Author: rgorgol

The Liability of Churches for Acts of Child Molestation

A federal court issues an important decision.

Richard R. Hammar, Attorney, CPA
Bio

A federal court issues an important decision—Kendrick v. East Delavan Baptist Church, 886 F. Supp. 1465 (E.D. Wis. 1995)

Article summary. The potential legal liability of churches for acts of child molestation occurring on their premises or in the course of church activities remains a serious risk. A federal district court in Wisconsin issued an important ruling finding that a church was not responsible for the molestation of a young boy by a teacher at its school on the basis of negligent hiring or negligent supervision. The court also ruled that the church was not liable on the ground that it failed to comply with a state child abuse reporting statute. However, the court cautioned that its ruling was based on the fact that the victim could not prove that any of the incidents of abuse occurred after the time the church received notice of the offender’s misconduct. This case should provide church leaders with a powerful incentive to respond promptly and responsibly to any allegation of child abuse. Failure to do so will expose the church to needless and avoidable risk.

A federal district court in Wisconsin ruled that a church was not legally responsible for the molestation of a young boy by a teacher at the church’s school. It rejected the victim’s claim that the church was responsible on the basis of negligent hiring, negligent supervision, a failure to notify parents of the offender’s conduct, and a failure to report the abuse to civil authorities as required by state law. The court’s decision was based largely on the fact that the acts of molestation occurred prior to the time that the church had any reason to suspect that the teacher was a child molester. As a result, the case illustrates the critical importance of church leaders promptly and thoroughly investigating allegations of child abuse, and taking appropriate measures to protect children during and after the investigation. This article will review the facts of the case, summarize the court’s decision, and assess the relevance of the case to other churches.

Facts

A church hired a full—time teacher at its private school. The school’s administrator did not recall obtaining an application or resume from the teacher. Nor did the administrator recall contacting the teacher’s previous employers, or college, for references or grade reports. The teacher lived with the administrator (and his wife and small children) from 1982 through 1984, and frequently helped care for the administrator’s children. During the time the teacher taught at the school, a written policy permitted corporal punishment of students to be inflicted only by a parent with a teacher present. The school also had an “unwritten policy” that allowed teachers to administer corporal punishment outside the presence of a student’s parents if another adult were present and the parents were later notified.

While the teacher was employed by the school he removed a young boy (the victim) from class and disciplined him on at least ten occasions. On four of these occasions, the teacher engaged in sexual contact with the victim. The victim never informed either his parents or any church or school officials about the teacher’s behavior. Two months before the end of the teacher’s tenure at the school, the administrator received complaints from the parents of another boy regarding inappropriate behavior by the same teacher. These parents alleged that (1) when the teacher visited their son when he was home ill from school, he took his temperature using a rectal thermometer; and (2) during an overnight church trip with the teacher and a number of other children their son was awakened in the night with a hand near his genitals. The administrator immediately launched an investigation of these charges under the direction of the church board. He interviewed the teacher and the boy whose parents made the accusations, and held a number of meetings with the parents and the church board. While the investigation was in process, the teacher was allowed to remain in the classroom and was not restricted in any way. The administrator’s investigation did not address whether or not the teacher had molested other children. The administrator ultimately concluded that the allegations involving the teacher could not be “proved or disproved.” He noted that the teacher had some medical background and as a result it may have been appropriate for him to use a rectal thermometer. Further, there was no proof that it was the teacher’s hand that was near the boy’s genitals. The administrator decided not to report the allegations to the civil authorities pursuant to the state child abuse reporting statute.

The boy’s parents were not satisfied with this result, and they continued to demand the teacher’s removal. It was at this time that the administrator heard a rumor that the teacher had “had some problem with homosexuality” prior to his employment by the church. In response to this rumor, the administrator contacted the church—affiliated college the teacher had attended, and was informed that the teacher had been temporarily dismissed from the college for a brief period after confessing that he had engaged in homosexual activity on a weekend retreat. Another round of meetings occurred involving the teacher, the administrator, and the president of the college. The three agreed that, even though there was no wrongdoing by the teacher had been proven, the best way to resolve the controversy was for the teacher to resign. He immediately did so—both as a teacher and as a member of the church.

Prior to the parents’ accusations neither the church nor school had any knowledge of improper conduct by the teacher with the victim or any other student.

The victim experienced severe emotional and psychological problems as he matured. When he was in high school, a friend put his hand on the victim’s knee while he was driving a car. The victim reacted by beating his friend uncontrollably. He later explained his behavior as an attempt to punish his friend for what the teacher had done to him years before. After this outburst, the victim was taken to a hospital emergency room where he knocked down a police officer. He was taken to a psychiatric hospital for two weeks, where he was diagnosed with several disorders stemming from the teacher’s abuse.

When the victim was twenty years old, he sued the church claiming that it was legally responsible for the teacher’s misconduct. The victim claimed that the church was responsible for his injuries on the following grounds:

(1) Negligent selection. The victim alleged that the church was negligent in failing to exercise reasonable and sufficient care in the selection of the teacher. Specifically, the victim claimed that the church had failed to perform an adequate background check prior to hiring the teacher by failing to (1) have the teacher complete an employment application, (2) contact prior employers for a reference, and (3) obtain an academic transcript from the college he attended.

(2) Negligent supervision. The victim alleged that the church was negligent in failing to properly supervise the teacher. Specifically, the victim noted that the teacher had disciplined him on several occasions in a manner contrary to the school’s written and unwritten policies on corporal punishment.

(3) Failure to notify. The victim alleged that the church failed to notify the victim’s parents about the teacher’s molestation of the second boy (whose parents made the initial accusations).

(4) Failure to report the abuse. The victim alleged that the church was responsible for his injuries because the administrator, who was a mandatory reporter of child abuse under state law, failed to report the accusations made by the parents of the second boy.

The church asked the court to issue a “summary judgment” in its favor. A summary judgment in favor of a defendant is an extraordinary remedy in which a court summarily dismisses a lawsuit without allowing it to be presented to a jury on the ground that reasonable minds would not rule in favor of the plaintiff.

The court’s ruling

The court issued a summary judgment in favor of the church. Its discussion of each of the victim’s theories of liability is presented below.

negligent selection

The court noted that “negligence” requires proof that (1) the church had a duty to the victim to exercise reasonable care to protect him from harm; (2) the church breached its duty by acting carelessly or in a manner creating an unreasonable risk of harm; (3) the church’s carelessness was the cause of the victim’s injuries; and (4) the victim suffered actual injuries or damages.

The court concluded that the church owed a duty to the victim to exercise reasonable care for his protection. It based this conclusion in part on the Wisconsin child abuse reporting statute, which provides in part:

EXT A … school teacher, administrator or counselor … having reasonable cause to suspect that a child seen in the course of professional duties has been abused or neglected or having reason to believe that a child seen in the course of professional duties has been threatened with an injury and that abuse of the child will occur shall report ….

A violation of this statute may result in criminal penalties. The court observed: “The Wisconsin legislature, then, has specifically imposed on school officials an affirmative duty to protect students from actual or threatened abuse by reporting such conduct to the authorities.” This duty is also based on common sense, since “it is eminently logical to expect that teachers, school administrators, day care employees, and other professionals entrusted with the daily care of children will exercise some degree of care in ensuring their wellbeing and protecting them from harm.”

The court also agreed with the victim that the church breached this duty by failing to exercise reasonable care in the selection of the teacher. It observed:

EXT [I]t is our view that a reasonable jury could nevertheless find that school officials breached their duty to protect students by failing to exercise ordinary care …. [The administrator] does not recall obtaining a job application from [the teacher] nor contacting [his] prior employers [or college] for references or grade reports. [The administrator] did talk to [the teacher’s former pastor] but did so only after [the teacher] had already been employed by the church …. [The teacher] had also lived with [the administrator] and his family from the time he became a volunteer youth pastor for the church; through this experience [the administrator] no doubt became well—acquainted with [the teacher] and observed his demeanor around [the administrator’s] own children.

EXT In sum [the administrator] based his assessment of [the teacher’s] qualifications as a teacher on personal experience and observation as well as one conversation with his former pastor; he did not, however, review any information regarding [the teacher’s] academic record or seek input from previous employers regarding his work experience. Whether a more thorough background check would have revealed any irregularities is a question of [causation]; for purposes of this analysis, however, we believe that a reasonable jury could find that, when hiring someone who was to supervise and interact with young children [the administrator] did not use ordinary care by failing to adequately investigate [the teacher’s] background.

While the court ruled that the victim had established the first two elements of negligence (a duty to exercise reasonable care in the protection of children from harm, and a breach of that duty), it concluded that the victim failed to establish the third element—that his injuries were caused by the church’s actions. Causation in the context of negligence means that the defendant’s negligence was a “substantial factor” in causing the victim’s injuries. It emphasized that “a mere possibility of such causation is not enough; and when the matter remains one of pure speculation or conjecture or the probabilities are at best evenly balanced, it becomes the duty of the court [to rule in favor of the defendant].” The victim insisted that the administrator’s failure to more adequately screen the teacher prior to hiring him was the cause of his injuries since the administrator would not have hired the teacher had he more thoroughly checked his academic and work history and discovered that he had been temporarily suspended from college for “homosexual activity.” The court disagreed:

EXT There is no evidence … to indicate what [the administrator] would have done had he made this discovery …. Absent any other information [a jury] would be left to speculate whether or not a more thorough background check would have even uncovered this information and, if so, whether or not [the administrator] would have nevertheless hired [the teacher]. Had [the administrator] sought [the teacher’s] academic transcript, it is not clear whether he would have noticed this gap in [his] attendance record; and even if he had, attempting to determine the explanation [the teacher] would have given is a matter or pure conjecture. And even assuming that [the teacher] would have told the truth, or that [the administrator] would have contacted [college] officials directly, it is not clear what he would have discovered. Had he reached [the president] or other administrative officers, it appears that he would not have been told of the rumor of [the teacher’s] “homosexual problem,” let alone the details of the incident, given their lack of awareness. And because the reason for disciplinary action taken against students is often times not a matter of public record, it is not clear that he would have received any such information even if he had reached [college officials]. This is especially true where, as here, [the student’s] conduct was not criminal or dangerous to others, and apparently was not considered to be so serious that it precluded his readmission to [the college] and subsequent graduation.

EXT Of course, even assuming that [the administrator] would have become privy to this information had he checked [the teacher’s] academic record, the [victim] has provided no proof that [the administrator] would have found [the teacher] unfit to teach at the [school] …. [I]t is important to note that there is no evidence that [the teacher] had performed unsatisfactorily in any previous jobs or had a substandard academic record; nor is there any indication that [he] had ever been disciplined by any previous employer or for any other conduct at [college] …. [G]iven the fact that [the college] only temporarily suspended [him] after his confession, it appears that his transgression (whatever it was) was deemed a one—time “mistake,” and not a permanent character flaw rendering him unfit for accreditation. It, in fact, seems highly unlikely that [the administrator], after observing [the teacher’s] conduct in his home over the past year and with his own children, would have rejected his teaching application based on a single incident which seemed totally out of character.

The court then turned its attention to the important question of the relevance of homosexual activity when assessing the suitability of an adult to work with minors. This is a question that many church leaders have asked. Does evidence of prior or current homosexual activity automatically disqualify a person for any position involving contact with minors? The court responded as follows:

EXT [T]here is a complete lack of evidence in the record regarding any connection between engaging in homosexual activity (whether or not one identifies himself as a homosexual) and pedophilic behavior. There is no evidence in the record to indicate that the incident at [college] involved children. Based on this, it seems clear that, had [the administrator] learned of this information prior to [the time he hired the teacher] he would not have breached a duty of care to protect students had he hired [the teacher]. And if hiring [the teacher] under such circumstances would not have constituted a breach of duty, then hiring him without the benefit of such information cannot … be considered a cause in fact of the [victim’s] harm. Even assuming, then, that a more thorough background check would have uncovered this information, a [jury] would have no logical basis for concluding that, based on issues relating to sexual orientation, [the administrator] would have found [the teacher] to be unfit to teach, or an increased risk to children.

• Key point. The court concluded that a church is not responsible for acts of molestation by a teacher even if the church hired the teacher with knowledge of prior homosexual behavior, so long as (1) the prior homosexual behavior was a one—time and isolated event; (2) the behavior did not involve children; (3) no statistical evidence is offered showing a connection between a homosexual orientation and pedophilia; and (4) the church was aware of no other allegations of inappropriate contact of minors by the individual. Other courts may not reach the same conclusion.

negligent supervision

The victim claimed that the church was negligent in the supervision of the teacher’s activities, and that this negligence contributed to his injuries. Specifically, the victim argued that the school should have limited the number of times the teacher could have disciplined students, since this would have minimized the risk of molestation. In other words, the victim insisted that a church school has a continuing duty to supervise teachers. The court disagreed that churches or schools have so pervasive a duty of supervision. It based this conclusion on the following considerations:

It noted that the right of teachers to discipline students is “unquestionably reasonable and done in nearly every educational setting.”

It “is not unusual for some students to be reprimanded … numerous times over the course of a school year.”

The administrator received no complaints regarding the improper removal of the victim or any other student from class. Accordingly “from the perspective of [church] officials [the teacher] was administering discipline in the same manner as other instructors. While [he] could have been abusing his trust during the process, there is absolutely no indication that [the administrator] or other school officials were notified or should have been aware that child abuse or any violation of the [church’s] corporal punishment policies was occurring.”

The court concluded that

EXT in order to pursue a claim of negligent supervision in this case, the [victim] must show that [church] officials had notice of [the teacher’s] improper conduct with [the victim] or other students. What from the outside appeared to be a normal and common exercise of authority in this case may very well have been something quite different; [church] officials, however, had no reason to suspect [the teacher] of wrongdoing at any time prior to the [accusations made by the parents of the other boy].

However, the court ruled that the church was “placed on notice” of the teacher’s potential wrongdoing when the parents of the other student communicated their accusations to school officials. The school had a duty to supervise the teacher’s actions from this time forward, and as a result any molestation occurring during this period of time could be attributable to the church’s negligent supervision. The court observed:

EXT After [the allegations of the other student’s parents] were raised, one could arguably conclude that [the administrator] failed to exercise ordinary care by not limiting [the teacher’s] unsupervised contact with students pending his investigation; prior to that time, however, one could not conclude that [church] officials, with no reason to suspect any wrongdoing, acted unreasonably in their supervision of him.

The court noted that the allegations of the second student’s parents were made two months before the teacher left the school, and there was no evidence that the victim was molested during this time. As a result, even if church or school officials breached their duty of adequately supervising the teacher during the last two months of his tenure, this breach was not the cause of the victim’s injuries. The court noted that the victim himself could not recall the dates when he was molested, and it refused to assume that any of the four alleged acts of molestation occurred during the final two months of the teacher’s tenure. The court refused to speculate regarding when the alleged incidents of abuse occurred. It concluded:

EXT [The victim has] not established facts which would allow a reasonable jury to [find that the church’s negligence caused his injuries]. Because [the victim] cannot recall with any degree of reliability the approximate dates on which he was abused, the [jury] would have no logical basis for concluding that any such incident occurred during the sliver of time in which any such breach of duty by [church] officials could be said to have contributed to the [victim’s] injuries. At best, it can be said that the [church] could share responsibility for [the teacher’s] conduct during the last 20 to 25 percent of his teaching tenure; coupled with the fact that [the victim] only recalls being abused four times, the probability that any such incident occurred [during the last two months of the teacher’s tenure] is very low, and cannot be ascertained with any degree of reliability …. [I]t is impossible to base a judgment on conjecture, unproved assumptions, or mere possibilities.

failure to report

The victim claimed that the church breached its duty to report to civil authorities the allegations of abuse made by the parents of the second student, and that this failure to report contributed to the victim’s injuries. It is interesting to note that the court concluded that the accusations of abuse by the parents of the second boy constituted “reasonable cause to suspect” that abuse had occurred thereby triggering a duty to report under the state child abuse reporting law. The court observed:

EXT [T]he use of a rectal thermometer on a school—age child, especially by someone other than a parent or a medical professional, clearly raises eyebrows, and seems difficult to justify absent compelling circumstances. And while the allegations regarding [the teacher’s] alleged fondling of the [second boy] may not have been independently substantiated, it nevertheless seems that a reasonable jury could conclude that [the administrator] would have had “reasonable cause to suspect,” if not believe, that [the teacher] had committed sexual abuse, and would have been obligated to alert the authorities under [the state child abuse reporting law].

