not. For I mean not that other men be eased, and ye burdened: But by an equality, that now at this time your abundance may be a supply for their want, that their abundance also may be a supply for your want: that there may be equality: As it is written, He that had gathered much had nothing over; and he that had gathered little had no lack' (II Corinthians 8.12-15).

"If you at some time in the future wish to share in meeting others’ needs just as yours are now being met, we encourage you to give privately and confidentially to the [Church Benevolent Fund]."

Housing Designation of 403(b) Plan Retirement Distributions

2010-09-05T19:50:00.000-07:00

Question 1:

An investment advisor "once heard regarding 403(b) plans that distributions from such plans could not qualify for the housing allowance." Later, he "came across several tax sources that say 403(b)(9) distributions may qualify for housing allowance [designation] (the "nine" apparently being the distinguishing characteristic)."

Can 403(b) distributions qualify for housing designation?

Answer 1:

Distributions from 403(b) plans qualify for housing designation. I point readers of this blog to my posting of October 28, 2009:
http://ministrycpa.blogspot.com/2009/10/retired-minister-continued-support-from.html

Question 2:

How does a 403(b)(9) differ from traditional 403(b) plans?

Answer 2:

Section 403(b)(1) describes TSAs (also known as 403(b) plans) as annuities (Tax-Sheltered Annuities). Section 403(b)(9)(a)(i) clarifies that “a retirement income account shall be treated as an annuity contract described in [section 403(b)]." Section 9 simply indicates that annuities are not the only form of permissible 403(b) plan investments.

Is Office Space Provided to a Missionary "In-kind" Compensation?

2010-08-25T10:58:00.000-07:00

Question:

A church provides office space within its church to a local missionary who is raising his support. The church is one of the missionary's financially supporters. This office space is provided rent-free. The missionary is not an employee of the church, but does serve as a member within the church. Is the missionary responsible for any taxes in regards to this office space?

Answer:

The use is certainly consistent with the church's tax-exempt purposes and ministry emphases. Is is my opinion that the office space as described for use in his mission endeavor is non-taxable. Further, even if it did represent taxable income, the missionary would have an immediate and equal business deduction for rent.

Pastor in Transition to Missionary Receives Help from Former Congregation

2010-08-25T06:06:00.000-07:00

Question 1:

Can a pastor who is leaving the church for a position as a full-time foreign missionary (the church will contribute missionary support as the sending church) receive retirement compensation for past services by declaration of the church? What would be the taxability of such an arrangement? Does it matter how long is is paid or whether it is in a lump sum or a monthly obligation?

Answer 1:

Probably the easiest way for the retirement contributions to be made as implied in this question is to have the church send support to the former pastor's account with his mission agency employer. Then the pastor may make elective deferrals into an Internal Revenue Code 403(b) plan. He can likely contribute in excess of $20,000 per year (IRS Publication 571 describes the limits).

Question 2:

Can the church continue to pay for health insurance as a tax-free fringe if the senior pastor is no longer an employee but simply a missionary from the church?

Answer 2:

Similar to my answer for Question 1, the pastor's mission agency employer can provide health coverage using funds supplied by supporting churches, including the pastor's former congregation.

Question 3:

Can the church compensate the outgoing pastor with severance pay before he goes to the field? Would that be taxable like his pastoral salary?

Answer 3:

Yes, the church can provide severance pay, but it will be taxable as any other compensation. To mitigate the tax costs, standard ministerial tax law benefits should be pursued (e.g., housing allowance designation, elective deferrals into IRC 403(b) retirement plan).

Missionary "Start-Up"

2010-08-24T05:37:00.000-07:00

Background:

A new missionary endeavor has prompted a "missionary start-up" series of questions. His situation is very typical and may be helpful to rehearse with all viewers of this blog.

"The Lord has called me to be a missionary. At this time, I am still working and earning money in the United States. I not ordained at this time.

