Author: rgorgol

Supreme Court Tackles “Ministerial Exception”

High Court will examine rule’s scope.

Richard R. Hammar, Attorney, CPA
Bio

introduction

Many courts have ruled that the First Amendment guaranty of religious freedom prevents them from resolving employment disputes between churches and ministers. This so-called “ministerial exception” has been applied to a range of employment disputes, including discrimination, wrongful dismissal, and compensation claims. The exception has been applied in several cases to persons who are not ordained ministers but whose functions are central to the promotion and furtherance of a church’s mission.

Though several state and federal courts have addressed the ministerial exception, the United States Supreme Court has yet to do so. That is about to change. The Supreme Court has agreed to hear an appeal involving the dismissal of a teacher by a church-operated secondary school. A federal district court in Michigan ruled that it was barred by the ministerial exception from resolving a disability discrimination claim brought by the teacher (the “plaintiff”) against her employing school. The court began its opinion by observing that “for the ministerial exception to bar an employment discrimination claim, the employer must be a religious institution and the employee must have been a ministerial employee.” There was no dispute that the school was a religious institution and so the focus shifted to the question of whether the plaintiff was a ministerial employee. The court concluded that she was. It noted that the exception “most clearly applies to clergy and ordained ministers,” but “it is not limited to such employees.”

To determine if other employees fall within the exception, courts consider whether “the employee’s primary duties consist of teaching, spreading the faith, church governance, supervision of a religious order, or supervision or participation in religious ritual and worship.” Accordingly, “an employee may be considered ministerial, although not ordained, depending on the function and actual role of his or her position in the religious institution.” The court concluded that the duties of the plaintiff in this case clearly made her a ministerial employee to whom the ministerial exception applied:

The separation of church and state in the United States has made federal courts inept when it comes to religious issues; the inquiry into the value of an employee in furthering a religious institution’s sectarian mission is no different. The lack of clarity in federal court cases regarding elementary school teachers should not hinder churches from valuing teachers as important spiritual leaders and deciding who will fill those positions as ministerial employees, subject, of course, to inappropriate uses of the title “minister” as subterfuge. For these reasons, it seems prudent in this case to trust [the school’s] characterization of its own employee in the months and years preceding the events that led to litigation. Because it considered the plaintiff to be a “commissioned minister” and the facts surrounding her employment in a religious school with a sectarian mission support this characterization, the court concludes that the plaintiff was a ministerial employee. If, on these circumstances, the Court were to conclude otherwise, it would risk infringing upon the school’s right to choose its spiritual leaders.”

Having found that the school was a religious institution, and the plaintiff was a ministerial employee, the court concluded that it had no alternative but to dismiss the case. E.E.O.C. v. Hosanna-Tabor Church and School, 582 F.Supp.2d 881 (E.D. 2008).

the appeals court’s decision

The plaintiff appealed, and a federal appeals court vacated the district court’s ruling and ordered the case to proceed to trial. E.E.O.C. v. Hosanna-Tabor Evangelical Lutheran Church and School, 597 F.3d 769 (6th Cir. 2010). The appeals court acknowledged that the ministerial exception “precludes jurisdiction over claims involving the employment relationship between a religious institution and its ministerial employees, based on the institution’s constitutional right to be free from judicial interference in the selection of those employees.” It quoted from an earlier federal appeals court ruling: “The right to choose ministers without government restriction underlies the well-being of religious community . . . for perpetuation of a church’s existence may depend upon those whom it selects to preach its values, teach its message, and interpret its doctrine both to its own membership and to the world at large.” Rayburn v. General Conference of Seventh Day Adventists, 772 F.2d 1164 (4th Cir. 1985).

The court observed that “as a general rule, an employee is considered a minister if the employee’s primary duties consist of teaching, spreading the faith, church governance, supervision of a religious order, or supervision or participation in religious ritual and worship.” It added that “the overwhelming majority of courts that have considered the issue have held that parochial school teachers who teach primarily secular subjects, do not classify as ministerial employees for purposes of the exception. . . . By contrast, when courts have found that teachers classify as ministerial employees for purposes of the exception, those teachers have generally taught primarily religious subjects or had a central role in the spiritual or pastoral mission of the church.”

The court concluded that the plaintiff was not a ministerial employee:

Her employment duties were identical when she was a contract teacher and a called teacher . . . she taught math, language arts, social studies, science, gym, art, and music using secular textbooks. Furthermore, the record indicates that she taught a religion class four days per week for thirty minutes and that she attended a chapel service with her class once a week for thirty minutes. She also led each class in prayer three times a day for a total of approximately five or six minutes. The record also indicates that she seldom introduced religion during secular discussions. Approximately twice a year, she led the chapel service in rotation with other teachers. However, teachers leading chapel or teaching religion were not required to be called or even Lutheran, and, in fact, at least one teacher was not. In all, the record supports the district court’s finding that activities devoted to religion consumed approximately forty-five minutes of the seven hour school day.

[In summary] she spent approximately six hours and fifteen minutes of her seven hour day teaching secular subjects, using secular textbooks, without incorporating religion into the secular material. Thus, it is clear that her primary function was teaching secular subjects, not “spreading the faith, church governance, supervision of a religious order, or supervision or participation in religious ritual and worship.” The fact that she participated in and led some religious activities throughout the day does not make her primary function religious. This is underscored by the fact that teachers were not required to be called or even Lutheran to conduct these religious activities, and at least one teacher was not Lutheran.

In addition, that [the school] has a generally religious character—as do all religious schools by definition—and characterizes its staff members as “fine Christian role models” does not transform a teacher’s primary responsibilities in the classroom into religious activities. This is underscored by the fact that the plaintiff can only recall twice in her career when she introduced the topic of religion during secular discussions.

The court conceded that the school gave the plaintiff the title of “commissioned minister,” but concluded that “the title of commissioned minister does not transform the primary duties of these called teachers from secular in nature to religious in nature. The governing primary duties analysis requires a court to objectively examine an employee’s actual job function, not her title, in determining whether she is properly classified as a minister. In this case, it is clear from the record that [the plaintiff’s] primary duties were secular, not only because she spent the overwhelming majority of her day teaching secular subjects using secular textbooks, but also because nothing in the record indicates that the Lutheran church relied on her as the primary means to indoctrinate its faithful into its theology.”

The court also pointed out that the primary duties of “called” teachers were identical to those of contract teachers who do not have the title of minister.

The court concluded:

Given the undisputed evidence that all teachers at [the school] were assigned the same duties, a finding that [the plaintiff] is a “ministerial” employee would compel the conclusion that all teachers at the school—called, contract, Lutheran, and non-Lutheran—are similarly excluded from coverage under the ADA and other federal fair employment laws. However, the intent of the ministerial exception is to allow religious organizations to prefer members of their own religion and adhere to their own religious interpretations. Thus, applying the exception to non-members of the religion and those whose primary function is not religious in nature would be both illogical and contrary to the intention behind the exception.

One judge filed a concurring opinion in which she observed:

[The plaintiff’s] daily duties resemble to some extent those of the plaintiffs in [several other] cases in which the courts found the [teacher’s] primary duties to be ministerial in nature. Tipping the scale against the ministerial exception in this case is that, as the majority points out, there is evidence here that the school itself did not envision its teachers as religious leaders, or as occupying “ministerial” roles. The teachers are not required to be called or even Lutheran to teach or to lead daily religious activities. The fact that the duties of the contract teachers are the same as the duties of the called teachers is telling. This presence (or lack) of a predominantly religious yardstick for qualification as a teacher is a key factor in decisions finding the ministerial exception applicable and those finding it inapplicable alike. . . . By this measure, even courts that have found ministerial plaintiffs who have daily schedules that have roughly the same ratio of religious to non-religious activities as the plaintiff would find that the ministerial exception should not apply here.

United States Supreme Court review

The United States Supreme Court has agreed to review the federal appeals court decision, and this will give it an opportunity for the first time to address the ministerial exception, and in particular, to clarify the meaning of “ministerial” employees.

The courts have formulated the following two primary definitions of the term “ministerial employee” in the context of the ministerial exception:

“If the employee’s primary duties consist of teaching, spreading the faith, church governance, supervision of a religious order, or supervision of participation in religious ritual and worship, he or she should be considered ‘clergy.'” Rayburn v. General Conference of Seventh-Day Adventists, 772 F.2d 1164 (4th Cir. 1985).

The following three factors are considered in deciding if a church employee is a “minister” for purposes of the ministerial exception: (1) Are employment decisions regarding the position at issue made “largely on religious criteria”? (2) Is the employee authorized to perform the ceremonies of the church? (3) Does the employee engage in activities traditionally considered ecclesiastical or religious? Starkman v. Evans, 198 F.3d 173 (5th Cir. 1999).

There is little doubt that the Court will acknowledge the ministerial exception in the context of ministers performing pastoral duties for churches and church agencies. The challenge will be to clarify the meaning of “ministerial employees” in the context of lay employees performing some pastoral functions. The Court may apply one of these two definitions, or formulate its own definition. Its decision will determine the application of a range of federal and state employment laws to lay church employees whose duties include some pastoral functions.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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Clawing Out of the Recession

How churches are faring during the slow economic recovery.

Matthew Branaugh, Business Owner
Bio
Church Law and Tax Report

Clawing Out of the Recession

How churches are faring during the slow economic recovery.

Matt Branaugh

A new survey of more than 1,500 church leaders shows the negative effects of the Great Recession eased for some during 2010, with more churches reporting giving increases compared to 2009.

In the 2011 State of the Plate, co-sponsored by Christianity Today International’s Church Finance Today, Maximum Generosity, and the Evangelical Council for Financial Accountability, 43 percent said collections at their church rose, compared to 36 percent who said the same the prior year.

But 39 percent reported giving declined, virtually unchanged from the 38 percent who indicated the same in 2009, meaning challenges remain for many congregations. The Southeast and Pacific regions struggled most, as did small congregations of 250 people or less, according to the constituency survey, which did not involve random sampling and contained no margin of error.

Beyond actual collections, the survey also asked churches how their giving affected budget priorities and planning:

for budgets:

46 percent said their current budgets were bigger than last year’s;
22 percent said their budgets remained flat;
31 percent said their budgets shrunk.

for expenditures:

Spending increased most on staff salaries, missions, facilities, and benevolence/help for the needy;
Spending decreased most for staff travel/conferences, ministry programs, and building expansions/renovations.

Ruling Leaves Door Open for Housing Allowance Defense

background

Section 107 of the federal tax code exempts from federal income tax

the fair rental value of a church-owned parsonage provided to a minister as compensation for ministerial services, and
the amount of a minister’s compensation that is designated in advance as a housing allowance to the extent that the allowance represents compensation for ministerial services, is used to pay housing expenses, and does not exceed the fair rental value of the home (furnished, plus utilities).

Section 265(a)(6) of the federal tax code allows a minister of the Gospel to claim itemized deductions for residential mortgage interest and property taxes, even though the money used to pay such amounts was received from a church or other employer in the form of a tax-exempt housing allowance.

The Freedom from Religion Foundation (“FFRF”) and several other plaintiffs have filed a lawsuit in a federal district court in California challenging the constitutionality of the parsonage exclusion and housing allowance. The lawsuit also challenges the constitutionality of section 265(a)(6). The lawsuit alleges:

Sections 107 and 265(a)(6) of the Revenue Code … violate the Establishment Clause of the First Amendment, in part, because they provide tax benefits only to “ministers of the gospel,” rather than to a broad class of taxpayers.

Sections 107 and 265(a)(6) subsidize, promote, endorse, favor, and advance churches, religious organizations, and “ministers of the gospel,” and they discriminate against secular organizations, including nonprofit organizations such as FFRF that promote atheism, humanism, secularism, and other non-religious worldviews, as well as their employees and members.

Sections 107 and 265(a)(6) are not permissible “accommodations” of religion under the Establishment Clause, in part, because the income taxation of ministers of the gospel under the general rules that apply to other individuals would not interfere with the religious mission of churches or other organizations or the ministers themselves.

The [housing allowance] has the effect each year of excluding hundreds of millions of dollars from taxation, and this exclusion is available only to ministers of the gospel. The tax preferences granted to ministers of the gospel under the Internal Revenue Code … also enables churches and other religious organizations to reduce their salaries and compensation costs. The employees of secular organizations such as FFRF are not allowed these tax preferences, and FFRF and other secular organizations incur comparatively greater compensation costs than they would if their employees could be considered “ministers of the gospel.”

The tax preferences afforded ministers of the gospel constitute a subsidy that results in tangible and direct economic injury to FFRF, and to its members and employees, who cannot claim these benefits.

The FFRF’s lawsuit asks the court to rule that sections 107 and 265(a)(6) of the federal tax code violate the Establishment Clause of the First Amendment to the United States Constitution, which prohibits any governmental establishment of religion.

the government’s motion to dismiss

The federal government, which is defending the constitutionality of the housing allowance (since it is a federal statute) asked the court to dismiss the lawsuit on the ground that the FFRF lacked “standing” to pursue its claim. Standing is a requirement of any plaintiff in a federal case. It has been described by the United States Supreme Court as follows:

The party who invokes the power [of the federal courts] must be able to show not only that the statute is invalid, but that he has sustained or is immediately in danger of sustaining some direct injury as a result of its enforcement, and not merely that he suffers in some indefinite way in common with people generally. Doremus v. Board of Ed. of Hawthorne, 342 U.S. 429 (1952).

The California district court ruled last year that the FFRF had standing, and so it denied the government’s request to dismiss the case.

But FFRF’s challenge to the constitutionality of the housing allowance may have been dealt a lethal blow by a recent decision by the United States Supreme Court. The Supreme Court ruled that a group of Arizona taxpayers lacked standing to challenge the constitutionality of a state law that gave tax credits for contributions to “school tuition organizations” (STOs). STOs provided scholarships to students attending private schools, including religious schools. It noted that the courts have consistently ruled that standing cannot be based on a plaintiff’s status as a federal taxpayer because the “injury” is too remote or speculative.

The Court acknowledged a limited exception to taxpayer standing in cases challenging legislation on the basis of the First Amendment’s nonestablishment of religion clause. Taxpayers have standing in such cases to challenge direct transfers of tax revenue to religious organizations since “the taxpayer’s allegation in such cases would be that his tax money is being extracted and spent in violation of specific constitutional protections against such abuses of legislative power.”

FFRF argued that they had standing because the Arizona tax credit was in essence a governmental expenditure for religion. The Court disagreed, noting that there is a fundamental difference between granting a tax credit to taxpayers, and using tax dollars to directly benefit religion. It observed:

It is easy to see that tax credits and governmental expenditures can have similar economic consequences, at least for beneficiaries whose tax liability is sufficiently large to take full advantage of the credit. Yet tax credits and governmental expenditures do not both implicate individual taxpayers in sectarian activities. A dissenter whose tax dollars are [diverted to religious organizations] knows that he has in some small measure been made to contribute to an establishment [of religion] in violation of conscience. In that instance the taxpayer’s direct and particular connection with the establishment [of religion] does not depend on economic speculation or political conjecture. The connection would exist even if the conscientious dissenter’s tax liability were unaffected or reduced. When the government declines to impose a tax, by contrast, there is no such connection between dissenting taxpayer and alleged establishment [of religion]. Any financial injury remains speculative. And awarding some citizens a tax credit allows other citizens to retain control over their own funds in accordance with their own consciences.

The distinction between governmental expenditures and tax credits refutes [the plaintiffs’] assertion of standing …. [The Arizona tax credit] does not spend a conscientious dissenter’s funds in service of an establishment [of religion] or force a citizen to contribute … to a sectarian organization. On the contrary … Arizona taxpayers remain free to pay their own tax bills, without contributing to an STO. They are likewise able to contribute to an STO of their choice, either religious or secular. And they also have the option of contributing to other charitable organizations, in which case they may become eligible for a tax deduction or a different tax credit. The STO tax credit is not tantamount to a religious tax or to a tithe. It follows that [the plaintiffs] neither alleged an injury for standing purposes under general rules nor met the exception.

The Supreme Court’s ruling in the Arizona case may well spell the end of the constitutional challenge to the housing allowance, since a housing allowance, like the Arizona tax credit, involves no direct transfer of tax revenue for religious purposes.