However, the court again emphasized that the church’s breach of its duty to report the suspected abuse of the second boy to civil authorities could not have been the cause of the victim’s injuries since the victim could not prove that any of the acts of molestation occurred after the time a child abuse report should have been filed.

failure to notify

The victim claimed that the church failed to notify other parents of the accusations made by the parents of the other student, and that this failure contributed to his injuries. The court agreed that the church had a duty to inform other parents of the accusations made by the parents of the second boy (so they could “ascertain whether or not their children had been harmed by similar conduct”), and that the church breached this duty by not informing them. As noted above, however, the church’s breach of this duty did not cause the victim’s injuries since the victim could not prove that any of the acts of molestation occurred after the church’s duty to notify other parents arose.

Significance of the case to other churches

What is the relevance of this ruling to local churches? Obviously, a decision of a federal district court in Wisconsin is of limited significance since it has no direct or binding effect in any other state. Nevertheless, there a number of aspects to the ruling that will be instructive to church leaders in every state. Consider the following:

1. Negligent selection. All churches use volunteers or paid employees to work with children. If a child is molested by one of these workers, the church may be legally responsible for the injuries on the basis of the “negligent selection” of the worker. “Negligence” consists of a duty to exercise reasonable care with respect to another, a breach of that duty, and injuries that are caused by the breach. The court concluded that the church had a duty to use reasonable care when selecting teachers, and that it breached this duty. It based this conclusion on the following considerations:

The administrator did not recall obtaining a job application from the teacher prior to hiring him.

The administrator did not recall contacting the teacher’s former employers for references.

The administrator did not recall contacting the college the teacher attended for a reference and an academic transcript. What is the relevance of an academic transcript? The court pointed out that it would have shown “gaps” in an individual’s college attendance that might indicate disciplinary action.

• Key point. The court emphasized that it was dealing with an individual who had been hired to teach children. It concluded that “when hiring someone who was to supervise and interact with young children [the school administrator] did not use ordinary care by failing to adequately investigate [the teacher’s] background.”

• Key point. This case illustrates the importance of church and school leaders adequately screening those applicants for volunteer and compensated positions who will be “supervising and interacting with young children.” Failure to do so may subject the church or school to liability for acts of child molestation on the basis of negligent selection.

While the church breached its duty of reasonable care in the selection of teachers, it was not guilty of negligence since its failure to exercise reasonable care was not the “cause” of the victim’s molestation. The court based this conclusion on the following factors:

There was no evidence that the teacher performed unsatisfactorily in any previous job, or that he had ever been disciplined by a former employer. As a result, it was not clear that a more thorough background check would have uncovered any information indicating that the teacher should not be allowed to work with children.

Failure to contact college officials for a reference or academic transcript probably would not have revealed the one homosexual incident since college officials generally do not disclose the nature or basis of disciplinary actions to outsiders. The court observed that

EXT because the reason for disciplinary action taken against students is often times not a matter of public record, it is not clear that he would have received any such information even if he had reached [college officials]. This is especially true where, as here, [the student’s] conduct was not criminal or dangerous to others, and apparently was not considered to be so serious that it precluded his readmission to [the college] and subsequent graduation.

The importance of the court’s decision that the church breached a duty of care to the victim when selecting the teacher is not lessened by the fact that the court found that this breach was not the “cause” of the victim’s injuries. The court reached this conclusion because of two factors that often will not be present in the church context: (1) There was no evidence of any unsatisfactory job performance in the teacher’s previous jobs, and so the church’s failure to conduct a reference check of previous employers could not be the cause of the victim’s injuries. That is, even if the previous employers would have been contacted by the church, no information would have been shared indicating that the teacher posed a risk to children. (2) Failure to contact the teacher’s former college would have been futile, since college administrators generally do not reveal information concerning student discipline.

• Key point. The church was fortunate that nothing in the teacher’s employment or college backgrounds indicated that he might pose a risk to children. If it were likely that reference checks with the teacher’s prior employers and college would have raised questions, then the church’s failure to conduct these checks would have been the cause of the victim’s injuries and the church would have been responsible for the victim’s injuries on the basis of negligent selection. As a result, sound risk management dictates that churches conduct reference checks on employees and volunteers who will be working with minors.

• Key point. While colleges often refuse to disclose to outsiders disciplinary actions taken against students, this is not necessarily true for other institutions (churches, employers, etc.).

• Key point. Churches that are sued on the basis of the negligent selection of a child molester because they failed to conduct a reference check should consider making the same argument that the court adopted in this case—a church cannot be negligent for failing to conduct reference checks if such checks would have revealed no information suggesting that the molester posed a risk of harm to children.

2. The relevance of homosexual activity. Another significant aspect of the court’s ruling was its handling of homosexuality. Many churches have wrestled with the question of whether or not to allow a person to work with children who is a homosexual. Some churches absolutely refuse to allow such an individual to work with children, based on a belief that all homosexuals are pedophiles. Very few courts have addressed this issue, and that makes cases such as this one especially instructive. The court concluded that

EXT there is a complete lack of evidence in the record regarding any connection between engaging in homosexual activity (whether or not one identifies himself as a homosexual) and pedophilic behavior. There is no evidence in the record to indicate that the incident at [college] involved children. Based on this, it seems clear that, had [the administrator] learned of this information prior to [the time he hired the teacher] he would not have breached a duty of care to protect students had he hired [the teacher] …. Even assuming, then, that a more thorough background check would have uncovered this information, a [jury] would have no logical basis for concluding that, based on issues relating to sexual orientation, [the administrator] would have found [the teacher] to be unfit to teach, or an increased risk to children.

• Key point. The court concluded that a church is not responsible for acts of molestation by a teacher even if the church hired the teacher with knowledge of prior homosexual behavior, so long as

(1) the prior homosexual behavior was a one—time and isolated event;

(2) the behavior did not involve children;

(3) no statistical evidence is offered showing a connection between a homosexual orientation and pedophilia; and

(4) the church was aware of no other allegations of inappropriate contact of minors by the individual.

If any one or more of these conditions would not have been met, the court presumably would have found the church negligent for hiring the teacher.

3. Negligent supervision. While churches and schools have a duty to properly supervise youth activities, this duty is not absolute. Churches and schools are not “guarantors” of the safety of children. They will be legally responsible on the basis of negligent supervision for a child’s injuries only if they breach their duty of exercising reasonable care in the supervision of youth activities. The court in this case ruled that neither the church nor school had a “continuing duty” to supervise teachers, and were not automatically liable for the teacher’s acts of molestation. The court observed that

EXT in order to pursue a claim of negligent supervision in this case, the [victim] must show that [church] officials had notice of [the teacher’s] improper conduct with [the victim] or other students. What from the outside appeared to be a normal and common exercise of authority in this case may very well have been something quite different; [church] officials, however, had no reason to suspect [the teacher] of wrongdoing at any time prior to the [accusations made by the parents of the other boy].

But, the court cautioned that once church officials are presented with information indicating that a worker may pose a risk of harm to children, they have a duty to supervise the worker. If the church fails to adequately supervise the worker, and the worker injures a child, the church may be responsible for the injury on the basis of negligent supervision.

• Key point. It is critical for church leaders to respond promptly to allegations of inappropriate sexual conduct by youth or children’s workers. Such allegations immediately impose upon the church (and church leaders) a duty of supervision. Failure to discharge this duty can result in legal liability for the church, and perhaps its leaders, on the basis of negligent supervision.

• Key point. The court concluded that the church could not be liable on the basis of negligent supervision for the teacher’s acts of molestation. However, the court cautioned that its ruling was based on the fact that the victim could not prove that any of the incidents of abuse occurred after the time the church received notice of the offender’s misconduct. This case should provide church leaders with a powerful incentive to respond promptly and responsibly to any allegation of child abuse. Failure to do so will expose the church to needless and avoidable risk.

• Key point. The court concluded that unsubstantiated accusations of misconduct by a parent were enough to impose a duty on the church to supervise the teacher.

4. The church’s investigation. When presented with an allegation of inappropriate sexual conduct by a youth worker, church leaders often are unsure how to respond. This case provides some helpful insight.

the allegations

The school administrator received the following accusation from the parents of a minor concerning the teacher: (1) when the teacher visited their son when he was home ill from school, he took his temperature using a rectal thermometer; and (2) during an overnight church trip with the teacher and a number of other children their son was awakened in the night with a hand near his genitals.

the investigation

The administrator immediately launched an investigation, which included the following steps: (1) He interviewed the teacher; (2) he interviewed the boy whose parents made the accusations; (3) he held a number of meetings with the parents of the boy and the church board.

The administrator’s investigation did not address whether or not the teacher had molested other children.

During the investigation the teacher was allowed to remain in the classroom and was not restricted in any way.

The administrator ultimately concluded that the allegations involving the teacher could not be “proved or disproved.” He noted that the teacher had some medical background and as a result it may have been appropriate for him to use a rectal thermometer. Further, there was no proof that it was the teacher’s hand that was near the boy’s genitals.

The administrator decided not to report the allegations to the civil authorities pursuant to the state child abuse reporting statute.

what should have been done

The administrator’s investigation was potentially inadequate in a number of ways, including the following:

(1) The administrator did not address whether or not the teacher had molested other children.

(2) The teacher was not immediately suspended (with or without pay) from teaching or other school activities pending the investigation.

(3) The administrator did not report the alleged abuse to civil authorities pursuant to the state child abuse reporting law.

(4) The administrator’s conclusion that the allegations of misconduct could not be “proved or disproved” missed the point. The question in such cases is not whether the accusations can be “proved or disproved.” In many cases accusations will not be proved or disproved, but this does not mean that the alleged offender is vindicated and may be allowed to have further contact with minors. The question is whether or not there is a reasonable basis for concluding that the allegations are true. Absolute certainty is not required, and in most cases will not be possible. Many child molesters will deny that they have engaged in wrongdoing, and this forces church leaders to make decisions based on reasonable inferences from the evidence. Finding that there is sufficient evidence of wrongdoing, when the alleged offender denies it, can be unnerving for church leaders who want absolute certainty. Church leaders must recognize that absolute certainty regarding the guilt or innocence of an alleged child molester will often not be possible. What is needed is a reasonable basis for concluding that the alleged offender is guilty. This makes a thorough investigation essential. The investigation should seek out other possible victims, witnesses, and any documentary evidence (photos, letters) that may substantiate the charges.

A church’s investigation can be assisted in some cases by reporting the alleged abuse to civil authorities who receive reports of child abuse. In many cases the civil authorities will conduct their own investigation, which can greatly assist church leaders in reaching an appropriate decision.

• Key point. The court concluded that unsubstantiated accusations of misconduct by a parent were enough to impose a duty on the church to supervise the teacher.

5. Failure to report the abuse. The court concluded that the church had “reasonable cause” to suspect that child abuse had occurred on the basis of the parents’ allegations that the teacher used a rectal thermometer to take their minor son’s temperature and that during an overnight church trip with the teacher and a number of other children their son was awakened in the night with a hand near his genitals. Under the state child abuse reporting law, the church had a duty to report these allegations since there was “reasonable cause” to suspect that abuse had occurred. The Wisconsin child abuse reporting statute provides in part:

EXT A … school teacher, administrator or counselor … having reasonable cause to suspect that a child seen in the course of professional duties has been abused or neglected or having reason to believe that a child seen in the course of professional duties has been threatened with an injury and that abuse of the child will occur shall report ….

The court observed:

EXT [T]he use of a rectal thermometer on a school—age child, especially by someone other than a parent or a medical professional, clearly raises eyebrows, and seems difficult to justify absent compelling circumstances. And while the allegations regarding [the teacher’s] alleged fondling of the [second boy] may not have been independently substantiated, it nevertheless seems that a reasonable jury could conclude that [the administrator] would have had “reasonable cause to suspect,” if not believe, that [the teacher] had committed sexual abuse, and would have been obligated to alert the authorities under [the state child abuse reporting law].

What lessons can be learned here? There may be a duty to report child abuse under state law, even if church officials cannot “prove or disprove” that it occurred, if there is a reasonable basis for believing that it occurred. Absolute certainty is not necessary. Further, note that the court’s interpretation of “reasonable cause” was a broad one. Finally, the court concluded that the child abuse reporting statute imposed a duty on school officials to exercise reasonable care in the protection of children.

• Key point. The court emphasized that the church’s breach of its duty to report the suspected abuse of the second boy to civil authorities could not have been the cause of the victim’s injuries since the victim could not prove that any of the acts of molestation occurred after the time a child abuse report should have been filed.

6. Failure to inform parents. The court recognized a potentially new and significant theory of liability against churches that has not been recognized in any other case. It concluded that a church has a duty to inform parents of accusations of sexual misconduct made against a youth worker so they can “ascertain whether or not their children have been harmed by similar conduct.” However, the court ruled that the church was not responsible for the victim’s injuries on the basis of its failure to notify his parents of the accusations made against the teacher since the victim could not prove that any of the acts of molestation occurred after the church failed to notify his parents.

• Key point. This potential basis of liability makes it even more critical for church leaders to respond immediately to accusations of sexual misconduct by youth workers. Ignoring such accusations subjects the church to liability for future incidents of molestation on the basis of negligent supervision as well as negligent failure to notify other parents.

© Copyright 1996, 1998 by Church Law & Tax Report. All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: M67 M10 M86 C0396
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

The Discipline of Church Members

The Iowa Supreme Court issues an important ruling.

Richard R. Hammar, Attorney, CPA
Bio


Article summary.
 Churches occasionally are compelled to discipline unruly members. These members sometimes sue their church, claiming that their discipline was defamatory, inflicted emotional distress, or violated the church’s internal rules. Most courts refuse to resolve such lawsuits on the ground that a church’s decisions regarding membership eligibility is an inherently ecclesiastical matter over which the civil courts lack jurisdiction. Such as the conclusion reached by the Iowa Supreme Court in an important decision.

Some churches, when confronted with an unruly or disruptive member who creates dissension within the congregation, respond by either disciplining the individual or dismissing him or her from church membership. Some church leaders resist administering discipline for fear of legal reprisals. This fear is not entirely unfounded, since disciplined members occasionally sue their church on the basis of a number of perceived wrongs including defamation, infliction of emotional distress, and a violation of church procedures. However, most courts that have addressed such lawsuits have dismissed them on the ground that they lack jurisdiction to resolve them. This was the conclusion of the Iowa Supreme Court in an important decision. This article will review the facts of this case, discuss the court’s ruling, and then assess the significance of the case to other churches and ministers.

Facts

In 1990 a member (“John”) in a local Reformed Church was suspended and later excommunicated in a disciplinary action taken by the church’s governing body. The church is affiliated with the Reformed Church of America, a hierarchical body with an established structure and procedures. The governing body of the local church is the consistory, which is made up of the installed ministers of the local church, the elders, and the deacons. The members of the board of elders are the elected spiritual leaders of the church and have the power to discipline members of the congregation. That power includes the power of excommunication.

John had been a member of the church for most of his life. His parents were founding members, and his father donated the land where the church is now located. In 1986 John became concerned over the direction the church was taking when his wife lost her job as janitor of the church and the church’s senior pastor introduced the practice of “spiritual healing.” The introduction of spiritual healing caused discord in the congregation. John became involved in a movement to remove the pastor from the church. The pastor left the church in 1989.

There was great discord in the church, so an interim pastor was immediately selected who was specially trained in interim ministry to assist troubled churches through their difficulties and make them viable again. John became angry with the interim pastor because he thought he was encouraging his wife to divorce him and his son to disobey him. In April of 1990 the board of elders temporarily suspended John’s privileges of membership and barred him from attending the church services. The congregation was informed of this move. Later the elders asked the police to be present at the church in case John showed up and attempted to disrupt services.

In May of 1990, a church member wrote a letter making formal charges against John. The charges instituted excommunication proceedings. The letter stated, in part:

EXT I feel that the time has come to place before the elders of the [church] the formation of actual written charges against [John] as a member …. These charges come only after much prayer and serious consideration and are being brought forth out of great concern for the well—being of all members of [the church]. The specific charges which are to follow do not come out of any personal vendetta … but rather out of the deep desire for the problems to be resolved for our church. It appears that everyone involved is anxious to get this over with so that we can all get on with our lives. The charges which I am about to present involve the offensive behavior patterns … as witnessed to over a period of time. Some of these offensive behaviors I have witnessed personally; others come from the shared testimony of others. I am hereby charging him with abusing his privileges as a member of the church and for disrupting the communion of the body of Christ. The examples of the offensive behaviors are as follows: First of all, there have been the relentless and demanding phone calls from [him] over a period of the past several months. This includes the many, many phone calls I have personally received, as well as that reported to me by [pastors of the church] and the other elders. These phone calls have been offensive, abusive, harassing, disruptive and threatening in nature. [John] has personally made such statements about [the interim pastor] to me as: “He is a life wrecker, traitor and marriage wrecker”; “I’m going to an institution because of him; My teeth will go a long ways in him”; “I’m going to kick him in the shins” ….

