MinistryCPA - Corey A. Pfaffe, CPA, LLC

This is another posting in the MinistryCPA Top 10 series: Filing your not-for-profit (NFP) organization government reports can be a daunting task, even more stressful than Form 1040. We have compiled a list of some of the top questions that we have received when dealing with Form 990. We recommend that NFPs consider asking their accountants these questions. This list is by no means comprehensive, but it does cover some of the areas for which we receive the most questions.   1. Does the organization need to file a Form 990?  The IRS has established a list of requirements to help tax-exempt organizations determine whether they need to file Form 990 and which one to file. Most not-for-profit organizations need to file Form 990, but if the organization is small enough it may only need to file an e-postcard (990-N). Churches are automatically recognized as a tax-exempt organization and generally exempt from filing Form 990. The IRS has published articles that give c...

Question: Our church is looking to apply for 501(c)(3) status. What are the advantages and disadvantages of pursuing formal recognition as a 501(c)(3) organization? Answer: To be tax-exempt under Internal Revenue Code § 501(c)(3), organizations (e.g., churches) must be organized and operated exclusively for exempt purposes set forth in the IRC. Additionally, a 501(c)(3) organization must not be organized or operated for the benefit of private interests (referred to as "private inurement"). Churches are automatically classified as IRC § 501(c)(3) entities regardless whether they have been formally recognized by the IRS. Yet, there are reasons to pursue formal recognition. Those that do receive this recognition receive from the IRS a Tax Determination Letter. Advantages : 1. Church schools that wish to apply for grants will likely need to provide a Tax Determination Letter since foundations do not want to disseminate funds only to find that they were contributed to disqu...

Question: A church is looking to rent out its parsonage to a non-staff member. Can the income that is received for the rent be used for church expenses not related to the property without affecting the church's tax-exempt status? Answer: The church tax-exempt status will not be affected by the use of the rental income for expenses not related to the property. However , the church may lose its real estate tax exemption for the property because it is not used for an exempt purpose. There are both potential Unrelated Business Income Tax (UBIT) and local property tax concerns. First, tax-exempt organizations generally do not need to report rental income as unrelated business income (UBI) unless it is financed with tax-exempt debt instruments. According to IRS Publication 598  (Page 10), "Rents from real property, including elevators and escalators, are excluded in computing unrelated business taxable income. Rents from personal property are not excluded." The IRS cite...

Question: Can a church member conduct piano lessons in her church's auditorium without threatening the loss of the congregation's tax-exempt status? Answer: Our answer comes from Matthew Davis, J.D., former attorney with the nationally recognized Christian Law Association, who currently practices law in Wisconsin, Illinois, and Florida. "As a tax-exempt entity, churches must be careful not only in what activities they engage in directly, but also in how they allow the facilities to be used. "The primary way in which this can come up relates to the requirement for tax-exempt status that the ministry's activities must relate to its exempt purpose. Assuming the church's exempt purposes are 'religious, charitable, and educational,' (three of the purposes specifically mentioned in the Internal Revenue Code 501(c)(3)), piano lessons would certainly fit within that expectation as 'educational' and therefore not be a problem on the tax-exempt...

Question :  A pastor approaches a church treasurer and requests that money be withheld from his paycheck for his tithe. How should a ministry handle this request? Answer : There are two ways to look at this. The first way involves directly reducing the pastor's taxable income. Although this may be considered a "great" tax planning move by some, it is possible this choice will run into trouble with the IRS. From a statutory perspective, the IRS would likely invoke the constructive receipt doctrine which states, in effect, that income you earn and are offered cannot be turned away simply for purposes of tax avoidance ( IRS Publication 525 ). Under these circumstances, the IRS would likely choose to add the income to the pastor's Form W-2 and tax it accordingly. The IRS would then permit him an itemized deduction; however, that may not turn out to be helpful if he chooses to take the standard deduction. On the other hand , if the pastor is simply asking for...

Question: A church treasurer asks, “Is tithing from payroll legally acceptable? And, if yes, how can I set it up through QuickBooks?” Answer: Many church and not-for-profit organizations find that their own staff members are among their most faithful donors! And, yes, it’s actually a good option for some employees. Of course, the same confidentiality and fidelity that oversees the charitable gifts of others to the employer must be exercised on behalf of staff members. In QuickBooks (Desktop version), set up a new payroll item and follow the sequence presented below. Give the deduction a name. The church or NPO could even set up multiple payroll items if some employees wanted to make designated gifts other than unrestricted contributions. Keep working through the sequence of intuitive QuickBooks windows until you reach the following setup window. None of the options here should be checked. Next…  AND VERY CRITICAL to calculate on net pay. ...

Question : One of a camp’s fulltime maintenance men is paid $600 per week ($31,200 per year). Some weeks he puts in less than 40 hours. But during camping season, he easily works 60 to 70 hours a week. Is the camp required to pay him overtime? Answer : As a general rule, the camp is not required to pay overtime if the employee meets two requirements. The employee meets the salary test and is paid on a salary basis of at least $913 per week (or $47,476 per year),* and  The employee meets the duties test of the executive, administrative, professional, or other exemption.** Because the maintenance man is paid $600 per week, he does not meet the salary test (No. 1 above). The camp is then required to do one of two options: Option A. Increase the employee’s weekly salary, or Option B. Reclassify the employee to a nonexempt employee, which means the employee will be paid on an hourly basis.  Option A is the simplest. The camp can just increase the maintenan...