The government will likely renew its motion to dismiss the FFRF lawsuit on the basis of the Supreme Court’s recent decision. Even if the California district court reaffirms its conclusion that FFRF has taxpayer standing, this does not necessarily spell the end of the housing allowance. There are several considerations that support the constitutionality of the parsonage exclusion and housing allowance, including the following:

In Walz v. Commission, 393 U.S. 664 (1970) the United States Supreme Court concluded that “the grant of a tax exemption is not sponsorship.” Further, the Court noted, “an unbroken practice of according the exemption to churches, openly and by affirmative state action, not covertly or by state inaction, is not something to be lightly cast aside.” The Court quoted Justice Oliver Wendell Holmes’ aphorism that “if a thing has been practiced for two hundred years by common consent, it will need a strong case for the Constitution to affect it.” This is a compelling argument. The parsonage exclusion has been with us since 1921, and the housing allowance since 1954. Not covertly, but by action of Congress. As one law professor has noted, “The parsonage exclusion has a remarkably ‘unambiguous and unbroken’ history of acceptance.” There has not been a single case in which its constitutionality has been challenged.

The courts have consistently upheld the constitutionality of state and federal grants, loans, and financial aid programs that benefit ministerial students attending seminaries. Why? Because the beneficiary is the individual, not “religion.”

Section 119 of the tax code exempts from income tax free lodging that is provided to an employee for the “convenience of the employer.” This benefit applies to all, regardless of profession or faith, and the same concept underlies the housing allowance. So, the FFRF lawsuit is wrong in asserting that section 107 singles out clergy. The fact is that section 119 extends a very similar benefit to everyone.

While not a constitutional argument, it should be noted that an elimination of the housing allowance would have an immediate and, in some cases, catastrophic financial effect on hundreds of thousands of ministers who have purchased a home and secured a mortgage loan in reliance on the housing allowance exclusion. Many of these ministers no longer would be able to afford their mortgage loan payments, and would be forced to sell their home in a stagnant and severely undervalued real estate market. Any federal court decision invalidating the housing allowance would have the effect of punishing countless ministers for justifiably relying on a nearly century-old tax benefit.

Church Law & Tax Report is published six times a year by Christianity Today International, 465 Gundersen Dr. Carol Stream, IL 60188. (800) 222-1840.© 2011 Christianity Today International. editor@churchlawandtax.com All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold 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. “From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations.” Annual subscription: $69. Subscription correspondence: Church Law & Tax Report, PO Box 37012, Boone, IA 50037-0012.
Matthew Branaugh is an attorney, and the business owner for Church Law & Tax.
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A Valuable Tax Credit for Churches

How Small Church Staffs May Benefit from a Health Care Reform Provision

Richard R. Hammar, Attorney, CPA
Bio
Church Law and Tax Report

How small church staffs may benefit from a health care reform provision.

A Valuable Tax Credit for Churches

Richard R. Hammar

One of the main objectives of President Obama’s health care reform law (the “Affordable Care Act”) is universal health coverage. The Act contains several provisions to achieve this goal. One of them is a new tax credit that will help small businesses and small tax-exempt organizations (including churches) afford the cost of providing health insurance for their employees. The credit is up to 25 percent of the cost of health insurance premiums paid by a qualifying employer for its employees.

Many church leaders are confused by this provision. After all, how will a tax credit (a reduction in taxes) benefit churches that pay no taxes? In fact, the credit does benefit tax-exempt entities because the law makes it “refundable,” meaning that it is payable in cash.

For churches whose fiscal year ends on December 31, the deadline to apply for the 2010 tax year already passed. Those using a different fiscal year may still have time to apply. It is important for church leaders to become familiar with this credit, since it will help many churches afford the cost of health care coverage for their employees, possibly for up to six tax years.

The new credit is specifically targeted for those employers with low- and moderate-income workers, and is designed to encourage small employers to offer health insurance coverage for the first time or maintain coverage they already have. In general, the credit is available to small employers that pay at least half the cost of single coverage for their employees.

Example. A church has five employees, but does not pay health insurance premiums for any of them. The church is not eligible for the Small Employer Health Insurance Tax Credit since the credit is not available to employers that pay less than 50 percent of the premium cost for each employee’s health care coverage.

This article will explain the credit, and its application to churches.

1. eligible employers

In order for an employer to qualify for the credit it must meet the following three requirements:

it has fewer than 25 “full-time equivalent employees” (FTEs) for the tax year;
the average annual wages of its employees for the year is less than $50,000 per FTE; and
it pays premiums for health insurance coverage under a “qualifying arrangement.”

The credit is reduced for employers with more than 10 FTEs for the tax year. It is reduced to zero for employers with 25 or more FTEs. Further, the credit is reduced for employers that paid average annual wages of more than $25,000 for the year. It is reduced to zero for employers that pay average annual wages of $50,000 or more.

The terms FTE, average annual wages, and qualifying arrangement are defined below.

Key point. The same definition of qualified employer applies to tax-exempt employers, including churches.

2. figuring FTEs and average annual wages

The number of an employer’s FTEs is determined by dividing the total hours of service for which the employer pays wages to employees during the year (but not more than 2,080 hours for any employee) by 2,080. The result, if not a whole number, is then rounded to the next lowest whole number (unless the result is less than one, in which case, the employer rounds up to one FTE).

An employee’s hours of service for a year include each hour for which an employee is paid, or entitled to payment, for the performance of duties for the employer during the employer’s tax year and each hour of paid leave (except that no more than 160 hours of service are required to be counted for an employee on account of any single continuous period of paid leave). To calculate the total number of hours of service that must be taken into account for an employee for the year, the employer may use any of the following methods:

(1) determine actual hours of service from records of hours worked and hours for which payment is made or due, including hours for paid leave;

(2) use a days-worked equivalency whereby the employee is credited with eight hours of service for each day for which the employee would be required to be credited with at least one hour of service under Method 1; or

(3) use a weeks-worked equivalency whereby the employee is credited with 40 hours of service for each week for which the employee would be required to be credited with at least one hour of service under Method 1.

Key point. Employers do not have to use the same method for all employees, but may apply different methods for different classifications of employees, if the classifications are reasonable and consistently applied. For example, it is permissible for an employer to use Method 1 for all hourly employees and Method 3 for all salaried employees. Employers may change the method for calculating employees’ hours of service for each taxable year.

Example. For 2011, a church’s payroll records indicate that an employee worked 2,000 hours and was paid for an additional 80 hours on account of vacation, holiday and illness. In calculating hours of service, the church uses a method that counts hours actually worked. Under this method of counting hours, the employee must be credited with 2,080 hours of service (2,000 hours worked and 80 hours for which payment was made or due).

Example. For 2011, a church employee worked 49 weeks, took two weeks of vacation with pay, and took one week of leave without pay. In calculating hours of service, the church uses the weeks-worked equivalency method. Under this method of counting hours, the employee must be credited with 2,040 hours of service (51 weeks multiplied by 40 hours per week).

Example. For 2011, a church has 26 FTEs with average annual wages of $23,000 per FTE. Only 20 of the church’s employees are enrolled in the church’s health insurance plan. The hours of service and wages of all employees are taken into consideration in determining whether the church is a qualified employer for purposes of the credit. Because the church does not have fewer than 25 FTEs for the tax year, it is not a qualified employer for purposes of the credit.

Example. For 2011, a church pays five employees wages for 2,080 hours each, three employees wages for 1,040 hours each, and one employee wages for 2,300 hours. In calculating hours of service, the church uses a method that counts hours actually worked. The church’s FTEs are calculated as follows:

(1) Total hours not exceeding 2,080 per employee is 15,600 hours, calculated as the sum of:

  • 10,400 hours for the five employees paid for 2,080 hours each (5 x 2,080)
  • 3,120 hours for the three employees paid for 1,040 hours each (3 x 1,040)
  • 2,080 hours for the one employee paid for 2,300 hours (lesser of 2,300 and 2,080)

    • (2) Based on 15,600 hours of service, the employer has seven FTEs (15,600 divided by 2,080 = 7.5, rounded to the next lowest whole number).

    Note that a church with 25 or more employees may qualify for the credit if some of its employees are parttime. This is because the limitation on the number of employees is based on FTEs. So, a church with 25 or more employees could qualify for the credit if some of its employees work parttime.

    The amount of average annual wages is determined by first dividing the total wages paid by the employer during the employer’s tax year to employees who perform services for the employer during the tax year by the number of the employer’s FTEs for the year. The result is then rounded down to the nearest $1,000 (if not otherwise a multiple of $1,000). Only wages that are paid for hours of service are taken into account. Wages for this purpose means wages subject to Social Security and Medicare tax withholding.

    Key point. The $50,000 average annual wage limit is adjusted for inflation beginning in 2013.

    Example. For the 2010 tax year, a church pays a total of $224,000 in wages to employees who perform services during the tax year and has 10 FTEs. The church’s average annual wages are $22,000 ($224,000 divided by 10 = $22,400, rounded down to the nearest $1,000).

    3. calculating the credit

    Only premiums paid by the employer under an arrangement meeting certain requirements (a “qualifying arrangement”) are counted in calculating the credit. Under a qualifying arrangement, the employer pays premiums for each employee enrolled in health care coverage offered by the employer in an amount equal to a uniform percentage (not less than 50 percent) of the premium cost of the coverage. However, a qualifying arrangement also includes an arrangement under which the employer pays at least 50 percent of the premium cost for single (employee-only) coverage for each employee enrolled in any health insurance coverage offered by the employer.

    Key point. If an employer provides employees with more than one type of health insurance coverage or if the employer’s health insurance provider does not charge the same premium for all employees enrolled in single (employee-only) coverage, the employer may meet the qualifying arrangement requirement even though the employer paid less than 50 percent of the premium cost for some employees enrolled in single (employee-only) coverage.

    For tax years beginning in 2010 through 2013, only premiums paid to a health insurance provider for health care coverage are counted for purposes of the credit. A health insurance provider is either an insurance company or another entity licensed under state law to provide health insurance coverage.

    The IRS has clarified that the term health insurance provider also includes “an arrangement under which an otherwise qualifying small church employer pays premiums for employees who receive medical care coverage under a church welfare benefit plan.” This conclusion is based on the Church Plan Parity and Entanglement Prevention Act of 1999, which states that “for purposes of enforcing provisions of state insurance laws that apply to a church plan that is a welfare plan, the church plan shall be subject to state enforcement as if the church plan were an insurer licensed by the state.” Based on this provision the IRS concluded that a church welfare benefit plan is subject to state insurance law enforcement as if it were licensed as an insurance company, and therefore meets the definition of a health insurance provider for purposes of the credit. As a result, insurance premiums paid by churches to many denominational health plans will be counted for purposes of the credit.

    Premiums for health care coverage that covers a wide variety of conditions, such as a major medical plan, are counted, and premiums for certain coverage that is more limited in scope, such as limited scope dental or vision coverage, are also counted. However, if an employer offers more than one type of coverage, such as a major medical plan and a separate limited scope dental or vision plan, the employer must separately satisfy the requirements for a qualifying arrangement with respect to each type of coverage the employer offers (meaning the employer cannot aggregate these different plans for purposes of meeting the qualifying arrangement requirement).

    Key point. An arrangement under which an otherwise qualifying small church employer pays premiums for employees who receive medical care coverage under a church welfare benefit plan may be a qualifying arrangement for purposes of the small business health care tax credit.

    Key point. Employer contributions to health reimbursement arrangements (HRAs), health flexible spending arrangements (FSAs), and health savings accounts (HSAs) are not taken into account for purposes of the small business health care tax credit.

    If an employer pays only a portion of the premiums for the coverage provided to employees under the arrangement, with employees paying the rest, the amount of premiums counted in calculating the credit is only the portion paid by the employer. For purposes of the credit, including the requirement to make a uniform contribution of no less than 50 percent of the premium, any premium paid pursuant to a salary reduction arrangement under a section 125 cafeteria plan is not treated as paid by the employer.

    Example. A church pays 80 percent of the premiums for employees’ health insurance, with employees paying the other 20 percent pursuant to a salary reduction arrangement under a cafeteria plan. Only the 80 percent premium amount paid by the church counts in calculating the credit.

    In addition, the amount of an employer’s premium payments that counts for purposes of the credit is capped by the premium payments the employer would have made under the same arrangement if the average premium for the small group market in the state in which the employer offers coverage were substituted for the actual premium. For example, if an employer pays 80 percent of the premiums for coverage provided to employees and the employees pay the other 20 percent, the premium amount that counts for purposes of the credit is the lesser of 80 percent of the total actual premiums paid or 80 percent of the premiums that would have been paid for the coverage if the average premium for the small group market in the state were substituted for the actual premium. The average premium for the small group market does not apply separately to each type of coverage the employer offers, but rather provides an overall cap for all health insurance coverage provided by a qualified employer.

    Key point. The average premium is determined by the Department of Health and Human Services (HHS). IRS Revenue Ruling 2010-13 sets forth the average premium for the small group market in each state for the 2010 tax year. This data is reproduced in Table 1 at the end of this article.

    Example. In 2011 a church has two ministers and seven lay employees for a total of nine FTEs with average annual wages of $23,000 per FTE (excluding the ministers’ compensation, which is not considered “wages” in computing the credit). The church pays $80,000 in health care premiums for its nine employees, which does not exceed the average premium for the small group market in the employer’s state, and otherwise meets the requirements for the credit. The total amount of the church’s income tax and Medicare tax withholding plus the employer’s share of the Medicare tax is $30,000 in 2011. The credit is calculated as follows:

    (1) Initial amount of credit determined before any reduction: (25% x $80,000) = $20,000
    (2) Employer’s withholding and Medicare taxes: $30,000
    (3) Total 2011 tax credit is $20,000 (the lesser of $20,000 and $30,000).

    In 2014, the maximum tax credit for eligible tax-exempt small employers increases to 35 percent.

    4. maximum credit amount

    For tax years beginning in 2010 through 2013, the maximum credit for a tax-exempt qualified employer is 25 percent of the employer’s premium expenses that count towards the credit. However, the amount of the credit cannot exceed the total amount of income and Medicare (i.e., hospital insurance) tax the employer is required to withhold from employees’ wages for the year and the employer share of Medicare tax on employees’ wages for the year.

    If a minister is an employee for income tax reporting purposes, he or she is taken into account in determining an employer’s FTEs for purposes of the health care tax credit. Also, premiums paid by the church for the health insurance coverage of a minister who is an employee can be taken into account in computing the credit, subject to limitations on the credit. If the minister is self-employed for income tax reporting purposes, he or she is not taken into account in determining an employer’s FTEs or premiums paid.

    5. reducing the credit

    The maximum credit goes to smaller employers—those with 10 or fewer full-time equivalent employees—paying annual average wages of $25,000 or less. The credit is completely phased out for employers that have 25 or more FTEs or that pay average wages of $50,000 or more per year. Because the eligibility rules are based in part on the number of FTEs, not the number of employees, employers that use part-time workers may qualify even if they employ more than 25 individuals.

    If the number of FTEs exceeds 10, or if average annual wages exceed $25,000, the amount of the credit is reduced as follows:

    If the number of FTEs exceeds 10, the reduction is determined by multiplying the otherwise applicable credit amount by a fraction, the numerator of which is the number of FTEs in excess of 10 and the denominator of which is 15.

    If average annual wages exceed $25,000, the reduction is determined by multiplying the otherwise applicable credit amount by a fraction, the numerator of which is the amount by which average annual wages exceed $25,000 and the denominator of which is $25,000.

    In both cases, the result of the calculation is subtracted from the otherwise applicable credit to determine the credit to which the employer is entitled. For an employer with both more than 10 FTEs and average annual wages exceeding $25,000, the reduction in the credit amount is equal to the sum of the amount of the two reductions. This sum may reduce the credit to zero for some employers with fewer than 25 FTEs and average annual wages of less than $50,000.

