In the midst of the financial scandals involving several prominent companies in 2002 and 2003, the media began focusing on allegations of questionable conduct by trustees and executives of public charities. In some cases the alleged abuses were clear violations of the law. In others the issue was whether certain practices met the high ethical standards expected of the charitable sector.
These disclosures caught the attention of Congress. In September of 2004 the chairman of the Senate Finance Committee, Senator Charles Grassley (R-IA), and the ranking member, Senator Max Baucus (D-MT), sent a letter to the Independent Sector encouraging it to assemble an independent group of leaders from the charitable community to consider and recommend actions “to strengthen governance, ethical conduct, and accountability within public charities and private foundations.” The Senate Finance Committee leadership requested a final report in 2005.
• Key point. The Independent Sector is a nonprofit, nonpartisan coalition of approximately 500 national public charities, foundations, and corporate philanthropy programs, collectively representing tens of thousands of charitable groups in every state across the nation.
The Independent Sector responded by creating a Panel on the Nonprofit Sector consisting of 24 leaders of public charities. The Panel embarked upon a wide-ranging examination of how to strengthen the governance, accountability, and ethical standards of public charities. It convened several public hearings, obtained valuable input from advisory groups and work groups, and consulted with dozens of professionals. The Panel’s final report was submitted to the Senate Finance committee on June 22, 2005. It consists of nearly 100 recommendations for changes to be adopted by Congress, the IRS, or charities themselves.
Application of the Panel’s Recommendations to Churches
Many of the Panel’s recommendations pertain to public charities that file Form 990 with the IRS. Churches and many other religious organizations are exempt from this requirement, and on this basis are not targeted by many of the recommendations. However, some religious organizations are required to file Form 990. In addition, many churches and religious organizations are required to file Form 990-T if they generate unrelated business taxable income. The Panel’s recommendations do not address the question of whether Form 990-T filers are subject to the recommendations that target Form 990 filers. It is doubtful that they are, based on several comments contained in the Panel’s report including the following:
- “Recommendations for changes in the law or regulations would primarily apply to organizations required to file a Form 990 or 990-PF, and thus smaller organizations or religious congregations would generally be exempt.”
- “Form 990 – The IRS form that tax-exempt organizations (other than private foundations) that have annual revenues of $100,000 or more or total assets above $250,000 must file annually to report on their financial and program operations. Religious congregations and specific related institutions, specified government agencies, and other organizations identified by the IRS are exempt from this filing requirement.”
- Several of the Panel’s recommendation apply to filers of “all Form 990 series returns.” Does this broad term apply to churches that report unrelated business taxable income to the IRS on Form 990-T? A glossary at the end of the Panel’s recommendation defines “Form 990 series” as follows: “Used in this report to refer to three forms (Form 990, Form 990-EZ and Form 9909-PF) filed annually with the IRS by charitable organizations.” Most churches and religious organizations are not required to file any of these three forms. Note that the definition of “Form 990 series returns” does not mention Form 990-T.
While many of the Panel’s recommendations specifically exempt churches and some other religious organizations, it is worth noting that several points “consistently came through” in the 15 field hearing conducted by the Panel around the country, and one of these points was that “religious groups should be held to the same standards of ethical conduct” as other charities. Because of the widespread acceptance of this principle, it is possible that Congress or the IRS may choose to apply some of the Panel’s recommendations to churches even though the Panel concluded that they should be exempt. Also relevant in this regard is the following statement by Senator Grassley (chairman of the Senate Finance Committee) who requested the Panel to provide recommendations for strengthening the accountability of charitable organizations: “I want to make certain that the vitality of nonprofits, particularly small charities and churches, is not unduly burdened by governance reforms.”
The case for voluntary compliance
Several of the Panel’s recommendations call for voluntary action (without intervention by Congress or the IRS) by charities themselves. While churches are exempt from many of these recommendation, some church leaders may want to voluntarily comply with them for the same reasons that support voluntary compliance with the Sarbanes-Oxley Act. After all, the recommendations constitute what a large panel of experts believe to be the “best practices” for public charities. Why would a church not want to voluntarily comply with at least some of them? Further, note that some church board members will be aware of the Panel’s work and may see no reason why their church should not comply even if not legally required to do so.
Summary of the Panel’s recommendations
The Panel made nearly 100 recommendation, divided into 15 categories. The recommendations, and their possible application to churches, are summarized in a table contained in this article.
