Two Religious Organizations Lost Tax-Exempt Status

First, the Tax Court revoked the exempt status of the "Ecclesiastical Order of the Ism

Bio

State: Federal
Categories: Tax Exemption

First, the Tax Court revoked the exempt status of the "Ecclesiastical Order of the Ism of Am" since the organization was not operated exclusively for exempt purposes. In particular, the organization counseled individuals on the purported tax benefits available to ministers of the Ism of Am under federal tax law.

The court concluded that the organization was "nothing more than a commercial tax service, albeit in a narrow range of matters of interest to its members, operating under the cover of a professed religious purpose. That religious belief may be the body of the automobile but its engine and the gasoline on which it runs consist of tax information and advice as to methods of tax avoidance, if not downright tax evasion." Baustert v. Commissioner, T.C.Memo. 1987-488 (1987)

Similarly, the Court of Claims revoked the tax-emempt status of the Universal Life Church on the basis that the supplying of tax advice and information by the church constituted a substantial nonexempt purpose. Universal Life Church v. Commissioner

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

State: Federal
Categories: Income Taxes - Clergy, Tax Exemption

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

The Omnibus Budget Reconciliation Bill of 1987

Provisions of interest to churches and clergy

Richard R. Hammar, Attorney, CPA

Bio

On October 29, 1987, the House of Representatives passed the Omnibus Budget Reconciliation Bill of 1987 (H.R. 3545).

Provisions of interest to churches and clergy include the following:

(1) repeal of the motor fuels and tires excise tax exemptions for buses owned and operated by churches and other nonprofit organizations;

(2) the IRS will begin charging fees for some of its services, including $320 for each exempt organization ruling and $200 for each exempt organization determination;

(3) delays until 1988 the provision in the Tax Reform Act of 1986 requiring taxpayers (including many clergy) who use the estimated tax procedure to pay at least 90% of their current year's taxes in their quarterly estimated tax payments;

(4) employers (including churches) must give effect to replacement withholding allowance certificates (W-4 or W-4A) no later than the start of the first payroll period ending on or after the 30th day after the day on which the employee furnishes the certificate to the employer;

(5) a tax-exempt organization that filed an application for exemption (Form 1023) with the IRS must make available for inspection a copy of the application (including all supporting documentation) at its principal office to any individual during regular office hours; further, if the exempt organization maintains one or more regional or district offices having three or more employees, the required material similarly must be made available for public inspection at each such regional or district office;

(6) the House Ways and Means Committee urged the IRS to monitor the extent to which taxpayers are being properly advised by charitable organizations that their contributions are deductible only to the extent that they exceed the fair market value of any benefits or premiums received in exchange (e.g., if a religious radio program promises to send donors a book in exchange for a suggested donation, the donation is deductible only to the extent that it exceeds the fair market value of the book);

(7) charitable organizations must make available for public inspection during regular business hours their three most recent annual information returns (Form 990); a copy of the annual information return must also be kept at any regional or district office employing three or more persons; however, if a national religious denomination files annual information returns, copies of the return are not required to be made available at local churches since churches would not constitute offices of the national denomination;

(8) various changes have been made in the application for tax exemption (Form 1023), which pertain to information regarding predecessor and affiliated organizations;

(9) a provision in the bill clarifies that tax-exempt organizations will lose their exempt status by participating or intervening in any political campaign in opposition to as well as in support of any candidate for public office;

(10) tax-exempt organizations' distributive share of income from any publicly traded limited partnership is treated as unrelated business taxable income;

(11) benefits payable under certain church self-insured death benefit plans would be excludable from income;

(12) the restrictive rules that now apply to "eligible deferred compensation plans" of tax-exempt organizations (under revised Code section 457) would not extend to "nonelective" deferred compensation plans.

Source: CLTR January/February 1988

Legal Developments

Seventh Day Adventists Did Not Qualify for the Exemption of Parsonages under State Law

Church Property

Richard R. Hammar, Attorney, CPA

Bio

State: Indiana
Categories: Church Property, Tax Exemption

An Indiana state tax court held that a duplex owned by the state conference of the Seventh Day Adventists did not qualify for the exemption of parsonages under state law.

