Income Taxes - Clergy

Legal Developments

Lost Receipts Cost Pastor, Wife Almost $37,000 in Unreimbursed Business Expenses

Although a pastor and his wife sought large deductions for unreimbursed business expenses, the IRS denied them after a through examination.

Richard R. Hammar, Attorney, CPA
Bio

 

Key point. The Tax Cuts and Jobs Act of 2017 suspended from 2018 through 2025 a tax deduction for unreimbursed employee business expenses. It also suspended all other miscellaneous itemized deductions that were subject to the two-percent floor under prior law. 

While no itemized deduction is allowed from 2018 through 2025 for unreimbursed employee business expenses, this case remains relevant for the following reasons: (1) calculating business expenses that are reimbursable under an accountable reimbursement arrangement (and the effectiveness and conveniences offered by one); (2) calculating  the business expenses reported by self-employed persons on Schedule C (Form 1040); and (3) computing unreimbursed and nonaccountable reimbursed expenses incurred after 2025. 

The Internal Revenue Service (IRS) disallowed a couple’s tax deduction of $36,510 for unreimbursed employee expenses for lack of receipts supporting those expenses, instead allowing a deduction of only $877.86. 

Hop down for details on the couple’s tax returns and IRS examination.

Skip ahead to learn about “heightened substantiation requirements.”

Jump to the end to read what this case means for churches.

A new job causes financial strain

A husband and wife lived in Oklahoma from the beginning of 2014 until August 2014. The husband was pastor of a church. His wife sold furniture at a store.

The husband’s role as pastor was not just religious and ministerial. He performed maintenance, tech work, and graphic design for the church. 

He also traveled, whether for conferences and retreats, meetings with ministers at other churches, or to pick up large equipment the church needed, such as a soundboard or lighting rigs.

In July 2014, the husband began discussions with a Florida church about an executive youth pastor position. On July 15 he traveled to Florida for an interview. His wife joined him to interview for a teaching position with the church’s school. The couple were offered the positions, and they moved to Florida the next month. 

But the move to Florida proved to be a financial strain. 

 

Out-of-pocket costs, lower pay

Because the Florida church is in a rural area, everything is spread far apart.

Therefore, the pastor logged tens of thousands of miles for meetings, hospital visits, and other pastoral duties. He paid for this out of pocket and was not reimbursed (i.e., the expenses were unreimbursed employee business expenses).

In addition, the wife took a significant pay decrease to accept the teaching position at the church’s school. 

She paid for her own chalk, pencils, paper, notebooks, markers, classroom decorations, and other common supplies. 

She also bought basic classroom supplies for many low-income students, and rewards for good behavior. 

None of these purchases were reimbursed by the school.

The wife’s mother moved to Florida when the couple did, but struggled to find employment. In August 2015 she moved into the couple’s extra bedroom. To make room, they moved records, documents and office supplies from the bedroom to the garage.

The financial stress and family issues persisted. The couple’s first child had been born in early 2016, and they expended much of their savings. 

Return to Florida

By early 2016, the couple decided to leave Florida. They requested a few months to transition, but the Florida church granted only three weeks. 

The husband reached out to his former church in Oklahoma, and was offered a position there. In the ensuing weeks, the couple rushed to find a new place to live, sold their home in Florida, and returned to Oklahoma.

At the time, the couple had the funds available to rent only one moving truck. They took what they could carry back with them to Oklahoma, but the wife’s mother had to put some items from the garage into storage in Florida with the intent of returning in a few months to retrieve them. In doing so, the couple inadvertently moved the boxes containing their business and tax records into the storage unit. 

By August 2017 the wife’s mother had stopped paying for the storage unit, and the unit had been repossessed.

Tax return and examination

The couple timely filed their 2014 joint income tax return. They reported total income of $68,899 and claimed above-the-line deductions of $250 for educator expenses and $4,950 for moving expenses, resulting in adjusted gross income of $63,699. They claimed itemized deductions totaling $50,116 and exemptions totaling $7,900 for taxable income of $5,683.

On Schedule A, the couple reported (before application of the two-percent floor) unreimbursed employee expenses totaling $37,460 and tax preparation fees of $75. The couple’s unreimbursed employee expenses consisted of $950 of excess educator expenses related to the wife’s employment at the Florida church school, and $36,510 related to the husband’s employment as a minister. 

The husband’s expenses were calculated on Form 2106, Employee Business Expenses, as follows:
Unreimbursed employee business expenses Amount
Vehicle expenses $31,360
Travel expenses while away from home overnight $2,800
50% of meals and entertainment $750
Other business expenses $1,600
Total $36,510

The couple reported business use of two vehicles. For vehicle 1, a 2003 Dodge truck, they reported 34,000 business miles. For vehicle 2, a 2009 Nissan Altima, they reported 22,000 business miles. They multiplied the claimed 56,000 total business miles driven by the then-standard mileage rate of 56 cents to arrive at the vehicle expense of $31,360.

The IRS selected their return for examination in 2017, and it was during the examination that the husband discovered that his records were lost. He was unable to provide the IRS with the requested documentation but attempted to reconstruct his mileage log from memory. 

The IRS determined that the couple was not entitled to the deductions for unreimbursed employee expenses or tax preparation fees and issued a notice of deficiency. The couple appealed to the United States Tax Court.

Heightened substantiation requirements 

The Court noted that section 274 of the tax code prescribes stricter substantiation requirements for travel expenses, meals, and lodging away from home, and expenses with respect to the business use of a car. 

So, “even if such an expense would be otherwise deductible, section 274 may still preclude a deduction if the taxpayer does not present sufficient substantiation.”

To meet the heightened substantiation requirements, taxpayers must substantiate by adequate records “(1) the amount of the expense, (2) the time and place of the expense, (3) the business purpose of the expense or use, and (4) the business relationship.”

To substantiate car expenses through adequate records, taxpayers must maintain a contemporaneous log, trip sheet, or similar record, as well as corroborating documentary evidence, that together establish each required element of the expense.

In the absence of adequate records, taxpayers must establish each required element by their own statement, whether written or oral, containing specific information in detail as to such element and by other corroborative evidence sufficient to establish such element. 

The Court then addressed the deductibility of several unreimbursed employee business expenses:

Vehicle expenses.

The Court concluded that the couple had not satisfied the heightened substantiation requirements with respect to the claimed $31,360 deduction for vehicle expenses. The husband testified that his mileage log and other records from 2014 were lost, likely left in his mother-in-law’s storage unit in Florida and abandoned after she neglected to pay the rent on the unit following the family’s move back to Oklahoma in 2016. 

The husband attempted to reconstruct his mileage from memory, including on his list only those trips for which he could recall the specific dates and other details. While the Court found the husband to be 

forthright and believes he attempted to reconstruct his mileage in good faith, the reconstructed mileage log does not satisfy the requirements of section 274. It lacks sufficient specificity with respect to many of the trips …

Accordingly, the Court sustained the government’s disallowance of a vehicle expense deduction.

Travel expenses.

With respect to the claimed $2,800 travel expense deduction, the couple introduced into evidence copies of email receipts and itineraries from Priceline.com for a July 15 flight from Dallas to [Florida] for their job interviews for $748; a July 14 hotel stay in Dallas for $96.19; an August 1 hotel reservation for two rooms for the husband and a colleague in Columbus, Mississippi, for $156.26; a September 4 flight from Fort Lauderdale to Atlanta for $324.18; and a car rental in Atlanta from September 4 through September 7, for $83.49.

The Court was satisfied that: 

the taxpayers have met the strict substantiation requirements with respect to the Dallas hotel stay, the husband’s flight from Dallas to [Florida], the flight from [Florida] to Atlanta, and the car rental. The information in the email receipts, along with the other evidence in the record, meets the requirements of section 274. The [wife’s] flight is not a deductible business expense, however, because expenses incurred in seeking or investigating a new trade or business are not deductible under [tax code] section 162(a) and there is insufficient information in the record to substantiate the business purpose of the Columbus trip or the portion, if any, that was paid by the husband himself. Accordingly, the Court holds that [the taxpayers]  are entitled to a travel expense deduction of $877.86. 

Meals and entertainment expenses.

The couple claimed a deduction of $750 (50 percent of $1,500) for meals and entertainment expenses, but provided no receipts or other evidence beyond general testimony in support of the claimed meals and entertainment expenses. The Court disallowed a deduction.

Other business expenses.

The couple claimed a deduction for other expenses of $1,600. These expenses included $1,000 for a used MacBook laptop, $200 for a used Nexus 7 tablet, and a used HTC One smartphone. The husband could not recall at trial whether the $1,600 figure included any other purchases. 

The Court noted that section 280F(d)(4) of the tax code defines “listed property” to include any computer or peripheral equipment, including laptops and tablets. The laptop and the tablet “are thus subject to the heightened substantiation requirements of section 274.” But because the couple did not provide any evidence beyond their own testimony to back up the reported expenses, the Court denied a deduction for them.

Tax preparation fees.

Finally, the couple claimed, and the IRS disallowed, a deduction of $75 for tax preparation fees. The Tax Court agreed with the IRS that the couple “did not introduce any evidence or other substantiation in support of this amount beyond testimony that they generally used TurboTax to prepare their tax returns.” 

What this means for churches 

This case occurred before the Tax Cuts and Jobs Act of 2017, when unreimbursed employee business expenses were tax deductible as an itemized deduction on Schedule A (Form 2106) if a taxpayer had sufficient documentation to substantiate the deduction. In this case, a deduction was disallowed, because the taxpayers produced insufficient substantiation to qualify for a deduction of their unreimbursed employee business expenses.