Recommendations of the Panel on the Nonprofit Sector:
Application to Churches
Note. This table summarizes the recommendations made by the Panel on the Nonprofit Sector. None of these recommendations has been adopted. The second column (“relevance to churches”) addresses the relevance to churches if the corresponding recommendation is adopted. A number of the recommendations reflect an attempt to apply selected provisions of the Sarbanes-Oxley Act to public charities.
|1. Federaland State Enforcement|
|1. Congress should increase IRS funding for oversight of charities.||An indirect impact on churches because of the Church Audit ProceduresAct which provides churches with significant protections when faced with IRSinquiries and examinations. For more information see Chapter 12 (section A.8)in Richard Hammar’s Church & Clergy Tax Guide.|
|2. Congress should authorize funding to be provided to states toincrease oversight and education of charities.||Minimal impact on churches since most states donot regulate charities beyond charitable solicitation (and churches often areexempted from these laws).|
|3. Congress should amend the law to allow state attorneys general toaccess certain IRS information.||Churches would be affected if the next recommendation is adopted bythe state legislature.|
|4. Charities should encourage state legislatures to adopt federalstandards for public charities into state law, including the prohibition ofexcess benefit transactions.||The federal tax code’s prohibition of excess benefit transactionsdirectly applies to certain persons who perform services for churches. Formore information see Chapter 4 (section A.3) in Richard Hammar’sChurch & Clergy Tax Guide.|
|5-10. Several recommendations for federal legislation pertaining toIRS “Form 990 series returns.”||No impact on most churches, which generally are exempt from filingForm 990. Some religious organizations are not exempt from the Form 990filing requirement and these would be affected.|
|11-18. Several recommendations for IRS revisions to Form 990.|
|19. Boards of charities should review the Form 990 filed by theircharity each year.|
|3. PeriodicReview of Tax-Exempt Status|
|20. Congress should provide the IRS with additional funds to improveoversight of Form 990 reporting and audits.||No impact on most churches, which generally are exempt from filingForm 990 (except Form 990-T that reports unrelated business income tax). TheChurch Audit Procedures Act provides churches with significant protectionswhen faced with IRS inquiries and examinations. See Chapter 12 (section A.8)in Richard Hammar’s Church & Clergy Tax Guide.|
|21. Congress should direct the Treasury Department to require taxexemption applications (Form 1023) to be filed electronically.||Some impact on churches. Churches are not required to file Form 1023to obtain IRS recognition of exempt status, and many have not done so whileothers have. Many churches are covered by a denominational group exemptionruling which provides IRS recognition of exemption without having to fileForm 1023.|
|22. Boards of any charity required to file Form 990 should (as a”recommended practice”) do a full review of the charity’s”organizational and governing instruments, key financial transactions,and compensation policies and practices at least once every five years.”||No impact on most churches, which generally are exempt from filingForm 990. Some religious organizations are not exempt from the Form 990filing requirement and these would be affected.|
|4.Financial Audits and Reviews|
|23-24. Congress should amend the tax code to require charitiesrequired to file Form 990 to have a CPA audit of their financial statementsif they have annual revenue of $1 million or more, or a CPA”review” of their financial statements if annual revenues are $250,000 to $1 million. Audited financial statements should be attached to Form990 and made available for public inspection.||No impact on most churches, which generally are exempt from filingForm 990. Some religious organizations are not exempt from the Form 990filing requirement and these would be affected.|
|5.Disclosure of Performance Data|
|25. “Every charitable organization should, as a recommendedpractice, provide detailed information about its programs, including methodsit uses to evaluate outcomes of programs, and other statements available tothe public through its annual report, website, or other means.”||This recommendation identifies a “best practice” that manychurches will want to follow voluntarily.|
|26-33. Several recommendations for congressional and IRS action toaddress perceived abuses in the operation of donor-advised funds. Thisarrangement allows philanthropic donors to donate substantial amounts to acharity while retaining the authority to recommend distributions from thedonated funds for charitable purposes.||Little impact on churches, since few have created donor-advised funds(some denominations have). The recommendations would bar donors fromrecommending distributions that would personally benefit them, and wouldprohibit “asset parking” (donors who create a donor-advised fundand delay making recommendations regarding distributions).|
|7. Type IIISupporting Organizations|