The exemption was available only if the parsonage is actually used to house a minister, and the evidence was not clear that this was the exclusive use of the conference-owned duplex. The court did acknowledge that the duplex might qualify for exemption under another statutory provision exempting any property used for religious purposes, and accordingly remanded the case to the trial court for further consideration. Seventh-Day Adventists v. Board of Tax Commissioners, 512 N.E.2d 936 (Ind. Tax 1987)

Legal Developments

Coverage of Church Employees Under the Social Security (FICA) System

There are three important developments to report concerning the coverage of church employees under the

Richard R. Hammar, Attorney, CPA

Bio

State: Pennsylvania
Categories: Payroll Tax Reporting, Tax Exemption

There are three important developments to report concerning the coverage of church employees under the Social Security (FICA) system:

1. A federal appeals court recently rejected the contention of a local church that the current treatment of churches and church employees under the Social Security program amounts to a violation of the constitutional guaranty of religious freedom.

Here are the facts. In 1983, Congress amended the Internal Revenue Code to make church employees subject, for the first time, to mandatory Social Security (FICA) taxation effective January 1, 1984. Congress later partially restored the previous exemption (retroactive to January 1, 1984) for any church that (1) was opposed for religious reasons to the payment of the employer's share of FICA taxes, and (2) irrevocably elected to exempt itself from Social Security taxation by filing a Form 8274 with the IRS no later than the day prior to the due date of the first employer's quarterly tax report (IRS Form 941) that the church was required to file after July 17, 1984. For churches with nonminister employees as of July 17, 1984, Form 8274 was due not later than October 30, 1984.

A timely election relieves a church of the obligation to pay the employer's share of FICA taxes (7.15% of employee wages in 1987), and relieves each nonminister employee of the obligation to pay the employee's share of FICA taxes (an additional 7.15% of wages in 1987). However, the employee is not relieved of all Social Security tax liability. On the contrary, the nonminister employees of an electing church are required to report and pay their Social Security taxes as self-employed individuals (the "self-employment tax"). And, this tax is significantly greater than the employee's share of FICA taxes. In 1987, for example, the self-employment tax rate is 12.3% of earnings. Therefore, a church employee receiving a salary of $10,000 in 1987 would pay $715 in FICA taxes if his or her church did not file an election on Form 8274 (the church would pay an additional $715). However, if the church filed the election to exempt itself from FICA taxes, the following consequences occur: (1) the church pays no FICA tax; (2) the employee pays no FICA tax; and (3) the employee must report and pay a self-employment tax liability of $1,230.

Many churches and church employees consider this situation unfair. Churches are free to exempt themselves from Social Security taxes, but only at the cost of significantly increasing the tax liability of their employees. In response, many electing churches have increased the salary of their employees to compensate for the increase in taxes. Of course, this leaves the church in essentially the same position as if it had not elected to be exempt—it in effect is paying Social Security taxes "indirectly."

This dilemma, argued a Baptist church in Pennsylvania, unconstitutionally restricts the religious freedom of churches by forcing them (contrary to their religious convictions) to divert church resources away from religious and charitable functions in order to increase employee compensation (and thereby "indirectly" pay the Social Security tax).

A federal appeals court rejected this contention. The court based its ruling on a 1982 Supreme Court decision that upheld the imposition of the Social Security tax to employees of Amish farmers though this directly violated the farmers' religious beliefs. The Supreme Court had observed that "tax systems could not function if denominations were allowed to challenge the tax systems because tax payments were spent in a manner that violates their religious belief." It concluded that the broad public interest in the maintenance of the federal tax systems was of such a high order that religious belief in conflict with the payment of the taxes provides no constitutional basis for resisting them. The appeals court found this precedent controlling in resolving the challenge to Social Security coverage of church employees.

The appeals court also rejected the church's argument that the taxation of church employees violates the first amendment's nonestablishment of religion clause by creating an "excessive entanglement" between church and state. It also rejected the claim that the Internal Revenue Code was impermissibly discriminatory in granting clergy an exemption from Social Security coverage but not churches or church employees. Bethel Baptist Church v. United States, 822 F.2d 1334 (3rd Cir. 1987).

2. The Tax Reform Act of 1986 permits churches that have elected to exempt themselves from the employer's share of FICA taxes by filing a timely Form 8274 to revoke their exemption.