As noted, the Tax Cuts and Jobs Act of 2017 suspended, from 2018 through 2025, a tax deduction for unreimbursed employee business expenses and all other miscellaneous itemized deductions that were subject to the two-percent floor under prior law.

However, this case is helpful in assisting self-employed church staff in computing the business expenses reported on Schedule C (Form 1040).

And, should the Tax Cuts and Jobs Act expire, this case will be helpful in assisting in assisting self-employed church staff in computing unreimbursed and nonaccountable reimbursed expenses after 2025.

The importance of accountable reimbursement plans

While no itemized deduction is allowed from 2018 through 2025 for unreimbursed employee business expenses, the suspension of an itemized deduction for unreimbursed employee business expenses (through 2025) does not affect the deductibility of business expenses reimbursed by an employer under an accountable reimbursement plan.

The Tax Cuts and Jobs Act of 2017 left intact a tax deduction for these expenses. The deductibility of business expenses reimbursed under an accountable plan is a primary reason for employers to maintain such a plan for the reimbursement of employee business expenses.

An accountable plan is one with the following four characteristics:
  • only ordinary and necessary employee business expenses are reimbursed; 
  • no reimbursement is allowed without an adequate accounting of expenses within a reasonable period of time (not more than 60 days after an expense is incurred); 
  • any excess reimbursement or allowance must be returned to the employer within a reasonable period of time (not more than 120 days after an excess reimbursement is paid); and 
  • an employer’s reimbursements must come out of the employer’s funds and not by reducing the employee’s salary. 

Under an accountable plan, an employee reports to the church rather than to the IRS. The reimbursements are not reported as income to the employee, and the employee does not claim any deductions. In general, this is the best way for churches to handle employee business expenses. But it is especially needed now with the disallowance of itemized deductions for unreimbursed employee business expenses mandated by the Tax Cuts and Jobs Act of 2017.

 

Philips v. Commissioner, T.C. Sum. Op. (2023).

Legal Developments

Minister Fined After Failing to Pay $25K in Income Tax

US Tax Court tosses minister’s ‘frivolous’ argument for underreporting tens of thousands of dollars in W-2 income, levies fine under section 6673 of Tax Code.

Richard R. Hammar, Attorney, CPA
Bio

A minister’s federal tax return (Form 1040) was selected for examination by the IRS. The IRS determined that the minister had underreported his taxes by $24,884. The case was appealed to the Tax Court, which affirmed the IRS determination.

A frivolous argument

The minister’s tax return failed to report any wage income despite his church issuing a Form W-2 reporting $63,652 in compensation for his ministerial services.

Tip: The 2023 Church and Clergy Tax Guide is out. If you’re an Advantage Member, there’s nothing to do – it’ll come to you. If you’re not, visit Church Law & Tax’s store to pick up your guide (available in hard copy or .pdf) today.

The minister argued he was not an employee, meaning his compensation was not taxable. The court observed, “The courts uniformly have rejected as frivolous the argument that money received in compensation for labor is not taxable income.”
The court noted that the church paid the minister as part of his compensation what were deemed “offsets” of the Social Security and Medicare taxes for which the minister was responsible.

It observed:

Because the minister’s compensation was not subject to the withholding and payment of such taxes by the church, the payments made by the church to [the minister] as “offsets” of his taxable income remain includible in his gross income. “To the extent that the church pays any amount toward the minister’s obligation for income tax or self-employment tax other than from the minister’s salary, the minister is in receipt of additional income that is includible in his gross income and must be considered in determining his income tax and self-employment tax liability.” (Quoting Rev. Rul. 68-507, 1968-2 C.B. 485.)

Ministers’ wages subject to self-employment tax

The Tax Court agreed with the IRS’s conclusion that the minister owed additional self-employment taxes:

[The minister] has also failed to carry his burden of showing that [the IRS’s] determination of additional self-employment tax was erroneous. Individuals are subject to tax under section 1401 [of the tax code] on their net earnings from self-employment, which is defined as the net income from any trade or business carried on by the individual. Section 3401(a)(9) provides that compensation for services paid to a “duly ordained, commissioned or licensed minister of a church” (church minister) is not wages for purposes of employment taxes and thus not subject to withholding and payment by a church employer. See Section 3402(a); see also Section 3121(b)(8).

In another case out of Florida, the IRS flexed its lien power on a minister who owed more than $7 million in unpaid taxes. Read about what the case means for churches and pastors here.

Instead, the provision of services by a church minister generally constitutes a trade or business, and a church minister’s wages are subject to self-employment tax. Section 1402(c)(4); see also Knight v. Commissioner, 92 T.C. 199, 201-202 (1989). While a church minister is permitted to submit a certificate seeking exemption from self-employment tax on religious or conscientious grounds, see section 1402(e), [the minister] has not alleged — nor does the record indicate — that he timely did so . …

[The minister] performed the duties and functions of a minister in his role at the church, which included leading worship services and ministering to members. … [He] received wages as compensation for those services. Due to his status as a minister under section 1402, the church did not withhold employment taxes from his compensation, which was properly subject to self-employment tax. We hold that the minister has failed to demonstrate that the IRS’s determination of self-employment tax was erroneous.

Section 6673 of the tax code authorizes the Tax Court, on its own initiative, to impose a penalty not in excess of $25,000 when it appears that (1) the proceedings have been instituted or maintained primarily for delay or (2) the taxpayer’s position in such proceeding is frivolous or groundless. A position maintained by the taxpayer is “frivolous” where it is “contrary to established law and unsupported by a reasoned, colorable argument for change in the law.” (Quoting Coleman v. Commissioner, 791 F.2d 68 (7th Cir. 1986)).

Here, the court noted the minister “contended that he is a ‘worker of common right and a nontaxpayer’ and thus ‘not subject to the jurisdiction of revenue law because of his occupation.’” The court found the argument frivolous, and despite warnings from the court, the minister continued to advance them. The court fined the minister $2,500 under section 6673.

What this means for churches

First, wages paid to employees for services rendered constitute taxable income and must be so reported by both the employer and employee.

The argument that ministers are not employees of their church and so their church compensation is not taxable is regarded as frivolous and can result in substantial penalties for both the employer and employee.

Second, as this case illustrates, churches often assist ministers with payment of self-employment taxes. The reasoning typically is that the church pays half of the Federal Insurance Contributions Act (FICA) taxes of non-minister employees, and so, as a matter of simple equity, the church should pay some portion of its minister’s self-employment taxes (Self-Employed Contributions Act (SECA)) which otherwise would be paid entirely by the minister. But note that any portion so paid by the church represents taxable income to the minister in computing both income taxes and self-employment taxes.

Third, section 6673 of the tax code authorizes the Tax Court to impose a penalty not in excess of $25,000 when it appears that (1) the proceedings have been instituted or maintained primarily for delay or (2) the taxpayer’s position in such proceeding is frivolous or groundless.

Van Pelt v. Commissioner, 2021 U.S. Tax Ct. LEXIS 69 (2021).

Legal Developments

Pastor Left Without Retirement Benefits Sues Church

The church had no obligation to withhold the minister’s Social Security and Medicare taxes, says court.

Key point. Ministers always are self-employed for Social Security with respect to services performed in the exercise of ministry (with the exception of some government-employed chaplains). As a result, ministers pay the self-employment tax rather than the employee’s share of Social Security and Medicare taxes—even if they report their federal income taxes as employees.

A federal district court in New York ruled that a church did not act improperly in failing to withhold Social Security taxes from its pastor’s compensation.

Background

A pastor was employed by a denominational agency (the “church”) for 20 years. During his employment, the church classified him as an employee and issued him annual W-2 forms, but it did not withhold FICA taxes (Social Security and Medicare) from his compensation.

In 2017, the pastor retired and the Social Security Administration informed him that he was not eligible for retirement benefits or Medicare because his employer had failed to withhold FICA taxes from his compensation.

Pastor sues his church for failing to withhold FICA taxes

The pastor sued the church claiming that it had negligently failed to withhold FICA taxes from his compensation. A federal court in New York dismissed the pastor’s claims. It concluded:

Because FICA exempts [the church] from withholding contributions on behalf of a person employed as a pastor, dismissal . . . is warranted here. FICA mandates that all employers are subject to “an excise tax, with respect to having individuals in his employ . . . paid by the employer with respect to employment.” The statute, however, excludes from its definition of employment “service performed by a . . . minister of a church in the exercise of his ministry.” For FICA purposes, “minister” encompasses “individuals who are duly ordained, commissioned, or licensed by a religious body” and who “have the authority to conduct religious worship.”

Employees not covered by FICA are required, under the Self-Employment Contributions Act (“SECA”) to pay taxes for Social Security and Medicare. SECA explicitly applies to “an individual who is a duly ordained, commissioned, or licensed minister of a church.” Ministers may be exempt from mandatory SECA contributions only if they have been granted an exemption [by the IRS]. [The church’s] purported mischaracterization of the pastor as an independent contractor does not alter the outcome because [the church] had no obligation to withhold FICA taxes on his behalf. . . . The court concludes, therefore, that the pastor has failed to state a claim upon which relief can be granted [and the church’s] motion to dismiss the complaint is granted.

What this means for churches

The pastor in this case was understandably shocked to find out after he retired that he was not eligible for retirement benefits or Medicare under Social Security, because his church had not withheld Social Security or Medicare taxes from his compensation for the 20 years of his employment.

Two special rules apply to ministers under the payroll reporting rules. Unfamiliarity with these two rules has created untold confusion.

The first special rule is that ministers always are self-employed for Social Security with respect to services performed in the exercise of ministry (with the exception of some government-employed chaplains).

As a result, ministers pay the self-employment tax rather than the employee’s share of Social Security and Medicare taxes—even if they report their federal income taxes as employees. It is incorrect for churches to treat ministers as employees for Social Security and to withhold the employee’s share of Social Security and Medicare taxes from their wages. It was this rule that the pastor did not understand.

