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.