    Example. A church has two ministers and five lay employees. All seven workers are treated as employees for income tax purposes by the church. The ministers’ combined wages are $85,000, and the lay employees’ combined wages are $130,000. The church pays $75,000 in health care costs for its employees. For 2010, it is eligible for the small business health care credit. The two ministers are taken into account in determining the church’s FTEs for purposes of the health care tax credit. But, compensation paid to ministers for duties performed in the exercise of their ministry is not subject to FICA taxes and therefore is not compensation taken into account for the purposes of computing average annual wages. Therefore, the church’s average annual wages are $130,000/7 or $18,571. Since this is less than $25,000, and the church has only seven employees, it is entitled to a full credit, computed by multiplying 25 percent times its health care expenditures of $75,000 ($18,750). Note that if the ministers’ wages were included in computing average annual wages, the church would not be eligible for any credit since its annual average wages would be more than $25,000.

    Example. A church has 29 full-time equivalent employees, consisting of six ministers and 23 lay employees. The ministers’ wages are not considered in computing the church’s average annual wages for purposes of the small employer health care tax credit since they are not subject to Social Security and Medicare withholding (ministers are self-employed for Social Security with respect to compensation received for ministerial services). But, ministers are counted in computing FTEs, and so the church’s total workforce consists of 29 FTEs. Since this exceeds 25, the church is not eligible for the credit. This illustrates the purpose of the credit—to assist small employers in providing health coverage for their employees.

    Example. In 2011, a church has 12 FTEs (including three ministers) with average annual wages of $30,000 per FTE (excluding the ministers’ compensation, which is not considered “wages” in computing the credit). The church pays $48,000 in health care premiums for its employees, which does not exceed the average premium for the small group market in the state, and otherwise meets the requirements for the credit. Its payroll taxes (income tax and Medicare withholdings plus the church’s share of Medicare taxes on persons deemed employees under FICA) are $15,000. The credit is calculated as follows:

    (1) Initial amount of credit determined before any reduction: (25% x $48,000) = $12,000.
    (2) Credit reduction for FTEs in excess of 10: ($12,000 x 2/15) = $1,600.
    (3) Credit reduction for average annual wages in excess of $25,000: ($12,000 x $5,000/$25,000) = $2,400.
    (4) Total credit reduction: ($1,600 + $2,400) = $4,000.
    (5) Total 2011 tax credit without considering payroll taxes: ($12,000 – $4,000) = $8,000.
    (6) Payroll taxes of $15,000.
    (7) Total credit is the lesser of (5) or (6), or $8,000.

    6. how to claim the credit

    Small businesses can claim the credit for 2010 through 2013 and for any two years after that. For tax years 2010 to 2013, the maximum credit is 25 percent of premiums paid by eligible tax-exempt organizations. Beginning in 2014, the maximum tax credit will increase to 35 percent of premiums paid by eligible tax-exempt organizations.

    Tax-exempt organizations will first use Form 8941 to figure their refundable credit, and then claim the credit on Line 44f of Form 990-T. Though primarily filed by those organizations liable for the tax on unrelated business income, Form 990-T will also be used by any eligible tax-exempt organization to claim the credit, regardless of whether they are subject to this tax. Form 990-T has been revised for the 2011 filing season to enable eligible tax-exempt organizations to claim the health care tax credit.

    The deadline for filing Form 990-T is the 15th day of the fifth month following the end of a church’s tax year (May 15 of the following year for most churches).

    To illustrate, to claim the credit for 2011, a church will need to file Form 990-T by May 15, 2012. For churches that operate on a fiscal year basis, the deadline is the 15th day of the fifth month following the end of their fiscal year.

    Note that qualifying tax-exempt employers (including churches) having no taxable income to be offset with a tax credit will claim a “refundable” tax credit, meaning that the amount of the credit that would otherwise have offset taxable income is refunded to them.

    Tip. If a tax-exempt eligible small employer is filing Form 990-T only to request a credit for small employer health insurance premiums, the IRS recommends the following steps:

    1. Fill in the heading (the area above Part I) of Form 990-T except items E, H and I.
    2. Enter -0- on line 13, column (A), line 34, and line 43.
    3. Enter the credit from line 25 of Form 8941 on line 44f.
    4. Complete lines 45, 48, 49 and the signature area.
    5. Write “Request for 45R Credit Only” on the top of the Form 990-T.

    Key point. The credit is refundable so long as it does not exceed the employer’s income tax withholding and Medicare tax liability.

    Key point. Although the tax code requires section 501(c)(3) organizations to make their Form 990-T available for public inspection, this requirement does not apply to returns filed only to request a credit for the small employer health insurance premiums. Also, there is no requirement that section 501(c)(3) organizations make Form 8941 available for public inspection. An organization filing a Form 990-T only to request a credit for the small employer health insurance premium must write “Request for 45R Credit Only” across the top of the Form 990-T.

    7. transition relief

    For tax years beginning in 2010, certain transition relief applies with respect to the requirements for a qualifying arrangement. Specifically, an employer that pays at least 50 percent of the premium for each employee enrolled in coverage offered to employees by the employer is deemed to satisfy the qualifying arrangement requirement even though the employer does not pay a uniform percentage of the premium for each such employee. Accordingly, if the employer otherwise satisfies the requirements for the credit described above, it will qualify for the credit.

    8. years the credit is available

    The credit is initially available for any taxable year beginning in 2010, 2011, 2012, or 2013. Qualifying health insurance for claiming the credit for this first phase of the credit is health insurance coverage purchased from an insurance company licensed under state law. As noted above, the IRS has clarified that qualifying health insurance includes “an arrangement under which an otherwise qualifying small church employer pays premiums for employees who receive medical care coverage under a church welfare benefit plan.”

    For taxable years beginning in years after 2013, the credit is only available to a qualified small employer that purchases health insurance coverage for its employees through a state “exchange” and is only available for a maximum coverage period of two consecutive taxable years beginning with the first year in which the employer or any predecessor first offers one or more qualified plans to its employees through an exchange.

    The maximum two-year coverage period does not take into account any taxable years beginning in years before 2014. As a result, a qualified small employer could potentially qualify for this credit for six taxable years, four years under the first phase and two years under the second phase.

    9. questions

    This section addresses some common questions pertaining to the application of the small employer health insurance tax credit to churches.

    Question 1. Our church has a preschool with six employees. Are these employees taken into account in computing the small employer health insurance tax credit?

    Answer. Unfortunately, the tax code does not directly address this question, and the IRS has not provided any clarification. It is likely, though not certain, that the IRS would apply the “common law rules” pertaining to the definition of an “employer” for employment tax purposes (i.e., withholding and payment of Social Security, Medicare, and income taxes) in computing the number of employees for purposes of the small employer health insurance credit. These rules are found in several sources, including IRS Publication 15A:

    Under common-law rules, anyone who performs services for you is your employee if you have the right to control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed ….

    If you have an employer-employee relationship, it makes no difference how it is labeled. The substance of the relationship, not the label, governs the worker’s status. It does not matter whether the individual is employed full time or part time …. You generally have to withhold and pay income, social security, and Medicare taxes on wages that you pay to common-law employees.

    However, section 3401(d) of the tax code contains an important exception to the common law rules by defining an employer as “the person for whom an individual performs or performed any service, of whatever nature, as the employee of such person, except that if the person for whom the individual performs or performed the services does not have control of the payment of the wages for such services, the term employer means the person having control of the payment of such wages.” (emphasis added)

    According to this provision, the fact that a preschool employee is performing services directly for the preschool rather than the church, and would therefore be an employee of the preschool under the common law rules, is subject to the general rule of section 3401(d) that “if the person for whom the individual performs or performed the services does not have control of the payment of the wages for such services, the term employer means the person having control of the payment of such wages.”

    According to this precedent, it is likely that the employees of a church preschool would be considered church employees and included in computing the church’s eligibility for the small employer health insurance credit, if: (1) the preschool is not separately incorporated; (2) the preschool uses the church’s employer identification number for reporting employment taxes; and (3) the church pays the wages of preschool employees.

    On the other hand, if a church-affiliated preschool is separately incorporated, and has its own employer identification number, and pays the wages of its employees, then it is unlikely that these employees would be included in determining the number of church employees for purposes of the small employer health insurance tax credit.

    In some cases, a preschool may be separately incorporated, but use the church’s employer identification number. Are the employees of such a preschool counted in computing the number of church employees for purposes of the credit? The answer is less clear in “hybrid” scenarios like this. Perhaps the main point would be the definition of an “employer” under section 3401(d) of the tax code as the entity “having control of the payment of wages.” If the preschool employees’ wages are paid by the church, then the church would be the employer, even if the preschool operates with some level of independence under the governing documents of itself and the church.

    This analysis is necessarily tentative given the lack of clarification from the IRS. Any future developments will be reported in the Church Law & Tax Report and Church Finance Today newsletters, as well as in future editions of the Church & Clergy Tax Guide.

    Question 2. The instructions for Form 8941, page 2, under the heading “Individuals Considered Employees—Excluded employees,” states that “hours and wages of these [excluded] employees and premiums paid for them are not counted when you figure your credit.” So this seems to contradict the view that ministers are included in the employee count but not their wages.

    Answer. There are a number of employees who are excluded in computing the credit, and they are listed on page 2 of the instructions to Form 8941. None of these applies to ministers, at least in most cases. They include the owner of a sole proprietorship, a partner, certain shareholders, and some family members. These employees are all identified specifically in tax code section 45R(e)(1) as “excluded employees” for purposes of the credit. Note that ministers are not included in the list of excluded employees, and so the statement in the instructions that the “hours and wages of these employees and premiums paid for them are not counted when you figure your credit” does not apply to ministers.

    At the bottom of page 2 of the instructions to Form 8941 there is another section that addresses ministers directly. It states:

    Ministers. A minister performing services in the exercise of his or her ministry is treated as self-employed for social security and Medicare purposes. However, for credit purposes, whether a minister is an employee or self-employed is determined under the common law test for determining worker status. Self-employed ministers are not considered employees.

    This section correctly states that ministers are treated as employees in computing the credit so long as they satisfy the definition of a “common law employee.” The common law employee test is a test that is used for determining if someone is an employee or self-employed for income tax reporting purposes. Most pastors will satisfy this test, meaning that they will be counted in computing the number of church employees for purposes of the credit. However, in those rare instances where a pastor does not satisfy the common law employee test, he or she would not be counted in computing the number of church employees for purposes of the small employer credit.

    Section 45R of the tax code states that in computing the credit the term “wages” has the meaning as in section 3121(a). Section 3121(a)(8) specifies that for Social Security, a duly ordained, commissioned, or licensed minister of a church is self-employed with respect to services performed in the exercise of ministry. This is true even if a minister is an employee for income tax purposes. So, the typical pastor who is an employee for income tax reporting, and self-employed for Social Security, is deemed an employee in computing the number of church employees for purposes of the credit, but, since his or her compensation is not “wages” under section 3121 of the tax code, the minister’s compensation is not taken into account in computing the church’s average annual wages.

    IRS Notice 2010-82 provides the following explanation:

    A minister performing services in the exercise of his or her ministry is treated as self-employed for Social Security and Medicare tax purposes. See §§ 1402(c)(2)(D)4 and 3121(b)(8)(A). However, for other tax purposes, including § 45R, whether a minister is an employee or self-employed is determined under the common law test for determining worker status. If, under the common law test, a minister is self-employed, the minister is not taken into account in determining an employer’s FTEs and premiums paid because § 45R(e)(A)(i) excludes a self-employed individual from the term “employee” for purposes of the credit. If, under the common law test, the minister is an employee, the minister is taken into account in determining an employer’s FTEs and premiums paid by the employer for the minister’s health insurance coverage can be taken into account in computing the credit, subject to limitations on the credit. (Note that, under § 45R(f)(1)(B), a tax-exempt employer’s § 45R credit cannot exceed the total of the tax-exempt eligible small employer’s income tax and Medicare tax withholding and its Medicare tax liability for the year).

    Because compensation of a minister performing services in the exercise of his or her ministry is not subject to Social Security or Medicare tax under the Federal Insurance Contributions Act (FICA), a minister has no wages as defined under § 3121(a) for purposes of computing an employer’s average annual wages.

    Similarly, the following two questions and answers appear on the IRS website in the course of an explanation of the credit:

    24. Can a tax-exempt organization described in section 501(c) include a minister in its calculation when determining eligibility for the small business health care tax credit?

    A. The answer depends on whether, under the common law test for determining worker status, the minister is considered an employee of the tax-exempt organization or self-employed. If the minister is an employee, he or she is taken into account in determining an employer’s FTEs for purposes of the health care tax credit. Also, premiums paid by the employer for the health insurance coverage of a minister who is an employee can be taken into account in computing the credit, subject to limitations on the credit. If the minister is self-employed, he or she is not taken into account in determining an employer’s FTEs or premiums paid.

    25. Are the wages of a minister taken into account when computing average annual wages for purposes of determining eligibility for the credit?

    A. No. Compensation paid to ministers who are common law employees for duties performed in the exercise of their ministry is not subject to FICA taxes and is not wages as defined in section 3121(a). Thus, the wages of a minister that is a common law employee are not (to) be taken into account for purposes of computing average annual wages.

    In conclusion, ministers who are employees under the common law test (most ministers) are taken into account in computing the number of church employees, but their compensation is not considered in computing a church’s average annual wages.

    Question 3. Some ministers have elected voluntary withholding of income taxes and self-employment taxes. Will the wages of these ministers be counted in computing a church’s average annual wages?

    Answer. No. Section 45R of the tax code states that in computing the credit the term “wages” has the meaning as in section 3121(a), which pertains to Social Security and Medicare taxes (“FICA” taxes) for employees. However, since 3121(a)(8) specifies that for Social Security and Medicare taxes, a duly ordained, commissioned, or licensed minister of a church is self-employed with respect to services performed in the exercise of ministry, his or her compensation is not “wages” under section 3121 of the tax code and therefore is not taken into account in computing the church’s average annual wages even if a minister has entered into a voluntary withholding arrangement with the church. As the IRS notes in Notice 2010-82: “Because compensation of a minister performing services in the exercise of his or her ministry is not subject to Social Security or Medicare tax under the Federal Insurance Contributions Act (FICA), a minister has no wages as defined under § 3121(a) for purposes of computing an employer’s average annual wages.”

    Question 4. Why can’t the small employer health insurance credit exceed the amount of payroll taxes paid by the church?

    Answer. For small taxable employers the credit is a dollar-for-dollar reduction in actual tax liability that is computed and reported on their tax returns. Since tax-exempt employers, including churches, pay no taxes, the credit is “refundable.” However, to comply with the basic principle that the credit is available only to offset actual tax liability, the maximum refundable credit for tax-exempt employers is the amount of their payroll tax liability, which is defined by section 45R as the sum of the following three amounts:

    income taxes withheld from employees
    Medicare (hospital insurance) taxes withheld from employees, and
    the employer’s share of Medicare taxes

    Question 5. What is the maximum credit for a tax-exempt qualified employer?

    Answer. For tax years beginning in 2010 through 2013, the maximum credit for a tax-exempt qualified employer is 25 percent of the employer’s premium expenses that count toward the credit. However, the amount of the credit cannot exceed the total amount of income and Medicare (i.e., hospital insurance) tax the employer is required to withhold from employees’ wages for the year and the employer’s share of Medicare tax on employees’ wages for the year.

    Question 6. What about churches that filed Form 8274 several years ago electing to exempt themselves from the employer’s share of Social Security and Medicare taxes?

    Answer. By filing Form 8274, a church exempts itself from the employer’s share of Social Security and Medicare taxes for its lay employees. But, in addition, by filing the form, the church’s lay employees are treated as self-employed for Social Security, meaning that they pay the self-employment tax rather than Social Security and Medicare taxes. While the IRS has not yet addressed this question, it is likely that the “payroll taxes” limitation on the small employer health insurance credit will be affected since the church will not be withholding Medicare taxes and will not be paying Medicare taxes. This means that the only component of payroll taxes as defined by section 45R of the tax code will be income taxes withheld. The effect is a lower payroll tax limit on the amount of the credit.

    Question 7. What about ministers who have elected voluntary withholding of taxes? Will this affect the amount of the church’s credit? If so, should churches reconsider whether they want to accommodate a pastor’s request for voluntary withholding of income taxes and self-employment taxes?

    Answer. Section 45R of the tax code, which contains the small employer health insurance credit, limits the credit for tax-exempt employers (including churches) to “the amount of the payroll taxes of the employer during the calendar year in which the taxable year begins.” Section 45R(f)(3) defines “payroll taxes” as the sum of the following three amounts:

    (1) income taxes “required to be withheld from the employees of the tax-exempt eligible small employer,”
    (2) Medicare taxes “required to be withheld from such employees,” and
    (3) the employer’s share of Medicare taxes.