EXT [John] phoned [me again] and demanded a meeting with the consistory on Sunday April 29 and if he did not get his way that he would actually disrupt that morning’s worship services. [He] phoned late that night of April 28 and demanded that I should go over to [the interim pastor’s] house and “kick him out.”

EXT On Sunday April 29 [the interim pastor’s wife] answered the parsonage phone and after telling who he was [John] asked if “Judas was there”?, then went on to ask her “what it was like to live with a Judas”? He also asked her what she thought of “someone who breaks up a marriage”? He also informed her that he “got his directions from God” and that “God was on his side.” At about this time [John] also referred to me as “Judas”. To the best of my knowledge I have stated the above as accurately as possible.

A trial to the church judiciary was held in June of 1990 and John was found guilty of the charges. He was notified that if he failed to show marks of repentance, the board of elders would proceed to excommunication. At a July meeting between John and the elders, the conversation heated up and an elder exploded and called John a “lying bastard.” The elder later apologized to John for the outburst. Later, the board of elders met and voted to excommunicate John. The board sent him a letter informing him that he would be excommunicated from the church effective July 21. The congregation was informed on July 22 that John had been excommunicated.

In September of 1990 the clerk of the consistory sent a letter to John informing him that the consistory of the church, including the interim pastor, would no longer accept any telephone calls from him and that any future calls from him would be considered harassment.

In December the church hired a new pastor to start in February of 1991. The new pastor decided not to become involved in the former conflict. He asked the board of elders to write John a letter informing him that he would not accept his phone calls.

John sued the church, and various pastors and elders, on the basis of the following alleged wrongs:

(1) failure by the church and denominational agencies to follow their ecclesiastical procedures in the excommunication process

(2) defamation

(3) intentional infliction of emotional distress (also called “outrageous conduct”)

John alleged that nine statements made by the defendants were defamatory and constituted outrageous conduct: (1) A letter informing John he was being temporarily suspended from privileges of membership and attending services and setting forth the reasons for the suspension. (2) An oral communication to the church members that John’s privileges of membership and attending services were temporarily suspended. (3) A letter informing John he was excommunicated from the church. (4) An oral communication to the church members that John had been excommunicated. (5) Statements made the week of July 22 through July 28, 1990, allegedly informing church members not to communicate with John. (6) The letter initiating excommunication proceedings against John. (7) A letter from the board of elders mentioning John’ excommunication. (8) The letter informing John that any attempts to call the interim pastor and the members of the consistory would be considered harassment. (9) The letter informing John that the new pastor would not accept his telephone calls and that any calls to him would be considered harassment.

The church asked the trial court to dismiss the lawsuit. The court dismissed all charges, and John appealed.

The court’s ruling

The court reached the following conclusions with regard to the three allegations of wrongdoing contained in John’s lawsuit.

failure to follow church procedure

John appealed the church’s decision to excommunicate him to the regional synod—the final court of appeal from all cases originally heard by a board of elders. The synod affirmed the decision to excommunicate him. John insisted that “proper procedures” were not followed in the excommunication proceedings. The court ruled that John’s dismissal was an internal church matter over which the civil courts have no jurisdiction. It observed: “The general rule is that civil courts will not interfere in purely ecclesiastical matters, including membership in a church organization or church discipline. Iowa’s civil courts have a long tradition of refraining from interfering in purely ecclesiastical matters.” The court referred to an earlier decision of the Iowa Supreme Court involving a lawsuit by individuals who had been expelled from church membership. The plaintiffs in that case asked a civil court to reverse their expulsions. The Iowa Supreme Court refused to do so, and observed: “[O]rdinarily the courts have no jurisdiction over, and no concern with, purely ecclesiastical questions and controversies, including membership in a church organization ….” Brown v. Mt. Olive Baptist Church, 124 N.W.2d 445 (1963).

The court concluded: “[The church’s decision to excommunicate [John] was purely ecclesiastical in nature, and therefore we will not interfere with the action. Interfering with the decision would contravene both our history of leaving such matters to ecclesiastical officials and the first and fourteenth amendments of the United States Constitution.”

defamation

John claimed that although the alleged defamatory statements were made in an ecclesiastical context, defamation involves his civil rights and therefore it was appropriate for a civil court to exercise jurisdiction over his claim. The court rejected this basis of liability. First, it pointed out that defamation requires “publication” of the defamatory material to persons other than the individual who claims to have been defamed. Since at least four of the letters that John claimed were defamatory were sent only to him, they could not be defamatory.

Further, the court pointed out that truth “is a complete defense to defamation,” and therefore oral communications to church members that John’s membership was being temporarily suspended and that he had been excommunicated merely conveyed true and non—defamatory information to the congregation.

The court also found that all of the allegedly defamatory statements made by church officials were protected by a qualified privilege from being defamatory. The court explained the concept of “qualified privilege” as follows:

EXT The qualified privilege arises from the necessity of full and unrestricted communication concerning a matter in which the parties have an interest or duty, and is not restricted within narrow limits. A qualified privilege applies to otherwise defamatory statements when the statements are made in good faith on any subject matter in which the person communicating has an interest, or in reference to which that person has a right or duty, if made to a person having a corresponding interest or duty in a manner and under circumstances fairly warranted by the occasion. The elements of a qualified privilege are (1) good faith, (2) an interest to be upheld, (3) a statement limited in its scope to this purpose, (4) a proper occasion, and (5) publication in a proper manner and to proper parties ….

EXT We believe it is appropriate to apply a qualified privilege to statements made in the context of a church disciplinary proceeding. The May 31 letter constituted formal disciplinary charges against [John]. The statements in the letter were made by a church elder who had a duty imposed by the church to look after the spiritual well—being of the church members. The statements were made only to other church officials who would have a role in the disciplinary proceedings. Any statements made during the course of the ecclesiastical trial would also be qualifiedly privileged.

Even untrue statements may be qualifiedly privileged. The privilege, however, only protects statements made without actual malice …. Actual malice requires proof that the statement was made with ill—will, hatred, the desire to do another harm, or wrongful motive. It may also result from reckless or wanton disregard of the rights of others.

John claimed that church officials acted with malice in communicating some of the information about him. As proof, he cited evidence that (1) a neighboring pastor who assisted the church in finding an interim pastor assisted John’s wife in filing commitment papers against him, and (2) a one—time elder allegedly remarked that the church would be better off without certain families. The court concluded that this information did not prove actual malice on the part of church officials. The neighboring pastor was “not a defendant in this case, so his actions are irrelevant to whether these defendants acted with actual malice.” And, the former elder who made the other statement was “not a defendant and was not on the board of elders when [John] was disciplined. His statement cannot be attributed to the defendants.” As a result, the court concluded that “no actual malice exists and the statements are qualifiedly privileged.”

intentional infliction of emotional distress

John’s lawsuit claimed that the nine allegedly defamatory comments statements constituted “outrageous conduct” by the church officials which caused him to be severely and emotionally distressed. The court noted that “outrageous conduct” or intentional infliction of emotional distress requires proof of the following four elements: (1) outrageous conduct by the alleged perpetrator; (2) the perpetrator’s intentional causing, or reckless disregard of the probability of causing emotional distress; (3) the victim’s suffering severe or extreme emotional distress; and (4) actual and proximate causation of the emotional distress by the perpetrator’s outrageous conduct.

The court added that

EXT to be outrageous, the conduct must be so extreme in degree, as to go beyond all possible bounds of decency, and to be regarded as atrocious, and utterly intolerable in a civilized community. There must be substantial evidence of extreme conduct: It has not been enough that the defendant has acted with an intent which is tortious or even criminal, or that [he or she] has intended to inflict emotional distress, or even that [his or her] conduct has been characterized by malice, or a degree of aggravation that would entitle the plaintiff to punitive damages for another tort.”

John insisted that the filing of commitment papers against him constituted outrageous conduct. However, the court pointed out that the papers were executed by John’s own wife and a neighboring pastor. Therefore, “because neither is a defendant in this action that conduct is irrelevant.” While acknowledging that John “is understandably disappointed” with the church’s actions, “we do not believe a [jury] could reasonably conclude their conduct rose to the level of outrageousness.”

Significance to other churches and ministers

What is the relevance of this ruling to other churches? Obviously, a decision of the Iowa Supreme Court is of limited significance since it has no direct or binding effect in any other state. Nevertheless, there a number of aspects to the ruling that will be instructive to church leaders in every state. Consider the following:

1. Failure to follow church procedures. The Iowa Supreme Court, like nearly every other court that has addressed the issue in recent years, concluded that a church’s decision to discipline or dismiss a member is an inherently ecclesiastical matter over which the civil courts lack jurisdiction. This is so even if a dismissed member claims that the church failed to follow its own bylaws or other internal rules in disciplining or dismissing him or her. Church leaders should be familiar with the church’s internal rules, and strive to follow them. But most courts refuse to resolve lawsuits by disgruntled members who claim that a church failed to follow these rules.

2. Defamation. Church leaders sometimes confront potentially explosive issues, such as the discipline or dismissal of a member or trusted employee on the basis of misconduct that is known only to a few. Members of a congregation react with confusion and even anger to what is perceived to be an arbitrary action by the church leadership. Church leaders often are reluctant to disclose the basis for their decision for fear of being sued. This case illustrates that the law provides a measure of protection to church leaders under these circumstances who want to make appropriate disclosures of information. Such disclosures will not be defamatory if they communicate truthful information, or if they are protected by a qualified privilege. As the court pointed out:

EXT A qualified privilege applies to otherwise defamatory statements when the statements are made in good faith on any subject matter in which the person communicating has an interest, or in reference to which that person has a right or duty, if made to a person having a corresponding interest or duty in a manner and under circumstances fairly warranted by the occasion.

That is, statements by church members or officials to other members of officials on matters of common interest are protected by a qualified privilege, which means that they cannot be defamatory unless made with actual malice. The court defined actual malice as

“ill—will, hatred, the desire to do another harm, or a wrongful motive. It may also result from reckless or wanton disregard of the rights of others.”

3. Intentional infliction of emotional distress. Many persons have claimed that a church’s actions caused them emotional distress. As this court noted, the concept of “intentional infliction of emotional distress” is clearly defined and will rarely apply to a church. Few church actions or decisions will “be outrageous … so extreme in degree, as to go beyond all possible bounds of decency, and to be regarded as atrocious, and utterly intolerable in a civilized community.”

John v. Estate of Hartgerink, 528 N.W.2d 539 (Iowa 1995)

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Tax Court Addresses Minister Car Expenses

Ruling illustrates importance of maintaining proper records.

Richard R. Hammar, Attorney, CPA
Bio
Church Finance Today

Tax Court Addresses Minister Car Expenses

Ruling illustrates importance of maintaining proper records.

Richard R. Hammar

The Tax Court ruled that a minister could not use the “actual expense” method to compute his car expenses, since he failed to keep records to prove the percentage of total miles that he drove the car for personal reasons. Ministers, like any other taxpayer, can deduct the actual expenses they incur in using a car for business purposes. However, their business expense deduction must be reduced by a “personal use percentage”. This refers to the percentage of total miles that the car is used for personal reasons. The idea is this—expenses incurred in operating a car are deductible as a business expense only to the extent the car is used for business purposes. There is no deduction for expenses allocated to the personal use of a car. Since the minister could not establish the number of miles he drove the car for personal reasons, the personal use percentage could not be computed. This meant that the “actual expense” method could not be used to calculate the deduction for the business use of the car. The court permitted the minister to use the standard mileage rate to compute a deduction for the business use of the car. The court multiplied the standard mileage rate for the year in question times the number of miles the car was driven for business purposes.

What is the relevance of this case to church treasurers? Consider the following: (1) Church employees who use the actual expense method to compute a deduction for the business use of a car should be reminded to maintain adequate records documenting miles driven for both business and personal reasons so they can reduce their business expense deduction by the “personal use percentage.” Employees who use the standard mileage rate should be reminded to keep records to prove the number of miles a car is driven for business purposes. (2) If your church reimburses business expenses under an “accountable” arrangement, you will need to be sure that these same requirements are followed before reimbursing expenses associated with the business use of a car. Parker v. Commissioner, 65 T.C.M. 1740 (1994).

This article originally appeared in Church Treasurer Alert, April 1996.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

IRS Issues Ruling on Car Expense Reimbursements

Helpful guidance for church treasurers.

Richard R. Hammar, Attorney, CPA
Bio
Church Finance Today

IRS Issues Ruling on Car Expense Reimbursements

Helpful guidance for church treasurers.

Richard R. Hammar

Private Letter Ruling 9547001

Background. The IRS has issued a ruling that addresses the correct tax treatment of employer reimbursements of employee car expenses using the “standard mileage rate.” The ruling provides excellent guidance to church treasurers.

Facts. An employer adopted two approaches for reimbursing its employees’ business use of their privately-owned cars. “Non-supervisory employees” were required to supply odometer readings to document all business miles for purposes of calculating their reimbursable business mileage. Employees were reimbursed under this arrangement at the standard mileage rate specified by the IRS (30 cents per mile in 1995). “Supervisory employees” were reimbursed at a specified “per diem” (daily) rate or the standard mileage rate, whichever was greater. Odometer readings were not required on supervisory employees’ claim forms. The integrity of the claim was the responsibility of the employee. If the employer for any reason questioned a particular claim, the employee had to provide evidence supporting the claim of distance traveled.

What the IRS ruled. The IRS concluded that the employer’s method of reimbursing the business travel expenses of non-supervisory employees was “accountable,” and so the employer’s reimbursements did not represent taxable income to the employees. The IRS concluded that these reimbursements satisfied the three requirements of an “accountable” arrangement: (1) the expenses were for a legitimate business purpose, (2) the reimbursed expenses were adequately substantiated, and (3) any reimbursements in excess of substantiated expenses were returned to the employer. The IRS observed:

[E]mployees … who occupy non-supervisory positions are reimbursed for official use of their privately-owned vehicles at the applicable cents-per-mile rate. The … arrangement requires substantiation of the business use of privately-owned vehicles with mileage records and, thus, satisfies the substantiation requirement of … the regulations. Because non-supervisory employees are reimbursed at the applicable cents-per-mile rate, the return of excess requirement is deemed to be satisfied.

However, the IRS ruled that the supervisory employees were not reimbursed under an accountable arrangement. As a result, all of the employer’s reimbursements of these expenses had to be reported as additional income on the employees’ W-2 forms. The IRS observed:

The supervisors auto arrangement does not require supervisory employees to submit mileage records or return amounts in excess of substantiated expenses. This arrangement also establishes a different rate of reimbursement for supervisory employees. Reimbursements are calculated at [a daily rate] or the applicable cents-per-mile rate, whichever is greater.

To meet the substantiation requirement … of the regulations for passenger automobiles, an arrangement must require the submission of information sufficient to [demonstrate the amount, date, and business purpose of each reimbursed expense]. The supervisors auto arrangement does not require the submission of mileage records and, thus, does not meet the applicable substantiation requirements. In addition, the automobile arrangement provides for reimbursements at the rate of the greater of [a daily rate] or the applicable cents-per-mile rate without requiring the return of amounts in excess of actual or deemed substantiated expenses. Accordingly, the supervisors auto arrangement does not meet the substantiation or return of excess requirements of … the regulations. Therefore, the supervisors auto arrangement is a nonaccountable plan.

Importance to church treasurers. Many churches reimburse the business use of a privately-owned car by a pastor or other staff member using the standard mileage rate. Church treasurers must recognize that the use of the standard mileage rate to reimburse these expenses can be either “accountable” or “nonaccountable,” and that the differences between these two approaches is significant.
  • Accountable. Under an accountable arrangement, the church multiplies the standard mileage rate times the number of business miles that a pastor or other staff member substantiates (through a log book, diary, trip sheet, or odometer readings). To satisfy the substantiation requirement the records produced by the minister or other staff member must demonstrate the number of miles driven for business purposes along with the dates of travel. The substantiation and reimbursement should occur no less often than every two months. The church does not include any of the reimbursements as income on the employee’s W-2, and there are no business expenses to deduct.
  • Nonaccountable. This ruling illustrates that the use of the standard mileage rate to reimburse business use of a privately-owned car can be “nonaccountable” if the worker is not required to substantiate the business miles that are being reimbursed. In this case the “supervisory employees” were reimbursed for the business miles they claimed without any documentation. The fact that they were required to produce documentation to the employer upon request was not sufficient to make the arrangement accountable.