The second special rule is that ministers’ compensation is exempt from federal income tax withholding whether ministers report their income taxes as employees or as self-employed. They can elect voluntary withholding, but this is not required. However, this rule does not exempt ministers from filing federal income tax returns and paying income tax. Kuma v. Greater N.Y. Conference of Seventh-Day Adventist Church, 2020 U.S. Dist. LEXIS 156665 (S.D.N.Y. 2020).

Legal Developments

A Church’s Tax-Exempt Status Does Not Extend to Its Minister

Tax court confirms imposition of substantial penalties on taxpayer who claimed he functioned as a church.

Richard R. Hammar, Attorney, CPA
Bio

A taxpayer did not pay federal income taxes or self-employment taxes for six years. He was audited by the Internal Revenue Service (IRS) and was assessed back taxes and penalties. The IRS rejected his defense that he was “functioning as a church.”

On appeal, the US Tax Court agreed with the IRS. The Court observed:

No provision in [the tax code] exempts an individual functioning as a church from the obligation to pay tax on his taxable income. Ministers may be entitled to exclude the rental value of a parsonage from gross income . . . but they are taxable on the income they earn from ministering . . . and section 501(c)(3) exempts religious organizations from income tax. But, again, there is no exemption from the . . . income tax for income earned by individuals from religious activities.

Imposition of penalties

The Court concurred with the imposition by the IRS of the following penalties for the six years under review (references are to the tax code):

  • Unpaid back taxes of $400,297.
  • Section 6651(a)(1) imposes an addition to tax for failure to file a timely tax return. The addition equals 5 percent of the amount required to be shown as tax on the delinquent return for each month or fraction thereof during which the return remains delinquent, up to a maximum addition of 25 percent for returns more than four months delinquent. The IRS concluded that this penalty amounted to $90,061.
  • The IRS determined that the taxpayer was liable for an addition to tax for each year under either section 6651(a)(1) (for failure to file a timely return) or section 6651(f) (which imposes an increased addition to tax when a taxpayer’s failure to file is fraudulent). The IRS conceded that the section 6651(f) addition to tax does not apply in this case.
  • Section 6654 provides for an addition to tax in case of any underpayment of estimated tax. The IRS assessed section 6654(a) additions to tax of $14,387 for all of the years at issue.
  • Section 6673(a)(1) imposes a penalty of up to $25,000 if the taxpayer has instituted or maintained proceedings before the Tax Court primarily for delay or the taxpayer’s position in the proceeding is frivolous or groundless. A taxpayer’s position is frivolous if it is contrary to established law and unsupported by a reasoned, colorable argument for change in the law. The purpose of section 6673 is to compel taxpayers to conform their conduct to settled principles before they file returns and litigate. The Court noted that it could, on its own initiative, require a taxpayer to pay a section 6673(a)(1) penalty. It noted that the taxpayer “failed to report substantial amounts of income for six years and his argument that the Code is null and void is frivolous. . . . We need not decide whether his other argument, that he is functioning as a church (which, in the context of this case, we reject), is also frivolous. A taxpayer who makes frivolous arguments is not immune from penalty just because some of his arguments may not be frivolous. . . . He was warned by the IRS . . . that he was making frivolous arguments in challenging the constitutionality of the federal income tax system. He ignored those warnings at his peril.” The Court imposed a penalty of $2,500.

What this means for churches

This case affirms that a church’s tax-exempt status does not extend to its ministers. Additionally, it contains a good summary of the substantial tax penalties the IRS can impose on taxpayers who fail to file a tax return or pursue frivolous tax positions. Lloyd v. Commissioner, T.C. Memo 2020-92 (2020).

Legal Developments

Tax Court Rejects Pastor’s Attempt to Avoid Taxes Through Vow of Poverty, Salary Renunciation

The use of funds for personal purposes indicates dominion and control, even over an account titled in the name of a church or other religious organization.

Richard R. Hammar, Attorney, CPA
Bio

Key point. Ministers cannot avoid taxes by making a vow of poverty, renouncing a salary, and having their church pay for all of their expenses, if they maintain effective control over the payment of expenses.

The United States Tax Court rejected an attempt by a pastor to avoid income taxes by making a “vow of poverty,” renouncing a salary, having his church pay all of his expenses, but retaining effective control over the funds.

In 2001 a pastor recommended to his church’s board of advisers that the church be restructured to include a “corporation sole” as an office of the church. The board of advisers unanimously agreed with this recommendation, and a nonprofit corporation sole was created in the name of “the Office of Presiding Head Apostle” currently held by the pastor. The church was located in Florida, which does not recognize corporations sole, so the corporation sole was established under the laws of Nevada

Later that year, the pastor signed a document titled “Vow of Poverty” in which he agreed to divest his property and future income to the church and in turn the church would provide for his physical, financial, and personal needs. By resolution, the church resolved that “the church accepts … the pastor’s declaration and will provide all his needs as Apostle of this church ministry,” and affirmed that “the church shall pay his housing, all ministry expenses, and any other needs necessary for his care.” The church established an apostolic bank account, and the pastor had “signatory authority over this account for his use.”

The IRS audited the pastor for four years during which he did not file a Federal income tax return nor did he file a timely certificate of exemption from self-employment tax. The IRS assessed unreported income of $46,642, $18,430, $16,824, and $26,865 for the four years being examined. Most of these amounts represented payments made by the church on the pastor’s behalf. The pastor did not dispute that the church made those payments on his behalf for his personal expenditures. The only issue was whether the vow of poverty insulated him from paying Federal income tax and self-employment tax on those amounts.

Income taxes
The Tax Court agreed with the IRS that the amounts in question represented taxable income. The court began its opinion by rehearsing basic facts:

Section 61(a) [of the tax code] defines gross income as “all income from whatever source derived”, including compensation for services. This definition includes all accessions to wealth, clearly realized, and over which the taxpayers have complete dominion. A taxpayer has dominion and control when the taxpayer is free to use the funds at will. The use of funds for personal purposes indicates dominion and control, even over an account titled in the name of a church or other religious organization.

The court noted that in previous decisions it held that a vow of poverty does not insulate a pastor from tax liability even when the pastor receives funds directly from his church in exchange for services rendered if the pastor “does not remit those funds to the church in accordance with his vow of poverty, has control over the funds, and uses the funds for personal expenditures.” The pastor insisted that such rulings did not apply to him since they dealt with clergy who earned money from a secular employer and thereafter “assigned” the funds to a church or religious order, whereas in the present case the pastor executed a vow of poverty to his church and received payments for his well-being from the church.

The court acknowledged that “income earned by a member of a religious order on account of services performed directly for the order or for the church with which the order is affiliated and remitted back to the order in conformity with the member’s vow of poverty is not includible in the member’s gross income.” But such was not the case here. The “critical difference in this case” was that the pastor did not remit income to his church pursuant to his vow of poverty, he had signatory authority over the “apostolic bank account,” and the payments the church made on his behalf served only to benefit him in meeting his living expenses.” Therefore, “the compensation he received from his church in the form of the church or its related entities made on his behalf must be included in his gross income.”

Self-employment taxes
The court also agreed with the IRS that the amounts in question were subject to self-employment tax:

Unless an exemption certificate is timely filed, the minister is liable for self-employment tax on income derived from the ministry. The time limitation [for filing for exemption] is mandatory and is to be complied with strictly. [The pastor] did not file a timely application for exemption from self-employment tax for any of the years at issue. He therefore does not qualify for an exemption from self-employment tax.

What this means for churches

The lesson of this case is that schemes to avoid income taxes by vows of poverty and “corporations sole” never work, at least if a minister retains effective control over the funds and their distribution. As the court noted, the tax code defines taxable income broadly to include “all income from whatever source derived,” and this includes “all accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.” A taxpayer has dominion and control “when the taxpayer is free to use the funds at will. The use of funds for personal purposes indicates dominion and control, even over an account titled in the name of a church or other religious organization.” T.C. Memo. 2016-167.

Legal Developments

Tax Court rules ‘Love Gifts’ to Pastor Represent Taxable Compensation

“Love gifts” made by churches and church members to clergy constitute taxable compensation

Richard R. Hammar, Attorney, CPA
Bio

Key point. "Love gifts" made by churches and church members to clergy constitute taxable compensation for services performed rather than nontaxable gifts.

The United States Tax Court ruled that "love gifts" made by a church to its pastor represented taxable compensation.

A church had 25 to 30 active members and as many as 7 ministers, and offered services three days each week. The lead pastor had informed the church's board of directors that he did not want to be paid a salary for his pastoral services but would not be opposed to receiving "love offerings," gifts, or loans from the church.

The pastor and his wife managed the church's checking account, and jointly signed all of the church's checks. They signed numerous checks in 2012, made payable to the pastor, with handwritten notations such as "Love Offering" or "Love Gift" on the memo line. The church transferred "love offerings" to other members of the church, including the pastor's wife.

In 2012, the church's bookkeeper prepared and sent to the pastor a Form 1099-MISC reporting that he had received nonemployee compensation of $4,815 from the church. When the bookkeeper left the church in late 2015, the pastor's daughter became the church's bookkeeper.

The pastor filed a joint federal income tax return for 2012, claiming a deduction for a charitable contribution of $6,478 to the church. He did not, however, include as an item of income the $4,815 of nonemployee compensation reported on Form 1099-MISC. Although the pastor did not dispute that he had received $4,815 from the church, he insisted that the amounts transferred to him were improperly reported as nonemployee compensation when in fact they were nontaxable "love offerings," gifts, or loans.