    Ministers wages are exempt from income tax withholding with respect to services performed in the exercise of their ministry, and they are not subject to Medicare taxes with respect to these services (instead, they pay self-employment taxes). So, the “payroll tax limit” on the amount of the credit will not be affected by ministerial employees.

    However, many pastors and churches have entered into “voluntary” withholding arrangements whereby the church withholds income taxes from a pastor’s wages. In some cases, a pastor requests that additional income taxes be withheld to offset self-employment tax liability. These additional withheld taxes are deemed income taxes and not Social Security or Medicare taxes.

    Of the three components of “payroll taxes” under section 45R(f)(3), the only one that would be affected by pastoral compensation would be withheld income taxes for pastors who have elected voluntary withholding. Are these voluntarily withheld income taxes counted in computing the “payroll tax” limit on the amount of the small employer health insurance credit? The obvious answer is “no,” since these taxes are voluntarily withheld and not required to be held (to use the language of section 45R(f)(3)). However, this issue has not been addressed or clarified by the tax code, regulations, IRS, or the courts, and so a definitive answer is not possible. Church leaders should consult with a tax professional in making a final decision. Note that if these voluntarily withheld taxes are included in computing the payroll tax limit, this will have the effect of increasing the credit for some churches.

    Question 8. Does a church have to use Form 990-T if it is only claiming the credit?

    Answer. The IRS has stated that “tax-exempt organizations will include the amount of the credit on Line 44f of revised Form 990-T (Exempt Organization Business Income Tax Return). Form 990-T has been revised to enable eligible tax-exempt organizations, even those that owe no tax on unrelated business income, to claim the small business health care tax credit.” An organization filing a Form 990-T only to request a credit for the small employer health insurance premium must write “Request for 45R Credit Only” across the top of the Form 990-T.
    Although the tax code requires section 501(c)(3) organizations to make their Form 990-T available for public inspection, this requirement does not apply to returns filed only to request a credit for the small employer health insurance premiums. Also, there is no requirement that section 501(c)(3) organizations make Form 8941 available for public inspection.

    Question 9. Are health insurance premiums paid by a church for its pastors included in computing the credit?

    Answer. Yes. The following question and answer appears on the IRS website in the course of an explanation of the credit:

    24. Can a tax-exempt organization described in section 501(c) include a minister in its calculation when determining eligibility for the small business health care tax credit?

    A. The answer depends on whether, under the common law test for determining worker status, the minister is considered an employee of the tax-exempt organization or self-employed. If the minister is an employee, he or she is taken into account in determining an employer’s FTEs for purposes of the health care tax credit. Also, premiums paid by the employer for the health insurance coverage of a minister who is an employee can be taken into account in computing the credit, subject to limitations on the credit. If the minister is self-employed, he or she is not taken into account in determining an employer’s FTEs or premiums paid.

    Question 10. When calculating the number of employees, are we to include all employees, or only full-time employees?

    Answer. To be eligible for the credit, an employer must have fewer than 25 “full-time equivalent employees” (FTEs) for the tax year and pay average annual wages of less than $50,000 per FTE.

    The number of an employer’s FTEs is determined by dividing (1) the total hours of service for which the employer pays wages to employees during the year (but not more than 2,080 hours for any employee) by (2) 2,080. The result, if not a whole number, is then rounded to the next lowest whole number (unless the result is less than one, in which case, the employer rounds up to one FTE).

    To calculate the total number of hours of service, which must be taken into account for an employee for the year, the employer may use any of the following methods:

    Method 1. Determine actual hours of service from records of hours worked and hours for which payment is made or due, including hours for paid leave;

    Method 2. Use a days-worked equivalency whereby the employee is credited with eight hours of service for each day for which the employee would be required to be credited with at least one hour of service under Method 1; or

    Method 3. Use a weeks-worked equivalency whereby the employee is credited with 40 hours of service for each week for which the employee would be required to be credited with at least one hour of service under Method 1. Employers do not have to use the same method for all employees, but may apply different methods for different classifications of employees, if the classifications are reasonable and consistently applied. For example, it is permissible for an employer to use Method 1 for all hourly employees and Method 3 for all salaried employees. Employers may change the method for calculating employees’ hours of service for each taxable year.

    Question 11. Does this credit apply in a situation where the only paid staff member is the pastor, assuming the annual salary is less than $50,000?

    Answer. Yes. The minister is counted in computing the number of employees, but his or her wages are not deemed to be compensation in computing the average annual wages limit of $50,000. So, in the case of a church with one pastor and no other paid staff, the church would have one employee and average annual wages of under $25,000 (ministers’ compensation is excluded from the definition of “wages” in computing the credit), entitling it to the full credit of 25 percent times the health insurance premiums paid by the church for the pastor, assuming that the church pays at least half of the premium amount.

    The credit is limited to the income taxes and Medicare taxes withheld by the church plus the church’s share of Medicare taxes. But, since ministers’ wages are exempt from income tax withholding, and ministers are not subject to FICA taxes with regard to compensation received for their ministerial services, a church will have no “payroll taxes” (income taxes and Medicare taxes withheld, plus the church’s share of Medicare taxes). This probably means that a church with only one pastor and no other compensated employee will be ineligible for the credit since it will have no payroll taxes and its credit cannot exceed the amount of payroll taxes paid. This is an open question that has not been answered by section 45R of the tax code or the IRS.

    One possible solution would be for the pastor to elect voluntary withholding of income taxes. If the pastor increases income tax withholding to account for both income tax and self-employment tax liability, this could have the effect of increasing the “payroll tax” ceiling by enough to make the credit worthwhile. Note, however, that voluntary withholding is available only to ministers who report their income taxes as employees, which may be the incorrect status for some ministers who are the sole compensated worker at their church. Also, note that if the pastor is a church’s sole compensated worker, and the pastor reports income taxes as a self-employed worker, this may affect the church’s eligibility for the credit since the credit only applies to health insurance provided by an employer for its employees.

    Churches with no employees other than a pastor should consult with a tax professional to resolve this issue. Any clarification will be presented in future editions of this newsletter.

    Question 12. Churches can obtain a six-month extension to file Form 990-T to report unrelated business income taxes. Can they obtain a six-month extension to file this form if they have no unrelated business income taxes to report and are using it solely to claim the small employer health insurance tax credit?

    Answer. The instructions to Form 990-T state that “corporations may request an automatic six-month extension of time to file Form 990-T by using Form 8868, Application for Extension of Time To File an Exempt Organization Return.” Unfortunately, the instructions do not state that an extension is available if the sole reason for filing Form 990-T is to claim the credit, and this question has not been addressed by section 45R, the IRS, or the courts. Church leaders should contact the IRS, or a tax professional, for advice if an extension is needed. Of course, given the relatively few lines on Form 990-T that a church needs to complete to claim the credit, the need for a filing extension should be rare.

    What about Ministers?

    Note the following two points regarding the treatment of ministers for purposes of the health insurance tax credit:

    1. If a minister is an employee under the so-called “common law employee test,” he or she is taken into account in determining an employer’s FTEs for purposes of the health care tax credit. Also, premiums paid by the church for the health insurance coverage of a minister who is an employee can be taken into account in computing the credit, subject to limitations on the credit. If the minister is self-employed for income tax reporting purposes, he or she is not taken into account in determining an employer’s FTEs or premiums paid.

    2. Compensation paid to ministers who are employees for duties performed in the exercise of their ministry is not subject to FICA taxes and is not compensation subject to income tax withholding. As a result, their wages are not taken into account for the purposes of computing average annual wages.

    The fact that ministers are taken into account in determining a church’s FTE count, but their wages are not considered in computing the average annual wages paid by a church, makes it more likely that some churches will benefit from the credit since the generally higher wages paid to ministers are removed from consideration.

    See chapter 2 in Richard Hammar’s 2011 Church & Clergy Tax Guide for a full explanation of the common law employee test. This is one of the tests used by the IRS and the courts in determining a minister’s reporting status for federal income tax reporting purposes.

    Checklist for Computing the Credit

    The following checklist is based on a three-step procedure available on the IRS website:

    STEP 1. Determine the total number of employees (include all employees meeting the “common law employee” test, which will include most ministers):

    _________ Full-time employees (enter the number of employees who work at least 40 hours per week):

    +

    _________Add full-time equivalent of part-time employees (calculate the number of full-time equivalents by dividing the total annual hours of part-time employees by 2,080)

    = _______________ total employees

    If the total number of employees is less than 25, go to STEP 2.

    STEP 2. Calculate the average annual wages of employees (excluding compensation paid to ministers):

    _________ Take the total annual wages paid to employees

    ÷

    Divide by the number of employees from STEP 1 (total wages, number of employees)

    = ____________ average wages

    If the result is less than $50,000, AND

    STEP 3. You pay at least half of the health insurance premiums for your employees at the single (employee-only) coverage rate, then:

    You may be able to claim the small business health care tax credit of up to 25 percent of the amount of health insurance premiums paid for your employees. Note the following limits and conditions:

    The credit is reduced if you have more than 10 full-time equivalent employees.

    The credit is reduced if you pay average annual wages in excess of $25,000 per employee.

    The credit cannot exceed the average premium for the small group market in your state.

    The credit is “refundable” for tax-exempt employers, meaning that it is refunded in cash. However, it cannot exceed an employer’s “payroll taxes,” which are defined as income tax and Medicare withholdings and the employer’s share of Medicare taxes.

    Constitutionality of the Affordable Care Act

    In late 2010, a federal district court judge in Florida declared the entire Affordable Care Act unconstitutional. The judge ruled that the requirement that American citizens obtain health insurance, with criminal penalties for noncompliance, exceeded the constitutional authority of Congress. And, given the centrality of this provision to the Act’s purposes, the judge ruled that the entire Act was unconstitutional. That ruling is on appeal. Other challenges are pending. Ultimately, the United States Supreme Court may determine the law’s validity. For now, it is important to recognize that there is some doubt as to the continuing availability of the small employer health care tax credit.

    Table 1: State Average Premiums for Small Group Markets

    The following chart sets forth the average premium for the small group market in each state (and Washington, D.C.) for the 2010 taxable year. Family coverage includes any coverage other than employee-only (or single) coverage.

    StateEmployee-only coverageFamily coverage
    Alaska $6,024 $13,723
    Alabama $4,441 $11,275
    Arkansas $4,329 $9,677
    Arizona $4,495 $10,239
    California $4,628 $10,957
    Colorado $4,972 $11,437
    Connecticut $5,419 $13,484
    District of Columbia $5,355 $12,823
    Delaware $5,602 $12,513
    Florida $5,161 $12,453
    Georgia $4,612 $10,598
    Hawaii $4,228 $10,508
    Iowa $4,652 $10,503
    Idaho $4,215 $9,365
    Illinois $5,198 $12,309
    Indiana $4,775 $11,222
    Kansas $4,603 $11,462
    Kentucky $4,287 $10,434
    Louisiana $4,829 $11,074
    Massachusetts $5,700 $14,138
    Maryland $4,837 $11,939
    Maine $5,215 $11,887
    Michigan $5,098 $12,364
    Minnesota $4,704 $11,938
    Missouri $4,663 $10,681
    Mississippi $4,533 $10,501
    Montana $4,772 $10,212
    North Carolina $4,920 $11,583
    North Dakota $4,469 $10,506
    Nebraska $4,715 $11,169
    New Hampshire $5,510 $13,624
    New Jersey $5,607 $13,521
    New Mexico $4,754 $11,404
    Nevada $4,553 $10,297
    New York $5,442 $12,867
    Ohio $4,667 $11,293
    Oklahoma $4,838 $11,002
    Oregon $4,681 $10,890
    Pennsylvania $5,039 $12,471
    Rhode Island $5,887 $13,786
    South Carolina $4,899 $11,780
    South Dakota $4,497 $11,483
    Tennessee $4,611 $10,369
    Texas $5,140 $11,972
    Utah $4,238 $10,935
    Virginia $4,890 $11,338
    Vermont $5,244 $11,748
    Washington $4,543 $10,725
    Wisconsin $5,222 $12,819
    West Virginia $4,986 $11,611
    Wyoming $5,266 $12,163

    Church Law & Tax Report is published six times a year by Christianity Today International, 465 Gundersen Dr. Carol Stream, IL 60188. (800) 222-1840.© 2011 Christianity Today International. editor@churchlawandtax.com All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold 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. “From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations.” Annual subscription: $69. Subscription correspondence: Church Law & Tax Report, PO Box 37012, Boone, IA 50037-0012.
    Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

    Supreme Court Tackles “Ministerial Exception”

    Church Law and Tax Report Supreme Court decision sets stage for possible new dismissal request.

    Richard R. Hammar, Attorney, CPA
    Bio
    Church Law and Tax Report

    Supreme Court decision sets stage for possible new dismissal request.

    The government will likely renew its motion to dismiss the FFRF lawsuit on the basis of the Supreme Court’s recent decision.

    Richard R. Hammar

    Introduction

    Many courts have ruled that the First Amendment guaranty of religious freedom prevents them from resolving employment disputes between churches and ministers. This so-called “ministerial exception” has been applied to a range of employment disputes, including discrimination, wrongful dismissal, and compensation claims. The exception has been applied in several cases to persons who are not ordained ministers but whose functions are central to the promotion and furtherance of a church’s mission.

    Though several state and federal courts have addressed the ministerial exception, the United States Supreme Court has yet to do so. That is about to change. The Supreme Court has agreed to hear an appeal involving the dismissal of a teacher by a church-operated secondary school. A federal district court in Michigan ruled that it was barred by the ministerial exception from resolving a disability discrimination claim brought by the teacher (the “plaintiff”) against her employing school. The court began its opinion by observing that “for the ministerial exception to bar an employment discrimination claim, the employer must be a religious institution and the employee must have been a ministerial employee.” There was no dispute that the school was a religious institution and so the focus shifted to the question of whether the plaintiff was a ministerial employee. The court concluded that she was. It noted that the exception “most clearly applies to clergy and ordained ministers,” but “it is not limited to such employees.”

    To determine if other employees fall within the exception, courts consider whether “the employee’s primary duties consist of teaching, spreading the faith, church governance, supervision of a religious order, or supervision or participation in religious ritual and worship.” Accordingly, “an employee may be considered ministerial, although not ordained, depending on the function and actual role of his or her position in the religious institution.” The court concluded that the duties of the plaintiff in this case clearly made her a ministerial employee to whom the ministerial exception applied:

    The separation of church and state in the United States has made federal courts inept when it comes to religious issues; the inquiry into the value of an employee in furthering a religious institution’s sectarian mission is no different. The lack of clarity in federal court cases regarding elementary school teachers should not hinder churches from valuing teachers as important spiritual leaders and deciding who will fill those positions as ministerial employees, subject, of course, to inappropriate uses of the title “minister” as subterfuge. For these reasons, it seems prudent in this case to trust [the school’s] characterization of its own employee in the months and years preceding the events that led to litigation. Because it considered the plaintiff to be a “commissioned minister” and the facts surrounding her employment in a religious school with a sectarian mission support this characterization, the court concludes that the plaintiff was a ministerial employee. If, on these circumstances, the Court were to conclude otherwise, it would risk infringing upon the school’s right to choose its spiritual leaders.”

    Having found that the school was a religious institution, and the plaintiff was a ministerial employee, the court concluded that it had no alternative but to dismiss the case. E.E.O.C. v. Hosanna-Tabor Church and School, 582 F.Supp.2d 881 (E.D. 2008).

    the appeals court’s decision

    The plaintiff appealed, and a federal appeals court vacated the district court’s ruling and ordered the case to proceed to trial. E.E.O.C. v. Hosanna-Tabor Evangelical Lutheran Church and School, 597 F.3d 769 (6th Cir. 2010). The appeals court acknowledged that the ministerial exception “precludes jurisdiction over claims involving the employment relationship between a religious institution and its ministerial employees, based on the institution’s constitutional right to be free from judicial interference in the selection of those employees.” It quoted from an earlier federal appeals court ruling: “The right to choose ministers without government restriction underlies the well-being of religious community … for perpetuation of a church’s existence may depend upon those whom it selects to preach its values, teach its message, and interpret its doctrine both to its own membership and to the world at large.” Rayburn v. General Conference of Seventh Day Adventists, 772 F.2d 1164 (4th Cir. 1985).

