Forbes v. Commissioner, T.C. Sum. Op. 1992-167 (unpublished)
Most ministers support their church with regular contributions. Some also make regular contributions to a denominational agency. Must this financial support be treated as a charitable contribution? Or, is it possible to treat it as "professional dues"? This question was addressed directly in an unpublished Tax Court decision that will be summarized in this article. The court's decision, and its significance to church treasurers, will be summarized in this article.
facts of the case
A local church adopted a "tithing policy" requiring every employee to pay a tithe of ten percent of total compensation back to the church. The church strictly enforces the tithing policy. Tithing records are maintained on a computer and are periodically examined for all employees. Employees found to be delinquent in their tithes are required to become current. The church has dismissed several employees for failing to comply with the tithing requirement.
The church views its tithing policy as both moral and managerial. Morally, the church believes that "a church member whose wages are paid from the tithes of the parishioners, but refuses to participate in the support of the ministry, is dishonest and hypocritical." From a management standpoint, the church believes that an employee who disagrees with its basic tenets and is unwilling to comply with its policies is not fulfilling his or her employment commitment.
One of the church's ministers received $24,600 in wages from the church in one year, which consisted of salary, housing allowance, and miscellaneous amounts received for services performed at weddings, funerals, and other occasions. She paid a tithe of $2,460 back to the church, as required by the tithing policy. In computing her self-employment (social security) taxes for the year she deducted this tithe as a "business expense."
the IRS position
The IRS audited the minister's tax return and claimed that she could only claim her tithe as a charitable contribution deduction and not as a business expense. As a result, the IRS concluded that it was improper for the minister to deduct the tithe in computing her social security taxes. While taxpayers can deduct business expenses in computing self-employment taxes, they cannot deduct charitable contributions. The minister appealed the IRS ruling to the Tax Court, claiming that her tithe was a business expense that she was entitled to deduct in computing her self-employment taxes.
the court's decision
The Tax Court concluded that the minister's tithes to the church represented a business or professional expense rather than a charitable contribution under the facts of this case. As a result, the minister properly deducted her tithes in computing her social security taxes. The court observed:
Under consideration of the record in this case, we agree with [the minister]. Tithing is required by [the church] as a matter of employment policy, and [the minister] must annually tithe ten percent of the income she receives as a result of her position as a minister. Since [the church's] tithing policy is rigorously enforced, [the minister's] employment is, in a very real sense, dependent upon her willingness to give. The fact that she is tithing to a charitable organization to which she belongs and to which she might tithe ten percent anyway is of little consequence given the facts in this case. Accordingly … we hold that [the minister] is entitled to compute her net earnings from self-employment by reducing her gross income from self-employment by the $2,460 she paid to [the church] during the year in issue as a tithe.
Federal tax law permits taxpayers to deduct business and professional expenses, which are defined as "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business". The court concluded that the minister's tithes satisfied this definition and accordingly could be deducted as a business expense. It is significant that the IRS conceded that the minister's tithes could be deducted as a business or professional expense, except for a provision in federal law preventing taxpayers from claiming a business expense deduction for an item that could be claimed as a charitable contribution. The IRS claimed that this provision prevented the minister from deducting her tithes as a business expense—since she could have claimed them as a charitable contribution. Not so, said the court. It concluded that "payments made as an integral part of a taxpayer's trade or business" are deductible as business or professional expenses even if "the recipient of the payment is a charitable organization." That is, the critical question to ask is whether or not a payment satisfies the definition of a business expense. Is it an ordinary and necessary expense paid or incurred in carrying on a trade or business? If so, it is deductible as a business expense even though it may be possible to characterize it as a charitable contribution.
Further, the court suggested that it would be unrealistic to treat the minister's tithe to the church as a voluntary charitable contribution, since in no sense was it a voluntary transfer of funds to the church. Rather, it was a mandatory payment, and as such it could not be characterized as a charitable contribution.
Key point. The United States Supreme Court has observed that a gift or charitable contribution "proceeds from a detached and disinterested generosity … out of affection, respect, admiration, charity, or like impulses." Surely, it would be inappropriate to classify mandatory financial support paid to a church by a minister or lay employee as a gift or contribution under this test, since in no sense does such support "proceed from a detached and disinterested generosity."
importance to church treasurers
What is the relevance of this case to church treasurers? Consider the following:
1. The case suggests that mandatory contributions made by ministers and lay employees to a church can be treated as business expenses. What is the practical effect of this result? Most importantly, it means that ministers may be able to deduct such contributions as a business expense in computing their self-employment (social security) tax on Schedule SE (of Form 1040). Remember, ministers always are considered to be self-employed for social security purposes with respect to their ministerial income. Consider the following examples:
Example. Rev. D receives compensation of $40,000 for 1994 from his church (of which $10,000 is designated as a housing allowance). Rev. D makes mandatory contributions of $4,000 to his church, and has other business expenses of $3,000. If the $4,000 in contributions to the church are mandatory, the Tax Court's ruling suggests that these can be deducted as a business expense in computing both income taxes and self-employment taxes. Rev. D would pay self-employment taxes on $33,000 (total compensation including housing allowance less the mandatory contributions and business expenses). Without taking into account any other facts or deductions (for the sake of simplicity) this would result in a tax of $5,049.