"After sharing my burden with our local church, a mission agency was created by our local church to help facilitate the funding for my family's’ mission needs. The only step that was taken to create the mission agency was to open an account at our church’s bank in the name of [the] Agency. We also opened a sub-account under the agency in my own personal name. [The church's agency] received a Tax ID number for this account. [Since 2009, contributions] have been accumulating in the two accounts since.

"No money was taken or used from either account until August of [2010] when I took a survey trip. During my trip, I incurred expenses for taxi services, hotels, eating, obtaining a passport, and purchasing plane tickets. This money was taken from the sub-account in my personal name, most of which had been transferred from the “missions agency” account."

Question 1:

Were we required to report the income that was given in 2009 to the government in last years’ taxes?

Answer 1:

No, as long as the church agency maintains complete control of the funds and their disbursement, you have no income until you are compensated for your personal services. In fact, to avoid potential confusion, if asked for my personal counsel I would likely advise you to close the personal sub-account under the church agency Tax ID. When the agency distributes personal living expense money to you, it should pay it to you for deposit into your own personal family account. At that point, these earnings must be reported to you and the IRS at year end on Form 1099-MISC or Form W-2 (depending on your employment or independent contractor status with the church agency).

Question 2:

How do we claim income in 2010?

Answer 2:

As you have described it so far, you have no taxable income in 2010. It appears that the monies disbursed to you were in reimbursement for business expenses, not for compensation of your personal services. The church agency should maintain copies of substantiation of your business expenses to document that all of the disbursements were business travel costs.

Question 3:

Does the fact that the church [has not pursued formal incorporation] mean that the church cannot consider me [its] employee, legally speaking?

Answer 3:

This should not make a difference. To my understanding and experience, virtually all state statutes recognize churches as corporations regardless of their formal status.

Commentary:

There are many other issues this new missionary will need to consider. A careful reading of past entries in this blog could probably be a good start. They include choices regarding ordination/licensure, employee vs. independent contractor status, financial management arrangements with the church agency, self-employment tax, and many other issues.
　

Taxability of In-kind Payments by Church for Intern

2010-08-23T19:12:00.000-07:00

Question:

An intern at a church receives as part of his compensation a direct payment by the church to reduce his school debt. If the church pays off his loans will that be considered income for tax purposes?

Answer:

The loan payments will be taxable as standard wages. If he is or should be treated as a licensed minister then he will have no withholding. However he will be obligated for both income and self-employment tax. A housing allowance could reduce his income tax to the extent he pays for his own housing. Of course, he could also consider "opting out."

If he is not a minister (not recognized by the church as called to the gospel Ministry and eligible to marry, bury and baptize) then both the cash and loan payments are subject to FICA withholding and matching by the church. His compensation will be classified as any other non-ministerial employee (e.g., administrative assistant, facilities manager). He would not qualify for a housing allowance since only ministers do.

Church Support of a Missionary with No Mission Agency

2010-08-23T18:54:00.000-07:00

Question:

A church provides direct support to a missionary -- both through the church budget and from additional contributions received designated to his ministry. What reporting requirements does the church have?

Answer:

Since the church disburses directly to the missionary, it should issue Form 1099-MISC. If it wishes, the church can establish arrangements, for example, to reimburse documented business expenses and to designate a portion of the support toward housing. Absent these provisions, the entire amount should be reported annually on Form 1099-MISC.

Timing of Taxability of Missionary Support Handled by an Agency

2010-08-19T06:05:00.000-07:00

Question:

A mission agency inquires as to the amount included on Form 1099-MISC filed each year. The office believes that the should be the total of all of the support that came in for the missionary during the year. Most of its missionaries zero out their accounts each month (i.e., what comes in to the agency's account each month goes out to the missionary immediately).

A missionary asks the agency to deposit a set amount each month into his/her personal account and to leave the rest in the hands of the agency. A clarification is needed as to whether the amount received by the agency or the amount disbursed to the missionary is the proper amount to record on Form 1099-MISC.