    The court observed that “as a general rule, an employee is considered a minister if the employee’s primary duties consist of teaching, spreading the faith, church governance, supervision of a religious order, or supervision or participation in religious ritual and worship.” It added that “the overwhelming majority of courts that have considered the issue have held that parochial school teachers who teach primarily secular subjects, do not classify as ministerial employees for purposes of the exception …. By contrast, when courts have found that teachers classify as ministerial employees for purposes of the exception, those teachers have generally taught primarily religious subjects or had a central role in the spiritual or pastoral mission of the church.”

    The court concluded that the plaintiff was not a ministerial employee:

    Her employment duties were identical when she was a contract teacher and a called teacher … she taught math, language arts, social studies, science, gym, art, and music using secular textbooks. Furthermore, the record indicates that she taught a religion class four days per week for thirty minutes and that she attended a chapel service with her class once a week for thirty minutes. She also led each class in prayer three times a day for a total of approximately five or six minutes. The record also indicates that she seldom introduced religion during secular discussions. Approximately twice a year, she led the chapel service in rotation with other teachers. However, teachers leading chapel or teaching religion were not required to be called or even Lutheran, and, in fact, at least one teacher was not. In all, the record supports the district court’s finding that activities devoted to religion consumed approximately forty-five minutes of the seven hour school day.

    [In summary] she spent approximately six hours and fifteen minutes of her seven hour day teaching secular subjects, using secular textbooks, without incorporating religion into the secular material. Thus, it is clear that her primary function was teaching secular subjects, not “spreading the faith, church governance, supervision of a religious order, or supervision or participation in religious ritual and worship.” The fact that she participated in and led some religious activities throughout the day does not make her primary function religious. This is underscored by the fact that teachers were not required to be called or even Lutheran to conduct these religious activities, and at least one teacher was not Lutheran.

    In addition, that [the school] has a generally religious character—as do all religious schools by definition—and characterizes its staff members as “fine Christian role models” does not transform a teacher’s primary responsibilities in the classroom into religious activities. This is underscored by the fact that the plaintiff can only recall twice in her career when she introduced the topic of religion during secular discussions.

    The court conceded that the school gave the plaintiff the title of “commissioned minister,” but concluded that “the title of commissioned minister does not transform the primary duties of these called teachers from secular in nature to religious in nature. The governing primary duties analysis requires a court to objectively examine an employee’s actual job function, not her title, in determining whether she is properly classified as a minister. In this case, it is clear from the record that [the plaintiff’s] primary duties were secular, not only because she spent the overwhelming majority of her day teaching secular subjects using secular textbooks, but also because nothing in the record indicates that the Lutheran church relied on her as the primary means to indoctrinate its faithful into its theology.”

    The court also pointed out that the primary duties of “called” teachers were identical to those of contract teachers who do not have the title of minister.

    The court concluded:

    Given the undisputed evidence that all teachers at [the school] were assigned the same duties, a finding that [the plaintiff] is a “ministerial” employee would compel the conclusion that all teachers at the school—called, contract, Lutheran, and non-Lutheran—are similarly excluded from coverage under the ADA and other federal fair employment laws. However, the intent of the ministerial exception is to allow religious organizations to prefer members of their own religion and adhere to their own religious interpretations. Thus, applying the exception to non-members of the religion and those whose primary function is not religious in nature would be both illogical and contrary to the intention behind the exception.

    One judge filed a concurring opinion in which she observed:

    [The plaintiff’s] daily duties resemble to some extent those of the plaintiffs in [several other] cases in which the courts found the [teacher’s] primary duties to be ministerial in nature. Tipping the scale against the ministerial exception in this case is that, as the majority points out, there is evidence here that the school itself did not envision its teachers as religious leaders, or as occupying “ministerial” roles. The teachers are not required to be called or even Lutheran to teach or to lead daily religious activities. The fact that the duties of the contract teachers are the same as the duties of the called teachers is telling. This presence (or lack) of a predominantly religious yardstick for qualification as a teacher is a key factor in decisions finding the ministerial exception applicable and those finding it inapplicable alike …. By this measure, even courts that have found ministerial plaintiffs who have daily schedules that have roughly the same ratio of religious to non-religious activities as the plaintiff would find that the ministerial exception should not apply here.

    United States Supreme Court review

    The United States Supreme Court has agreed to review the federal appeals court decision, and this will give it an opportunity for the first time to address the ministerial exception, and in particular, to clarify the meaning of “ministerial” employees.

    The courts have formulated the following two primary definitions of the term “ministerial employee” in the context of the ministerial exception:

    “If the employee’s primary duties consist of teaching, spreading the faith, church governance, supervision of a religious order, or supervision of participation in religious ritual and worship, he or she should be considered ‘clergy.'” Rayburn v. General Conference of Seventh-Day Adventists, 772 F.2d 1164 (4th Cir. 1985).

    The following three factors are considered in deciding if a church employee is a “minister” for purposes of the ministerial exception: (1) Are employment decisions regarding the position at issue made “largely on religious criteria”? (2) Is the employee authorized to perform the ceremonies of the church? (3) Does the employee engage in activities traditionally considered ecclesiastical or religious? Starkman v. Evans, 198 F.3d 173 (5th Cir. 1999).

    There is little doubt that the Court will acknowledge the ministerial exception in the context of ministers performing pastoral duties for churches and church agencies. The challenge will be to clarify the meaning of “ministerial employees” in the context of lay employees performing some pastoral functions. The Court may apply one of these two definitions, or formulate its own definition. Its decision will determine the application of a range of federal and state employment laws to lay church employees whose duties include some pastoral functions.

    Church Law & Tax Report is published six times a year by Christianity Today International, 465 Gundersen Dr. Carol Stream, IL 60188. (800) 222-1840.© 2011 Christianity Today International. editor@churchlawandtax.com All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold 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. “From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations.” Annual subscription: $69. Subscription correspondence: Church Law & Tax Report, PO Box 37012, Boone, IA 50037-0012.
    Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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    Q&A: Replacing Lost Social Security Cards

    I lost my Social Security card–what should I do?

    Richard R. Hammar, Attorney, CPA
    Bio
    Am I required to replace my lost Social Security card?

    There is no requirement to replace a lost Social Security card. Knowing your Social Security number is what is important. If you choose to replace a lost card you will need to complete a Form SS-5 (Application for a Social Security Card). Form SS-5 is available from your local Social Security office, or you can download a copy from the Social Security website (ssa.gov). You also will need to gather documents proving your identity and U.S. citizenship (if you have not already established your citizenship with Social Security).

    Social Security can accept only certain documents as proof of identity. An acceptable document must be current (not expired) and show your name, identifying information (date of birth or age), and preferably a recent photograph. Examples include:
    • U.S. driver’s license;
    • State-issued non-driver identification card; or
    • U.S. passport.

    Social Security can accept only certain documents as proof of U.S. citizenship. These include:
    • U.S. birth certificate;
    • U.S. consular report of birth;
    • U.S. passport;
    • Certificate of Naturalization; or
    • Certificate of Citizenship.

    All documents must be either originals or copies certified by the issuing agency. Social Security will not accept photocopies or notarized copies of documents.

    Take or mail your completed Form SS-5 and documents to your local Social Security office.

    There is no charge to replace your Social Security card if it is lost or stolen. However, you are limited to three replacement cards in a year and 10 during your lifetime. Legal name changes and changes in immigration status that require card updates may not count toward these limits. Also, you may not be affected by these limits if you can prove you need the card to prevent a significant hardship.

    In summary, while you are not required to replace a lost Social Security card, it is often advisable to do so. But remember that the number of replacement cards you may receive is limited, and so it is a good practice to keep your card in a safe place. Do not carry it with you unless you need it for a specific purpose, such as to apply for a job.
    Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
    Image: skynesher | Getty

    The Top Three Reasons Fraud Happens at Church

    Trust is not a sufficient strategy for protecting the church’s assets.

    Vonna Laue, CPA
    Bio

    Embezzlement in churches is on the rise. Regardless of a church’s size, three factors can make it more vulnerable to fraud.

    Lack of segregation of duties

    Churches often fall victim to embezzlement when they rely on one person to handle too many tasks related to handling the cash. For instance, even if Jane, the church bookkeeper, is able to sign checks, if she also has access to the check stock and the general ledger, she is in a prime position to steal money from the church. Her duties are not sufficiently segregated. A better practice would be to have Bill, the treasurer, sign the checks. By dividing the duties, there’s a greater degree of accountability and oversight.

    Trust

    Churches need to trust their employees, but trust itself can’t stand in the way of making good decisions regarding internal controls. Almost every church I have worked with that has experienced fraud said, “We trusted her.” Trust is not a sufficient strategy for protecting the church’s assets. Churches owe it to their congregation–and to their employees–to implement financial safeguards that help prevent fraud from occurring.

    Change

    Churches that experience fast growth are especially vulnerable to fraud. New personnel may not be trained properly or understand the importance of the procedures that are in place. If the church is growing quickly, leaders may not provide enough oversight of new employees to immediately recognize when certain practices are not being followed as assumed. Slow-growing churches are at risk too.

    Like a frog in a pot of simmering water, if your church is growing gradually, you may continue doing things the way you’ve always done them without recognizing that some of your internal controls have fallen by the wayside or are no longer effective given your new, larger size. You may also be at risk because of changes such as new technology. If people aren’t properly trained on the necessary controls in software, there can be breakdowns there as well.

    Is lack of segregation of duties, trust, or change putting your church at risk for embezzlement? What steps are you taking to prevent it?
    Vonna Laue has worked with ministries and churches for more than 20 years. Vonna was a partner with a national CPA firm serving not-for-profit entities through audit, review, tax, and advisory services. Most recently, she held the role of executive vice president for a Christian ministry that works to enhance trust in the church and ministry community.

    Planning the Pastor’s Retirement Package

    How should our church plan for our minister’s retirement?

    Lee A. Dean

    There’s something about the greeter at the local department store. He’s well-spoken and exudes a personal touch that must come from a career made shaking hands and offering kind words with a smile.

    As troubling as it may sound, though, he may be a retired pastor under financial pressure to take the job because he had an underperforming retirement plan—or no plan at all.

    Who takes the initiative in setting up a retirement plan for pastors? In many cases, the denomination or individual church steps up. If not, the pastor can at least contribute to his or her own Individual Retirement Account (IRA) or make retirement packages part of salary negotiation.

    “In a great many churches, the pastors/employees have to be the ones that demand this type of benefit,” says Elaine Sommerville, a CPA in charge of the tax practice of Ratliff & Sommerville, a Texas firm specializing in ministry and nonprofit finances.

    A vision with numbers attached

    New pastors begin planning for retirement by looking 30 to 40 years into the future, calculating their needs and creating a program that will meet those needs.

    According to Richard Hammar, attorney, CPA and senior editor of the Church Finance Today newsletter, this means “deciding how much you will need for living expenses when you retire, and then planning a retirement plan that meet those needs, being sure to include Social Security and any other sources of income.”

    The question underlying all the other questions for pastors: How much money will you need?

    “In general, most financial planners recommend that you contribute enough to your retirement plan that it, along with Social Security and all other forms of retirement income, will yield between 70 and 100 percent of your pre-retirement income,” Hammar says.

    Financial planners use a variety of tools to help pastors calculate their future needs. No one-size-fits-all formula exists, but these questions should be carefully considered and assigned specific dollar amounts:
    • How long will I work?
    • How will my investments perform?
    • What will be my housing arrangements?
    • How much debt will I carry?
    • What will be my tax burden?
    • What will my cost of living be at retirement?

    “Then determine whether, at your retirement age, there will be enough money there to fund the standard of living for what you estimate to be the remainder of your life,” says Michael Batts, president of the Florida nonprofit CPA firm Batts, Morrison, Wales and Lee. Any plan should be “prudent and consistent with goals and the risk tolerance of the individual,” he adds.

    The level of funding depends greatly on when a plan is set up. Earlier is better.

    “Some may believe that annual contributions of, say, $5,000, is a lot. After all, it is more than $400 per month. But, if ministers do not begin deferring this amount into a retirement fund until they are in their 40s or older, it simply is not going to accumulate into a fund large enough to provide adequate retirement income in most cases, especially at the current low rates of return,” Hammar says.

    Pieces of a good plan

    Retirement plans have a great deal of variety, but the best ones have certain pieces in place that protect the pastor.

    First, have a plan that designates a housing allowance each year. This is particularly helpful for pastors who live in parsonages or have had housing allowances as part of their salary packages.

    Second, the plan should have maximum flexibility.

    “The plan should contain several different financial choices and the participant should be able to move between those options as they progress through the various life stages,” Sommerville says.

    Because pastors usually move a few times during their careers, their retirement plans should be portable. Hammar notes that 403(b) plans, the most common retirement plans for ministers, are fully portable. If a pastor leaves, the amount accumulated can move into the next employer’s plan or roll into an IRA.

    Third, pastors should get a plan that allows them to make their own additional contributions.

    Types of plans

    Retirement plans for pastors fall into four general categories.

    Qualified plans are so labeled because they qualify for tax deferral. The most common kind of a qualified plan for minis- try employees is the 403(b), also known as a tax-sheltered annuity, where a pastor does not pay taxes on the amount of money contributed in the year the contribution was made. Taxes on any earnings gained from the investment are also tax-deferred.

    “At the end of each year, make a salary reduction election for the new year that will be adequate to cover your expected retirement needs,” Hammar says.

    Non-qualified plan: These plans do not qualify for tax deferrals. They typically come into play when a pastor has already contributed the maximum amount to a qualified plan and wants to add more. They are funded with employee contributions made through a payroll deduction agreement.

    Qualified individual plan: An IRA is the most common type of plan in this category. An individual will set up this kind of account with a bank or an investment company.

    “I would tell anybody that the best and first option is a qualified plan that is set up and maintained by the employer,” Batts says. “You get the best tax advantage that way. Qualified plans allow for the largest amount of money that goes in on a tax- favored basis. Larger churches, particularly denominational churches, will typically have this in place at the denominational level. Independent churches will have to do it themselves.”

    An option to consider for both IRA and pre-qualified plans is a Roth arrangement, which allows money to be put into the plan on an after-tax basis. The earnings grow on a tax-exempt basis, and withdrawals are not taxed.

    “This Roth feature is allowed in the majority of plans and provides huge benefits to those who have many years to contribute to their plans,” Sommerville says.

    Another kind of plan, called a nonqualified deferred compensation plan (better known as a rabbi trust), is a specialized plan normally used only after a person has contributed the maximum amount into a qualified plan. In a rabbi trust, the church promises to compensate the pastor at a future date for services performed currently. The trust is funded by a salary reduction agreement, employer contributions, or an unfunded promise to pay the pastor in the future.

    One advantage to this kind of plan is that the church’s transfer of funds to the trust is generally not currently taxable. A church can set aside large amounts of money in the trust that exceed the limits imposed by other kinds of retirement plans.

    The disadvantage is that the requirements for these plans are stringent and should be set up only with the guidance of expert legal counsel.

    “A mistake in this type of plan can not only cause the minister to pay tax on contributions in the year they are contributed to the plan, but it can also carry a penalty of 20 percent,” Sommerville says.

    Keeping it legal

    The rabbi trust is one example of a church plan, a phrase used to describe a retirement plan established by a church or denomination that is exempt from some of the regulations that apply to similar retirement plans in the private sector.

    Whatever plan is chosen, the plan’s administrator and legal counsel need to make sure it follows the law.

    “Every plan has a set of rules to follow. Anyone who thinks it just involves setting up a brokerage account or buying an annuity should familiarize themselves with all of the rules surrounding retirement options,” Sommerville says.

    Changes in laws will only add to the complexity. For example, a federal court case in California is challenging the constitutionality of housing allowances.

    “If the courts ultimately rule that the housing allowance exclusion is unconstitutional, this not only means that churches no longer will be able to declare housing allowances for their ministers, but also that denominational pension plans will not be able to declare the distributions made to retired clergy as nontaxable housing allowances,” Hammar says.