The IRS audited the pastor's 2012 tax return, and determined that the $4,815 represented taxable income, and not a nontaxable love gift. The IRS also ruled that none of this amount could be characterized as a tax-free loan since neither the church nor the pastor was able to produce objective evidence, such as bank records or a promissory note, showing that the church made any loans to the pastor.

The pastor appealed to the Tax Court, which affirmed the decision of the IRS. The court concluded:

In Commissioner v. Duberstein, 363 U.S. at 284-285, the United States Supreme Court stated that the problem of distinguishing gifts from taxable income "does not lend itself to any more definitive statement that would produce a talisman for the solution of concrete cases." The Supreme Court concluded that, in cases such as this one, the transferor's intention is the most critical consideration, and there must be an objective inquiry into the transferor's intent. In other words, rather than relying on a taxpayer's subjective characterization of the transfers, a court must focus on the objective facts and circumstances.

The record shows that the transfers were made to compensate [the pastor] for his services as pastor. As the pastor candidly explained at trial, he had informed the board of directors that he would accept "love offerings" and gifts as substitutes for a salary. The church's bookkeeper at the time considered the payments to be compensation as is reflected in the Form 1099-MISC that she issued to him. In the light of these facts, the pastor's subjective characterization of the transfers as nontaxable "love offerings" and "love gifts" is misguided.

The pastor did not offer the testimony of any members of the congregation (including the other directors) or [the former bookkeeper] that would allow the court to conclude that the transfers were anything other than compensation for services. The frequency of the transfers and the fact that they purport to have been made on behalf of the entire congregation is further objective evidence that the transfers represented a form of compensation.

In conclusion, we hold that the amounts that the pastor received from the church in 2012 represented compensation for services and, thus, constituted taxable income to him.

What this means for churches

This case addresses the recurring question of the distinction between nontaxable gifts and taxable compensation for the performance of services. Note the following points:

1. Ministers often receive "love gifts" from their employing church or directly from individuals. Love gifts from a church typically are funded by a "love offering" collected by the church from members. Whether collected in an offering, or paid directly by members to their minister, the question is whether such payments represent taxable compensation or tax-free gifts. The tax code excludes "gifts" from taxable income. IRC 102. But it also broadly defines taxable income as "all income from whatever source derived, including (but not limited to) the following items … compensation for services, including fees, commissions, fringe benefits, and similar items." IRC 61. This means that any "love gift" provided to a minister, whether from individuals or a church, constitutes taxable income if the transferor's intent was to more fully compensate the pastor for services rendered.

2. The Tax Court stressed that a donor's intent must be assessed in light of objective facts and circumstances. The court concluded that in this case the facts unequivocally demonstrated that the intent of donors and the church itself was to compensate the pastor for services he performed. The court pointed to the following facts:
The pastor informed the board of directors that he would accept "love offerings" and gifts as substitutes for a salary. The church's bookkeeper at the time considered the payments to be compensation as is reflected in the Form 1099-MISC that she issued to him. The pastor did not offer the testimony of any members of the congregation (including those on the board) that would allow the court to conclude that the transfers were anything other than compensation for services. The frequency of the transfers and the fact that they purported to have been made on behalf of the entire congregation is further objective evidence that the transfers represented a form of compensation.

3. The court referenced section 102(c) of the tax code, which specifies that the definition of the term gift does not include "any amount transferred by or for an employer to, or for the benefit of, an employee." However, it noted that the IRS did not raise this issue or contend that the pastor was an employee of the church.

4. Love gifts almost always will constitute taxable income rather than tax-free gifts because the donor's intent is to more fully compensate the pastor for services performed. There is a significant risk of getting this wrong. If a love gift is not reported as taxable income by the church or the recipient in the year it is provided, the IRS may be able to assess intermediate sanctions in the form of substantial excise taxes against the recipient, and possibly members of the church board, regardless of the amount of the benefit, under section 4958 of the tax code.

Jackson v. Commissioner of Internal Revenue, T.C. Summ. 2016-69 (2016).

Legal Developments

Taxpayers Must Meet Strict Requirements for Continuing Education Expense Deductions

Key point. Continuing education expenses that are part of a program of study that will


Key point. Continuing education expenses that are part of a program of study that will lead to qualifying a taxpayer in a new trade or business are not deductible as a business expense even if the taxpayer did not intend to enter that trade or business.

The Tax Court denied a taxpayer's deduction for continuing education expenses because he failed to meet the strict requirements of the tax code. A physician claimed a business expense deduction on his tax return for flight lessons that would enable him to provide medical services to persons in remote areas. The IRS denied the deduction, and the taxpayer appealed. The Tax Court observed:

Section 162 [of the tax code] allows a deduction for all ordinary and necessary expenses paid in carrying on a trade or business. Section 162 does not explicitly provide for a deduction for continuing education expenses, but such expenses may be deductible under section 162 if they fall within its regulations. The regulations under section 162 allow a taxpayer to deduct expenditures for education if that education either (1) maintains or improves skills that are required by an individual in his employment, trade, or business or (2) meets express requirements set by the individual's employer or by a law or regulation as a condition of continued employment, status, or compensation. Education undertaken by an individual to meet minimum education requirements for qualification in his own or any other trade or business are not deductible.

The court noted that "in deciding whether the taxpayer's flying lessons are deductible education expenses under section 162, we need to determine whether the education expenses were incurred to maintain or improve his skills for use in his business or whether the education would qualify him to meet the minimum education requirements of some other trade or business."

The court cited previous decisions in which it held that if the education for which deductions are claimed qualify a taxpayer "to perform tasks and activities that are significantly different from those that he could perform before receiving the education, then the education qualifies the taxpayer for a new trade or business … . It is irrelevant whether this education actually leads to qualification in a new trade or business." The court concluded:

The taxpayer paid educational expenses for flight instruction. He testified that he intended to use these skills in his business. However, he failed to demonstrate that his flying lessons improved or maintained his skills as a doctor. The skills petitioner learned during the flying lessons were significantly different from the skills he already possessed. Consequently, the cost of his flying lessons are not deductible continuing education expenses under section 162. It is irrelevant that these lessons may have helped him reach patients in rural areas.

What This Means For Churches:

It is common for pastors to enroll in continuing education courses at local universities and seminaries, or through online courses. Can the costs of these educational opportunities be deducted as a business expense on a pastor's tax return? As the Tax Court noted, you may deduct expenses you incur for education, such as tuition, books, supplies, correspondence courses, and certain travel and transportation expenses, even though the education may lead to a degree, if the education (1) is required by your employer, or by law or regulation, to keep your salary, status, or job or (2) maintains or improves skills required in your present work.

However, you may not deduct expenses incurred for education, even if one or both of the above-mentioned requirements are met, if the education (1) is required in order to meet the minimum educational requirements to qualify you in your trade or business or (2) is part of a program of study that will lead to qualifying you in a new trade or business, even if you did not intend to enter that trade or business. You can deduct the costs of qualifying, work-related education as a business expense even if the education could lead to a degree.

Once you have met the minimum educational requirements for your job, your employer may require you to get more education. This additional education is qualifying work-related education if all three of the following requirements are met:

• it is required for you to keep your present salary, status, or job;

• the requirement serves a bona fide business purpose of your employer; and

• the education is not part of a program that will qualify you for a new trade or business.

If you get more education than your employer requires, the additional education can be qualifying work-related education only if it maintains or improves skills required in present work.

In a previous case, the Tax Court ruled that a minister could not deduct the cost of courses he took at a local university to complete his undergraduate degree, even though he took the courses to enhance his ministerial skills. The minister enrolled in various courses at a local university (including Introduction to Counseling, Internship in Ministry Practice, Death and Dying as a Life Cycle, Modern Social Problems, The Family, Community, Ethics in Human Services, Symphonic Choir, Basic Writing, and Writing Strategies). These courses were not required for him to continue as a local pastor. He later earned a bachelor's degree in human services. On his tax return he claimed a deduction of $9,698 for "continuing education." The amount claimed represented tuition, books, and course-related fees incurred for the courses taken at the university.

The IRS disallowed the deduction, and the minister appealed. The Tax Court agreed that the educational expenses were not deductible. It acknowledged that education expenses are deductible as business expenses if the education "maintains or improves skills required by the taxpayer in his employment or meets the express requirements of an employer imposed as a condition for the taxpayer's continued employment." However, education expenses are not deductible if they are "made by an individual for education which is part of a program of study being pursued by him which will lead to qualifying him in a new trade or business." This is so even if the courses meet the express requirements of the employer.

Whether the education qualifies a taxpayer for a new trade or business depends upon the "tasks and activities which he was qualified to perform before the education and those which he is qualified to perform afterwards." The court noted that it had "repeatedly disallowed education expenses where the education qualified the taxpayer to perform significantly different tasks and activities. Further, the taxpayer's subjective purpose in pursuing the education is irrelevant, and the question of deductibility is not satisfied by a showing that the taxpayer did not in fact carry on or did not intend to carry on a new trade or business." The court agreed that the courses the minister took qualified him for a new trade or business and that the expenses of a college education are almost always nondeductible personal expenses.

The court concluded, "We conclude that the courses, which ultimately led to his bachelor's degree, qualified him in a new trade or business. The courses provided him with a background in a variety of social issues that could have prepared him for employment with several public agencies and private nonprofit organizations outside of the ministry. Whether or not he remains in the ministry is irrelevant; what is important under the regulations is that the degree 'will lead' him to qualify for a new trade or business." The court noted that it is "all but impossible" for taxpayers to establish that a bachelor's degree program does not qualify them for a new trade or business. Warren v. Commissioner, T.C. Memo. 2003-175 (2003). Holden v. Commissioner, T.C. Memo. 2015-83 (2015).