Answer:

The answer to this question relates to a tax concept called "constructive receipt." If a mission is simply acting as a clearing house for contributions and missionaries have unlimited and unsupervised access to funds held on their behalf, then all funds are taxable to the missionary as they are received by the mission. In these cases, all contributions received by the missionary are immediately reported as taxable income since he or she had unrestricted access to them. They were constructively received even if not deposited into a personal bank account.

However, to my understanding, most mission agencies take an active role in serving both the donors and the missionaries. Donors understand that such agencies receive contributions on the behalf of their missionaries and provide oversight in disbursements to them. Missionaries must submit budgets for their personal living expenses. They must document business expenses for appropriate reimbursement out of funds received by the agency from donors.

If donors designate contributions to special projects on a missionary's post, then the agency ensures compliance with the designation.

In these cases, a missionary is taxed only as he or she receives funds from the mission for personal living expenses.

Benevolent Fund Disbursements to Employees

2010-08-19T05:53:00.000-07:00

Question:

An employee of a church was given a gift from the church benevolent fund to assist with curing a personal financial problem. Should the church withhold the taxes on this benevolence from the employee's pay check, or simply issue a W-2 to the employee, or do nothing?

Answer:

It is wise to be careful when distributing gifts to employees from the church's benevolent fund. As one might imagine, supplementing an employee's low pay with, presumably, non-taxable gifts from the benevolent fund could be tempting.

Nevertheless, most churches do distribute benevolent fund gifts to members and non-members in the community who have emergency financial needs. These funds have been collected from donors who wish to be generous with those in need; they are not motivated to disguise compensation. Accordingly, I believe that one-times gifts such as the one described above should be classified as benevolent gifts that are non-taxable and non-reportable on Form W-2 or any other form.

On the other hand, if a church congregation encourages benevolent fund contributes to help supplement an employee's low pay and, subsequently, disburses these funds to him/her, then these payments should be reported as taxable income to the employee.

Non-Taxable Life Insurance for the Pastor

2010-07-22T19:37:00.000-07:00

Question:

May a church pay for variable universal life insurance for the pastor and his wife without showing it as income?

Answer:

Right "out of the horse's mouth" -- IRS Executive Compensation - Fringe Benefits Audit Techniques Guide (02-2005):

"Group term life insurance premiums paid to insure the lives of a spouse or dependent of an executive are included in the gross income of the executive (Treasury Regulation §1.61-21(b)(1)) . Employers attempt to classify such payments as a deminimis fringe benefit; however, the Government takes a very narrow view of this provision (PLR 200033011)."

IRS Publication 15-B, Employer's Tax Guide to Fringe Benefits, explains that only group, term life insurance policies may enjoy these benefits and then only the first $50,000 of death benefit.

Clearly, the above scenario strikes out in two respects: 1) it's not group term life insurance, and 2) the spouse is covered.

Employee Loan by Church to a Pastor

2010-07-15T11:58:00.000-07:00

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.

Love Offerings to Pastor Need Restructuring

2010-07-15T11:20:00.000-07:00

Question:

A minister gets quite a bit of love offerings each week, usually cash. The minister then turns around and gives the majority of it to the church. What is your opinion of the treatment both from an income and deduction standpoint?

Answer:

As currently structured, the church must submit the minister a Form W-2 with the full amount of his weekly receipts recorded as taxable income in Box 1 of the form. This income is subject to both income tax and self-employment tax. The contributions should be reported by the church to the minister, as it would to all of its donors, consistent with IRS Publication 1771. He may, in turn, deduct these contributions on Schedule A.

It appears that the church finances could benefit from planning that most often takes place during observation of church budget processes. The budget should establish a salary and benefits package, including a housing allowance designation. This will likely reduce the pastor's weekly receipts, but also leave the church with more of the funds currently received as donations from the pastor.