    Perhaps the most important legal issue, and one with deep economic consequences as well, deals with how a pastor handles Social Security. It is estimated that one-third of clergy have opted out of Social Security, which means they do not have to pay Social Security taxes on their ministerial earnings.

    “This attracts ministers because the economic benefit of electing out saves them so much in taxes,” Batts says.

    Opting out also means that the pastors are not building up any Social Security benefits for themselves. Therefore, they are not eligible for Social Security benefits unless they have 40 or more quarters of coverage from secular employment, Hammar explains.

    Without Social Security benefits, modest though they may be, the retirement plan is asked to carry that much more weight.

    Settling with the taxman

    The central tax decision regarding retirement plans is whether to be taxed now or later. Most plans choose to have taxes taken out when funds are withdrawn.

    Another tax issue arises when a pastor receives a large retirement gift. The pastor doesn’t usually get to keep all the money. Any payment to a pastor is taxable unless it meets a specific provision in the Internal Revenue Code to exempt it from taxation.

    “The bottom line is that churches and pastors should assume that retirement gifts are fully taxable, but understand that in very limited situations it may be possible to argue that they are not. No pastor or church should treat a retirement gift as nontaxable without the advice of legal counsel. In the vast majority of cases, they simply will not be,” Hammar says.

    A church and its people may consider a retirement gift in the form of a large contribution to the pastor’s retirement plan. If so, make sure the gift amount does not exceed the limit that may be contributed.

    Within reach for your church?

    If your church has not established a retirement plan for pastors and staff, the reason may be because it is small and has limited financial resources. However, a plan such as a 403(b) costs the church nothing because it is funded from agreed-upon payroll deductions.

    In some cases, pastors are reluctant to bring up the issue for fear it may indicate excessive self-interest or a lack of faith in God’s provision. In other circumstances, a pastor’s retirement plan is simply not on the board’s radar.

    “Retirement savings is always a matter of attitude. Since even saving a $1,000 per year starting when you are 20 can create a large retirement account when you are 65, there are few instances that a church cannot ‘afford’ to assist a pastor in this manner,” Sommerville says.

    In any organization, the amount of available funds is limited. The same is true for pastors. The matter of funding a retirement plan thus becomes one of choosing priorities.

    “The reality is, it’s a need and it should be put on the table,” Batts says. “The church has the option to decide what level of priority to give retirement funding. The pastor has a prioritization issue in choosing which portion of his own pay will be deferred to the plan. Granted, there are so many dollars in the bucket no matter what, but it becomes an issue of priority for both sides.”
    Lee A. Dean is a frequent contributor to Christianity Today International’s resource websites. He has experience in local church leadership, and currently serves as the director of discipleship at Lighthouse Community Church in Kalamazoo, Michigan. He is a graduate of Cornerstone University and Grand Rapids Theological Seminary.

    Should Your Church Conduct Criminal Records Checks?

    These factors should guide the policies set by church leaders.

    Richard R. Hammar, Attorney, CPA
    Bio
    Church Law & Tax Report2011-05-01

    Should Your Church Conduct Criminal Records Checks?

    These factors should guide the policies set by church leaders.

    Richard R. Hammar, J.D., LL.M., CPA

    Editor’s Note: Historically, the May/June issue of Church Law & Tax Report features an annual 50-state review of child abuse reporting laws. Because these laws change infrequently, we will instead publish this review every other year. In its place, we gladly offer an article on background checks and the critical role they play in selecting suitable staff and volunteers to work with children. For the 2010 50-State Review of Child Abuse Reporting Laws, please visit http://bit.ly/aWoGlP.

    There are several factors for church leaders to consider in deciding whether or not to conduct criminal records checks on persons who potentially could have unsupervised access to minors on church property, in church vehicles, or in the course of church activities. These factors include the following:
    1. No court has found a church liable for a youth worker’s sexual misconduct on the ground that it failed to conduct a criminal records check.
    2. Churches are not legally required to conduct criminal records checks unless specifically required by law. To illustrate, in many states, church-operated schools and preschools must conduct criminal records checks on employees.
    3. Criminal records checks will reduce a church’s risk of being found liable for the negligent selection of youth workers.
    4. The minimum acceptable standard of care in the selection of youth workers appears to be changing. It is possible, if not likely, that the courts someday will find churches liable on the basis of negligent selection for the sexual misconduct of a volunteer or employee having unsupervised access to minors if no criminal records check was performed before the individual was hired. This conclusion is based on several considerations, including the following:
    5. Over the past few years, many national youth-serving charities have begun mandating criminal records checks for volunteers who work with minors. This list includes the Boy Scouts, Little League, and Youth Soccer. As more and more youth-serving charities conduct criminal records checks on volunteers, it is only a matter of time before a court concludes that such checks are a necessary component of “reasonable care” in the selection of youth workers. Such a finding would make it negligent for a church not to conduct such checks.
    6. The 106th Congress, 2nd session, stated during discussions of the Volunteer Organization Safety Act of 2000 (HR 4424) that: “It is the sense of Congress that to be effective, a background check must be fast, accurate, cost-effective and performed on everyone having regular contact with young people in a youth service organization.”
    7. The federal General Accounting Office noted in a recent study that “national fingerprint-based background checks may be the only effective way to readily identify the potentially worst abusers of children, that is the pedophiles who change their names and move from state to state to continue their sexually perverse patterns of behavior.”
    8. A number of courts have suggested that a charity’s duty of care in selecting workers is higher when those workers will be working with children. Some of these cases are summarized earlier in this section. While the courts have clearly defined what this “higher” duty of care means in practical terms, it is certainly predictable that one day it will mean the use of criminal records checks in selecting such workers.
    9. Criminal records checks are relatively inexpensive, and fast.
    10. There is little justification for a church not conducting a sex offender registry search at a minimum, especially in states where these checks are available online, and for free. However, such checks have serious limitations and should never be regarded as the only screening procedure.
    11. There are different kinds of criminal records checks available. The best options are a FBI fingerprint check (obtained through your designated state agency, which often will be the state police), or a search of multiple state databases using a reputable private company. There are hundreds, if not thousands, of private companies that will perform criminal records checks for a fee. But be careful when selecting one. Remember, private companies cannot access the FBI database, and so be wary of companies that offer “national” checks. Ask what they mean by “national” (in particular, what criminal records are searched, and in which states). If in doubt, go with a private company that has been selected by national youthserving charities to conduct their criminal records checks on volunteers. Companies such as Safe Hiring Solutions and Choicepoint have been selected by a number of national and local charities on the basis of their review of the many options. You can find more information on selecting a background check provider at http://bit.ly/hacPTR).
    12. Church Law & Tax Report is published six times a year by Christianity Today International, 465 Gundersen Dr. Carol Stream, IL 60188. (800) 222-1840. © 2011 Christianity Today International. editor@churchlawandtax.com All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold 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. “From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations.” Annual subscription: $69. Subscription correspondence: Church Law & Tax Report, PO Box 37012, Boone, IA 50037-0012.
    Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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    The Ministerial Exception

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

    Proposal Would Reinstate Form 1099 Exemption

    What would this legislation mean for churches?

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

    Proposal Would Reinstate Form 1099 Exemption

    What would this legislation mean for churches?

    Richard R. Hammar

    Section 6041 of the tax code requires all persons or entities engaged in a trade or business who make payments to a “non-employee” in any year of $600 or more in the course of that trade or business to report the income to the IRS on Form 1099-MISC. This reporting requirement is designed to improve tax compliance based on the assumption that payees are more likely to correctly report their taxable income if they realize that payors are reporting that income to the IRS.

    The income tax regulations specify that “all persons engaged in a trade or business” includes not only for-profit organizations, but also nonprofit and tax-exempt organizations. Treas. Reg. 1.6041-1(b)(1).

    Payments made to corporations are exempt from this reporting requirement.

    The Patient Protection and Affordable Care Act (part of last year’s healthcare reform legislation) made two significant amendments to section 6041. Both take effect for payments after December 31, 2011:

    First, a Form 1099-MISC must be issued to corporations that are paid $600 or more during the year in the course of the payor’s trade or business (with a copy going to the IRS). Exempted from this requirement are payments made to tax-exempt corporations.

    Second, all persons engaged in a trade or business (including nonprofit organizations) are required to report to the IRS payments aggregating $600 or more in a calendar year to a single payee for goods and certain services using tax form 1099.

    These requirements generated a firestorm of controversy because of their extraordinary expansion of the Form 1099 reporting requirement. Many persons claimed that the new law would impose a crushing administrative burden on countless nonprofit and for-profit entities as a result of the obligation to file billions of new 1099 forms. Read literally, the new law would require churches to issue a Form 1099 to any vendor from whom it purchased goods or services of $600 or more during the year.

    Previous attempts to repeal these expanded reporting requirements have failed. But that may soon change. Senate Finance Committee Chairman Max Baucus (D-Mont.) and Senate Majority Leader Harry Reid (D-Nev.) have introduced (and pledged to pass) a bipartisan bill that would repeal the new reporting requirements. The name of their bill is the Small Business Paperwork Mandate Elimination Act of 2011. “We have heard small businesses loud and clear and are responding to their concerns,” Baucus said.

    “Small businesses … told us the 1099 provision was burdensome, and we are responding quickly to ensure that they can keep running smoothly,” Reid said. “Making it easier for small businesses to thrive should be something Republicans and Democrats can agree on. I hope we can come together on common-sense reforms like this.”

    Key point. It is important for church leaders to be aware of the new reporting requirements beginning in 2012, since a failure to issue a Form 1099-MISC can result in penalties under sections 6721, 6722, and 6723 of the tax code.

    Example. In 2011, a church hires a local landscaping contractor to provide landscaping services for an annual fee of $5,000. The contractor is unincorporated and self-employed. The church is required to issue the contractor a Form 1099-MISC reporting the compensation paid to him. It sends a copy of the Form 1099-MISC to the IRS.

    Example. Same facts as the previous example, except that the contractor is incorporated. The church is not required to issue a Form 1040-MISC to a corporation since it is assumed that the corporation will issue the appropriate form (W-2 or 1099) to the contractor.

    Example. Same facts as the previous example, except that the year is 2012. Unless Congress changes the law, the church is required to issue a Form 1099-MISC to the contractor, even though he is incorporated, with a copy going to the IRS.

    Example. A self-employed, incorporated evangelist conducts religious services at a church on two occasions during 2012, and is paid $500 on each occasion. The church also reimburses the evangelist’s substantiated travel expenses under its accountable reimbursement plan. The church is not required to issue a Form 1040-MISC to the evangelist even though he is incorporated, since the health care reform legislation exempts payments to tax-exempt corporations from the Form 1099-MISC reporting requirement. It is a good practice for churches to confirm an evangelist’s representation that he or she is a tax-exempt corporation. This is easily done by (1) checking with the secretary of state’s office in the state in which the evangelist is allegedly incorporated to confirm nonprofit corporate status (in most states this can be done on the secretary of state website), and (2) confirming that the corporation is tax-exempt by searching the online directory of tax-exempt organizations (publication 78) on the IRS website.

    Example. In 2012, a church purchased $2,000 worth of goods from a local Walmart. Unless the expanded reporting requirement is repealed, the church will be required to issue a 2012 Form 1099-MISC to Walmart, and every other vendor from whom it purchased goods or services of $600 or more during the year. Compensation paid to tax-exempt corporations is exempt from the reporting requirement.

    Any developments will be reported in future editions of Church Finance Today.

    This article first appeared in Church Finance Today, April 2011.
    Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

    The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010

    Church Law & Tax Report 2011-03-01 The Tax Relief, Unemployment Insurance Reauthorization and Job Creation

    Richard R. Hammar, Attorney, CPA
    Bio
    Church Law & Tax Report 2011-03-01

    The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010

    Richard R. Hammar, J.D., LL.M., CPA

    Several tax provisions expired at the end of 2009, and several more expired at the end of 2010. Congress enacted legislation (referenced below as the “Tax Relief and Jobs Creation Act” or “the Act”) late in 2010 extending many of these provisions, meaning that they will be available when preparing your 2010 tax return and when computing estimated taxes and payroll tax withholding in 2011. Here is a summary of the extended provisions of most relevance to clergy and church staff:
    • Income tax brackets. The lower income tax rates enacted by Congress in 2001 and 2003 were to expire at the end of 2010. The Act extends these lower rates for all taxpayers through the end of 2012.
    • Capital gains and dividends. Under prior law, the capital gains and dividend rates for taxpayers below the 25-percent income tax bracket was equal to zero percent. For those in the 25-percent tax bracket and above the capital gains and dividend rates were 15 percent. These rates were to expire at the end of 2010, and higher rates (10 percent and 20 percent) were to apply. The Act extends the lower capital gains and dividends rates for all taxpayers through the end of 2012.
    • Child tax credit. Generally, taxpayers with income below certain threshold amounts may claim the child tax credit to reduce federal income tax for each qualifying child younger than age 17. In 2001, Congress increased the credit from $500 to $1,000 and made it refundable up to 15 percent of earnings above $10,000. In 2009, Congress amended the law to allow earnings above $3,000 to count toward refundability for 2009 and 2010. The Act extends these changes (which were scheduled to expire at the end of 2010) through the end of 2012.
    • Marriage penalty relief. For many years, married couples filing a joint tax return paid more taxes than if they were unmarried filing individual returns. In 2001 Congress ended this so-called “marriage penalty” by (1) increasing the basic standard deduction for a married couple filing a joint return to twice the basic standard deduction for an unmarried individual filing a single return; and (2) increasing the 15-percent income tax rate bracket for a married couple filing a joint return to twice the size of the corresponding rate bracket for an unmarried individual filing a single return. Both of these provisions were extended through the end of 2012.
    • Dependent care credit. The dependent care credit allows taxpayers a credit for a percentage of child care expenses for children younger than 13 and disabled dependents. In 2001, Congress increased the amount of eligible expenses from $2,400 for one child and $4,800 for two or more children to $3,000 and $6,000, respectively, and increased the applicable percentage from 30 percent to 35 percent. The Act extends these changes through the end of 2012.
    • Earned income tax credit. Under prior law, working families with two or more children qualified for an earned income tax credit equal to 40 percent of the family’s first $12,570 of earned income. In 2009, Congress increased the earned income tax credit to 45 percent of the family’s first $12,570 of earned income for families with three or more children and increased the beginning point of the phaseout range for all married couples filing a joint return (regardless of the number of children). The Act extends the increased credit for families with three or more children and the higher phase-out ranges for all married couples filing a joint return through the end of 2012.
    • Coverdell Education Savings Accounts. Coverdell Education Savings Accounts are tax-exempt savings accounts used to pay the higher education expenses of a designated beneficiary. In 2001, Congress increased the annual contribution amount from $500 to $2,000 and expanded the definition of education expenses to include elementary and secondary school expenses. These changes were extended by the Act through the end of 2012.
    • Employer-provided educational assistance. An employee may exclude from taxable income up to $5,250 per year of employer-provided education assistance. Prior to 2001, this incentive was temporary and only applied to undergraduate courses. Congress enacted legislation in 2001 that expanded this provision to graduate education and extended it to the end of 2010. The Act extends the changes to this provision through the end of 2012.
    • American Opportunity Tax Credit. The American Opportunity Tax Credit is available for up to $2,500 of the cost of tuition and related expenses paid during the taxable year. Under this tax credit, taxpayers receive a tax credit based on 100 percent of the first $2,000 of tuition and related expenses (including course materials) paid during the taxable year and 25 percent of the next $2,000 of tuition and related expenses paid during the taxable year. Forty percent of the credit is refundable (i.e., payable to individuals with no income tax liability). This tax credit is subject to a phaseout for taxpayers with adjusted gross income in excess of $80,000 ($160,000 for married couples filing jointly). The Act extends this credit through the end of 2012.
    • Alternative minimum tax. The Act allows an individual to offset the entire regular tax liability and alternative minimum tax liability by nonrefundable personal credits for 2010 and 2011. The provision provides that the individual AMT exemption amount for taxable years beginning in 2010 is (1) $72,450, for married individuals filing a joint return and surviving spouses; (2) $47,450 for other unmarried individuals; and (3) $36,225 for married individuals filing separate returns. The provision provides that the individual AMT exemption amount for taxable years beginning in 2011 is (1) $74,450, in the case of married individuals filing a joint return and surviving spouses; (2) $48,450 in the case of other unmarried individuals; and (3) $37,225 in the case of married individuals filing separate returns. Without these changes, the AMT exemption amounts would have plummeted in 2010 and beyond, exposing tens of millions of Americans to the AMT.
    • Energy-efficient existing homes. The Act extends the credit for energy-efficient improvements to existing homes through the end of 2011. Standards for eligible improvements are updated to reflect advances in energy efficiency.
    • Above-the-line deduction for certain expenses of elementary and secondary school teachers. The Act extends the $250 above the-line tax deduction for teachers and other school professionals for expenses paid or incurred for books, supplies (other than nonathletic supplies for courses of instruction in health or physical education), computer equipment (including related software and service), other equipment, and supplementary materials used by the educator in the classroom through the end of 2011.
    • Deduction of state and local general sales taxes. Congress enacted legislation in 2004 that provided an itemized deduction for state and local general sales taxes in lieu of the itemized deduction for state and local income taxes. Taxpayers could deduct the total amount of general state and local sales taxes they paid by accumulating receipts showing general sales taxes paid, or they could use tables created by the IRS. This provision was adopted to address the unequal treatment of taxpayers in the nine states that have no income tax. Taxpayers in these states cannot take advantage of the itemized deduction for state income taxes. Allowing them to deduct sales taxes helps offset this disadvantage. The Act extends this deduction through the end of 2011.
    • Above-the-line deduction for qualified tuition and related expenses. Under prior law an above-the-line deduction of up to $4,000 was available for qualified education expenses incurred by a taxpayer or a taxpayer’s spouse or dependent. Qualified education expenses included tuition and certain related expenses required for enrollment or attendance at an eligible educational institution (any college, university, vocational school, or other post-secondary educational institution eligible to participate in a student aid program administered by the Department of Education). Student activity fees and expenses for course-related books, supplies, and equipment were included in qualified education expenses only if the fees and expenses had to be paid to the institution as a condition of enrollment or attendance. This deduction was extended by the Act through the end of 2011.
    • Extension of tax-free distributions from individual retirement plans (“IRAs”) for charitable purposes. The Act extends a provision that permits tax-free distributions to charity from an IRA of up to $100,000 per taxpayer, per taxable year, through the end of 2011. Distributions are eligible for the exclusion only if made on or after the date the IRA owner attains age 70½ and only to the extent the distribution would be includible in gross income (without regard to this provision). The Act allows individuals to make charitable transfers during January of 2011 and treat them as if made during 2010.
    • Parity for mass transit benefits. The Act extends the increase in the monthly exclusion for employer-provided transit and vanpool benefits to that of the exclusion for employer-provided parking benefits through the end of 2011.
    • Refund and tax credit disregard for means-tested programs. Prior law ensured that the refundable components of the earned income tax credit and child tax credit did not make households ineligible for means-tested benefit programs, and did not count as income in determining eligibility (and benefit levels) in such programs. Without these provisions, the receipt of a tax credit could put a substantial number of families over the income limits for these programs in the month that the tax refund was received. The Act disregards all refundable tax credits and refunds as income for means-tested programs. The proposal is effective for amounts received after December 31, 2009, and does not apply to amounts received after December 31, 2012.
    • Extension of enhanced charitable deduction for contributions of food inventory. The Act extends a provision allowing businesses to claim an enhanced deduction for the contribution of food inventory through the end of 2011.
    • Personal Exemption Phaseout. Personal exemptions allow a certain amount per person to be exempt from tax (currently $3,650). Due to the Personal Exemption Phase-out (“PEP”), the exemptions are phased out for taxpayers with income above a certain level. The PEP was repealed in 2010. This repeal was extended by the Act through the end of 2012.
    • Itemized deduction limitation. Generally, taxpayers itemize deductions if their total deductions are more than the standard deduction amount. Since 1991, the amount of itemized deductions is reduced for taxpayers with income above a certain amount. This limitation is generally known as the “Pease limitation.” It was repealed for 2010.