Question: A church helped start a coffee shop which is a separate entity from the church. The primary goal of the coffee shop is to donate the profits to the church. Individuals have donated equipment to the church to establish the business. Can the donors claim charitable contribution deductions for the equipment? Answer:   Donors of non-cash gifts maybe be entitled to write-offs and should refer to IRS Publication 526  for further details regarding possible deductions. The question brings up greater concerns than whether the donors can deduct contributions. For example: Who takes responsibility for any legal compliance or liability concerns? Does the ministry hold a Seller's Permit from the State in which it operates? Is the ministry complying with all IRS and State employment laws for withholding taxes and other regulations? Who is responsible for income taxes on profit, if it happens to fall under the classification as Unrelated Business Income? ...

Question: A church member rents the church parsonage for $1,000 per month. But in lieu of paying rent, he performs services for the church. 1.) Should the church report his earnings on a Form W-2? 2.) Is the church's tax-exempt status affected by the renting of the parsonage to a non-staff member? Answer:   The renter must include the $1,000 dollars per month as taxable income, and the church should issue him a Form 1099-MISC if he is an independent contractor or Form W-2 if he is an employee (likely also subject to FICA tax). The major issue is not that the church will lose its overall tax-exempt status, but that it may lose the real estate tax-free status of the parsonage being rented to a non-staff member. The situation here relates to bartering for services actually performed as a part-time employee of the church, so the concern may be unwarranted. For information regarding the effect on tax exempt status follow the link below: http://minist...

Question: A church renting its parsonage to a non-staff member: 1.) Must a special account be established for funds received from rental of a church parsonage? 2.) Can these funds be used for church expenses not related to the property without affecting the church's tax-exempt status? Answer: We will address some significant concerns with the actions of the church; but first, in order to answer the questions above, the subject of Unrelated Business Income Tax (UBIT) must be considered .  According to IRS Publication 598 , " Rents from real property ... are excluded in computing unrelated business taxable income. " The IRS cites exceptions to this rule. One exception is if the rental is debt-financed, the organization may owe UBIT.  Now to answer the questions submitted: 1.) The church does not need to establish a separate account. It will not owe UBIT unless specialized debt-financing is employed which is beyond the scope of this blog post.   2.) T...

We (MinistryCPA) were recently asked our opinion on the setup of a church's budget. Question: A church wants to know if their budget should individually list the compensation of each staff person instead of combining employee salaries/wage for each type of employee that the church employs. For example, the church budget has a line for the pastor, youth minister, church secretary, etc., but then the budget combines all the part-time employees, such as nursery and accompanists. There have been discussions concerning the privacy of the employees, so how detailed should each line item be? Answer: In our experience, churches use a wide array of practices when it comes to budget and personnel. One extreme is including each employee's pay--even a breakdown of the compensation package. The opposite extreme is one number on the budget for the total of all the compensation, including benefits, of all the employees.  We like the approach of developing a budget on a per-program ...

Question: Does a church need an IRS Determination Letter? Answer: Generally, a church is already considered tax exempt and is eligible to receive tax-deductible contributions; therefore, a determination letter is not needed. But sometimes a church does need an IRS Determination Letter. To ascertain if a church needs a letter, the church should consult an attorney or CPA.  Requesting a 501(c)(3) IRS Determination Letter can be a time-intensive and costly process, if a letter is needed. Form 1023 needs to be filed to request the determination letter. The IRS's filing cost for Form 1023-EZ is $400. If a full Form 1023 is needed, the filing costs are higher. We encourage any nonprofit to work with a law firm or CPA firm when filing the Form 1023.   Here is an excerpt from the Form 1023 Instructions : Form 1023 not necessary. The following types of organizations may be considered tax exempt under section 501(c)(3) even if they do not file Form 1023.  Churches, i...

Question: At the end of each calendar year, a church has several members who make cash contributions to projects which the members have pledged to support in the upcoming year.  The church uses the modified cash basis of accounting. Believing that IRS regulations so require, the church's year end statement includes the donation even though it is designated for the next year.  For book purposes, can the church record the donation in a liability account as a "prepaid donation" rather than recognizing it as income in the year of receipt?  Answer: Taxpayers' donations are considered to be on a cash basis, so the understanding above is correct: the donor's year-end statement must include the donation even though it is designated for a project the church will emphasize in the next year.  If the church's financial statements are for internal purposes only (and they likely are since the modified-cash basis is not consistent with full-accrual GAAP accounting ...

Question: Our non-profit organization (NPO) participates in the Amazon affiliate program . We offer books on our website specifically related to our organization's exempt purpose. In addition, we also provide a link for individuals to purchase other non-related items from the Amazon website.  Are there any tax considerations our NPO needs to be aware of? Answer: There are three conditions that must be met in order for certain income producing activities to be taxed as Unrelated Business Tax Income (UBTI). Those three conditions that determine if an activity generates unrelated business income (UBI) are the following: Is the activity a trade or business? Is the activity regularly carried on? Is the activity not substantially related to the exempt purpose? If the answer is yes to each of the above conditions, it is likely the income producing activity is subject to UBTI, as defined under Internal Revenue Code Sections 512 and 513. We are familiar with a couple ways of...

Question: When is the sale of a parsonage taxable to a minister? When is it taxable to the church? Answer: We have recently received questions concerning the sale of church property, specifically related to parsonages. This blog post will try and tackle three possible scenarios of selling a parsonage, and how the owner should treat the gain or loss of the sale. Scenario #1 will assume that the minister (or taxpayer) is 100% owner of the parsonage. Scenario #2 will assume that the church is 100% owner of the parsonage. Scenario #3 will assume that the minister is 50% owner and the church is 50% owner of the parsonage. Scenario #1 If the minister (taxpayer) is the 100% owner of the parsonage at the time of sale, then a number of factors must be analyzed to determine the gain or loss. IRS Publication 523 has complete details on Selling Your Home . In this recent, associated blog posting , we provide a quick overview of how to determine a gain or loss on the sale of a home. ...