Donation of Vehicle to Church, Used by Minister

2010-07-15T08:38:00.000-07:00

Question:

A donor in a church donates a vehicle to the pastor for his personal use. The donors state that it is "his" van and want the van to stay with him in case he leaves. Church minutes record that the van was a gift and that the van would be gifted to the pastor after his employment ceases (as a benevolent gift). What are the tax effects of this transaction?

Answer:

There are several potential unanticipated pitfalls apparent in the above inquiry.

First, in order for the donor to receive a write-off as a charitable gift of the van it must be donated to the church. The van should have been titled in the church's name upon title transfer. The church and donor should be careful to follow instructions provided in IRS Publication 526. Publications 4302 and 4303 may also be helpful.

As an employee of the church, any personal use of the van will be subject to taxation. Publication 463 should be consulted by the church in preparation of the minister's Form W-2 to assure that the proper amount of income is reported.

Second, if at any time the vehicle is transferred by the church to its pastor, the value of the vehicle as of that date will be considered taxable income. The use of the word "benevolent" will not overcome the substance of the transaction that an employee of the church has been compensation with non-cash property.

A search of this blog will reveal additional information regarding "gifts" to church, including ministerial, employees.

"Exclusive Use Test" -- Business Use of Home Deduction by a Minister

2010-07-15T07:58:00.000-07:00

Question:

How much can an overseas missionary deduct from income for SE tax purposes for business use of his home? Much of his ministry is one-on-one or else small group Bible studies and takes place in his home living room. Obviously this part of the house is not used exclusively for business purposes. Are you aware of any basis for claiming a larger office in home expense beyond what would be allowed under the "used exclusively" test?

Answer:

Directly quoted from IRS Topic 509:

"Where the exclusive use requirement applies, you cannot deduct business expenses for any part of your home that you use for both personal and business purposes. For example, if you are an attorney and use the den of your home to write legal briefs and also for personal purposes, you may not deduct any business-use-of-your-home expenses. Further, under the principal-place-of-business test, you must determine that your home is the principal place of your trade or business after considering where your most important activities are performed and most of your time is spent, in order to deduct expenses for the business use of your home."

Since the pastor cited above does not use his living room regularly and exclusive for business purposes, no portion is deductible as a business expense. Further, if he is provided an office by the ministry, then it is unlikely that he will satisfy the principal-place-of-business test--an additional stipulation for business-use-of-home deductions.

Switch to Roth IRA from 403(b) Church Retirement Plan

2010-07-15T07:40:00.000-07:00

Question:

A church is currently contributing $6,000 per year to an Internal Revenue Code section 403(b) retirement plan for its pastor. He wants the church to stop putting that money into the 403(b) and start putting it into Roth IRAs for himself and his wife. Can the church pay for Roths for himself and his wife even if the wife is not an employee of the church? This benefits the pastor in that he sets aside tax-free income when he retires, but of course, he loses the tax deferment of the 403(b). Are there any other negatives for the pastor in making this move?

Answer:

Since standard Roth IRA plans are not employer plans, the arrangement discussed above will be treated as if the church had given the $6,000 as additional compensation to the pastor and he subsequently invested the funds into Roth IRAs for he and his wife. The church will simply facilitate his personal investment choices. The $6,000 would be reported as taxable compensation in Box 1 of his Form W-2 and no longer excluded from tax (nor listed as an elective deferred in Box 12a).

For ministers who have not opted out of self-employment tax, they lose not only the reduction of taxable income enjoyed by contributors to 403(b) plans, they no longer may exclude the contribution from SE income on Schedule SE. In effect, the change costs these ministers 15.3 percent of their retirement plan contributions.

Office in Home Deduction for Pastors

2010-03-27T07:44:00.000-07:00

Question:

A pastor receives a Form W-2 from the church reporting his compensation. The church cannot offer him an office at the church so he does most of his studies at home. Can he claim some of the home expenses for his church office? The pastor was told that he could do it if the church gave him a Form 1099 but not if he received a W-2.