    The Act extends the repeal of the Pease limitation through the end of 2012. The Act contained two other significant provisions that were not extensions of expiring provisions:

    • Payroll tax “holiday.” Under current law, employees pay a 6.2 percent Social Security tax on all wages earned up to $106,800 (in 2011) and self-employed individuals pay a 12.4 percent Social Security self-employment tax on all of their self-employment income up to the same threshold. The Act provides a payroll tax and self-employment tax “holiday” during 2011 of two percentage points. This means employees will pay only 4.2 percent on wages and self-employment individuals will pay only 10.4 percent on self-employment income up to the threshold. This provision will result in an increase in take-home pay for millions of workers. The IRS has issued new withholding tables (see Publication 15) that reflect this change, and churches should begin using the new tables as soon as possible. For any Social Security tax that is overwithheld during January, employers should make an offsetting adjustment in workers’ pay as soon as possible but not later than March 31, 2011. Employers and payroll companies will handle the withholding changes, so workers typically won’t need to take any additional action, such as filling out a new W-4 withholding form.

    The Act revives the estate tax, but establishes an exemption of $5 million per person and $10 million per couple and a top tax rate of 35 percent for two years, through 2012.

    • Estate tax relief. Beginning in 2001, Congress began phasing out the estate tax. It was fully repealed in 2010. The Act revives the estate tax, but establishes an exemption of $5 million per person and $10 million per couple and a top tax rate of 35 percent for two years, through 2012. The exemption amount is indexed beginning in 2012. The proposal is effective January 1, 2010, but allows an election to choose no estate tax and modified carryover basis for estates arising on or after January 1, 2010, and before January 1, 2011. Under prior law, couples had to do complicated estate planning to claim their entire exemption. The Act allows the executor of a deceased spouse’s estate to transfer any unused exemption to the surviving spouse without such planning. This provision is effective for estates of decedents dying after December 31, 2010.

    Some expired tax provisions were not extended by The Act. These include:
    • Additional standard deduction for state and local real property taxes. Congress enacted legislation in 2008 that provided a limited tax deduction for state and local property taxes to non-itemizers by increasing their standard deduction by the lesser of (1) the amount allowable to the taxpayer as a deduction for state and local taxes or (2) $500 ($1,000 in the case of a married individual filing jointly). The increased standard deduction was determined by taking into account real estate taxes for which a deduction was allowable to the taxpayer.
    • Making work pay credit. In the past, eligible individuals could claim a refundable income tax credit for two years (2009 and 2010). The credit was the lesser of (1) 6.2 percent of an individual’s earned income, or (2) $400 ($800 in the case of a joint return). Taxpayers could elect to receive this benefit through a reduction in the amount of income tax withheld from their paychecks, or through claiming the credit on their tax returns. The credit expired at the end of 2010 and was not renewed. The withholding tables for 2011 are no longer adjusted for this credit.
    • Deduction of state and local tax on the purchase of qualified motor vehicles. In the past, taxpayers could claim an above-the-line deduction for qualified motor vehicle taxes. Qualified motor vehicle taxes included any state or local sales or excise tax imposed on the purchase of a qualified motor vehicle. A qualified motor vehicle was a passenger automobile, light truck, or motorcycle (with a gross vehicle weight of not more than 8,500 pounds) that was acquired for use by the taxpayer after February 17, 2009, and before January 1, 2010, the original use of which begins with the taxpayer. The deduction was limited to the tax on up to $49,500 of the purchase price of a qualified motor vehicle. Congress has not extended this deduction.
    • Waiver of minimum required distribution rules for IRAs and defined contribution plans. In general, persons participating in IRAs and defined benefit plans must begin receiving “required minimum distributions” by a certain age in order to avoid penalties. Congress suspended this rule for 2009, but has not done so for any subsequent year.

    Church Law & Tax Report is published six times a year by Christianity Today International, 465 Gundersen Dr. Carol Stream, IL 60188. (800) 222-1840. © 2011 Christianity Today International. editor@churchlawandtax.com All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold 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. “From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations.” Annual subscription: $69. Subscription correspondence: Church Law & Tax Report, PO Box 37012, Boone, IA 50037-0012.
    Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

    Assessing the Tax Relief Act

    What should churches note when preparing taxes for 2010 and beyond?

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

    Assessing the Tax Relief Act

    What should churches note when preparing taxes for 2010 and beyond?

    Richard R. Hammar

    Several tax provisions expired at the end of 2009, and several more expired at the end of 2010. Congress enacted legislation (the “Tax Relief and Jobs Creation Act”) late in 2010 extending many of these provisions, meaning that they will be available when preparing your 2010 tax return and when computing estimated taxes and payroll tax withholdings in 2011.

    The Act contained a significant provision that was not an extension of an expiring provision. Under current law, employees pay a 6.2 percent Social Security tax on all wages earned up to $106,800 and self-employed individuals pay a 12.4 percent Social Security self-employment tax on all their self-employment income up to the same threshold. The Act provides a payroll tax and self-employment tax “holiday” during 2011 of two percentage points. During 2011, this means employees will pay only 4.2 percent on wages and self-employment individuals will pay only 10.4 percent on self-employment income up to the threshold. This provision will result in an increase in take-home pay for millions of workers. The IRS has issued new withholding tables (see Publication 15) that reflect this change, and churches should begin using the new tables as soon as possible. For any Social Security tax that is over-withheld during January, employers should make an offsetting adjustment in workers’ pay as soon as possible but not later than March 31, 2011. Employers and payroll companies will handle the withholding changes, so workers typically won’t need to take any additional action, such as filling out a new W-4 withholding form.

    Beyond this important change, here is a summary of extended provisions from the Act that are of the most relevance to clergy and church staff:
    1. Income tax brackets. The lower income tax rates enacted by Congress in 2001 and 2003 were to expire at?the end of 2010. They were extended through 2012 for all taxpayers.
    2. Capital gains and dividends. Under prior law, the capital gains and dividend rates for taxpayers below the 25 percent income tax bracket was equal to zero percent. For those in the 25 percent tax bracket and above the capital gains and dividend rates were 15 percent. These rates were to expire at the end of 2010, and higher rates (10 percent and 20 percent) were to apply. The Act extends the lower capital gains and dividends rates for all taxpayers through 2012.
    3. Child tax credit. Generally, taxpayers with income below certain threshold amounts may claim the child tax credit to reduce federal income tax for each qualifying child under the age of 17. In 2001, Congress increased the credit from $500 to $1,000 and made it refundable up to 15 percent of earnings above $10,000. In 2009, Congress amended the law to allow earnings above $3,000 to count toward refunds for 2009 and 2010. The Act extends these changes through 2012.
    4. Marriage penalty relief. For many years, married couples filing a joint tax return paid more taxes than if they were unmarried and filing individual returns. In 2001 Congress ended this so-called “marriage penalty” by (1) increasing the basic standard deduction for a married couple filing a joint return to twice the basic standard deduction for an unmarried individual filing a single return; and (2) increasing the 15-percent income tax rate bracket for a married couple filing a joint return to twice the size of the corresponding rate bracket for an unmarried individual filing a single return. These provisions were extended through 2012.
    5. Dependent care credit. The dependent care credit allows taxpayers a credit for a percentage of child care expenses for children under 13 and disabled dependents. In 2001, Congress increased the amount of eligible expenses from $2,400 for one child and $4,800 for two or more children to $3,000 and $6,000, respectively, and increased the applicable percentage from 30 percent to 35 percent. The Act extends these changes through 2012.
    6. Earned income tax credit. Under prior law, working families with two or more children qualified for an earned income tax credit equal to 40 percent of the family’s first $12,570 of earned income. In 2009, Congress increased the earned income tax credit to 45% of the family’s first $12,570 of earned income for families with three or more children and increased the beginning point of the phase-out range for all married couples filing a joint return (regardless of the number of children). The Act extends the increased credit for families with three or more children and the higher phase-out ranges for all married couples filing a joint return through 2012.
    7. Coverdell Education Savings Accounts. Coverdell Education Savings Accounts are tax-exempt savings accounts used to pay the higher education expenses of a designated beneficiary. In 2001, Congress increased the annual contribution amount from $500 to $2,000 and expanded the definition of education expenses to include elementary and secondary school expenses. These changes were extended through 2012.
    8. Employer-provided educational assistance. An employee may exclude from taxable income up to $5,250 per year of employer-provided education assistance. Prior to 2001, this incentive was temporary and only applied to undergraduate courses. Congress enacted legislation in 2001 that expanded this provision to graduate education and extended it to the end of 2010. The Act extends the changes to this provision through 2012.
    9. American Opportunity Tax Credit. The American Opportunity Tax Credit is available for up to $2,500 of the cost of tuition and related expenses paid during the taxable year. Under this tax credit, taxpayers receive a tax credit based on 100 percent of the first $2,000 of tuition and related expenses (including course materials) paid during the taxable year and 25 percent of the next $2,000 of tuition and related expenses paid during the taxable year. Forty percent of the credit is refundable (i.e., payable to individuals with no income tax liability). This tax credit is subject to a phase-out for taxpayers with adjusted gross income in excess of $80,000 ($160,000 for married couples filing jointly). The Act extends this credit through 2012.
    10. Alternative minimum tax. The Act allows an individual to offset the entire regular tax liability and alternative minimum tax liability by nonrefundable personal credits for 2010 and 2011. The provision provides that the individual AMT exemption amount for taxable years beginning in 2010 is (1) $72,450, for married individuals filing a joint return and surviving spouses; (2) $47,450 for other unmarried individuals; and (3) $36,225 for married individuals filing separate returns. The provision provides that the individual AMT exemption amount for taxable years beginning in 2011 is (1) $74,450, in the case of married individuals filing a joint return and surviving spouses; (2) $48,450 in the case of other unmarried individuals; and (3) $37,225 in the case of married individuals filing separate returns. Without these changes, the AMT exemption amounts would have plummeted in 2010 and beyond, exposing tens of millions of Americans to the AMT.
    11. Energy-efficient new homes credit. The Act extends, through 2011, the credit for manufacturers of energy-efficient residential homes.
    12. Energy-efficient appliances. The Act extends, through 2011, the credit for the U.S.-based manufacture of energy-efficient clothes washers, dishwashers, and refrigerators.
    13. Energy-efficient existing homes. The Act extends, through 2011, the credit for energy-efficient improvements to existing homes. Standards for eligible improvements are updated to reflect advances in energy efficiency.
    14. Above-the-line deduction for certain expenses of elementary and secondary school teachers. The Act extends, through 2011, the $250 above-the-line tax deduction for teachers and other school professionals for expenses paid or incurred for books, supplies (other than non-athletic supplies for courses of instruction in health or physical education), computer equipment (including related software and service), other equipment, and supplementary materials used by the educator in the classroom.
    15. Deduction of state and local general sales taxes. Congress enacted legislation in 2004 that provided an itemized deduction for state and local general sales taxes in lieu of the itemized deduction for state and local income taxes. Taxpayers could deduct the total amount of general state and local sales taxes they paid by accumulating receipts showing general sales taxes paid, or they could use tables created by the IRS. This provision was adopted to address the unequal treatment of taxpayers in the nine states that have no income tax. Taxpayers in these states cannot take advantage of the itemized deduction for state income taxes. Allowing them to deduct sales taxes helps offset this disadvantage. This deduction, which was scheduled to expire at the end of 2009, was extended through 2011.
    16. Above-the-line deduction for qualified tuition and related expenses. Under prior law, an above-the-line deduction of up to $4,000 was available for qualified education expenses incurred by a taxpayer or a taxpayer’s spouse or dependent. Qualified education expenses included tuition and certain related expenses required for enrollment or attendance at an eligible educational institution (any college, university, vocational school, or other post-secondary educational institution eligible to participate in a student aid program administered by the Department of Education). Student activity fees and expenses for course-related books, supplies, and equipment were included in qualified education expenses only if the fees and expenses had to be paid to the institution as a condition of enrollment or attendance. This deduction, which was scheduled to expire at the end of 2009, was extended through 2011.
    17. Extension of tax-free distributions from individual retirement plans (‘IRAs’) for charitable purposes. The Act extends, through 2011, a provision that permits tax-free distributions to charity from an IRA of up to $100,000 per taxpayer, per taxable year. Distributions are eligible for the exclusion only if made on or after the date the IRA owner attains age 701/2 and only to the extent the distribution would be includible in gross income (without regard to this provision). The Act allows individuals to make charitable transfers during January of 2011 and treat them as if made during 2010.
    18. Parity for mass transit benefits. The Act extends, through 2011, the increase in the monthly exclusion for employer-provided transit and vanpool benefits to that of the exclusion for employer-provided parking benefits.
    19. Extension of enhanced charitable deduction for contributions of food inventory. The Act extends, through 2011, a provision allowing businesses to claim an enhanced deduction for the contribution of food inventory.
    20. This article first appeared in Church Finance Today, February 2011.
    Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

    Tax Return Updates

    What you need to know before you file.