Tip. If your church uses the standard mileage rate to reimburse an employee’s business use of a privately-owned car, be sure you (1) only reimburse those miles for which the dates of travel and business purpose are adequately substantiated, and (2) reimburse substantiated business miles within 60 days.

Tip. Churches, like other employers, are free to use a rate different from the IRS “standard mileage rate” to reimburse an employee’s business use of a privately-owned car under an otherwise accountable arrangement. If the church uses a rate lower than the IRS approved rate, then the arrangement can be accountable up to the rate used by the church. The employee can treat the difference between the church approved rate and the IRS approved rate as an unreimbursed business expense. If the church uses a rate in excess of the IRS approved rate, then the arrangement can be accountable up to the IRS approved rate and all reimbursements in excess of this amount are then reported as taxable income to the employee on his or her W-2 at year end (assuming the employee is not required to return the excess to the church).

This article originally appeared in Church Treasurer Alert, March 1996.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Notifying Your Insurer of a Loss

Failure to promptly notify can result in loss of coverage.

Richard R. Hammar, Attorney, CPA
Bio
Church Finance Today

Notifying Your Insurer of a Loss

Failure to promptly notify can result in loss of coverage.

Richard R. Hammar

Shaw Temple v. Mount Vernon Fire Insurance Company, 605 N.Y.S.2d 370 (A.D. 2 Dept. 1994)

Background. Church insurance policies generally require that the church notify the insurance company in writing and within a specified period of time concerning any property damage or personal injury that occurs. Failure to do so can relieve the insurance company of any duty to defend the church in a lawsuit or pay a settlement or jury verdict as a result of the damage or injury. One church learned this lesson the hard way in a recent case.

Facts. A church member was injured when he fell on church property during a funeral. At the time of the injury the church had a general liability insurance policy that required the church to give the insurance company written notice of any accident “as soon as practicable.” Immediately following the accident the pastor instructed the chairman of the board of trustees to notify the church’s insurance broker about the accident. The chairman did so by calling the insurance broker’s office. An employee of the broker assured the chairman that the insurance company would be duly notified. In fact, the insurance company was not notified.

Nine months later the church received a letter from an attorney for the injured member threatening to sue the church unless it paid the member a large amount of money. The church immediately turned this letter over to its insurance broker, who in turn forwarded it to the church’s insurance company. The insurance company refused to provide the church with a defense of the lawsuit or pay any amount of money based on the accident since the church had failed to provide it with written notice of the accident “as soon as practicable” as required by the insurance policy.

The church responded by suing its insurance company. It sought a court order requiring the insurance company to defend the church under the terms of the policy and to pay for any damages awarded by a jury. A trial court ruled in favor of the church, and the insurance company appealed.

The court’s ruling. A state appeals court reversed the trial court’s decision and ruled that the insurance company had no legal duty to defend the church or pay for any jury verdict since the church had failed to notify it of the accident “as soon as practicable.”
  • First, the court concluded that when the church gave notice of the accident to its insurance broker it was not giving notice to its insurance company as required by the policy. Why? Because brokers are not necessarily “agents” of the insurance companies they represent. Rather, they are agents of the persons and organizations they insure. So, when the church gave notice to its broker it was not giving notice to its insurance company since the broker was not an agent of the insurance company.
  • Second, the court stressed that the insurance policy required that the church provide the insurance company with written notice of any accident. Even if the broker were an agent of the insurance company the church still failed to comply with the terms of the insurance policy since it provided the broker with oral rather than written notice of the accident.
  • Finally, the court concluded that the church’s nine-month delay in providing the insurance company with written notice of the accident was not “as soon as practicable” as required by the policy and as a result the insurance company had no legal duty to defend the church or pay any jury verdict based on the church’s negligence.

Importance to church treasurers. It is very important for church treasurers to be familiar with this case, for it illustrates three fundamental points:

1. Notifying your broker may not be enough. Many churches purchase their insurance through a local broker. Sometimes this person is a member of the congregation. Church leaders naturally assume that in the event of an accident or injury they can simply call this individual and everything will be “taken care of.” This case illustrates that such a conclusion may not always be correct. A broker may not be deemed to be an “agent” of the insurance companies he or she represents, and accordingly when a church provides its insurance broker with notice of an accident or loss it is not necessarily notifying its insurance company.

Tip. If you notify your insurance broker of a loss, insist on a written assurance that he or she will notify the insurance company in writing within the period of time specified in the insurance policy. If you do not hear back within a week or so, contact the broker again to follow up. Better yet, the church itself should notify both its broker and insurance company. The insurance company’s address will be listed on your insurance policy. Ask the insurance company to provide you with written confirmation of receipt of your notice.

2. Written rather than oral notice. If your insurance policy requires written notice, then be sure you provide written rather than oral notice of a loss.

Tip. Church treasurers should be familiar with the insurance policy’s provisions regarding notification of the insurance company. Is written notice required? If so, how soon after a loss? It is essential that these provisions be scrupulously followed in order to prevent a loss of coverage.

Tip. If you change insurance companies, be sure to review the new insurance policy. Do not assume that it will contain the same “notice” provisions as your previous policy.

3. A reasonable time. How soon does your church insurance policy require that notice be submitted to the insurance company following an accident or loss? Be sure you know, and that this requirement is followed whenever there is an accident, personal injury, or other kind of loss.

Tip. The duty to inform your insurance company of an accident or loss arises when the injury occurs, and not when a lawsuit is filed. The purpose of the notice requirement is to give your insurance company sufficient time to investigate the incident and provide a defense.

Example. On February 15, 1996 the church board at First Church is informed by a parent that her minor child was molested by a church volunteer. The volunteer is questioned, and admits having molested the child. This incident represents a potential “loss” under the church’s insurance policy, triggering a duty to inform the church’s insurance company of the loss within the period of time specified in the insurance policy. The church should inform its insurance company immediately. It is very important that it not wait until a lawsuit is filed to notify its insurance company. Such a delay not only hinders the insurance company’s ability to investigate the incident and defend the case, but it also may result in loss of coverage under the policy. This could have disastrous consequences to the church.

This article originally appeared in Church Treasurer Alert, February 1996.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Tax Changes of Interest to Churches

Changes churches should know.

Richard R. Hammar, Attorney, CPA
Bio

1. Increase in wages subject to FICA tax. The FICA tax rate (7.65% for both employers and employees, or a combined tax of 15.3%) did not change in 1995. However, the amount of earnings subject to tax increased. The 7.65% tax rate is comprised of two components: (1) a Medicare hospital insurance (HI) tax of 1.45%, and (2) an “old—age, survivor and disability” (OASDI) tax of 6.2%. For 1995 and future years there is no maximum amount of wages subject to the Medicare hospital insurance (the 1.45% “HI” tax rate). The tax is imposed on all wages regardless of amount. For 1995, the maximum wages subject to the “old—age, survivor and disability” (OASDI) portion of self—employment taxes (the 6.2% amount) increases to $61,200—up from $61,200 in 1994. Stated differently, employees who receive wages in excess of $61,200 in 1995 will pay the full 7.65% tax rate for wages up to $61,200, and the “HI” tax rate of 1.45% on all earnings above $60,000. Employers pay an identical amount. The new rule will impact churches and other religious organizations that have nonminister employees receiving wages in excess of $61,200. Such employers must be certain to properly withhold the Medicare tax in order to avoid any penalties.

2. IRS issues regulations clarifying the new charitable contribution substantiation rules. The IRS issued regulations in 1995 that clarify a few questions that have arisen in applying the new charitable contribution substantiation rules. The new regulations address the following matters:

Out—of—pocket expenses. Let’s say that Greg, a member of First Church, participates in a short—term missions project and in the process incurs $300 of unreimbursed out—of—pocket travel expenses. The IRS has long acknowledged that such expenses are deductible as a charitable contribution. But what about the new rules for substantiating charitable contributions of $250 or more? Do they apply to this kind of contribution? Is the church responsible for keeping track of Greg’s travel expenses in order to determine if they are $250 or more? The proposed regulations address this common problem. The IRS acknowledged that a charity “typically has no knowledge of the amount of out—of—pocket expenditures incurred by a taxpayer, and therefore, would have difficulty providing taxpayers with substantiation of unreimbursed expenditures.” To address this concern, the proposed regulations provide that where a taxpayer incurs unreimbursed expenses in the course of performing services for a charitable organization, the expenses may be substantiated by the donor’s normal records and an “abbreviated written acknowledgment” provided by the charitable organization. This “abbreviated written acknowledgment” from the charity must contain (1) a description of the services provided by the donor, (2) the date the services were provided, (3) whether or not the donee organization provided any goods or services in return and, (4) if the donee organization provided any goods or services, a description and good faith estimate of the fair market value of those goods or services.

In addition, the abbreviated written acknowledgment must be received by the taxpayer before the earlier of (1) the date he or she files a tax return claiming the contribution deduction, or (2) the due date (including extensions) for the tax return for that year.

Good faith estimate of value. To substantiate a individual charitable contribution of $250 or more, a donor must obtain a receipt from the charity that satisfies a number of requirements. One requirement is that the receipt state whether or not the charity provided any goods or services in exchange for a contribution of $250 or more (other than intangible religious benefits), and if so, a description and good faith estimate of the value of those goods and services. The regulations define a good faith estimate as an estimate of the fair market value of the goods or services provided by a charity in consideration of a donor’s contribution. The fair market value of goods or services may differ from their cost to the charity. The charity may use any reasonable method that it applies in good faith in making the good faith estimate. However, a taxpayer is not required to determine how the charity made the estimate.

Reliance on a charity’s estimate of value. The proposed regulations specify that a taxpayer generally may treat an estimate of the value of goods or services as the fair market value for purposes of computing a charitable contribution deduction if the estimate is in a receipt issued by the charity. For example, if a charity provides a book in exchange for a $100 payment, and the book is sold at retail prices ranging from $18 to $25, the taxpayer may rely on any estimate of the charity that is within the $18 to $25 range (the charitable contribution deduction is limited to the amount by which the $100 donation exceeds the fair market value of the book that is provided to the donor). However, a taxpayer may not treat an estimate as the fair market value of the goods or services if the taxpayer knows, or has reason to know, that such treatment is unreasonable. For example, if the taxpayer is a dealer in the type of goods or services it receives from a charity or if the goods or services are readily valued, it is unreasonable for the taxpayer to treat the charity’s estimate as the fair market value of the goods or services if that estimate is in error and the taxpayer knows, or has reason to know, the fair market value of the goods or services.

Intangible religious benefits. The regulations clarify that if a charity provides not goods or services to a donor in consideration for a contribution of $250 or more, other than intangible religious benefits, the receipt it issues to the donor must contain a statement that effect. This is an important point for church leaders to comprehend. Most churches will provide donors (of individual contributions of $250 or more) with no goods or services other than intangible religious benefits. The regulations remind religious organization’s that the receipts they issue to donors who make one or more individual contributions of $250 must state that no goods or services were provided to the donor other than intangible religious benefits.

Membership benefits. Under current law, a taxpayer who receives membership benefits in return for a payment to a charitable organization may not claim a charitable contribution deduction for more than the amount by which the payment exceeds the fair market value of the membership benefits. Accordingly, taxpayers and donee organizations must determine the fair market value of any membership benefits the charity provides to its donors. It is often difficult to value membership benefits, especially rights or privileges that are not limited as to use, such as free or discounted admission or parking, and gift shop discounts. In the new regulations the IRS recognized the difficulty charities often have in valuing benefits provided to members, and concluded that it is appropriate to provide limited relief with respect to certain types of customary membership Benefits. The regulations provide that both the charity and the donor may disregard membership benefits provided in return for a payment to the organization in calculating the value of a charitable contribution, if the benefits meet either of the following 2 tests:

(1) The benefits have an insubstantial value under existing IRS guidelines. Insubstantial value means that the benefits provided by the charity consist of low cost articles (items costing $6.60 or less for 1995), newsletters that are not commercial quality publications, and benefits worth 2% or less of a payment, up to a maximum of $66 for 1995.

(2) The benefits are given as part of an annual membership offered in return for a payment of $75 or less and fall into one of the following two categories: (i) Admission to events that are open only to members and for which the charity reasonably projects that the cost per person (excluding allocable overhead) for each event will be less than or equal to $6.60 in 1995. An example is a modest reception where light refreshments are served to members of a charity before an event. (ii) Rights or privileges that members can exercise frequently during the membership period. An example is free admission to a museum.

3. IRS provides some relief in complying with the new charitable contribution substantiation rules. Under a new law that took effect in 1994, donors must substantiate individual contributions of $250 or more with a receipt that satisfies a number of new requirements (discussed fully in chapter 8). Unfortunately, many charities have failed to provide receipts for 1994 contributions that comply fully with the new requirements. The result—the deductibility of millions of dollars in donations has been jeopardized. The IRS recently responded to this crisis by issuing a public notice informing taxpayers that they can still claim deductions for charitable contributions of $250 or more on their 1994 returns if they make a “good faith effort” on or before October 16, 1995 to obtain the required written receipt from the charity. The IRS noted that a “good faith effort” would include sending a letter to the charity requesting a receipt that complies with the new rules.

4. The IRS expresses concern over widespread failure by donors to properly substantiate their contributions of noncash property to charity. The IRS continues to express concern over the widespread lack of compliance with the substantiation requirements that apply to charitable contributions of noncash property valued by the donor at $500 or more (note that these rules are in addition to the new substantiation rules that took effect on January 1, 1994, as noted above). Any donor who contributes noncash property (i.e., homes, land, vehicles, equipment, jewelry) to a church or other charity, and who claims a deduction of $500 or more, must complete IRS Form 8283 and enclose it with the Form 1040 on which the deduction is claimed. If property valued at more than $5,000 is donated, then additional requirements apply. The donor must obtain a qualified appraisal and enclose an appraisal summary with the Form 1040 on which the deduction is claimed. These important requirements are discussed fully in chapter 8. Church treasurers should be familiar with these rules.

5. The Tax Court ruled that a taxpayer who sent contributions to a mosque in his family’s home town in Iran was not entitled to a charitable contribution deduction. Federal law specifies that a charitable contribution, to be tax—deductible, must go to an organization “created or organized in the United States or in any possession thereof.” In addition, the organization must be organized and operated exclusively for religious or other charitable purposes. This means that contributions made directly by church members to a foreign church or ministry are not tax—deductible in this country. Alisobhani v. Commissioner, T.C. Memo. 1994—629 (1994).

6. The IRS ruled that persons who give property to charity are eligible for a charitable contribution deduction even though their “gift” may revert back to them under specified conditions. A deceased person left a will giving $50,000 to a school to establish a scholarship fund for needy students attending the school (to be selected by the school). The will specified that in the event the school “ceases to exist as a school or ceases to be accredited by the state” the balance in the fund would revert to the deceased’s heirs. The question was whether the deceased’s estate could claim a charitable contribution deduction for the scholarship gift despite the possibility that the fund could one day revert to the donor’s heirs. The IRS ruled that the estate was entitled to a charitable contribution deduction—because the likelihood that the school would “cease to exist” was so remote as to be negligible. The IRS noted that the tax regulations specify that “if an interest passes to charity at the time of a decedent’s death and the interest would be defeated by … some act or the happening of some event, the possibility of occurrence of which appears at the time of the decedent’s death to be so remote as to be negligible, the deduction is allowable.” The IRS also noted that the tax regulations contain an example in which a decedent dies leaving a will which donates land to a city government “for as long as the land is used by the city for a public park.” The example concludes that “a deduction is allowable if, on the date of the decedent’s death, the possibility that the city will not use the land for a public park is so remote as to be negligible.”