Legal Developments

Synagogue Not Liable for Thousands of Dollars in Penalties

Court ruled rabbi in question wasn’t an employee of the synagogue.

Richard R. Hammar, Attorney, CPA
Bio

Church Law and Tax Report

Synagogue Not Liable for Thousands of Dollars in Penalties

Court ruled rabbi in question wasn’t an employee of the synagogue.

Richard R. Hammar

Key point. The Tax Court uses a seven-part test in deciding if a minister is an employee or an independent contractor for payroll reporting purposes.

The United States Tax Court ruled that a rabbi was not an employee of a synagogue, and therefore the synagogue was not liable for tens of thousands of dollars in penalties for failing to withhold Social Security and income taxes. A religious organization was incorporated to operate a synagogue. It paid a rabbi annual amounts ranging from $30,000 to $100,000 from 2004 to 2007. None of these amounts were reported as employee compensation, and so no FICA taxes or income taxes were withheld. The IRS audited the rabbi, determined that he was an employee, and assessed penalties (under section 6651 of the tax code) of more than $100,000 against the synagogue for failing to withhold and pay $95,000 in FICA taxes and $162,145 in federal income taxes. The synagogue appealed to the Tax Court, claiming that the rabbi was an independent contractor, rather than an employee, and so no taxes had to be withheld from his compensation.

The Tax Court began its opinion by noting: “Employers and employees are subject to employment taxes, including FICA. FICA provides a Social Security tax payable by both employers and employees. Employers are required to withhold FICA tax and federal income tax on wage payments that they make to their employees. These employment taxes do not apply to payments made to independent contractors.”

In resolving the rabbi’s status, the Court relied on a seven-step analysis it had adopted in a previous ruling involving the tax status of a minister. Weber v. Commissioner, 103 T.C. 378 (1994), aff’d 60 F.3d 1104 (4th Cir. 1995). The Court noted:

Whether an individual performing services for a principal is an employee (rather than an independent contractor) is a factual question to which common law principles apply … . In determining whether a worker is an employee, the court considers (1) the degree of control exercised by the principal over the details of the work; (2) which party invests in the facilities used by the worker; (3) the opportunity of the worker for profit or loss; (4) whether the principal can discharge the worker; (5) whether the work is part of the principal’s regular business; (6) the permanency of the relationship; and (7) the relationship the parties believed they were creating … . We consider all facts and circumstances; no one factor dictates the outcome. Although the determination of employee status is to be made by common law concepts, a realistic interpretation of the term “employee” should be adopted, and doubtful questions should be resolved in favor of employment in order to accomplish the remedial purposes of the legislation involved.

The Tax Court concluded, on the basis of its examination of each of these seven factors, that the rabbi was an independent contractor rather than an employee, and so the synagogue was not required to withhold FICA taxes of income taxes from his compensation.

What This Means For Churches:

This case illustrates the continuing relevance of the seven-factor test adopted by the Tax Court in the Weber case (1994) for determining the correct reporting status of ministers. Unfortunately, however, the Court failed to explain that clergy are not subject to FICA taxes with respect to their ministerial compensation (they are regarded as self-employed for Social Security and pay self-employment taxes), and their ministerial wages are exempt from income tax withholding unless they elect voluntary withholding. Ungvar v. Commissioner, T.C. Memo. 2013-161.

Legal Developments

Don’t Take Mileage Logs Lightly

Tax case shows employees must closely track miles.

Richard R. Hammar, Attorney, CPA
Bio

It is important for church leaders to recognize that the tax code imposes strict limitations on the use of the standard mileage rate.

A taxpayer kept a log of his travel. Each day, he noted the beginning and ending mileage but did not note each place he stopped or the business purpose of the stop. For three years he claimed deductions for 67,910 miles, 62,456 miles, and 58,616 miles for the business use of his cars. The IRS audited his returns for these years, and denied a deduction for any of these miles on the ground that they were not adequately substantiated. The taxpayer appealed to the Tax Court.

The court noted that a deduction is not allowed for the business use of a car unless the taxpayer substantiates: (1) The amount of such expense, (2) the time and place of the travel, and (3) the business purpose.

In the absence of adequate records, a taxpayer "may alternatively establish an element by his own statement, whether written or oral, containing specific information in detail as to such element" and by "other corroborative evidence sufficient to establish such element." However, the tax code specifically precludes the deduction of automobile expenses on the basis of an approximation or a taxpayer's uncorroborated testimony.

The court ruled that the taxpayer was not entitled to any deduction for his business miles, based on the following considerations:

  • For one of the years in question, the taxpayer offered a random sampling of invoices to corroborate his mileage. The court noted that the tax code "requires a specific showing of time, place of travel, and business purpose."
  • For one of the years in question, the miles reported in the taxpayer's log differed from the miles upon which he based a business expense deduction.
  • The taxpayer's logs "contain entries for only the beginning and ending odometer reading of the vehicle for each day. The logs do not contain any entries regarding the business purpose of the trips or the destination of each trip as required by [the tax code]."
  • The logs also indicate that the taxpayer drove multiple vehicles, but did not indicate which vehicle was being driven at the time entries were made.
  • The taxpayer offered only a sampling of total invoices.
  • The taxpayer's testimony regarding his business miles "was vague, unspecific, and unpersuasive as to the business purpose of the respective trips. Moreover [the tax code] specifically precludes the allowance of automobile expenses on the basis of an approximation or a taxpayer's uncorroborated testimony."

The court ruled that the taxpayer was liable for "accuracy-related penalties" pursuant to section 6662 of the tax code. This section imposes a 20-percent penalty for any underpayment of tax attributable to negligence or disregard of rules or regulations.

The IRS insisted that the taxpayer was liable for an accuracy-related penalty on account of negligence or disregard of rules or regulations. The court agreed: "The taxpayer has failed to meet his burden of proving that he was not negligent or that he acted with reasonable cause and in good faith. His mileage logs are not adequate records for his car expenses claimed on Schedules C. Furthermore, he was not able to provide sufficient additional evidence to meet the strict substantiation requirements of section 274(d). Accordingly, we hold that he is liable for the accuracy-related penalties."

What this means for churches

The standard mileage rate is a convenient way for taxpayers to compute a tax deduction for the business use of their car. Employers, including churches, can use the mileage rate to compute the amount of a reimbursement to be paid to employees for the business use of their cars. In either case, it is essential for the taxpayer to be able to prove the following:

  • The miles for each business use of the car;
  • Total miles driven during the year;
  • Date of each trip;
  • Business destination;
  • Business purpose.

As this case illustrates, a failure to maintain a logbook or other documents that substantiate these items may result in the denial of a tax deduction, or in the treatment of an employer reimbursement as nonaccountable (and therefore reportable as taxable income).

Royster v. Commissioner, TC Memo. 2010-16 (2010)

Legal Developments

Pastor Sentenced to Prison for Tax Fraud

Learn to properly identify and report taxable income.

Richard R. Hammar, Attorney, CPA
Bio

Church Law & Tax Report

Pastor Sentenced to Prison for Tax Fraud

Learn to properly identify and report taxable income.

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

Key Point. Failure to report taxable fringe benefits as taxable income can expose a pastor or lay church employee to significant criminal penalties.

A federal appeals court ruled that a pastor was properly convicted and sentenced to prison for filing a fraudulent tax return as a result of his failure to report several items of taxable income. A pastor (Pastor Phil) served as both senior pastor of his church and superintendent of a school operated by the church. The IRS began investigating Pastor Phil after receiving an anonymous letter. As part of its investigation, the IRS traced payments made by the church and the school to various sources on Pastor Phil’s behalf or for his benefit and determined that he failed to report a substantial amount of taxable income on his tax returns in violation of section 7206 of the tax code which imposes criminal penalties for willfully filing a fraudulent tax return.

At trial, the individuals who prepared Pastor Phil’s tax returns testified that his returns were based solely on the W-2’s and 1099’s he presented to them and that he did not declare any additional income from other sources. Pastor Phil reviewed the returns before they were filed with the IRS and never indicated that they were inaccurate or that they otherwise misstated his tax liability.

At his trial, the prosecution documented $110,000 of unreported taxable income, including the following:

  • The school paid disability insurance premiums on Pastor Phil’s behalf directly to a life insurance company.
  • The school made monthly payments on a loan Pastor Phil had taken out to purchase a car for his daughter.
  • Several persons paid Pastor Phil fees for speaking engagements, “bird-dog” fees for referring customers to a local car dealership, referral fees for sending loans to a mortgage company, and a $6,600 “finder’s fee” for bringing in investors to fund a real estate development project.
  • The church paid Pastor Phil’s life insurance premiums, totaling over $6000.
  • The church paid Pastor Phil a salary of $750 every two weeks ($15,000 per year) for serving as interim manager of a church-operated credit union.
  • The church or school made various other miscellaneous payments on Pastor Phil’s behalf, including a time-share property that he owned; his water bill; and a homeowner’s insurance policy. The water bill and homeowner’s insurance premium payment were treated as unreported income because the church made these payments over and above Pastor Phil’s $36,000 housing allowance.
  • Pastor Phil received $60,000 from the church for his work at a satellite location. This amount was designated by the church for “pastor’s housing expenses” and listed under the heading “salaries.” The church did not give this money directly to Pastor Phil, but deposited it into the church’s savings account at the credit union. Pastor Phil gave a church officer his bills as they became due and the officer paid them until the amounts disbursed totaled $60,000. Out of this $60,000, the church paid off Pastor Phil’s personal credit card debt and the loan on his home, and also wrote checks to cover his cosmetic dentistry and repairs to his home, including repainting and gutter work. The total amount paid out on Pastor Phil’s behalf was less than $60,000, and the remaining money was transferred into his housing allowance account.