Answer:

Employees (ones who receive Form W-2) are eligible to claim office-in-home deductions on Form 2106 if none is provided by their employers. Independent contractors who receive Form 1099-MISC from their customers may deduct an office-in-home using Form 8829.

Some churches erroneously issue Form 1099-MISC to their pastors but this does not prohibit legitimate office in home deductions. The office in home deduction may reduce his income tax by virtue of its inclusion as a miscellaneous itemized deduction (Schedule A); the calculation is determined on Form 2106 and transferred to Schedule A. (The use of a ministerial housing allowance will mandate reduction of this Schedule A amount.) Further, his self-employment income subject to SE tax on Schedule SE should be reduced by the Form 2106 unreimbursed employee business expenses, including his office in home deduction. This Schedule SE adjustment is not subject to the same partial loss of deduction experienced on Schedule A.

Reporting "Gifts" to Missionaries on Form 1099-MISC

2010-03-19T19:04:00.000-07:00

Question:

A church gives money directly to a missionary in honor of 25 years of service in the field. The church issued a 1099-MISC and reported it in Box 7 (non-employee compensation). The missionary's tax preparer tells him that the church incorrectly reported it in box 7 and that it should have reported it in Box 3 (other income) since it was a gift, trying to avoid him having to pay self-employment tax on the monies.

When, if ever, should monies paid to missionaries be reported in box 3 rather than box 7?

Answer:

The church has filed the form correctly. The instructions to Form 1099-MISC leave little room for negotiation in this matter (http://www.irs.gov/pub/irs-pdf/i1099msc_09.pdf).

The Ministers Audit Technique Guide produced by the IRS states:"There are numerous court cases that ruled the organized authorization of funds to be paid to a retired minister at or near the time of retirement were gifts and not compensation for past services. Rev. Rul. 55-422, 1955-1 C.B. 14, discusses the fact pattern of those cases which would render the payments as gifts and not compensation"
(http://www.irs.gov/businesses/small/article/0,,id=210018,00.html). Unless the minister qualifies in this sense, the income is reportable in Box 7. If the above situation does apply, then it should not be reported on Form 1099-MISC at all (or on any other form).

According to the Form 1099-MISC instructions, Box 3 might be used to report missionary payments if the following applies:

"Prizes and awards received in recognition of past accomplishments in religious, charitable, scientific, artistic, educational, literary, or civic fields are not reportable if:

The winners are chosen without action on their part,
The winners are not expected to perform future services, and
The payer transfers the prize or award to a charitable organization or governmental unit under a designation made by the recipient. See Rev. Proc. 87-54, 1987-2 C.B. 669."

Charitable Travel (Run it through the Church or Pay it Personally?)

2010-03-09T16:56:00.000-08:00

Question:

A donor gave a large sum of money in 2009 to a church's designated fund for missions travel. It was announced that only a small portion of the fund (essentially the portion not received from the donor) was available to the general congregation and that the remainder was sequestered for the donor's 2010 missions travel. Does this procedure comply with the Internal Revenue Code?

Answer:

Publication 526 indicates that travel for charitable purposes is deductible in many cases. Below, I've reproduced a significant section from the Publication.

To me, the bigger issue is not whether the travel is deductible but whether the deduction is allowable in 2009 or 2010 and who must defend its appropriateness in light of the tax rules. Had the donor simply paid for his own expenses, then he would have done so, presumably, in 2010. Also, he personally would stand responsible before the IRS to substantiate his answers to the questions implied in Publication 526 (again, see below). By accepting and disbursing the contribution, the church has put itself in the position of needing to ascertain whether the travel qualifies for a deduction (and in which year it qualifies), a potentially sticky position to be put in when the donor and his tax advisors could handle this themselves.

Publication 526: "Travel. Generally, you can claim a charitable contribution deduction for travel expenses necessarily incurred while you are away from home performing services for a charitable organization only if there is no significant element of personal pleasure, recreation, or vacation in the travel. This applies whether you pay the expenses directly or indirectly. You are paying the expenses indirectly if you make a payment to the charitable organization and the organization pays for your travel expenses.