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

    Tax Return Updates

    What you need to know before you file.

    Richard R. Hammar

    Completing Tax Forms

    Forms W-2, W-3, 1099 and 1096 can be confusing to fill out. If you have questions about completing these forms, the IRS operates a centralized call site to answer questions about how to fill them out and what reporting information is required. If you have any questions about completing these forms, call the IRS at 1 866-455-7438, Monday through Friday, 8:30 a.m. to 4:30 p.m. eastern time.

    KEY POINT. The Social Security Administration (SSA) is urging employers to be sure that amounts reported on Form W-3 correspond to amounts reported on quarterly 941 forms. The SSA also has noted that the main reason that W-2 forms are rejected is the use of incorrect Social Security numbers. Churches can verify the accuracy of Social Security numbers of up to ten employees on the SSA website. Up to five Social Security numbers can be verified by calling the SSA at 1-800-772-6270 or 1-800-772-1213.

    TIP. The IRS has provided the following suggestions to reduce the discrepancies between amounts reported on Forms W-2, W-3, and Form 941: First, be sure the amounts on Form W-3 are the total amounts from Forms W-2. Second, reconcile Form W-3 with your four quarterly Forms 941 by comparing amounts reported for: (1) Income tax withholding (box 2). (2) Social Security and Medicare wages (boxes 3, 5, and 7). (3) Social Security and Medicare taxes (boxes 4 and 6). Amounts reported on Forms W-2, W-3, and 941 may not match for valid reasons. If they do not match, you should confirm that the reasons are valid.

    TIP. What are the most common errors the IRS finds on W-2 forms? Using ink that is too faint; entries that are too small; adding dollar signs to dollar amounts (they are not required); and checking the “retirement plan” box when not applicable.

    Retaining W-2 Forms

    It is a good practice for employees to keep copies of all W-2 forms issued to them by their employer until they confirm that the earnings reported on their W-2s correspond to the earnings credited to them on the Social Security Statement that is automatically issued each year to all Americans aged 25 and over. One of the main purposes of the Social Security Statement is to encourage taxpayers to check the accuracy of Social Security records and to make corrections. If earnings reflected on an employee’s Social Security Statement are underreported, the easiest way to correct the record is for the employee to present a copy of his or her W-2 for the year in question to the nearest Social Security office. While proof of earnings is possible without a W-2 form, it is more difficult and time-consuming.

    TIP. Encourage church employees to retain each W-2 form they receive until they confirm that the earnings reported on the form show up as earnings for the same year on their annual Social Security Statement. You also may want to include a similar notice to your members in your church bulletin or newsletter.

    Updated W-4 Forms for Church Staff

    If you have not done so already, be sure to check with all nonminister church employees to see if they need to file new W-4 forms with the church. The W-4 form is used by employees to report withholding allowances. This information will determine how much income tax the church withholds from the wages of a nonminister employee. The important point is this—W-4 forms often become obsolete because of changes in an employee’s circumstances, but the employee fails to submit a new form to the church. This can result in withholding that is significantly above or below the actual tax liability.

    Here are some reasons why an employee’s W-4 may be inaccurate—the birth of a new child, a pay raise, a divorce, or significant medical expenses. These same considerations apply to ministers who have elected “voluntary withholding” of their taxes.

    TIP. The tax cuts passed by Congress in recent years have reduced taxes for most Americans, and this is another reason why church employees should review their W-4 form.

    This article first appeared in Church Finance Today, January 2011.
    Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

    Q&A: Social Security Death Benefits

    Are social security benefits pro-rated?

    Richard R. Hammar, Attorney, CPA
    Bio
    My mother, a widow, died on November 29. Social Security has informed me that I must return her November benefit (paid in December) even though she was alive for almost the entire month. Why is this?

    Social Security benefits are not pro-rated. To be entitled to a Social Security benefit check for a given month, the person must be alive the entire month. No benefit is payable for the month of death.

    This provision has been in the law since 1939 and can be changed only if Congress amends the Social Security Act. None of the congressional committee reports accompanying the 1939 law explain why benefits are not payable for the month of death. Note, however, that a provision in the same law allows Social Security to pay survivors benefits for the entire month of death.

    You can return the check to your local Social Security office. If the payment is made by direct deposit, the U.S. Treasury will automatically debit the bank account.
    Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

    Churches Weigh the Credit Card Question

    Leaders wrestle with payment option for online giving.

    Matthew Branaugh, Business Owner
    Bio

    Bryce Collman spent years as an executive in the electronic payment processing business. He saw an opportunity at the end of 2009 to start a company that offers churches lower rates for processing credit and debit card transactions, and he was eager to spread the word.

    But visits to church leaders to tout his money-saving method produced several surprising responses. “As we talked with organizations, churches specifically told us, ‘No credit,'” Collman recalls. “A Dallas-area church did not want to put their members at risk of creating debt in order to support the church. They were adamant about it.” He responded by developing an option for online giving that he says will reject a credit card if someone tries to use one.

    Churches who have adopted online giving generally say it steadies their weekly giving patterns, since someone can still tithe regardless of whether they’re sitting in church on Sunday. As online giving grows more popular—one-third in the “2010 View from the Pew” survey say they regularly give online—Collman says he expects more churches to look into the debit-only option from his Texas-based Ardent Giving Solutions

    The reason: church leaders likely hear horror stories about credit card debt through personal finance ministries like Financial Peace and Crown Financial, but still want the benefits of online giving, forcing them to wrestle with this question: Are credit cards appropriate for tithing?

    For some, the answer already is yes. Aside from more predictable weekly giving patterns, “we are fast moving to a cashless society,” says Glenn Wood, church administrator for Seacoast Church, where 10,500 people attend each week at 13 campuses in the Southeast. “We need to adapt along with that.” And many people treat a credit card like a tool, making purchases to collect points, and then paying off the balances each month so that no interest accrues. Some enjoy cashing in those points for things like airline miles to help with missions trips, leaders say.

    At Seacoast, more than 20 percent of its total giving this year has come from electronic giving, up from just 5 percent in 2005. At Faith Promise Church in Knoxville, Tennessee, about 40 percent of the weekly collections from 3,600 people come electronically, says Aaron Goin, finance director.

    Wood and others point out that some congregants bounce checks or possess insufficient funds for electronic bill payments, or they tithe with cash or check, only to rack up thousands in debt while shopping. Wood says his church tells its givers to pay off balances each month; it also offers stewardship and personal finance classes to teach sound money practices, regardless the payment preference.

    Preventing congregants from using credit cards would legislate how people can or can’t give, Wood says.

    “I don’t think we want to become a nanny church,” says John Gordon, executive pastor of the Wayside Church in San Antonio. Many churches use credit cards for staff members to cover monthly business expenses, Gordon adds. “If you’re going to take the stance of absolutely no credit cards, if you have these other venues, are you going to be consistent across the board?” he asks.

    Others see things differently, though. While overall credit card debt has fallen slightly in 2010, the average American still carries nearly $4,600 in balances, according to an August report from TransUnion, a credit bureau. Personal finance ministries urge people to avoid credit card use; in Proverbs, followers learn they should “honor the Lord with your wealth, with the firstfruits of all your crops,” (Proverbs 3:9-10, NIV). Paul’s instruction to “let no debt remain outstanding,” (Romans 13:8, NIV) suggests a “no debt” position.

    That makes the use of credit cards through online giving appear contradictory, says Mark Brockman, administrative pastor of Crestwood Baptist Church in Kentucky. “We are discouraging debt and we do not want to put anyone in a situation where a contribution to the church might contribute to their debt,” he says.

    ServiceU, a company offering online giving and event registration to churches and businesses since 2002, has never been asked about a debit-only option, says Tim Whitehorn, its president and chief executive. He anticipates the question with credit cards will come up more, though, especially as giving through mobile devices gains traction. The goal for businesses like his is to offer multiple solutions. “We don’t push our clients one way or the other,” he says.

    Flexible choices may prove to be the middle ground. Drew Wilborn, associate pastor of business at the Antioch Church in Dallas, where 10 percent of giving comes electronically, says he expects most churches will wind up catering to supporters of both traditional and electronic methods. “A wise church will know both types of members are part of the congregation,” he says.

    Copyright © December 2010 by the author or Christianity Today.
    Click here for reprint information on Your Church.
    Matthew Branaugh is an attorney, and the business owner for Church Law & Tax.

    Q&A: Stolen Identity

    My Social Security Number has been stolen—what should I do?

    Richard R. Hammar, Attorney, CPA
    Bio
    I believe that my Social Security Number has been stolen. Can the Social Security Administration place a “fraud alert” on my number like my credit card company will do if my credit card is stolen?

    Unfortunately, Social Security cannot place a fraud alert on a Social Security Number (SSN). However, if you suspect that someone else is using your SSN for work, or you have received notice from the IRS of unreported taxable income that is not yours, you should report the problem to the SSA by calling 1-800-772-1213. SSA representatives will take appropriate action to ensure that your Social Security records are correct.

    If your SSN has been used to charge bills or to obtain credit, Social Security cannot straighten out your credit record. However, the SSA suggests that you take the following steps:
    • Check your Social Security earnings record. You can request a Social Security Statement to verify the accuracy of the reported earnings and request correction if necessary. Details on requesting a Statement can be found at the following website: socialsecurity.gov/statement.
    • Notify the Federal Trade Commission (FTC) 1-877-ID-THEFT (438-4338). The FTC also makes available an identity theft web page.
    • File an online complaint with the Internet Crime Complaint Center at ic3.gov. IC3’s mission is to serve as a vehicle to receive, develop, and refer criminal complaints regarding the rapidly expanding arena of cyber crime. The IC3 gives the victims of cyber crime a convenient and easy-to-use reporting mechanism that alerts authorities of suspected criminal or civil violations. Every complaint is sent to one or more law enforcement or regulatory agencies that have jurisdiction over the matter.
    • File a report with the local police or the police department where the identity theft took place, and keep a copy of the police report as proof of the crime.
    • Contact the fraud units of the three major credit-reporting bureaus (Equifax, Trans Union, and Experian). Request that fraud alerts be placed on your credit records requiring creditors to contact you before approving new credit or making any changes to an existing account. Ask for copies of your credit reports (there may be a fee).
    • Call each creditor to report fraud for any account that has been tampered with or opened fraudulently.
    • Close the credit accounts that you know or believe have been tampered with or opened fraudulently.

    Congress passed the Identity Theft and Assumption Deterrence Act of 1998 (Identity Theft Act) to address the problem of identity theft. Specifically, the Act makes it a federal crime when anyone: “Knowingly transfers or uses, without lawful authority, a means of identification of another person with the intent to commit, or to aid or abet, any unlawful activity that constitutes a violation of federal law, or that constitutes a felony under any applicable state or local law.” Violations of the Act are investigated by federal investigative agencies such as the U.S. Secret Service, the FBI, and the U.S. Postal Inspection Service, and prosecuted by the Department of Justice.
    Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

    Q&A: Tax Benefits for Missionaries

    Can a contract missionary from our church receive any tax benefits while he is serving overseas?

    Vonna Laue, CPA
    Bio
    We have a retired ordained pastor who is now our contract missionary assigned in our international mission field. Can he receive any tax benefit, such as a housing allowance like our ordained pastor, if he files a 1099?
    There are a couple of tax issues surrounding this question. However, the easiest thing to consider is that individuals in a foreign country are already able to apply the foreign earned income exclusion, making it unnecessary to determine whether the housing allowance is applicable. I would recommend that you review those criteria first.
    Vonna Laue has worked with ministries and churches for more than 20 years. Vonna was a partner with a national CPA firm serving not-for-profit entities through audit, review, tax, and advisory services. Most recently, she held the role of executive vice president for a Christian ministry that works to enhance trust in the church and ministry community.

    Legislation Drops Cell Phones from “Listed Property”

    But churches should await IRS guidance before changing record-keeping policies.

    Michael E. Batts, CPA
    Bio

    The small business tax relief legislation just passed by Congress and signed by the president includes a long-awaited provision removing cell phones from “listed property” under federal tax law effective for tax years beginning after December 31, 2009. As a result, the stringent record-keeping requirements that have applied for decades will no longer apply to cell phones or similar devices.

    The practical impact of the legislation likely will be that employers will be able to provide employees with cell phones primarily for business use on a tax-free basis, with little requirement to document the actual business vs. personal use. The law should result in cell phones being treated like any other pieces of equipment, such as regular telephones, for which detailed usage records are not required.

    While the legislative change applies to all U.S. employers and employees, the impact on nonprofit organizations is especially important because violations of the record-keeping requirements for “listed property” by nonprofits can result in “automatic excess benefit transaction” penalties on the individuals involved.

    The IRS is expected to issue guidance soon on the practical impact of the legislation, which may affect the specific manner in which employer-provided cell phones are treated for tax purposes.

    Churches that would like to change their plans for providing cell phones to employees may wish to wait for IRS guidance to determine the best way to approach this issue. While awaiting IRS guidance, churches may want to use the time to begin shopping carriers and comparing prices for group plans.
    Michael (Mike) E. Batts is a CPA and the managing partner of Batts Morrison Wales & Lee, P.A., an accounting firm dedicated exclusively to serving nonprofit organizations across the United States.
    Video

    Publishing Copyrighted Material through Church Websites and Services

    Video Series

    David Middlebrook
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    Congress Fails to Repeal New Form 1099 Reporting

    New requirements will begin in 2012.

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

    Congress Fails to Repeal New Form 1099 Reporting

    New requirements will begin in 2012.

    Richard R. Hammar

    Section 6041 of the tax code requires all persons or entities engaged in a trade or business who make payments in any tax year of $600 or more in the course of that trade or business to an independent contractor report that income to the IRS on Form 1099-MISC. This reporting requirement is designed to improve tax compliance based on the assumption that payees are more likely to correctly report their taxable income if they realize that payors are reporting that income to the IRS.

    The income tax regulations specify that “all persons engaged in a trade or business” includes not only for-profit organizations, but also nonprofit and tax-exempt organizations. Treas. Reg. 1.6041-1(b)(1).

    Exempted from this reporting requirement are most payments made to corporations.

    The Patient Protection and Affordable Care Act (part of this year’s healthcare reform legislation) amended the tax code to require the issuance of a Form 1099-MISC to corporations that are paid $600 or more during the year in the course of the payor’s trade or business (with a copy going to the IRS). Exempted from this requirement are payments made to tax-exempt corporations. This provision applies to payments made after December 31, 2011.

    A bill (H.R. 5982) introduced in July by congressman Scott Murphy (D-NY) would have repealed this change in the tax code. It failed to pass.

    KEY POINT. When this provision takes effect in 2012 it will relieve churches of the obligation of determining if payees are incorporated or unincorporated, since a Form 1099-MISC must be issued to either (assuming the payee receives annual compensation of $600 or more)./i>

    KEY POINT. It is important for church leaders to be aware of this new reporting requirement beginning in 2012, since a failure to issue a Form 1099-MISC to corporate service providers can result in penalties under sections 6721, 6722, and 6723 of the tax code.

    EXAMPLE. In 2010 a church hires a local landscaping contractor to provide landscaping services for the church for an annual fee of $5,000. The contractor is unincorporated and self-employed. The church is required to issue the contractor a Form 1099-MISC reporting the compensation paid to him. It sends a copy of the Form 1099-MISC to the IRS.

    EXAMPLE. Same facts as the previous example except that the contractor is incorporated. The church is not required to issue a Form 1040-MISC to a corporation since it is assumed that the corporation will issue the appropriate form (W-2 or 1099) to the contractor.

    EXAMPLE. Same facts as the previous example, except that the year is 2012. The church is required to issue a Form 1099-MISC to the contractor, even though he is incorporated, with a copy going to the IRS.

    This article first appeared in Church Finance Today, October 2010.
    Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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