The prosecution noted that Pastor Phil’s annual salary was $115,000, but that he had acquired numerous “luxury items” that seemed excessive in light of his salary, including two time-shares, a 2.73-carat diamond ring, a projection television, a camcorder, a DVD player, and custom-made clothes. According to the prosecution, the excessiveness of his lifestyle relative to his reported income was indicative of fraud. Pastor Phil presented several witnesses who testified that the $60,000 payment from the church was a “gift” and not compensation for services rendered. These witnesses conceded, however, that there was no written evidence that the $60,000 payment was intended as a gift. The jury convicted Pastor Phil on all counts, and sentenced him to 21 months in prison.

Pastor Phil appealed his conviction on the ground that he had not acted willfully, as required under section 7206. The court disagreed: “His argument is without merit. The government presented ample evidence that he knew his income exceeded the amounts he reported on his tax returns and that he had the opportunity to review and correct his returns before fi ling them with the IRS. We have no difficulty finding that it was sufficient for a reasonable jury to conclude beyond a reasonable doubt that he willfully filed tax returns in which he knowingly and significantly under-reported his income and that he was aware of their falsity when he signed and subscribed them under penalties of perjury.”

The appeals court also rejected Pastor Phil’s claim that the trial court erred in “enhancing” his prison sentence based on his use of “sophisticated means.” Federal sentencing guidelines permit a prison sentence to be increased (“enhanced”) if an offense involved “sophisticated means.” The concluded that the following evidence warranted an increase in Pastor Phil’s sentence based on sophistical means: (1) depositing his salary from the church and the credit union into accounts that were not registered in his own name; (2) instructing the church to make payments out of these accounts directly to his personal creditors; and (3) having the school and the church pay his life and disability insurance premiums directly to the insurance carriers. The court concluded that Pastor Phil’s schemes to conceal income through the use of third-party accounts over a three-year period required intricate planning and therefore involved the use of sophisticated means.

Application. This case illustrates the importance of being familiar with the definition of taxable income. Pastor Phil failed to report various items of taxable income on his tax return, and these items totaled $110,000. It is not always easy to know whether various benefits are taxable or not. Chapter 4 of Richard Hammar’s 2009 Church & Clergy Tax Guide lists 22 categories of taxable income that are often made available to clergy and church staff. This information is designed to assist church leaders in properly identifying and reporting taxable income. 2009 WL 723206 (C.A.11 2009).

This Recent Development first appeared in Church Law & Tax Report, July/August 2009.

Legal Developments

Failing to Report Compensation

Pastors who take money from their church without authorization, and fail to report it on their tax return, may be subject to criminal liability.

Richard R. Hammar, Attorney, CPA
Bio

Church Law & Tax Report

Failing to Report Compensation

Pastors who take money from their church without authorization, and fail to report it on their tax return, may be subject to criminal liability.

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

Key point. Pastors who take money from their church without authorization, and fail to report it on their tax return, may be subject to criminal liability for willfully making a false tax return. Their punishment can be “enhanced” under federal sentencing guidelines if their acts amounted to an abuse of a position of trust, or a taking of over $10,000 from an illegal source without reporting it.

* A federal appeals court affirmed the enhanced prison sentence of a pastor who failed to report on his income tax return more than $500,000 in compensation and benefits received from his church. A church hired a new pastor (Pastor James) under whose leadership the church membership grew from 500 to 2,000 people. Weekly church income grew from $7,000 to $40,000. The church provided Pastor James with compensation of $110,000. However, Pastor James chose to supplement his salary by taking money directly from the Sunday collection without reporting it on his tax returns. According to church board members, shortly after Pastor James began his employment he demanded $1,000 from the Sunday collection, a practice that he followed on most Sundays. Pastor James explained that he wanted the money as cash rather than as part of his salary in order to “avoid taxes.”

Although the congregation was not aware of Pastor James’ actions, some officials apparently knew and raised questions about the practice. The chairman of the board, for instance, questioned Pastor James about it, telling him it amounted to “stealing” and “deceiving God’s people.” Pastor James rationalized his actions by saying “I bring it in, and I take it out.” He also warned the chairman of the board not to “muzzle the ox.” When a deacon told him that his actions were wrong, Pastor James responded, “You have a lot to learn about how to take care of your pastor.” In order to cover themselves, several church officials who were aware of Pastor James’s practice made notes about the payments to him in the records of the weekly offering sheets. Pastor James instructed them to stop making the records. Despite assurances that the church would raise his salary if it was not enough, Pastor James refused such an arrangement.

In addition to the money taken from the Sunday collections, Pastor James also failed to include on his tax returns various fringe benefits, such as a Mercedes that he used for both personal and church business, making personal credit card and life insurance payments with church funds, and using the church credit card for personal expenditures. From these benefits and the weekly draws on the collection plate, the government calculated that Pastor James had additional gross income in the amount of $520,602 in the years of 1996 through 2001, resulting in a large tax deficit.

The government indicted Pastor James on five counts of willfully making and subscribing a false income tax return, and one count of failure to file an income tax return. Pastor James pleaded guilty to one count of making a false tax return for the year 1997. At the sentencing hearing, the court heard testimony and arguments regarding potential “enhancements” of the prison sentence based on abuse of a position of trust and obtaining over $10,000 in income from illegal sources without reporting it. The court imposed both enhancements. Pastor James appealed, challenging the enhancements of his sentence imposed by the trial court.

Abuse of a position of trust

Federal sentencing guidelines specify that if a defendant “abused a position of public or private trust, or used a special skill, in a manner that significantly facilitated the commission or concealment of the offense,” his or her sentence can be enhanced. The appeals court noted that for the enhancement to apply, Pastor James must have: (1) occupied a position of trust and (2) abused that position in a manner that significantly facilitated the commission or concealment of his offense. The court concluded that both requirements were met:

Here, there can be no doubt that Pastor James held a position of trust in the church and used his position to facilitate this crime. Specifically, Pastor James, who was in complete control of the church, demanded cash payments directly from the Sunday offering. The church did not authorize this; the few people who knew about the practice challenged him, but were cowed by haughty rebukes about the proper treatment of a pastor. Pastor James also attempted to thwart the members of the church who were keeping track of these payments in order to better conceal his crime. Pastor James’s tax fraud was only possible because of his [position].

The court rejected Pastor James’ argument that the enhancement of his sentence was improper because the church, whose trust he abused, was not a victim of his tax fraud because it was financially prospering under his pastoral care. The court concluded:

It is clear that the church was a victim. Pastor James claims that the offers to improve his salary by the head of the church board (while trying to talk Pastor James out of stealing from the collection plate) and the healthiness of church finances prove his point that he deserved (and thus took) more. They do not. While the church might have been willing to increase his salary, that was a decision for the church, not for him. What Pastor James committed was theft; he did not tell the church that he wanted an increased salary and had not received permission for the additional money. Nor can the overall healthiness of church finances salvage his actions. Pastor James’ argument, essentially a slightly more sophisticated version of “I bring it in, and I can take it out,” betrays a fundamental misapprehension. The funds were not his. While no doubt his skillful ministry explains to a large extent the uptick in contributions, they were contributions to the church, not to him. The church was not entitled to just a healthy cut of the increased revenues; it was entitled to all of it. Clearly, the church was a victim of Pastor James’s scheme to extract tax-free income.

Failure to report more than $10,000 in income from an illegal source

Federal sentencing guidelines also permit an enhancement in a prison sentence for a crime involving a failure to report more than $10,000 in income from an illegal source. The appeals court upheld the trial court’s enhancement of Pastor James’ sentence on this ground. It concluded: “Pastor James stole from the Sunday offerings, taking thousands of dollars without permission from the church. Moreover, he used church funds to pay his personal credit cards and life insurance, and racked up thousands more on church credit cards for personal expenditures. Pastor James contends that the government failed to show his intent to commit theft by deception, but such intent can be shown from circumstantial evidence and has been shown by the evidence here. The more than $500,000 that Pastor James took from the church during the course of his episcopacy was derived from his illegal activities, making the enhancement completely appropriate.”

The court concluded its opinion by observing that “Pastor James committed a serious crime. He abused his position while pursuing his scheme to cheat the IRS. The district court thoughtfully weighed the various considerations bearing on Pastor James’s sentence and selected a reasonable one. Therefore, we affirm the decision of the district court.”

Application. This case illustrates three important points.

First, a church employee’s failure to report compensation and taxable fringe benefits as taxable income on his or her income tax return may result in criminal liability for making a false income tax return. Section 7206(1) of the tax code specifies that “any person who willfully makes and subscribes any return, statement, or other document, which contains or is verified by a written declaration that it is made under the penalties of perjury, and which he does not believe to be true and correct as to every material matter … shall be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 or imprisoned not more than 3 years, or both, together with the costs of prosecution.”

Second, the sentence prescribed by section 7206(1) can be “enhanced” due to several factors, including abuse of a position of trust, and obtaining over $10,000 in income from illegal sources without reporting it.

Third, Pastor James failed to report several fringe benefits as taxable income, including personal use of a church-owned Mercedes automobile, making personal credit card and life insurance payments with church funds, and using the church credit card for personal expenditures. These kinds of activities are not uncommon, and it is important for church leaders to understand the tax implications of failing to report them as taxable compensation. Chapter 4 of Richard Hammar’s 2007 Church & Clergy Tax Guide lists 22 different kinds of taxable income that are common in churches, and being familiar with this material can help to ensure that taxable benefits are being reported as taxable income.