"The deduction for travel expenses will not be denied simply because you enjoy providing services to the charitable organization. Even if you enjoy the trip, you can take a charitable contribution deduction for your travel expenses if you are on duty in a genuine and substantial sense throughout the trip. However, if you have only nominal duties, or if for significant parts of the trip you do not have any duties, you cannot deduct your travel expenses."

Temporary Versus Indefinite Assignment (travel deduction issues)

2010-03-09T16:42:00.000-08:00

Question:

A missionary was sent by his home church in one state to another state two years ago to help start a church and other ministries. His church sends monthly support. Can he claim the rent and utilities for his rental house in the mission location as business (travel) expenses? He maintains a permanent residence back in the state of his home church. Also, if the housing qualifies as travel expense is there a limit to the amount he can claim, such as an amount equal to the ministry support received?

Answer:

Travel away from one's tax home is only deductible if it is on a temporary assignment. IRS Publication 463 discusses temporary versus indefinite assignments.

"If your assignment or job away from your main place of work is temporary, your tax home does not change. You are considered to be away from home for the whole period you are away from your main place of work. You can deduct your travel expenses if they otherwise qualify for deduction. Generally, a temporary assignment in a single location is one that is realistically expected to last (and does in fact last) for 1 year or less.

"However, if your assignment or job is indefinite, the location of the assignment or job becomes your new tax home and you cannot deduct your travel expenses while there. An assignment or job in a single location is considered indefinite if it is realistically expected to last for more than 1 year, whether or not it actually lasts for more than 1 year.

"If your assignment is indefinite, you must include in your income any amounts you receive from your employer for living expenses, even if they are called travel allowances and you account to your employer for them."

It seems apparent that a missionary in the situation posed in the question above certainly does not qualify for business travel deductions on his housing away from his original tax home.

Departing Pastor Gift (or is it Compensation?)

2010-02-27T07:10:00.001-08:00

Question:

I have a question concerning the taxability of a “love gift” given to a departing pastor after he has left the church. We have been told by our convention that if the church follows certain steps, a gift made after the minister’s final day of payment for services will not be taxable to the minister.

The requirements include being voted on by the church, given after the minister’s final day of payment and completely voluntary on the part of the membership and including information in the churches minutes.

Answer:

The IRS "Minister Audit Technique Guide" available at the following link is particularly helpful in answering questions such as these:
http://www.irs.gov/businesses/small/article/0,,id=210018,00.html

I cite here a few sections from the guide, but more information is available there--particular in the section with the heading, "Gift or Compensation for Services."

"There are numerous court cases that ruled the organized authorization of funds to be paid to a retired minister at or near the time of retirement were gifts and not compensation for past services. Rev. Rul. 55-422, 1955-1 C.B. 14, discusses the fact pattern of those cases which would render the payments as gifts and not compensation.

"The Tax Court had ruled in Potito v. Commissioner, T.C. Memo 1975-187, aff'd 534 F2d 49 (5th Cir. 1976), that the value of a boat, motor and boat trailer was included in gross income as payment for services. The taxpayer, a minister, had not produced any evidence regarding the intention of the donors that the transfer of the property was out of 'detached and disinterested generosity.'"

In the contemplation of these issues, I encourage reference to my October 28, 2009, blog post as well.

Housing Allowance Expenses Paid Directly by Church

2010-02-24T18:49:00.000-08:00

Question:

Can a pastor's house payment and other expenses equal to his housing allowance be paid directly from the church bank account?

Answer:

Technically, the answer is yes. I know of no ministry that does this and I strongly recommend against it. Most church treasurers are busy enough without processing all the pastor's housing expenses. One check per pay period can be issued to the pastor to cover his cash compensation, plus his housing allowance.