7. IRS software to address worker status. One of the most difficult and confusing tasks church treasurers face is classifying workers are either employees or self—employed. The correct classification is essential, for it determines whether the church should (1) withhold taxes; (2) issue the worker a W—2 or 1099 form; and (3) include the worker’s wages and taxes withheld on the church’s quarterly 941 forms. In addition, this classification will determine the availability of a number of tax—free fringe benefits (such as employer—paid medical insurance premiums and cafeteria plans, which are taxable fringe benefits to self—employed workers). Unfortunately, it is often difficult to classify some kinds of church workers. Examples include part—time child care workers, musicians, custodians, and yard maintenance workers. Help may soon be on the way. The IRS has announced that it soon will be releasing computer software to assist employers in classifying a worker as either an employee or self—employed. The software (which the IRS calls the “SS—8 Determiner”) is based on the IRS 20—factor test. [See also Clergy Status—Employee or Self-employed.]

8. 403(b) retirement plans receive more scrutiny. One of the more popular retirement programs for employees of nonprofit organizations (including many churches) is the tax—sheltered annuity authorized by section 403(b) of the federal tax law. The IRS has expressed concern in recent months over the failure of many of these programs to comply with complex legal requirements. One IRS spokesman said recently that “we have made no secret of the fact that the IRS has yet to find a 403(b) plan fully in compliance,”and that the overall noncompliance rate may be as high as 90%! The IRS will be announcing a “voluntary correction program” in the near future under which nonprofit organizations can pay reduced fines in return for voluntarily correcting certain errors in their plans. One of the main areas of noncompliance for churches is excessive contributions (a church contributes more to a 403(b) on behalf of a pastor or other church employee than is permitted by law). Another problem—churches that permit self—employed workers to participate. These plans are available only to employees.

9. IRS says relief to specific bomb victims not deductible. The IRS has issued a public notice in response to many questions it has received concerning relief for the victims of the Oklahoma City bombing. Contributions to exempt organizations that are “earmarked for Oklahoma City federal building bomb attack relief” are tax—deductible. Not so for contributions that are “earmarked for relief of any particular individual or family.” What’s the difference? To be tax—deductible, a contribution must go to a charity and not directly to an individual. Contributions to a charity that “earmark” a specific person or family ordinarily are deemed to be gifts to the individuals and not to the charity. IRS Notice 95—33.

10. 1099 forms and church fund—raising programs. Many churches conduct sales of merchandise to raise funds for various programs and activities. Examples include bake sales, auctions, and bazaars. Should a church issue a 1099—MISC form to persons who purchase items at such events? No, said the IRS in a recent ruling. Charities that sell items in the course of fund—raising events need not issue 1099 forms to purchasers since no compensation is being paid to them. Form 1099—MISC is issued to non—employees who are paid compensation of $600 or more during the year. IRS Letter Ruling 9517010.

11. Tax Court denies charitable contribution deduction to church member for unsubstantiated contributions. A taxpayer claimed cash contributions of $3,500 to her church. She was audited and the IRS denied any deduction for these contributions. The IRS claimed that the woman had insufficient evidence to substantiate the contributions. The taxpayer claimed that these contributions were all made in cash, and so she had no canceled checks to substantiate them. She also claimed that she kept no records or receipts to prove her contributions. The only evidence she had was a letter from her church stating that the taxpayer made contributions of $3,500 to the church during the year in question “through tithes, offerings, and love donations.” No church representative testified during the woman’s trial. The Tax Court agreed with the IRS that the woman had failed to substantiate the $3,500 in charitable contributions to her church. It dismissed the church’s letter by noting that “the letter from the church is very general and provides no information as to how and when [her] contributions were made. The evidence presented does not satisfy the court that [she] made the contributions to the church in the amount claimed.” The court was satisfied that the woman made some contributions to the church, and allowed her a deduction in the amount of $450. Generic letters that merely report the total amount of contributions given by a donor during the year will not be enough to substantiate the donor’s individual cash contributions of less than $250. The letter, or receipt, must list church’s name and the dates and amounts of each contribution. Additional rules apply to the substantiation of individual contributions of $250 or more. Witherspoon v. Commissioner, T.C. Memo. 1994—593.

12. Impact of tax simplification. A number of sweeping proposals for tax reform are being discussed in Congress. Some “flat tax” proposals would eliminate most deductions, including a deduction for charitable contributions, in exchange for a flat income tax rate. How would such a tax impact churches and other charities? Would donations decline because of the loss of a contribution deduction? Two factors suggest that they would not. First—71% of all taxpayers can’t deduct their contributions under present law, because they cannot itemize deductions on Schedule A. A “flat tax” that eliminated charitable contribution deductions would only affect the remaining 29% of taxpayers that currently can deduct their contributions. Second—when the partial deduction of charitable contributions by nonitemizers expired in 1986, there was no decrease in charitable giving. We will be closely following the debate in Congress over tax reform. If any new laws emerge, we will let you know the details in future editions of this text.

13. IRS rules that a religious organization’s sales of books by its founder did not generate unrelated business income. The IRS noted that the books offered for sale provided information on the doctrine and principles constituting the basis for the religious beliefs of the organization’s members. The IRS further noted that the federal tax on unrelated business income does not apply to income generated from activities that are substantially related to an exempt organization’s exempt purposes. It concluded: “You will offer for sale books written by your founder. The books offered for sale are intended to provide additional information about your religious doctrine and principles. The books will be used to educate your members and prospective members about the tenets of your religion. Therefore, the sale of books written by your founder will be substantially related to the accomplishment of your religious purposes … Accordingly, this activity will not constitute an unrelated trade or business.” IRS Letter Ruling 9535050. [ Tax on Unrelated Business Income]

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

End of Year Contributions

How to address donations dated the previous year.

Richard R. Hammar, Attorney, CPA
Bio
Church Finance Today

End of Year Contributions

How to address donations dated the previous year.

Richard R. Hammar

The first Sunday in January often presents problems for church treasurers regarding the correct receipting of charitable contributions. For example, the first Sunday in January of 1996 falls on January 7th. Can a member who contributes a personal check to your church on Sunday, January 7th, deduct the check on his or her 1995 federal tax return if the check is backdated to read “December 31, 1995”? Many churches advise their congregations during worship services conducted on the first Sunday in January that checks contributed on that day can be credited to the previous year if they are dated December 31st of the previous year. Is this true? Unfortunately, the answer is no. The income tax regulations specify that “ordinarily, a contribution is made at the time delivery is effected. The unconditional delivery or mailing of a check which subsequently clears in due course will constitute an effective contribution on the date of delivery or mailing.” According to this language, a check dated December 31, 1995 but physically delivered in January of 1996 is deductible only on the donor’s 1996 federal tax return. This is so whether a donor “predated” a check to read “December 31, 1995” during church services conducted in January of 1996, or in fact completed and dated the check on December 31, 1995 but deposited it on or after January 1, 1996. The only exception to this rule is in the case of a check that is dated and mailed (and postmarked) in December of 1995. The fact that the church does not receive the check until January of 1996 does not prevent the donor from deducting it on his or her 1995 federal tax return. The rules are summarized in the table accompanying this article. Type of contributionChurch treasurer reports as a 1995 contributionChurch treasurer reports as a 1996 contribution
Checks written in December 1995 and deposited in church offering in January 1996.X
Checks written and deposited in church offering in January 1996 but “back dated” to December 1995.X
Checks written and deposited in church offering in December 1995 but “post dated” to January 1996.X
Checks written in December 1995 and deposited in the mail and postmarked in December 1995, but not received by the church until January 1996.X
Checks written in December 1995 and deposited in the mail in December 1995 but not postmarked until January 1996, and not received by the church until January 1996. X

This article originally appeared in Church Treasurer Alert, December 1995.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

IRS Issues New Charitable Contribution Regulations

Regulations clarify questions about contribution substantiation requirements.

Richard R. Hammar, Attorney, CPA
Bio
Church Finance Today

IRS Issues New Charitable Contribution Regulations

Regulations clarify questions about contribution substantiation requirements.

Richard R. Hammar

The IRS issued regulations in August that clarify a few questions that have arisen in applying the new charitable contribution substantiation rules. Perhaps the most relevant provision for church treasurers is the substantiation of “out-of-pocket” expenses incurred by a person who performs volunteer services on behalf of a charity.

To illustrate, let’s say that Greg, a member of First Church, participates in a short-term missions project and in the process incurs $300 of unreimbursed out-of-pocket travel expenses. The IRS has long acknowledged that such expenses are deductible as a charitable contribution. But what about the new rules for substantiating charitable contributions of $250 or more? Do they apply to this kind of contribution? Is the church responsible for keeping track of Greg’s travel expenses in order to determine if they are $250 or more?

The proposed regulations address this common problem. The IRS acknowledged that a charity “typically has no knowledge of the amount of out-of-pocket expenditures incurred by a taxpayer, and therefore, would have difficulty providing taxpayers with substantiation of unreimbursed expenditures.” To address this concern, the proposed regulations provide that where a taxpayer incurs unreimbursed expenses in the course of performing services for a charitable organization, the expenses may be substantiated by the donor’s normal records and an “abbreviated written acknowledgment” provided by the charitable organization.

This abbreviated written acknowledgment from the charity must contain the following information:
  • a description of the services provided by the donor
  • the date the services were provided
  • whether or not the charity provided any goods or services in return, and
  • if the charity provided any goods or services, a description and good faith estimate of the fair market value of those goods or services

In addition, the abbreviated written acknowledgment must be received by the taxpayer before the earlier of (1) the date he or she files a tax return claiming the contribution deduction, or (2) the due date (including extensions) for the tax return for that year.

Here is an example of an abbreviated written acknowledgement that complies with the new regulations: “Greg Jones participated on a missions trip sponsored by First Church from July 1-10, 1995, in the nation of Panama. His services included working in a medical clinic. The church provided no goods or services in return for these services.” The church should be sure that Greg receives this receipt before the earlier of (1) the date he files a tax return claiming the contribution deduction, or (2) the due date (including extensions) for the tax return for that year.

This article originally appeared in Church Treasurer Alert, October 1995.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

IRS Issues Audit Guidelines for Ministers

What church treasurers and ministers should know.

Richard R. Hammar, Attorney, CPA
Bio
Church Finance Today

IRS Issues Audit Guidelines for Ministers

What church treasurers and ministers should know.

Richard R. Hammar

On July 28, 1995, the IRS issued its audit guidelines for ministers under its “market segment specialization program” (MSSP). These guidelines will be used by IRS agents who audit ministers. Most of the information contained in the audit guidelines is a restatement of existing law. Here are some of the key provisions that will be interest to church treasurers:
  • Ministers “are generally considered employees” for income tax reporting purposes (although they are self-employed for social security with respect to their ministerial income).
  • The guidelines do not provide specific guidance in answering the sometimes troublesome question of who is a “minister” for federal tax purposes. Rather, they summarize some of the leading court decisions that have addressed this issue. Significantly, these cases include the Tax Court’s decision in Knight v. Commissioner, a case that has perhaps the most liberal definition of the term “minister.” See chapter 2 of Richard Hammar’s Church and Clergy Tax Guide for a full discussion of the Knight case.
  • “Special gifts” received by ministers from their employing church are includable in gross income for tax purposes.
  • “If the church or church agency pays amounts in addition to salary to cover the minister’s self-employment tax or income tax, these are also includable in gross income.”
  • “An accountable plan is an arrangement that meets all the [following] requirements: business connection, substantiation within a reasonable period of time, and return of amounts in excess of substantiated expenses within a reasonable period of time …. If an arrangement meets all the requirements for an accountable plan, the amounts paid under the arrangement are excluded from the minister’s gross income and are not required to be reported on his or her Form W 2. If, however, the arrangement does not meet one or more of the requirements, all payments under the arrangement are included in the minister’s gross income and are reported as wages on the Form W 2, even though no withholding at the source is required.”
  • If the church has a salary reduction arrangement which “reimburses” the minister for employee business expenses by reducing his or her salary, the arrangement will be treated as a nonaccountable plan because it does not meet the reimbursement requirement …. This is the result regardless of whether a specific portion of the minister’s compensation is designated for employee expenses or whether the portion of the compensation to be treated as the expense allowance varies from pay period to pay period depending on the minister’s expenses. As long as the minister is entitled to receive the full amount of annual compensation, regardless of whether or not any employee business expenses are incurred during the taxable year, the arrangement does not meet the reimbursement requirement.”
  • Ministers often pay a small annual renewal fee to maintain their credentials, which constitutes a deductible expense. However, ministers’ contributions to the church are not deductible as business expenses. They may argue that they are expected to donate generously to the church as part of their employment. This is not sufficient to convert charitable contributions to business expenses.”

Key point. The audit guidelines rely heavily on Richard Hammar’s annual Church and Clergy Tax Guide.

This article originally appeared in Church Treasurer Alert, September 1995.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Forgiving Our Debtors May Jeopardize Tax-Exempt Status

What a church should know before forgiving its debtors.

Richard R. Hammar, Attorney, CPA
Bio
Church Finance Today

“Forgiving Our Debtors” May Jeopardize Tax-Exempt Status

What a church should know before forgiving its debtors.

Richard R. Hammar

Background. Churches and other organizations that are exempt from federal income taxes must comply with several requirements in order to maintain their exempt status. One of these requirements is that none of the exempt organization’s resources “inures” to the benefit of a private individual—other than as reasonable compensation for services rendered or in direct furtherance of the organization’s exempt functions. Does an exempt organization’s forgiveness of a bad debt constitute prohibited “inurement”? That was the issue presented to a federal court in a recent case. While the case involved a non-religious charity, it has implications for churches and other religious organizations.

Facts. The founder of a tax-exempt charity also created a for-profit corporation. The for-profit corporation leased property from the charity, but did not pay rent in a timely manner and eventually accumulated hundreds of thousands of dollars in rental debt. The charity also “forgave” nearly $34,000 in interest owed by the for-profit corporation. The charity claimed that the interest was “forgiven” “because of the unlikelihood of repayment.” The IRS audited the charity and revoked its tax-exempt status. It concluded that the charity’s forgiveness of interest and failure to collect back rent from the for-profit corporation controlled by the charity’s founder amounted to prohibited “inurement” of the charity’s resources to the benefit of the founder. The charity appealed this ruling.

The court’s ruling. A federal court agreed with the IRS and upheld the revocation of the charity’s tax-exempt status. It noted a charity can lose its exempt status if it does not “operate exclusively” for exempt purposes, and if any part of its resources “inures” to the benefit of a private individual. The court observed:

First, the organization must “operate exclusively” for tax-exempt purposes. An organization’s tax-exempt status will not be revoked for providing “incidental” benefits while serving an exempt purpose. But a single substantial non-exempt purpose served by the organization does nullify the organization’s tax exemption regardless of the quantity or substance of its tax-exempt purposes. An organization does not operate exclusively for tax-exempt purposes if it serves a private rather than a public interest. This requirement applies to the organization’s actual, not purported, purposes.

Second, “no part of the net earnings” of the organization may “inure to the benefit of any private shareholder or individual.” “Private shareholder or individual” has been construed broadly by the courts as any person “having a personal or private interest in the activities of the organization,” including the organization’s founder and family.

These two requirements, “though separate, frequently overlap.” Failure to satisfy either requirement results in revocation of the organization’s tax-exempt status. The burden is on the organization to establish that it meets the statutory requirements for tax-exempt status.

The court concluded that the charity’s “forgiveness of the accrued interest is an example of how [its] earnings inured to private benefit,” namely to the benefit of a for-profit corporation owned by the charity’s founder.

Relevance to church treasurers. This ruling is directly relevant to any church treasurer whose church is considering the forgiveness of a debt owed to the church by anyone with a “a personal or private interest in the activities of the organization.” At a minimum this would include debts owed to the church by pastors or board members, and probably by church members as well. Often, these debts are in the form of a loan.

Key point. Churches often make loans to clergy in order to assist in the purchase of a home. In some cases the minister fails to pay the loan in full. Church treasurers and board members often do not know how to respond in such cases. This case illustrates an important point—delinquent loans should not be forgiven without careful consideration of the possible consequences to the church. In order to minimize jeopardizing the church’s exempt status, a church should not forgive a delinquent loan without, at a minimum, taking the following steps: (1) exhaust all reasonable means of collection, and (2) report the bad debt (principal and accrued interest) as income to the debtor. If the debtor is a current employee, the forgiven debt can be reported as income on the employee’s W-2. If the debtor is not an employee, use a Form 1099-MISC.

This article originally appeared in Church Treasurer Alert, August 1995.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

The New Social Security Reporting Procedures

What church treasurers should know.

Richard R. Hammar, Attorney, CPA
Bio
Church Finance Today

The New Social Security Reporting Procedures

What church treasurers should know.