Example. Same facts as the previous example, except that Rev. D's contributions to the church do not meet the Tax Court's definition of "mandatory". Rev. D would pay self-employment taxes on $37,000 (total compensation including housing allowance less business expenses but not less contributions). Without taking into account any other facts or deductions (for the sake of simplicity) this would result in a tax of $5,661. By not treating his contributions as a business expense Rev. D will pay $612 in additional self-employment taxes.
2. Income tax deduction. The Tax Court concluded that mandatory contributions to a church by a church employee can be claimed as a business expense. As a result, such expenses can be deducted as a miscellaneous itemized deduction on Schedule A (by church employees) or as a deduction on Schedule C (for self-employed workers). One problem—employees who do not have enough deductions to itemize on Schedule A (this is true of nearly 70%) cannot claim any deduction for income tax purposes. This is true whether the contribution is treated as a charitable contribution or as a business expense. Note however that a mandatory contribution can still be deducted in computing self-employment taxes, even if the taxpayer cannot itemize income tax deductions on Schedule A. This is the primary reason why some ministers want to treat their church contributions as a business expense.
3. Reimbursing mandatory contributions. Many church treasurers reimburse their minister's business expenses. If mandatory contributions to the church are considered to be business expenses for purposes of self-employment taxes, can a church treasurer reimburse them? This is a difficult question that the Tax Court's ruling did not address. Logically, if mandatory contributions are considered to be business expenses for self-employment tax purposes, they can be reimbursed under either an accountable or nonaccountable business expense reimbursement arrangement. There are two considerations to note: (1) Neither the IRS nor any court has directly addressed this issue. There is no clear precedent that can be cited in support of such a conclusion. This does not mean that the reimbursement of mandatory contributions would be wrong or illegal. It simply means that there is no direct precedent to support such a position. (2) Some would say there is a logical or theological inconsistency in a church reimbursing a minister's contributions. To illustrate, David refused to make a burnt offering to the Lord using donated oxen ("will I offer burnt offerings unto the Lord my God of that which cost me nothing?")
4. Contributions must be mandatory. For contributions to a church to be treated by ministers and lay employees as a business expense rather than as a charitable contribution, they must be "mandatory" under the Tax Court's rigid definition. Note the following elements that were noted by the court:
• the church adopted a formal "tithing policy" that required every employee to pay a tithe (ten percent) of gross income to the church
• the church maintained tithing records on every employee
• the church periodically reviewed the tithing records of all employees and required delinquent employees to become current
• the church dismissed several employees for failing to comply with the tithing requirement
• the church clearly articulated both a theological and managerial basis for its tithing policy
Example. Rev. K would like to reduce the amount of social security taxes that he pays. He decides to deduct his church contributions as a business expense in computing his self-employment taxes. He claims that if he does not set an example to his congregation by making contributions to the church, he may be asked to resign. The church has never adopted a formal "tithing policy," and has never dismissed (or even suggested dismissing) a minister for inadequate contributions. These contributions are not mandatory, and are not deductible (for income tax or social security tax purposes) as a business expense.
5. The IRS conceded that mandatory contributions could be treated as business expenses. As noted above, it is important to recognize that the IRS conceded that the minister's tithes could be deducted as a business or professional expense except for a provision in federal law preventing taxpayers from claiming a business expense deduction for an item that could be claimed as a charitable contribution. Since the court concluded that this provision did not apply, the contributions were deductible as a business expense.
6. Denominational support. Some denominations require ministers to make contributions for their support. If these contributions are mandatory, they can be treated as business expenses and deducted in computing self-employment taxes according to the Tax Court's decision. Once again, it is important to emphasize that the contributions must in fact be mandatory. For example, the denomination's governing documents specify that ministers can lose their ordained status for failure to pay the required support.
Key point. Ministers can elect to treat their mandatory contributions as a charitable contribution rather than as a business or professional expense. Why would they choose to do so? Some will do so for theological reasons. Others will do so to reduce their audit risk (since it is possible that the IRS will not accept the reasoning of the Tax Court in other cases).
7. Effect of a "small Tax Court case". The Tax Court's decision was a "small tax court case," meaning that it involved less than $10,000 and the taxpayer elected to pursue an expedited and simplified procedure authorized by section 7463 of the Internal Revenue Code. While small tax court cases are more quickly resolved, there is a trade off—section 7463 specifies that "a decision entered in any case in which the proceedings are conducted under this section shall not be reviewed by any other court and shall not be treated as precedent for any other case." In other words, the decision of the Tax Court was final, and it cannot be cited as precedent in other cases. Obviously, this greatly limits the impact of the case. The IRS is free to completely ignore the decision in future cases.