Question:

If a pastor has opted out of social security does he have to show housing on the Form W-2?

Answer:

First, he does not need to show it on Form W-2 because it is the church that prepares the form, not the pastor.

Regardless whether the pastor has opted out of social security, I strongly recommend that the church report the housing amount in Box 14 as a memo item. While it is not technically required, it reports to the pastor the amount that he must account for. Any excess designated amount above his actual expenses must be claimed as taxable income (Clergy Housing Allowance Clarification Act of 2002).

Sabbatical Trip Paid by a Church

2010-02-18T17:16:00.000-08:00

Question:

A pastor at a church is taking a 3-month sabbatical trip for "rest and renewal." The expenses for the trip are being paid by the church. Does the IRS require that these expenses be considered income to the pastor for Form W-2 purposes?

Answer:

IRS Publication 463 of helpful here. The taxation issue relates substantially to whether the trip is for "bona fide business (ministry) purposes" or for personal purposes. For example, a trip to visit ministries supported by a church for purposes of encouragement and accountability in the work of its people, and for the purpose of reporting back to the church are clearly business purposes.

Another question implied by the Publication relates to whether a pastor "would otherwise be allowed to deduct the travel expenses" had he paid for the trip himself (as an employee of the church).

More...
"You can deduct all of your travel expenses if your trip was entirely business related. If your trip was primarily for business and, while at your business destination, you extended your stay for a vacation, made a personal side trip, or had other personal activities, you can deduct your business-related travel expenses. These expenses include the travel costs of getting to and from your business destination and any business-related expenses at your business destination.

"If your trip was primarily for personal reasons, such as a vacation, the entire cost of the trip is a nondeductible personal expense. However, you can deduct any expenses you have while at your destination that are directly related to your business."

Travel outside the U.S. is also addressed in the Publication, requiring careful consideration of matters not addressed in this posting.

Accordingly, if a church pays for an entire trip that has both business and personal components, an accurate allocation will be required before Form W-2 can be prepared. The personal costs must be reported as taxable income.

Church Use of GAAP Accounting

2010-02-09T14:32:00.000-08:00

Question:

In response to your February 24, 2009, blog posting that suggests, "Unless a church wishes to report its financial results using full GAAP accounting, I recommend recording equipment purchases as expenses and omitting any depreciation concern," I am afraid the church will not have "formal control" over the assets nor a good record (or evidence) of its possession (other than the invoices) when unexpected events occur, say if it is stolen. Is it wise to ignore Generally Accepted Accounting Principles?

Answer:

You may wish to review the full blog posting, but the question allows me to address some important points. Each church should be able to identify the property it owns. Catastrophic events such as fire and vandalism do befall churches. It may be wise to video church property on a periodic basis for this very purpose. Of course, off-site storage of equipment lists will aid greatly in documenting a loss.

My point about using a strict cash basis of accounting does not address this need. My suggestion to use this very simple method relates 1) to the lack of trained accounting personnel in many small churches (including provision for turnover in often voluntary positions) and 2) to the lack of understanding of more complex accounting reports by the common layperson. The use of the cash basis does not excuse these churches from maintaining proper fund accounting for designated gifts.

Churches that have the ability to employ trained personnel should use GAAP. These same personnel will also have the understanding necessary to communicate financial results to others. Several of the Christian organizations that I serve maintain their books on the accrual (GAAP) basis, but budget on the cash basis. This requires trained and experienced accounting personnel but seems to satisfy the need for GAAP accounting systems and for lay-friendly reporting of receipts and disbursements. Readers who want more information regarding these issues may request a copy of a presentation I have given to students of college-level accounting courses.

Question:

What happens to the real and personal property purchased by the church in the event of its liquidation? To whom should it be distributed?

Answer:

These are questions that the church constitution should answer in a manner consistent with local law. Most U.S. church constitutions address this contingency by granting the transfer of its assets to another church or Christian ministry that can carry out the spirit of the original church's mission.