Richard R. Hammar

Background. For many years the Social Security Administration has sent a “personal earnings and benefit estimate statement” (PEBES) to any person who requested one. This statement displays the person’s earnings based on either self-employment income or information provided by employers on W-2 forms. The statement also provides an estimate of benefits that the person may be eligible for both now and in the future.

Unfortunately, few workers ever request this information and this has led to many undetected problems. Here are some common examples:
  • A nonminister church employee’s social security benefits are reduced because the church failed to report one or more taxable fringe benefits on the employee’s W-2 forms. To illustrate, a church fails to report the value of the personal use of a church-provided car as income on an employee’s W-2. By understating the employee’s wages subject to social security (FICA) taxes, the church is reducing the employee’s social security benefits which are based on those earnings.
  • A nonminister church employee’s social security benefits are reduced because the church underreported the wages paid to the employee on the W-2 forms it issued. To illustrate, a church pays an employee $20,000 in 1995, but it inadvertently reports $18,000 as wages on the employee’s W-2. This clerical error will cause a reduction in the earnings reported to the Social Security Administration and this in turn may cause a reduction in the employee’s social security benefits.
  • A church incorrectly reports an employee’s social security number on a W-2 form. This will prevent wages from being credited to the employee’s record. Uncredited earnings can affect the employee’s future benefits.
  • A church incorrectly reports an employee’s name on a W-2 form. To illustrate, a female employee is married and the church begins reporting her wage information (on Form W-2) under her new name. If the employee has not reported her name change to the Social Security Administration, then this can prevent wages from being credited to the employee’s record. Uncredited earnings can affect the employee’s future benefits.

Tip. Church employees should be encouraged to immediately report to the Social Security Administration any change in their name. This will ensure that all wages are properly credited to the employee’s record. Reporting a name change is easy. The employee simply submits a Form SS-5 (application for social security card) to the Social Security Administration. Church treasurers may want to keep some of these forms on hand, and give them to employees who have a name change. You can order a supply by calling 1-800-772-1213.

Observation. Many employees incorrectly assume that notifying their employer of a name change is all they need to do. Notifying an employer does not change the records of the Social Security Administration, and mismatches will occur until the government is notified.

  • A minister fails to include the fair rental value of a parsonage as earnings subject to the self-employment tax. Remember that all ministers are self-employed for social security purposes with respect to their ministerial income. As a result they pay the self-employment tax (the social security tax for self-employed workers) rather than FICA taxes (the social security tax for employers and employees).
  • A minister fails to include a housing allowance as earnings subject to the self-employment tax.

Unfortunately, these kinds of errors are common, and they can disqualify workers from social security coverage or cause a needless reduction in benefits. Often, retired workers are not even aware that their benefits have been reduced because of one or more of these errors. Obviously, the solution to these problems is easy. The government should recognize that few workers ever take the time to obtain and review a PEBES statement from the Social Security Administration. The Social Security Administration should simply begin sending these statements automatically to all workers and encourage them to review the information for accuracy. This is exactly what Congress has required the Social Security Administration to do! Church treasurers need to be aware of the new rules, and be prepared for the questions they may soon receive.

The new reporting procedures. Here are the new reporting procedures in a nutshell:
  • February 1995. Between February and September of 1995 the Social Security Administration will mail a PEBES statement to nearly 9 million people age 60 or older who (1) have earnings credited to their social security number, and (2) are not currently receiving social security benefits.
  • October 1995. Beginning in October of 1995 and each year thereafter the Social Security Administration will send a PEBES statement to persons who reach age 60 during the year.
  • January 2000. By January of the year 2000, some 123 million eligible workers age 25 and older will receive PEBES statements each year.

Each PEBES statement provides a year-by-year display of a worker’s earnings as either a self-employed person or an employee, provides the worker with an estimate of future benefits, and asks the worker to carefully inspect the statement for errors. While many workers will contact the Social Security Administration directly if they have questions, many will be contacting their employers directly.

How church treasurers should respond. What steps can church treasurers take in response to the new reporting procedures? Consider the following:

Step 1: education. Church treasurers should inform any worker who will reach 60 years of age during 1995 that he or she will be receiving a PEBES statement from the Social Security Administration. The same will be true in the years 1996 through 1999 for workers who reach age 60 in those years. Beginning in the year 2000, any worker who is 25 years of age or older will receive a PEBES statement. One way to inform workers is to provide them with an appropriate letter. Here is a sample letter prepared by the Social Security Administration:

[Employer’s name] matches your Social Security and Medicare taxes dollar-for-dollar. This investment serves as a base for your retirement planning when you combine it with savings, in individual retirement account, or investments. To help you plan for your financial future, the Social Security Administration (SSA) can provide you with a Personal Earnings and Benefit Estimate Statement (PEBES) showing the earnings recorded under your Social Security number (SSN). The statement also provides an estimate of the Social Security benefits you and your family may qualify for now and in the future.

If you are age 60 or older and are not already receiving Social Security benefits, SSA will automatically send you a PEBES sometime between February 1995 and September 1995. Beginning in October 1995, and each year thereafter, eligible people who turn 60 in that year will also automatically receive a PEBES. By the year 2000, 123 million eligible individuals age 25 and older will receive an earnings statement each year.

Once you receive a statement, please carefully check the earnings to make sure they match your records. You don’t need to do anything unless you believe the earnings information is incorrect. If the error involves recent earnings at your current job, report the discrepancy to Social Security’s toll-free number, 1-800-772-1213. When you call, be sure to have your records of the correct earnings handy—such as W-2s, pay stubs, and tax returns. You should also call the toll-free number to report an SSA from properly crediting your earnings record which could affect future Social Security benefits payable to you and your family.

Step 2: corrections. Church workers who receive the PEBES statements may have questions for their church treasurers. In some cases errors will be detected. If it is clear that an error has occurred, church treasurers should do the following:
  1. incorrect earnings. If the church issued a W-2 form for a prior year that failed to report the correct amount of wages subject to social security taxes, then the church should file a Form W-2c (a corrected W-2) with the Social Security Administration. The Form W-2c reports the correct amounts of wages and social security taxes.
  2. missing earnings. If an employee was not issued a W-2 in a prior year, then a Form W-2 (original Copy A) should be filed for the missing year.

  3. Key point. A church that files a W-2c form to correct a W-2 form that underreported an employee’s earnings for a prior year may be responsible for paying back taxes plus interest.

    • miscellaneous. Here are some helpful hints when preparing correcting W-2 or W-2c forms: (1) Send W-2 and W-2c forms (with an accompanying W-3 or W-3c form) to the Social Security Administration, Data Operations Center, Wilkes-Barre, Pennsylvania 18769. (2) Never use a W-2 form to correct a previously submitted W-2 form. Use a Form W-2c instead—with a separate form for each year needing correction. (3) If the only correction needed is to an employee’s name or social security number, file only Form W-2c (not a W-3c) and have the employee contact the Social Security Administration to obtain an SS-5 form to change his or her name on the government’s records. However, if you need to correct the money amounts on a previous Form W-2 then a Form W-3c must be filed along with a Form W-2c. (4) If incorrect information reported on prior W-2 forms was also incorrectly reported on the church’s 941 forms submitted to the IRS, then you may have to correct the corresponding 941 forms by filing a Form 941c with the IRS. (5) Be sure the church’s employer identification number reported on your W-2c and W-3c forms (and 941c if applicable) is correct, and that you reported the same number on all of these forms.
  4. Step 3: precautions. There are a number of steps that church treasurers can take to reduce the chance of reporting incorrect information on an employee’s W-2 forms. Consider the following:
  6. review social security cards. Review the social security cards of new workers and be sure that church payroll records correctly report each worker’s name and social security number.
  7. reconcile W-2 and 941 forms. Add up the total wages reported on your quarterly 941 forms for the year and compare this amount to the wages reported on all of the W-2 forms issued by the church.
  8. the correct treatment of clergy. Remember that clergy are self-employed for social security purposes with respect to their ministerial income. As a result, they pay self-employment taxes rather than FICA taxes—even though they may report their income taxes as employees. This rule has important applications that some church treasurers miss. For example, it means that no amount should be reported in boxes 3 (social security wages), 4 (social security tax withheld), 5 (Medicare wages and tips), and 6 (Medicare tax withheld) on a minister’s Form W-2. A similar rule applies to nonminister employees who are employed by churches that have exempted themselves from the employer’s share of FICA taxes by filing a timely Form 8274 with the IRS. Such employees, like clergy, are treated as self-employed with regard to their church compensation.
  9. name changes. Encourage workers who change their names to promptly notify the Social Security Administration. Provide them with an SS-5 form to simplify the process.
  10. annual check of payroll records. Each year have employees check the accuracy of their names and social security numbers on the church’s payroll records.

  12. Key point. For more information on a church’s reporting requirements, see chapter 10 in Richard Hammar’s annual Church and Clergy Tax Guide.

  13. This article originally appeared in Church Treasurer Alert, August 1995.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

IRS Will Issue Regulations Explaining New Contribution Rules

Goal is to help reduce widespread noncompliance.

Richard R. Hammar, Attorney, CPA
Bio
Church Finance Today

IRS Will Issue Regulations Explaining New Contribution Rules

Goal is to help reduce widespread noncompliance.

Richard R. Hammar

The IRS is working on comprehensive regulations that will provide churches and other nonprofit organizations with guidance on complying with the charitable contribution substantiation rules that took effect in 1994. The regulations are being released in response to widespread noncompliance with the new rules. The IRS believes that most charities want to comply, but simply do not understand the new rules. When will the regulations be released? By the end of the year, says an IRS spokeswoman.

Key point. Among other issues, the regulations will address a common church question—how to treat a volunteer’s travel expenses incurred on a short-term missions trip on behalf of a local church. Such expenses often are deductible as a charitable contribution. But what if a volunteer’s expenses are $250 or more? Do the new substantiation rules apply, and if so, how? Many times the volunteer pays the expenses directly, and the church does not know how much they are and so cannot report them on the volunteer’s contribution receipt. Your author asked the IRS to address this issue in the regulations, and the IRS has confirmed that it will. We will give you the details as soon as the regulations are issued, probably by the end of the year.

Key point. Another issue the regulations will address—how does a charity value the goods or services that it provides in exchange for a donation? A common example—church bazaars and auctions. An IRS spokesman says the new regulations will suggest a number of ways a charity can value such goods or services.

This article originally appeared in Church Treasurer Alert, July 1995.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Keeping Church Records (Part 2)

When to keep and when to toss your church’s records.

Richard R. Hammar, Attorney, CPA
Bio
Church Finance Today

Keeping Church Records (Part 2)

When to keep and when to toss your church’s records.

Richard R. Hammar

The February 1994 issue of Church Treasurer Alert! contained the first in a series of articles on recordkeeping requirements for church records. That article addressed corporate and tax records. This article addresses personnel records. Future articles will address recordkeeping recommendations for several other categories of church records including insurance, correspondence, contracts, property, financial, vehicles, members, investments, and legal.

The problem. Most churches have no policy addressing the retention and disposal of church records. As a result, churches often go through the following phases:

Phase 1—Don’t throw out anything. Church records are kept indefinitely out of a fear that they may be needed in the future.

Phase 2—Frustration. Phase 1 creates frustration as the volume of records and “clutter” expands out of control.

Phase 3—Get rid of the clutter. Church workers go on “search and destroy” missions, aggressively discarding records to “get control” of the situation.

Phase 4—Anxiety. Church leaders wonder, “What did we throw out that we shouldn’t have?” This results in a return to phase 1, and the cycle begins again.

The solution. What is needed is a records retention policy based on applicable legal considerations and your church’s needs that will make records retention and disposal decisions systematic and rational. The “guesswork” and arbitrary nature of record retention decisions must be replaced with a sound and consistent policy. The table reproduced in this newsletter will assist you in developing such a policy with regard to personnel. A similar table in the February 1994 issue of this newsletter addressed the retention and disposal of corporate and tax records.

Key point. It is possible to keep some records too long—well beyond what is required by law. In some cases this can result in the retention of records that might be harmful in future litigation. On the other hand, disposing of records too soon can lead to unanticipated problems—both with various state and federal government agencies and in future lawsuits.

Tip: You can use the chart as a quick glossary of commonly used terms.

Tip: In establishing a records retention policy you should consider a number of factors in addition to how long to keep records. These include: (1) when to make copies of records, (2) maintaining the security of records (especially records you plan to keep permanently), including backups of computer records, and (3) developing a record retention schedule (a document that summarizes records, lists how long you plan to keep them, and indicates where they are kept).

Here are some additional factors to consider in developing a records retention policy for your church:
  • Make an inventory of existing records.
  • The church board should develop and approve your records retention policy.
  • Your records retention policy should be reviewed by a local attorney (who can check local and state requirements), a CPA, and your insurance agent.
  • There are many reasons to keep church records. These include legal requirements, potential relevance in future litigation, the needs of the organization, and historical importance. The table reproduced in this article suggests minimum periods of time for retaining various church records. Some of the suggested retention periods are based on legal requirements, while others are based on practical considerations. You may want to keep some records longer than the table suggests.
  • Some organizations maintain a “destruction of records journal”. When the period of time for keeping a record has expired, the record is described in the journal before being destroyed.
  • Do not destroy records, even when the period for keeping them has expired, if they may be relevant in pending or threatened litigation or in pending or threatened government (including IRS) investigations.

Personnel records. Every church keeps personnel records. In small churches that employ only the pastor, these records may include an application for employment, reference checks, a job description, and annual W-2 or 1099 forms. In larger churches that employ one or more nonminister employees, the list of personnel records can be long (including many of the forms listed in the table). The table lists most of the kinds of personnel forms that a church will use, along with a description of each form and a minimum time to keep each record.

Key point. Some of the recordkeeping requirements summarized in the table are based on federal laws that apply only to employers that are engaged in “interstate commerce.” Most local churches are not engaged in interstate commerce, unless they have substantial commercial transactions across state lines. For example, a church that sells tapes of its weekly services to individuals in other states may be engaged in interstate commerce. If in doubt, church leaders should assume that their church is engaged in interstate commerce.

Key point. The rules listed in the table are based on federal law requirements. Most states have their own requirements which may apply to churches. A local attorney should be consulted to determine the application of state law.

Key point. The rules summarized in the table are designed for the typical local church. Additional requirements may apply to large churches, denominational agencies, and parachurch ministries. To illustrate, the federal Family and Medical Leave Act imposes additional recordkeeping requirements on employers engaged in interstate commerce and employing 50 or more employees. The Civil Rights Act of 1964 imposes additional recordkeeping requirements on employers engaged in interstate commerce and employing 100 or more employees.

Key point. The recordkeeping rules for corporate and tax records were addressed in a table appearing in the February 1994 edition of Church Treasurer Alert! This table included some personnel records, including W-2 forms, W-4 forms, 1099 forms, receipts substantiating business expense reimbursements, and housing allowance designations.