However, the Act did not specify how churches could revoke their exemption. Temporary regulations recently issued by the Treasury Department provide that churches can revoke their exemption (starting with any calendar quarter after December 31, 1986) by filing a Form 941 (employer's quarterly tax return) accompanied by full payment of Social Security taxes for that quarter. To illustrate, if a church with three employees elects in November of 1987 to revoke its previous election to be exempt from Social Security taxes, it should simply submit a Form 941 on or by January 31, 1988 (the deadline for filing a Form 941 for the fourth calendar quarter) along with the applicable FICA taxes for that quarter. Thereafter, the deposit rules described in the "Tax Calendar" feature of this newsletter will apply. Of course, if a church revokes its exemption, nonminister employees are no longer treated as self-employed for Social Security purposes, and accordingly should no longer file quarterly estimated tax payments (their FICA taxes will be withheld from their wages).

3. A number of churches having nonminister employees (e.g., an office secretary) apparently do not know whether or not they have elected to exempt themselves from the employer's share of Social Security (FICA) taxes by filing a timely Form 8274.

Churches having nonminister employees as of July of 1984 had until October 30, 1984 to file the election. Churches not having nonminister employees in July of 1984 have until the day before the due date of their first quarterly employer's tax report (Form 941) to file the election. Ordinarily, this form is not required until a church hires a nonminister employee. The due dates for Form 941 are the last day of the month following the end of each calendar quarter (i.e., April 30, July 31, September 30, and January 31). Churches that filed a timely election but that nevertheless paid all employment taxes due from the effective date of their election through December 31, 1986 (a fairly common practice by churches that could not remember if they ever filed the election) are treated as if they never filed the election. Internal Revenue News Release IR-87-94.

Source:Church Law & Tax Report, September-October 1987

Legal Developments

State Free to Select the Subjects of Taxation and to Grant Exemptions

A Texas appeals court rejected a claim that a state law exempting religious periodicals from

Richard R. Hammar, Attorney, CPA

Bio

State: Texas
Categories: Tax Exemption

A Texas appeals court rejected a claim that a state law exempting religious periodicals from the sales tax on magazines unconstitutionally discriminated against non-exempt periodicals.

The court observed that "it is inherent in the exercise of the power to tax that a state be free to select the subjects of taxation and to grant exemptions. Equal protection does not impose on a state any rigid equality of taxation. Inequalities which result from singling out one particular class for taxation or exemption infringe on no constitutional limitations." Bullock v. Texas Monthly, Inc., 731 S.W.2d 160 (Tex. App. 1987).

Legal Developments

Tax-Exempt Organizations Engaged in an Unrelated Trade or Business Not Reporting to the IRS

Representative J.J. Pickle (Democrat, Texas), chairman of the House Ways and Means Subcommittee on Oversight,

Richard R. Hammar, Attorney, CPA

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State: Texas
Categories: Tax Exemption

Representative J.J. Pickle (Democrat, Texas), chairman of the House Ways and Means Subcommittee on Oversight, has announced plans to conduct hearings later this year on the subject of television evangelists.

Representative Pickle's subcommittee recently concluded hearings on the unrelated business activities of tax-exempt organizations. Concern was expressed over the unfair competition that universities and certain health facilities allegedly pose to taxable entities. IRS records reveal that fewer than 3% of all tax-exempt organizations report unrelated business income to the IRS (on Form 990-T).

Many believe that there are several tax-exempt organizations engaged in an unrelated trade or business that are not reporting their activities to the IRS as required by law. Any legislative change in this area will probably await the results of an IRS technical compliance audit of 3,000 tax-exempt organizations.

Source: Church Law & Tax Report 1987

Legal Developments

Self-proclaimed Minister Denied Exemption from Social Security Taxes

The Tax Court denied a self-employed cabinet maker's application for exemption from social security taxes

Richard R. Hammar, Attorney, CPA

Bio

State: Federal
Categories: Tax Exemption

The Tax Court denied a self-employed cabinet maker's application for exemption from social security taxes on the ground that he was not an ordained, commissioned, or licensed minister of the gospel, despite his claim that he was a self-proclaimed minister. Loiler v. Commissioner.___ T.C .___ (1987).