Fourth, while the court did not address the issue, Pastor James could be assessed substantial excise taxes called “intermediate sanctions” as a result of excess benefits. Such benefits include (1) taxable benefits not reported as taxable compensation, regardless of amount, and (2) compensation and benefits reported as taxable income, if they exceed “reasonable” compensation. In either case, the recipient (if an officer or director, or relative of an officer or director) can be assessed excise taxes of up to 225% of the amount of the “excess benefit.” This significant issue is addressed fully in chapter 4 of Richard Hammar’s 2007 Church & Clergy Tax Guide. United States v. Ellis, 440 F.3d 434 (7th Cir. 2006).

Legal Developments

Recent Developments Regarding an IRS Ruling on Clergy Income Tax

The IRS ruled that three “ordained deacons” in a Methodist church, who served as the ministers of education, music, and stewardship, were “ministers” for federal tax purposes.

Richard R. Hammar, Attorney, CPA
Bio

• Key point. Persons who (1) are ordained, commissioned or licensed; (2) perform sacerdotal functions; (3) conduct worship; (4) are engaged in the "control, conduct, and maintenance of religious organizations"; and (5) who are considered to be religious leaders by their church, qualify as ministers for federal tax purposes.

The IRS ruled that three "ordained deacons" in a Methodist church, who served as the ministers of education, music, and stewardship, were "ministers" for federal tax purposes. After twenty years of study, the Church voted to establish the status of ordained deacon. Prior to this decision, elders were the only ordained members of the clergy. The Church defines ordination as the act of conferring ministerial orders. In accordance with Church traditions, an ordained minister is a baptized person who is called by God, authorized by the Church and ordained by a bishop to a lifetime ministry. To qualify for ordination as either a deacon or an elder, an individual must meet the requirements set by the Church that are specified in its governing document. In addition, to be ordained, the individual must be recommended by the regional Conference and receive the affirmative vote of the ministerial members of the Conference. Through ordination the ordained individual is given the approval of the Church to serve as an ordained minister and the authority to carry out those acts reserved to members of the clergy. As a result, following ordination, an ordained elder or deacon has the authority to exercise the responsibilities and duties of an ordained minister.

Duties of Ordained Deacons

According to the Church's governing document, an ordained deacon is permitted to give leadership in teaching and proclaiming the gospel, forming and nurturing disciples, performing marriages and funerals, and assisting the ordained elder in administering the sacraments. An ordained deacon has full right of voice and vote in the regional Conference where membership is held, may serve or hold office as a member of the clergy on the boards, commissions or committees of the Conference, may be elected as a clergy delegate to the national Conference, must attend all sessions of the regional Conference, and with the elder is responsible for all matters of ordination, character and Conference relations with members of the clergy. An ordained deacon is accountable to his or her regional Conference and bishop for the fulfillment of his or her call. An ordained elder is appointed to a position by a bishop. However, unlike an elder, an ordained deacon does not itinerate, nor does the Church guarantee an ordained deacon a position, salary, or place of employment. Ordained deacons are permitted to participate in the Church retirement plan for members of the clergy.

Diaconal Ministers

When it established the status of ordained deacons, the national Conference amended its governing document to include transitional rules that would allow certain "diaconal ministers" to become ordained deacons. A diaconal minister is a lay person who was consecrated by a bishop, but who the Church does not treat or consider as a member of the clergy. The Church expects that some, but not all of its diaconal ministers will become ordained deacons. The transitional rules are available for a limited period and provide that a diaconal minister in good standing with his or her regional Conference who has completed a minimum of three years in an approved service appointment may be ordained as a deacon provided he or she meets the following requirements: (1) apply in writing to the regional Conference for transfer of credentials to ordained deacon in full connection; (2) complete a prescribed education program; (3) demonstrate an understanding of the call to the order of deacon and a ministry that fulfills and exemplifies the definition and description of deacon found in the Church's governing document; and (4) receive a two-thirds positive vote of the clergy session of the regional Conference.

The Ruling Request

A Methodist church employs more than fifty employees, including three ordained deacons. The church asked the IRS whether these three ordained deacons are ministers of the gospel performing services in the exercise of their ministry for purposes of eligibility for a housing allowance, self-employed status for social security, and exemption from income tax withholding. The ordained deacons served in the following three positions in the church:

(1) Minister of education. This person plans and supervises youth, adult, and family activities, including Sunday education classes, Bible study, and various educational programs sponsored by the church; selects the educational curriculum; schedules activities; and, when needed, coordinates lay volunteers. One of the ordained deacons is the church's minister of music.

(2) Minister of music. This person coordinates all choir and music activities of the church.

(3) Minister of stewardship. This person performs financial and managerial functions. His primary function is to encourage members of the congregation to give their time, talent, and money to the church and community.

As integral members of the church's pastoral team, the three ordained deacons meet with the church's elder to plan the worship services, assist with the sacraments, and officiate at weddings and funerals. Each is required to preach at Sunday worship service. They participate with the elder in the weekly worship service. They also perform various other duties at the church, including confirmation preparation and membership reception.

Each of the three ordained deacons had been in good standing as a diaconal minister and had completed at least three years in a service appointment approved by the bishop since consecration as a diaconal minister. Each completed the continuing education program sponsored by the Conference and satisfied the applicable educational requirements. The ministers of education and music have bachelors degrees and have completed graduate theological courses as required by the Conference. The minister of stewardship has a masters degree in theology studies. Each demonstrated an understanding of the call to the order of deacon and received the full support of the regional Conference's ordained clergy.

The IRS Ruling

The IRS ruling is summarized below:

(1) Ministers of the gospel. The IRS ruled that the three ordained deacons were ministers of the gospel performing services in the exercise of their ministries. It observed:

As ordained members of the clergy in the Church [they] conduct worship and assist with the sacraments. In addition, as ordained members of the clergy in full connection they perform services in the control, conduct and maintenance of the Church. Further, [the local church and national church] consider [them] to be religious leaders who can perform substantially all of the religious functions within the scope of the Church's tenets and practices …. Accordingly [they] are performing services as "ministers of the gospel" within the meaning of section 107 of the Code. Thus, [they] are eligible to have a portion of their salary designated as a parsonage allowance. Any parsonage allowance will be excluded from gross income, provided the allowance is designated and paid in accordance with section 107. We further conclude that the services [they] perform are in the exercise of their ministry within the meaning of section 3121(b)(8) of the Code [which treats ministers as self-employed for social security purposes].

(2) The Wingo case applied. Unfortunately, the IRS applied the Tax Court's discredited ruling in Wingo v. Commissioner, 89 T.C. 922 (1989) in support of its conclusions. In the Wingo case the Tax Court defined the term minister as follows:

In determining whether [one] is a minister, we must look at whether he performed the duties and functions of a minister within the three types of services set out in the regulations [performance of sacerdotal functions and religious worship, and the "control, conduct, and maintenance of religious organizations" under the authority of a church or church denomination]. In making that determination, we will also consider the additional factors as to whether he was ordained, or commissioned, or licensed, and whether [his church] considered him to be a religious leader.

This language, along with other statements in the court's opinion, clearly indicates that to be a minister for tax purposes one must satisfy all three types of religious services mentioned in the regulations. To illustrate, the court noted that "the regulations … describe three types of services that a minister in the exercise of his ministry performs," and that "when a person performs all three types of services set forth in the regulations, and is recognized as a minister or religious leader by his denomination, that person is a minister …."

The Wingo case was disturbing for two reasons. First, it was contrary to the specific wording of the regulations, which provide that "if a minister is performing service in the conduct of religious worship or the ministration of sacerdotal functions, such service is in the exercise of his ministry whether or not it is performed for a religious organization." This language certainly recognizes that not all three types of services are essential. The Wingo case was also disturbing because it implied that only those clergy who work for churches or church-controlled organizations were eligible for the housing allowance and other special tax provisions since only such clergy satisfied the third type of service mentioned in the regulations (the control, conduct, and maintenance of a religious organization "under the authority of a religious body constituting a church or church denomination"). This was clearly contrary to the regulations, which specifically recognize that "if a minister is performing service in the conduct of religious worship or the ministration of sacerdotal functions, such service is in the exercise of his ministry whether or not it is performed for a religious organization."

The overly strict analysis in the Wingo case was rejected a few years later by the Tax Court in Knight v. Commissioner, 92 T.C. 199 (1989). In the Knight case, the court concluded that a person need not satisfy all three requirements of the regulations to qualify as a minister for federal income tax purposes. At a minimum, one must be ordained, commissioned or licensed. But then a "balancing" of the other elements noted in the Wingo case is performed. This more flexible approach was adopted by the IRS in its audit guidelines for ministers, which were released in 1995. It is unfortunate that the IRS relied on the discredited Wingo case in reaching its conclusion regarding the status of the ordained deacons.

(3) The Haimowitz case distinguished. In Haimowitz v. Commissioner, T.C.M. 1997-40, the Tax Court concluded that a synagogue administrator was not a minister of the gospel for purposes of qualifying for a housing allowance. He had been employed by a temple for 30 years and was recognized as a Fellow in Synagogue Administration. He performed various services for the temple, including assisting students with Bar and Bat Mitzvah preparation, serving as marriage ceremony director, and conducting services for mourners. On his income tax return he specified that he was a religious functionary and asserted that as a religious functionary he was a minister of the gospel. The Tax Court concluded that the duties he performed, although related to the Jewish religion, were organizational in nature and did not require performance from one with ministerial credentials. The court then noted the religious rites and ceremonies he did not perform. He never fulfilled the role of rabbi or cantor, and the services he did perform were secular in nature. For example, he never officiated at a wedding or a funeral, and he merely assisted the rabbi at religious services. As a result, the court concluded he did not perform regularly those duties that the ministers of the Jewish faith customarily perform. In addition, the court found taxpayer's recognition as a Fellow in Synagogue Administration was irrelevant, as that designation is not a recognized religious official of the Jewish religion. The court also noted that taxpayer did not present any evidence that the temple considered him to be a religious leader. Accordingly, the court concluded that taxpayer failed to demonstrate that he was a minister of the gospel.