CHURCH RECORDS—HOW LONG TO KEEP THEM

PERSONNEL RECORDS

Note. The recordkeeping periods are minimums. Do not destroy any record that may be relevant in pending or threatened litigation or a government investigation, that has historical value, or that otherwise may be useful or relevant.

documentdescriptionhow long to keep (choose the relevant rule or rules)
applications for employment (hired)churches often have prospective employees complete an application for employment that asks question about an applicant’s background, education, and prior work experienceRULE 1. Employers subject to Title VII of the Civil Rights Act of 1964 (15 or more employees, and engaged in interstate commerce) must retain “any personnel or employment record” for at least 1 year after the record was made, or until the disposition of a discrimination charge. 29 CFR 1602.14.
RULE 2. Employers subject to the Americans with Disabilities Act (15 or more employees, and engaged in interstate commerce) must retain such records for at least 1 year after the record was made, or until the disposition of a discrimination charge.
RULE 3. Employers subject to the Age Discrimination in Employment Act (20 or more employees, and engaged in interstate commerce) must retain such records for at least 1 year from the date of the personnel action to which the document relates. 29 CFR 1627.3.
RULE 4. If an employment application includes screening questions to determine an applicant’s fitness and suitability, or a statement authorizing the employer to obtain references (and releasing the references from liability) the application form should be retained permanently. If the employee later assaults or molests an adult or minor, this evidence will be helpful in proving that the church was not negligent in hiring the person.
applications for employment (not hired)churches often have prospective employees complete an application for employment that asks question about an applicant’s background, education, and prior work experienceRULE 1 (above).
screening formsused to determine the suitability of an individual to work with children (whether a paid employee or volunteer); includes background information on the individual’s criminal convictions, prior church membership, and prior involvement with youth activitiesRULE 5. Permanently. If the employee or volunteer later assaults or molests a minor, this evidence will be helpful in proving that the church was not negligent in hiring the person. Because of liberalized statutes of limitation in many states, lawsuits can be filed long after an alleged offender leaves the church.
reference forms—generalforms or letters completed by current or former churches, employers, schools, friends, or relatives, addressing the suitability of an applicant for employment RULE 6. Permanently—if the employee counsels adults (or works with minors—see below). If the employee or volunteer later assaults or molests a counselee, this evidence will be helpful in proving that the church was not negligent in hiring the person. Because of liberalized statutes of limitation in many states, lawsuits can be filed long after an alleged offender leaves the church.
reference forms—for youth workersforms or letters completed by current or former churches, employers, and youth organizations addressing the suitability of an applicant for youth work (paid or volunteer)RULE 7. Permanently. If the employee or volunteer later assaults or molests a minor, this evidence will be helpful in proving that the church was not negligent in hiring the person. Because of liberalized statutes of limitation in many states, lawsuits can be filed long after an alleged offender leaves the church.
job descriptionsa summary of the duties the employer expects an employee to performRULE 1 (above).
RULE 8. Retain for the duration of the employee’s employment. If the employee is dismissed (or resigns) under circumstances making a lawsuit against the employer reasonably foreseeable, then retain for the applicable statute of limitations period (for the foreseeable theory of liability, including breach of contract, discrimination, or personal injury) following the date of dismissal or resignation.
employee manuals or handbooksdocuments prepared by some employers setting forth the terms and conditions of employment, a summary of fringe benefits, and the grounds and procedures for discipline or dismissal RULE 9. Permanently. Be sure to retain copies of all editions or versions, and be able to demonstrate which manual or handbook applied to any given period of time.
employee statementa statement, signed by an employee, acknowledging that he or she understands the terms and conditions of employment (including grounds for discipline or dismissal) and agrees to themRULE 8 (above).
payroll recordsthe following records for each employee: name, address, date of birth (if under 19), gender, occupation, rate of pay, hours worked each workday and week, compensation earned each weekRULE 10. Employers subject to the Fair Labor Standards Act (any church-operated school or preschool, or a church engaged in interstate commerce regardless of the number of employees) must keep such records for 3 years “from the last date of entry.” 29 CFR 516.5.
RULE 11. Employers subject to the Age Discrimination in Employment Act (20 or more employees, and engaged in interstate commerce) must retain such records for at least 3 years after the record was made. 29 CFR 1627.3.
RULE 12. Employers subject to FICA (social security) taxes must retain these records for 4 years after the due date of the tax for the return period to which the records relate, or the date such tax is paid, whichever is later.
contracts of employmentan agreement setting forth the terms and conditions of employment between a church and an employeeRULE 10 (above).
performance evaluationsperiodic (i.e., annual) evaluations of several criteria of employee performance, including efficiency, ability, initiative, and attitudeRULE 1 (above).
RULE 8 (above).
dismissal recordsdocuments explaining the basis for an employee’s dismissalRULE 1 (above).
RULE 8 (above).
testing recordstests administered to employees or prospective employees to measure intelligence or various job skillsRULE 1 (above).
RULE 3 (above).
reports of work-related injuries and illnessesreports noting the dates and circumstances of work-related injuries or illnesses of any employee, and completed within 6 working days of the injury or illness (OSHA Form No. 200 can be used)RULE 13. Employers subject to the Occupational Safety and Health Act (any employer with 1 or more employees, that is engaged in interstate commerce) must keep such records for “5 years following the end of the year to which they relate.” 29 CFR 1904.6.
fringe benefit plansemployer-sponsored plans addressing the terms and conditions of “specified fringe benefit plans” described in section 6039D of the Internal Revenue Code, including employer paid group life insurance premiums, accident and health plans, employer paid medical insurance premiums, employer-provided group legal services, cafeteria plans, employer-provided educational assistance, and employer-provided dependent careRULE 14. Employers maintaining a “specified fringe benefit plan” for any year must keep such records as may be necessary to establish that the requirements for maintaining such a plan have been met—for 7 years following the end of the year the documents were created.
Form I-9immigration form completed by employers and new hires, demonstrating an employee’s identity and eligibility to workRule 15. All employers regardless of size must retain such records for 3 years after the date of hire or 1 year after an employee’s termination, whichever is later.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Donor Restrictions on Gifts of Property

IRS clarifies eligibility of restricted gifts for tax deductions.

Richard R. Hammar, Attorney, CPA
Bio
Church Finance Today

Donor Restrictions on Gifts of Property

IRS clarifies eligibility of restricted gifts for tax deductions.

Richard R. Hammar

IRS Letter Ruling 9443004

Background. Many churches are given some or all of the land upon which they build their facilities. In some cases, donors impose restrictions on such gifts. For example, some donors specify that the contributed property “reverts” to them (or their heirs) in the event the property ever ceases to be used for church purposes. There are two important issues here:
  • Can churches that own property subject to such a reverter clause inadvertently lose their property if they later sell it? Unfortunately, the answer to this question can be yes.

Key point. This is one reason why it is important to be familiar with the wording of your church deed. Does it contain a reverter clause? If so, what triggers it?

  • Can a donor who gives property to a charity with this kind of “reverter clause” claim a charitable contribution deduction? This second issue was addressed recently by the IRS in a private ruling.

Facts of the case. A deceased person left a will giving $50,000 to a school to establish a scholarship fund for needy students attending the school (to be selected by the school). The will specified that in the event the school “ceases to exist as a school or ceases to be accredited by the state” the balance in the fund would revert to the deceased’s heirs. The question was whether the deceased’s estate could claim a charitable contribution deduction for the scholarship gift despite the possibility that the fund could one day revert to the donor’s heirs.

What the IRS said. The IRS ruled that the estate was entitled to a charitable contribution deduction—because the likelihood that the school would “cease to exist” was so remote as to be negligible. The IRS noted that “[the tax regulations specify] that if an interest passes to charity at the time of a decedent’s death and the interest would be defeated by … some act or the happening of some event, the possibility of occurrence of which appears at the time of the decedent’s death to be so remote as to be negligible, the deduction is allowable.”

The IRS also noted that the tax regulations contain an example in which a decedent dies leaving a will which donates land to a city government “for as long as the land is used by the city for a public park.” The example concludes that “a deduction is allowable if, on the date of the decedent’s death, the possibility that the city will not use the land for a public park is so remote as to be negligible.”

Recommendation. Check the deed or deeds to your church property to determine if any conditions exist. If they do, it is possible in some cases to have them “released” by the previous owner (if he or she is willing to do so). Often this is done by having the previous owner execute a quitclaim deed. If the previous owner is no longer living (a fairly common circumstance) then the condition can be released only by all of the legal heirs of the deceased owner. This can be a very cumbersome process.

This article originally appeared in Church Treasurer Alert, April 1995.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Tax Court Rules Contribution to Foreign Charity Was Not Deductible

Contributions must go to U.S. charity organizations.

Richard R. Hammar, Attorney, CPA
Bio
Church Finance Today

Tax Court Rules Contribution to Foreign Charity Was Not Deductible

Contributions must go to U.S. charity organizations.

Richard R. Hammar

Alisobhani v. Commissioner, T.C. Memo. 1994-629 (1994)

Background. Church members sometimes make contributions directly to religious organizations or ministries overseas. Or, they make contributions to a United States religious organization for distribution to a foreign organization. Are these contributions tax-deductible? That was the issue addressed by the Tax Court in a recent ruling.

The Tax Court ruled that a taxpayer who sent contributions to a mosque in his family’s home town in Iran was not entitled to a charitable contribution deduction. The Court noted that to be deductible a charitable contribution must go to a charity organized in the United States.

Importance to church treasurers. Federal law specifies that a charitable contribution, to be tax-deductible, must go to an organization “created or organized in the United States or in any possession thereof.” In addition, the organization must be organized and operated exclusively for religious or other charitable purposes. This means that contributions made directly by church members to a foreign church or ministry are not tax-deductible in this country.

A related question, not addressed by the Court but addressed by the IRS in a 1963 ruling, is whether a donor can make a tax-deductible contribution to an American charity with the stipulation that it be transferred directly to a foreign charity. The IRS ruled that such a contribution is not deductible since it in effect is directly to the foreign charity. Revenue Ruling 63-252.

Key point. In its 1963 ruling, the IRS did concede that contributions to a United States charity are deductible even though they are earmarked for distribution to a foreign charity, so long as the foreign charity “was formed for purposes of administrative convenience and the [United States charity] controls every facet of its operations.” The IRS concluded: “Since the foreign organization is merely an administrative arm of the [United States] organization, the fact that contributions are ultimately paid over to the foreign organization does not require a conclusion that the [United States] organization is not the real recipient of those contributions.”

This article originally appeared in Church Treasurer Alert, March 1995.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Tax Court Denies Charitable Contribution

Donor did not meet new substantiation requirements, court ruled.

Richard R. Hammar, Attorney, CPA
Bio

New rules took effect in 1994 for the substantiation of individual charitable contributions of $250 or more. However, the rules for substantiating cash contributions of less than $250 remain the same. Donors making individual cash contributions of less than $250 must be able to substantiate such contributions with one of the following:
  1. canceled checks,
  2. a receipt or letter from the church showing the church’s name and the amounts and dates of the contributions, or
  3. any other reliable written record showing the name of the church and the amounts and dates of the contributions.
  4. Background
  5. In the case Witherspoon v. Commissioner, T.C. Memo. 1994-593, a taxpayer claimed cash contributions of $3,500 to her church. She was audited and the IRS denied any deduction for these contributions. The IRS claimed that the woman had insufficient evidence to substantiate the contributions. The taxpayer claimed that these contributions were all made in cash, and so she had no canceled checks to substantiate them.
  6. She also claimed that she kept no records or receipts to prove her contributions. The only evidence she had was a letter from her church stating that the taxpayer made contributions of $3,500 to the church during the year in question “through tithes, offerings, and love donations.” No church representative testified during the woman’s trial.
  7. The court’s ruling
  8. The court agreed with the IRS that the woman had failed to substantiate the $3,500 in charitable contributions to her church. It dismissed the church’s letter by noting that “the letter from the church is very general and provides no information as to how and when [her] contributions were made. The evidence presented does not satisfy the court that [she] made the contributions to the church in the amount claimed.” The court was satisfied that the woman made some contributions to the church, and allowed her a deduction in the amount of $450.
  9. What this means to churches?
  10. As noted above, donors making individual cash contributions of less than $250 must be able to substantiate such contributions with one of the following:
  12. canceled checks
  13. a receipt or letter from the church showing the church’s name and the amounts and dates of the contributions, or
  14. any other reliable written record showing the name of the church and the amounts and dates of the contributions
  16. The taxpayer did not keep canceled checks, and she had no other records to substantiate her contributions—other than the general letter from the church stating that she had contributed $3,500 during the year in question. Such a letter is not enough to substantiate contributions of less than $250, because it “provides no information as to how and when [the] contributions were made.” The woman would have been entitled to deduct her church contributions if the church’s letter had reported the “amounts and dates” of her contributions.

  17. Tip. Generic letters that merely report the total amount of contributions given by a donor during the year will not be enough to substantiate the donor’s individual cash contributions of less than $250. The letter, or receipt, must list church’s name and the dates and amounts of each contribution. Additional rules apply to the substantiation of individual contributions of $250 or more.

  18. Witherspoon v. Commissioner, T.C. Memo. 1994-593
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Are Pastors Employees or Self-Employed?

The Tax Court Issues an Important Ruling—Weber v. Commissioner, 103 T.C. (1994)

Richard R. Hammar, Attorney, CPA
Bio

Background. Church treasurers often are not sure whether to treat pastors or some lay workers as employees or self-employed for federal tax reporting purposes. The distinction is important for several reasons, including the following:

• W-2 or 1099? Churches issue a W-2 to employees at the end of the year reporting wages paid and taxes withheld. Churches issue a 1099 form to self-employed persons who are paid at least $600 during the year. The 1099 form reports compensation paid.

• 941 forms. Churches that are subject to income tax withholding, FICA (social security) taxes, or both, must file Form 941 quarterly. Form 941 reports the number of employees and amount of FICA taxes and withheld income taxes that are payable. No entries are made for self-employed workers, since they are not subject to tax withholding and they do not pay FICA taxes (they pay the self-employment tax).

• Tax withholding. Churches must withhold federal income taxes and the employee’s share of FICA taxes from the wages of nonminister employees. However, churches should not withhold FICA taxes from the wages of nonminister employees if the church filed a timely Form 8274 exempting itself from paying the employer’s share of FICA taxes. Nonminister employees of such a church are treated as self-employed for social security purposes and pay self-employment taxes rather than FICA taxes. Self-employed workers are not subject to federal tax withholding (other than “backup withholding,” which applies if a self-employed worker fails to provide an employer with a social security number). Note that ministers are exempt from income tax withholding even if they are treated as employees–unless they request “voluntary withholding.”

• Treatment of fringe benefits. Some fringe benefits provided by a church to a minister or other church worker are not taxed if the person is an employee. Examples include medical insurance premiums paid by a church on behalf of its minister; group term life insurance (up to $50,000) provided by a church on behalf of a minister; amounts payable to employees on account of sickness, accident, or disability pursuant to an employer financed plan; and employer sponsored “cafeteria plans” which permit employees to choose between receiving cash payments or a variety of fringe benefits.

• Social security. Churches must withhold the employee’s share of FICA taxes from the wages of all nonminister employees (unless, as noted above, the church exempted itself from paying the employer’s share of FICA taxes by filing a Form 8274). Self-employed workers pay their own social security (self-employment) taxes.

Conclusions. Obviously, it is very important for church treasurers to decide if each minister and lay worker is an employee or self-employed. How is this decision made? The United States Tax Court issued an important decision in 1994 that addressed the issue of whether a Methodist minister was an employee or self-employed for federal income tax reporting purposes. Weber v. Commissioner, 104 T.C.—(1994). In reaching its decision that the minister was an employee, the Court announced a new “7-factor” test that church leaders can use to determine whether a worker is an employee or self-employed for federal income tax reporting purposes. The 7 factors are summarized in a table in this newsletter, along with the Court’s analysis of each. Church treasurers will find the table useful in quickly understanding the Court’s new test, and in applying the test to individual ministers and lay church workers.

