Church and Clergy Tax Developments in 2004: Part 1 - Clergy and Lay Church Employees

Article summary. Congress enacted two major tax laws in the closing days of 2004 that include several provisions of direct relevance to churches and church employees. Tax laws enacted in prior years also contain provisions that took effect in 2004. In addition, a number of court decisions and IRS rulings provided clarification on a number of important tax issues. Nearly 90 of the most important changes and clarifications are summarized in this feature article.

A. Tax Law Changes Made by the IRS and the Courts

1. The IRS assesses "intermediate sanctions" against a pastor. In a series of four rulings published in August of 2004 the IRS for the first time assessed "intermediate sanctions" against a pastor as a result of "excess benefits" paid to him (and members of his family) by his church. Intermediate sanctions are substantial excise taxes the IRS can impose on persons who receive "excess benefits" from a tax-exempt organization. The IRS concluded that a pastor's personal use of church assets (vehicles, homes, credit cards, computers, cell phones, etc.) and nonaccountable reimbursements (not supported by adequate documentation of business purpose) that a church pays its pastor, are "automatic excess benefits" resulting in intermediate sanctions, regardless of the amount involved, unless they are reported as taxable income by the church on the pastor's W-2, or by the pastor on Form 1040, for the year in which the benefits are provided. This is a stunning interpretation of the tax code and regulations that will directly affect the compensation practices of most churches, and expose some ministers and church board members to intermediate sanctions. IRS Letter Rulings 200435019, 200435020, 200435021, 200435022.

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