The IRS noted that the ordained deacon who served as a minister of stewardship was distinguishable from the synagogue administrator in Haimowitz, since he "is an ordained member of the clergy in full connection … officiates at weddings and funerals and will regularly perform the duties that members of the clergy of the Church customarily perform."

(4) Ministers of music and education holding no ministerial credentials. The IRS cautioned that "nor does this ruling suggest that the Service has departed from its position in Revenue Ruling 59-270." In Revenue Ruling 59-270 (1959), the IRS ruled that a church's minister of music and minister of education who performed some of the duties of a minister of the gospel could not be treated as ministers for federal tax purposes since neither was ordained, commissioned, or licensed as a minister of the gospel. In other words, ministers of music and education who hold no ministerial credentials should not assume, based on the recent IRS ruling, that they now qualify for a housing allowance.

(5) Legal value of a private ruling. The IRS ruling was a private letter ruling. Such a ruling applies only to the individuals involved. In fact, the IRS declined the church's request that it rule that all ordained deacons employed by the church in the future can be treated as ministers for federal tax purposes. The IRS advised the church that it would not issue a ruling that all of its ordained deacons were ministers "without examining the facts relating to each individual minister." As a result, ordained deacons serving in Methodist churches should not assume that they qualify as ministers for federal tax purposes as a result of this ruling. IRS Letter Ruling 199910055. [Who is a minister for Tax Purposes]

© Copyright 1999 by Church Law & Tax Report. All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m25 m27 c0499

Legal Developments

Income Taxes for Ministers

Court rejects ministers’ claim that he is exempt from income taxes.

Richard R. Hammar, Attorney, CPA
Bio

Church Law and Tax 1992-09-01 Recent Developments

Clergy – Taxes

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

• A federal court in Colorado rejected a minister’s claim that he was not required to pay income taxes. The minister claimed that the religious tenets of his church forbid members to pay income tax, and therefore it would violate the first amendment guaranty of religious freedom for him to be required to pay taxes. The court summarily rejected this argument, noting that “imposing income taxes on individuals whose religious tenets forbid the payment of those taxes does not violate the first amendment,” and that “while the minister’s religious beliefs may be sincerely held, the payment of income taxes is not voluntary.” In responding to the fact that the minister purposely maintained no tax records, the court observed: “Under this scenario, the federal government is entitled to reconstruct his gross receipts and costs to arrive at an assessment for the unreported income. In this case, the IRS used Bureau of Labor statistics to estimate [the minister’s] gross income for the relevant years. While this method may result in some inaccuracies, such imperfections are permissible.” The court also repudiated the minister’s attempt to avoid an IRS lien on his property by transferring it to his church. Such a conveyance was a “fraudulent conveyance” that was void under state law. Finally, the court acknowledged that the minister had filed a timely application to exempt himself from self-employment taxes, but it noted that this exemption did not apply to any of the minister’s secular earnings. United States v. Gonzalez, 91-1 USTC 50,100 (D. Colo. 1991).

© Copyright 1992, 1998 by Church Law & Tax Report. All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m27 c0592

Legal Developments

Supreme Court Rules on Tax Evasion

The Supreme Court recently issued a surprise ruling.

Richard R. Hammar, Attorney, CPA
Bio

Church Law and Tax 1991-05-01 Recent Developments

Clergy – Income Tax

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

• In a ruling that no doubt will breathe new life into the “tax protestor” movement, the United States Supreme Court ruled that taxpayers cannot be guilty of a criminal violation of the tax law for taking positions based on ignorance or a misunderstanding of the law, or a sincere belief that they are not violating the law.

The tax law imposes criminal penalties upon a taxpayer “who willfully attempts in any manner to evade or defeat” the federal income tax. A commercial airline pilot who failed to pay taxes or file returns for several years was prosecuted on several counts of willfully violating the law. He maintained that he could not be convicted of willfully violating the law since he had a good faith belief that he was not a taxpayer and that wages are not taxable. The taxpayer’s beliefs arose from his own study of the constitution and federal tax law, and from information he received while attending several seminars sponsored by a tax protestor group. The trial court convicted the taxpayer on several counts of criminal tax evasion. It concluded that only “objectively reasonable” misunderstandings of the law negate the “willfulness” requirement, and that the taxpayer’s belief that wages are not taxable was not objectively reasonable. A federal appeals court upheld the convictions, and the taxpayer appealed to the United States Supreme Court. In a surprise ruling, the Supreme Court agreed with the taxpayer that he could not be convicted of willfully violating the law if he sincerely believed that wages are not taxable, even if this belief was not “objectively reasonable.” The Court made three very important qualifications. First, it emphasized that a jury may evaluate the sincerity of a taxpayer’s professed beliefs. But, if a jury concludes that a taxpayer sincerely and in good faith did not understand the law or believed that he was not violating it, then he cannot be guilty of criminal conduct. Second, the Court noted that “the more unreasonable the asserted beliefs or misunderstandings are, the more likely the jury will consider them to be nothing more than simple disagreement with known legal duties.” This would not negate willfulness. And third, the Court noted that federal tax law imposes various civil penalties even in the event of a good faith mistake as to the law. Two Justices dissented, noting that “it is incomprehensible to [us] in this day, more than 70 years after the institution of our present federal income tax system … [that] any taxpayer of competent mentality can assert as his defense to charges of statutory willfulness the proposition that the wage he receives for his labor is not income, irrespective of a cult that says otherwise and advises the gullible to resist income tax collections.” The dissenters predicted that the Court’s decision “will encourage taxpayers to cling to frivolous views of the law in the hope of convincing a jury of their sincerity. If that ensues, I suspect we have gone beyond the limits of common sense.” Cheek v. United States, S. Ct. (1991).

© Copyright 1991, 1998 by Church Law & Tax Report. All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m27 0391

Legal Developments

Court Struck Down a County “Occupational Tax” That Was Applied to a Catholic Priest

The Pennsylvania supreme court ruled that government may properly tax the income of a minister,

Richard R. Hammar, Attorney, CPA
Bio

The Pennsylvania supreme court ruled that government may properly tax the income of a minister, but it may not tax the occupation of a minister. The court relied in part on the following language in a 1943 ruling of the United States Supreme Court: "It is one thing to impose a tax on the income or property of a preacher. It is quite another thing to exact a tax from him for the privilege of delivering a sermon …. A state may not impose a charge for the enjoyment of a right granted by the federal constitution."

Stajkowski v. Carbon County Board of Tax Assessment, 541 A.2d 1384 (Pa. 1988)

Related Topics: Posted:

Legal Developments

Clergy

Taxes

Richard R. Hammar, Attorney, CPA
Bio

• The IRS recently clarified the availability of the "cents-per-mile" method of valuing the personal use (including commuting) of an employer-provided car. Churches that permit an employee to use a church-provided vehicle for personal purposes (including commuting) must include the value of such personal use on the employee's W-2 form. There are a number of ways that the personal use can be valued. A commonly used method is the "cents-per-mile" method, under which the standard mileage rate (22.5 cents per mile) is multiplied times the number of miles that an employee uses the vehicle for personal use. However, this method of valuing the personal use of an employer-provided vehicle is not available for vehicles whose fair market value exceeds a specified dollar limit. For 1985 and 1986, that value was $12,800. For 1987, the value dropped to $9,110. However, the IRS has announced that the figure for 1987 is being increased to $12,060. Accordingly, the cents-per-mile valuation method was available in 1987 to church employees if the fair market value of the church-owned vehicle was less than $12,060. IRS Notice 88-17.

Legal Developments

IRS Ruled Rabbi Qualified for the Housing Allowance Exclusion

In Private Letter Ruling 8739009, the IRS ruled that a rabbi's teaching and the performance

Richard R. Hammar, Attorney, CPA
Bio

In Private Letter Ruling 8739009, the IRS ruled that a rabbi's teaching and the performance of religious services for a Jewish education foundation were clearly ministerial in nature, and qualified for the housing allowance exclusion.

Legal Developments

Methodist Deacon Failed to File a Timely Application for Exemption from Social Security Taxes

An ordained United Methodist deacon who also served as pastor of a local church for

Richard R. Hammar, Attorney, CPA
Bio

An ordained United Methodist deacon who also served as pastor of a local church for two years attempted to argue that the deadline for filing an application for exemption from social security taxes had not elapsed since he was not acting as a minister.

The Tax Court rejected this argument, noting that the deacon had the authority to conduct divine worship, administer sacraments, perform marriages, and bury the dead. The court concluded that the deacon was a minister for self-employment tax purposes, and accordingly had failed to file a timely application for exemption from Social Security taxes. Wingo v. Commissioner, 89 T.C.____ (1987)

Legal Developments

IRS Acknowledged Clergy Can Deduct Interest and Property Taxes

In Internal Revenue Release IR-87-54, the IRS acknowledged that the Tax Reform Act of 1986

Richard R. Hammar, Attorney, CPA
Bio

In Internal Revenue Release IR-87-54, the IRS acknowledged that the Tax Reform Act of 1986 enables clergy who own their homes to deduct mortgage interest and property taxes ( if they itemize their deductions) in computing taxable income, even though these items also reduced gross income as part of the housing allowance exclusion.

The IRS also advised homeowning ministers to file amended federal income tax returns (Form 1040X) for any prior year beginning with 1983 in which they were unable to deduct mortgage interest and property taxes because of the more restrictive rule that applied prior to 1987. Amended returns ordinarily must be filed within three years of the date the original return was filed, or two years from when the tax was paid, whichever is later.

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