THE WEBER CASE

TAX COURT’S 7 FACTOR TEST for
DETERMINING THE TAX STATUS OF MINISTERS

factor facts suggesting employee status facts suggesting self-employed conclusion
#1—the degree of control exercised by the employer over the details of the work(1) less control required over a professional; (2) Methodist ministers are required to perform numerous duties set forth in the Discipline; (3) had to explain the position of the Discipline on any topic he chose to present in his sermons; (4) followed United Methodist theology in his sermons; (5) could not unilaterally discontinue the regular services of a local church; (6) under the itinerant system of the United Methodist Church ministers are appointed by a bishop to their pastoral positions; (7) Methodist ministers cannot establish their own churches; (8) Methodist ministers are bound by the rules stated in the Discipline regarding mandatory retirement at age 70 and involuntary retirement; (9) Methodist ministers cannot transfer to another Annual Conference without permission of a bishop; (10) the Annual Conference limits the amount of leave ministers can take during a year; (11) Methodist ministers are required by the Discipline to be “amenable” to the Annual Conference in the performance of their duties(1) Rev. Weber scheduled his own activities from day to day and took vacation days without obtaining prior approval; (2) ministers generally do not need day-to-day supervision; (3) Rev. Weber had the right to explain his personal beliefs to his congregation in addition to the position of the Discipline and the United Methodist Churchemployee
#2—which party invests in the facilities used in the work(1) local churches provided a home, office, and work facilities for Rev. Weber; (2) local churches bought religious materials used by Rev. Weber in his ministry(1) Rev. Weber prepared church bulletins at home; (2) Rev. Weber used his own computer for church work; (3) Rev. Weber purchased some of his own vestments; (4) Rev. Weber purchased his own libraryemployee
#3—the opportunity of the individual for profit or loss(1) Rev. Weber was paid a salary, and provided with a parsonage, a utility expense allowance, and a travel expense allowance from each local church; (2) if Rev. Weber was not assigned to a local church, the Annual Conference would pay him a minimum guaranteed salary, or if he were in special need, the Annual Conference could give him special support; (3) aside from minimal amounts earned for weddings and funerals and amounts spent on utilities and travel, Rev. Weber was not in a position to increase his profit, nor was he at risk for lossRev. Weber could not be fired at willemployee
#4—whether or not the employer has the right to discharge the individual(1) the Annual Conference had the right to “try, reprove, suspend, deprive of ministerial office and credentials, expel or acquit, or locate [Rev. Weber] for unacceptability or inefficiency”; (2) the clergy members of the executive session of the Annual Conference had the authority to discipline and fire Rev. Webernone cited by the courtemployee
#5—whether the work is part of the employer’s regular business(1) Rev. Weber’s work is an integral part of the United Methodist Church; (2) a Methodist minister has the responsibility to lead a local church in conformance with the beliefs of the United Methodist Church, to give an account of his or her pastoral ministries to the Annual Conference according to prescribed forms, and to act as the administrative officer for that churchnone cited by the courtemployee
#6—the permanency of the relationship(1) the relationship between Methodist ministers and the United Methodist Church is “intended to be permanent as opposed to transitory”; (2) Rev. Weber had been ordained since 1978; (3) Rev. Weber is likely to remain a Methodist minister for the remainder of his professional career; (4) the Annual Conference will pay a salary to a minister even when there are no positions with a local church available; (5) ministers are provided with retirement benefits; (6) Rev. Weber did not make his services available to the general public, as would an independent contractor; (7) Rev. Weber works at the local church by the year and not for individuals “by the job”none cited by the courtemployee
#7—the relationship the parties believe they are creatingRev. Weber received many benefits typical of those provided to employees rather than independent contractors, including (1) local church contributions to his pension fund, (2) continuation of salary while on vacation, (3) disability leave and paternity leave, (4) a guaranteed salary if no pastoral position was available, (4) life insurance paid by the local churches, (5) local churches paid 75% of health insurance premiums(1) Rev. Weber and his employing churches believed that he was self-employed rather than an employee; (2) Rev. Weber received a 1099 rather than a W-2 from the churchemployee
Conclusionsthese factors demonstrated that Rev. Weber was an employee for federal income tax reporting purposesthese factors did not overcome the conclusion that Rev. Weber was an employee for federal income tax reporting purposes
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Should Missions Offerings Be Reported as Taxable Income to Missionaries?

IRS rules that income need not be reported to agents acting on behalf of principals.

Richard R. Hammar, Attorney, CPA
Bio
Church Finance Today

Should Missions Offerings Be Reported as Taxable Income to Missionaries?

IRS rules that income need not be reported to agents acting on behalf of principals.

Richard R. Hammar

Private Letter Ruling 9434008

Background. Many churches have missionaries conduct missions services during the course of the year. Often, an offering is collected. Church treasurers often ask if these offerings need to be reported to the missionary as taxable income on a Form 1099. In some cases this may be required. For example, if the offering will be turned over directly to the missionary and not to a missions board or agency, then a 1099 form ordinarily must be issued to the missionary.

The IRS ruling. A recent IRS ruling addressed a situation in which a 1099 would not need to be issued. While the ruling did not address missionaries directly, it is still instructive. The IRS noted that “as a general rule, income is taxed to the person who earns it” and that “a taxpayer who assigns or transfers compensation for personal services to another individual or entity fails to relieve himself of federal income tax liability, regardless of the motivation behind the transfer.” However, the IRS added that “amounts received by an agent on behalf of a principal, and turned over to the principal, are not taxable to the agent.”

Example. In 1958 the IRS ruled that fees paid to staff physicians and returned to a hospital were not included in the physicians’ taxable income. The physicians held salaried positions. Under a written agreement with the hospital, the physicians would receive no fees or compensation for their individual benefit from or on behalf of any patients admitted to the hospital. In situations in which patients made checks payable to physicians, the physicians would endorse the checks and turn them over to the hospital. The fees so received were used entirely in the operation of the hospital. The IRS held that the physicians were not required to include these amounts in gross income. The ruling noted that the physicians were an agent for the hospital, merely acting as a “conduit” for the fees collected.

Relevance to church treasurers. What is the relevance of this ruling to church treasurers? Simply this—it is not necessary for church treasurers to issue 1099 forms to missionaries who collect an offering if they are acting as “agents” of a missions board or agency. What factors indicate that a missionary is acting as an agent of missions board or agency? The IRS noted the following:
  • The missionary is required by contract or written policy to turn over all church offerings to the missions board or agency, and is forbidden to retain any portion of such offerings for his or her personal benefit.
  • The missionary has no control over the amount of the offering that will be collected.
  • The missionary is paid a salary by the missions board or agency.
  • A missionary who receives a 1099 from a church is required by official policy to attach a statement to his or her tax return explaining that the amounts were received as an agent for the missions board or agency.

This article originally appeared in Church Treasurer Alert, December 1994.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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Complying with the New Charitable Contribution Rules

Take steps to ensure your church members will meet the new substantiation requirements.

Richard R. Hammar, Attorney, CPA
Bio
Church Finance Today

Complying with the New Charitable Contribution Rules

Take steps to ensure your church members will meet the new substantiation requirements.

Richard R. Hammar

Background. New rules for substantiating charitable contributions took effect in 1994. Now is a good time for church treasurers to be sure that the church’s receipts reflect the new requirements. These requirements were summarized in a table in the December 1993 issue of Church Treasurer Alert! The important points are these:

Individual contributions of $250 or more. Donors no longer can substantiate individual contributions of $250 or more with canceled checks. They must have a receipt from the church that contains the following information:
  • Name. The donor’s name (a social security number is not required).
  • Itemization. Each individual contribution of $250 or more must be shown on the receipt. Do not lump all contributions together.
  • Value of any goods or services provided by charity. A statement indicating whether or not the church provided any goods or services to the donor in exchange for the contribution, and if so, a good faith estimate of the value of those goods or services.
  • If charity provides no goods or services, or only “intangible religious benefits.” If the church provides no goods or services to a donor in exchange for a contribution, or if the only goods or services the church provides are “intangible religious benefits,” then the receipt must contain a statement to that effect. The term “intangible religious benefit” is defined by the new law as “any intangible religious benefit which is provided by an organization organized exclusively for religious purposes and which generally is not sold in a commercial transaction outside the donative context.” The committee report to the new law states that the term intangible religious benefit includes “admission to a religious ceremony” or other insignificant “tangible benefits furnished to contributors that are incidental to a religious ceremony (such as wine).” However, the committee report clarifies that “this exception does apply, for example, to tuition for education leading to a recognized degree, travel services, or consumer goods.”
  • Receipt must be contemporaneous. The receipt must be “contemporaneous,” meaning that it must be received by the donor on or before the earlier of the following two dates: (1) the date the donor files a tax return claiming a deduction for the contribution, or (2) the due date (including extensions) for filing the return.

Quid pro quo contributions of more than $75. A church has additional requirements with respect to individual quid pro quo contributions of more than $75. A quid pro quo contribution is a payment “made partly as a contribution and partly in consideration for goods or services” provided to the donor by the church. For example, a donor contributes $100 to her church, but in return receives a dinner worth $30. Under the new rules a church or other charity is required to provide a written statement to the donor that (1) informs the donor that the amount of the contribution that is tax deductible is limited to the excess of the amount of any money (or the value of any property other than money) contributed by the donor over the value of any goods or services provided by the church or other charity in return, and (2) provides the donor with a good faith estimate of the value of the goods or services furnished to the donor.

A written statement need not be issued in either of the following situations: (1) only token goods or services (with a value not exceeding the lesser of $64 or 2% of the amount of the contribution) are provided to a donor; or (2) the donor receives only intangible religious benefits (as defined above) in exchange for his or her contributions.

What church treasurers should do now. There are a number of ways for church treasurers to comply with the new substantiation and quid pro quo reporting requirements. Here are some suggestions.

1. A “2 form” approach. The simplest way for church treasurers to respond to the new substantiation rules will be to use the church’s current receipt form for all contributions not subject to the new substantiation rules, and then use a second form to report contributions that are covered by the new rules. The receipt form used by the church in 1993 (before the new rules took effect) can be used for all individual contributions of cash or property of less than $250, assuming that the new quid pro quo reporting rules do not apply. If this option is selected, the church’s customary receipt must enable multiple contributions on the same day to be recorded separately. If this is not possible, and multiple contributions made on the same day must be aggregated, then this will jeopardize the deductibility of contributions totaling $250 or more on the same day, unless the church’s customary receipt is modified to include the language required by the new rules.

For contributions of property valued by the donor at less than $250, a church’s receipt must comply with “Rule 5” (explained in the December 1993 issue of Church Treasurer Alert!).

2. The modified 2 form approach. The next easiest way for church treasurers to respond to the new substantiation requirements will be for a simplified receipt to be used that separately lists each cash contribution (date and amount), and contains the language required by the new rules. Illustration 1 represents such a form. Illustration 1 satisfies all of the new substantiation rules with the minimal complexity. However, it makes three very important assumptions: (1) the church provided no goods or services in connection with any individual contribution of $250 or more other than intangible religious benefits; (2) no donor made any quid pro quo contribution; and (3) only cash contributions were made (and not property). Obviously, these assumptions will hold true for many if not most donors. However, if any one or more assumptions is not met, then appropriate adjustments will be required. For example, if a donor did make a quid pro quo contribution, then an appropriate statement would need to be issued separately by the church. And, if the church provides goods or services or more than insubstantial value in exchange for a contribution of $250 or more, it would need to adapt this form or include a separate statement with the form describing and valuing the goods or services that were provided.

3. Keep donors informed. To avoid jeopardizing the tax deductibility of charitable contributions, churches should advise donors at the end of 1994 not to file their 1994 income tax returns until they have received a written acknowledgement of their contributions from the church. This communication should be in writing. To illustrate, the following statement could be placed in the church bulletin or newsletter for the last few weeks of 1994, or included in a letter to all donors:

IMPORTANT NOTICE: To ensure the deductibility of your church contributions, please do not file your 1994 income tax return until you have received a written acknowledgment of your contributions from the church. Under new rules that took effect this year, you may lose a deduction for some contributions if you file your tax return before receiving a written acknowledgement of your contributions from the church.

ILLUSTRATION

First Church
Chicago, Illinois
December 31, 1994

Cash Contributions Statement for October through December of 1994
John A. Doe

Codes:

10 = general fund –––30 = missions
20 = building fund –––40 = other

For the calendar quarter October through December of 1994, our records indicate that you made the following cash contributions. Should you have any questions about any amount reported or not reported on this statement, please notify the church treasurer within 90 days of the date of this statement. Statements that are not questioned within 90 days will be assumed to be accurate, and any supporting documentation (such as offering envelopes) retained by the church may be discarded. No goods or services were provided to you by the church in connection with any contribution, or their value was insignificant or consisted entirely of intangible religious benefits.
codedateamountcodedateamountcodedateamount
10Oct 230.0010Nov 630.0010Dec 1830.00
10Oct 930.0010Nov 1330.0010Dec 25100.00
10Oct 1630.0010Nov 2030.0030Dec 25200.00
30Oct 23500.0010Nov 2730.00
10Oct 2330.0010Dec 430.00
10Oct 3030.0010Dec 1130.00
TOTAL1160.00

This article originally appeared in Church Treasurer Alert, November 1994.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Court Finds Minister Filed a Timely Application for Exemption from Social Security

What church treasurers should know about this ruling.

Richard R. Hammar, Attorney, CPA
Bio
Church Finance Today

Court Finds Minister Filed a Timely Application for Exemption from Social Security

What church treasurers should know about this ruling.

Richard R. Hammar

Hall v. Commissioner, 94-2 USTC ¶ 50,392 (10th Cir. 1994)

Background. Federal law treats ministers in a very unique way for purposes of social security coverage. Consider the following 2 special rules:
  • Self-employed status. All ministers are treated as self-employed for social security purposes with respect to services performed in the exercise of their ministry. There are no exceptions. This is an absolute rule. As a result, ministers pay the “self-employment tax” (the social security tax on self-employed persons) not “FICA taxes” (the social security tax on employers and employees).
  • Exemption. Ministers may apply for exemption from self-employment (social security) taxes with respect to service performed in the exercise of their ministry if they are opposed on the basis of religious convictions to the acceptance of social security benefits and file a timely exemption application (Form 4361) that is approved by the IRS. The due date for the exemption application is the deadline for the federal tax return (Form 1040) for the second year in which the minister has net self-employment earnings of $400 or more, any part of which comes from ministerial services.

Can ministers ever again be eligible to exempt themselves from self-employment taxes after the deadline for filing the exemption application has expired? That was the question addressed by a federal appeals court in a recent decision.

Facts of the case. A Methodist minister was not opposed to accepting social security benefits on the basis of his religious convictions, and did not submit an application for exemption from self-employment taxes before the deadline for doing so. He later left the Methodist church, entered into secular employment for 5 years, was reordained by another church and became a pastor in his new faith. He then submitted an exemption application which was denied by the IRS on the ground that it was filed too late. The minister appealed.

The court’s decision. A federal appeals court ruled that the period of time during which the minister had to file an application for exemption from social security started all over when he
  • left the ministry for 5 years
  • converted to another faith
  • was reordained by his new church
  • developed religious-based opposition to accepting social security benefits based on his new faith, and
  • filed a timely exemption application after being reordained

The federal court’s recent decision will not open the floodgates to other ministers, except in rare cases. The decision applies only to those few ministers who change their church affiliation, are reordained, and develop an opposition, based on their new religious convictions, to the acceptance of social security benefits. Few ministers will satisfy these requirements. The ruling will not apply to ministers who do not change their church affiliation or doctrine. Ministers who did not file an exemption application within the prescribed period, and who have served a local church for several years, are not given a second chance to opt out of social security by this ruling.

Relevance to church treasurers. What is the significance of this ruling to church treasurers? Consider the following:
  • Self-employed status. The ruling confirms that ministers are always treated as self-employed for social security with respect to their ministerial services. This means that they pay the self-employment tax. Church treasurers should not withhold FICA taxes from the wages of a minister. This is incorrect and can lead to problems.

Example. First Church treats its minister as an employee for federal income tax purposes. The church treasurer assumes that FICA taxes must be taken out of the minister’s wages since the minister is treated as an employee for income tax purposes. This is incorrect. Ministers always are treated as self-employed for social security with respect to their ministerial services—even if they report their income taxes as an employee. As a result, they never pay FICA taxes on church compensation. They pay the “self-employment tax,” which is the social security tax (15.3%) imposed on self-employed persons.

  • Counseling the younger minister. It is helpful for church treasurers to be informed as to the basis for the ministerial exemption from social security, and the deadline for filing an exemption application. This information will enable church treasurers to counsel younger ministers who may be considering opting out of social security. Many younger ministers decide to exempt themselves solely for financial reasons (to avoid paying the 15.3% self-employment tax). Many receive erroneous advice from financial planners or insurance agents. Church treasurers are in a unique position to counsel younger ministers. Here are the points that should be made:

• Basis for exemption. Ministers are eligible for exemption from self-employment taxes, but only if they satisfy several conditions. One condition is that the minister is opposed on the basis of religious convictions to the acceptance of social security benefits based on ministerial services. Very few ministers satisfy this extraordinary requirement. Many may be opposed to paying excessive taxes, but how many can say they are opposed on the basis of religious convictions to accepting social security benefits?

• Deadline for filing the exemption application (Form 4361). An application for exemption must be submitted by the due date of the federal tax return (Form 1040) for the second year in which the minister has net self-employment earnings of $400 or more, any part of which come from ministerial services. This deadline is not extended because a minister belatedly develops religious-based opposition to accepting social security benefits. There is only one possible exception that was addressed in this article—the deadline may start all over if a minister experiences a change of faiths, is reordained in another church, develops a religious-based opposition to accepting social security benefits, and files a timely exemption application after being reordained.

• Exemption is irrevocable. Church treasurers should advise younger ministers that an exemption from social security is irrevocable. Ministers who opt out of social security cannot assume that they will someday be able to re-enter the system.

• Insurance coverages. The church treasurer should inform the younger minister of the many advantages of social security coverage, including retirement benefits, survivor benefits, disability benefits, and Medicare (hospital and medical benefits at age 65). These are significant benefits that are forfeited by a minister who opts out of social security (unless the minister has enough years of secular employment to be fully covered). If the church does not make some or all of these coverages available through private insurance, the treasurer should so inform the minister.

This article originally appeared in Church Treasurer Alert, November 1994.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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