|34-37. Several recommendations for congressional and IRS actionpertaining to certain “supporting organizations.”||No impact on most churches.|
|8. AbusiveTax Shelters and Charitable Organizations|
|38-42. Several recommendations for changes in the federal tax code torequire charities to disclose to the IRS their participation in “listed”tax shelters.||No impact on most churches, since churches generally do not participatein “listed” tax shelters, which include (1) accelerated employerdeductions for certain contributions to a 401(k) plan; (2) some welfarebenefit trusts; (3) some partnership transactions; (4) some distributionsfrom charitable remainder trusts; (5) debt straddles; and (6) offshoredeferred compensation arrangements. This is only a partial list todemonstrate the inapplicability of the Panel’s tax shelter recommendations tomost churches.|
|9A. Noncash Contributions: Appreciated Property|
|43. Congress should strengthen the definition of a qualified appraisaland a qualified appraiser for purposes of substantiating gifts to charity of noncash property valued by the donor at more than ,000.||Direct application to churches, which often receive gifts of noncash property valued by the donor at more than ,000.Such donations (other than publicly traded stock) must have a qualifiedappraisal by a qualified appraiser to be deductible as a charitablecontribution. While it is the donor’s responsibility to comply with theserequirements, many are not familiar with them, and so many churches assist inproviding information on the legal requirements to qualify for a deduction.Churches that provide this kind of information will need to update theiradvice if this recommendation is adopted.|
|44. Congress should enact a new penalty for persons who claim a taxdeduction for donated property if the value of the donated property exceedsthe market value of the property by 50% or more.|
|45. Congress should enact new penalties for appraisers of donatedproperty if the appraised value of donated property exceeds the market valueby 50% or more.|
|46. Congress should amend the tax code to mandate electronic filing ofForms 8283 and 8282, and require donors to complete information on Form 8283pertaining to the name of the appraiser and the appraised value before askingthe charity to substantiate that it received the donation.||Direct application to churches. Form 8283 is the “qualifiedappraisal summary” that donors of noncash propertyvalued at more than ,000 must attach to Form 1040 to substantiate adonation to charity of noncash property (other thanpublicly traded stock, or privately-held stock valued at less than ,000).Form 8282 (donee information return) is the formcharities submit to the IRS if they sell or dispose of donated propertywithin 2 years. Many churches are required to file Form 8282, and sign the”donee acknowledgment” in section B ofForm 1040, so church leaders should be aware if the Panel’s recommendationsregarding Forms 8283 and 8282 are adopted by Congress.|
|9B. Noncash Contributions: Conservation and Historic FaçeEasements|
|47-51. Several recommendations for congressional and IRS action tonarrow the availability of charitable contribution deductions for donationsof conservation and historic façe easements.||Minimal impact on churches, since it is rare for a church to receivethis form of contribution.|
|9C. Noncash Contributions: Clothing and Household Items|
|52. The IRS should establish a list of the value that taxpayers canclaim for donations of specific items of clothing and household goods basedon the sale price of such items identified by major thrift store operationsor similar assessments.||Churches often receive donations of clothing and household items.Church leaders often do not know how to receipt these donations. Of course,churches are not appraisers and are not required to provide a cash value forthese donated items in a receipt. A receipt simply describes the donateditems and their condition (additional requirements apply if the combinedvalue of a donor’s contribution of such items is 0 or more). If thisrecommendation is adopted, the IRS will publish a “value guide” toassist taxpayers in valuing gifts of clothing and household goods to charity.|
|53. Congress should amend the tax code to impose penalties on boardmembers of charities for approving an “excess benefit transaction”with a board member (or family member of a board member) not only if theyknew the transaction was improper (this is current law), but also if they”should have known” it was improper-unless they qualify for a”rebuttable presumption” based on duediligence in basing compensation on comparability data.||Direct application to churches, if enacted. For more information seeChapter 4 (section A.3) in Richard Hammar’s Church &Clergy Tax Guide.|
|54. Congress should increase the collective penalty (intermediate sanctions) on board members who approve an excess benefit transaction for aboard member from ,000 to ,000.|
|55. Congress should amend the tax code to prohibit loans to boardmembers.||Direct application to churches, if enacted. For more information seeChapter 4 (section B.9) in Richard Hammar’s Church &Clergy Tax Guide.|
|56. The Panel “generally discourages payment of compensation toboard members of charitable organizations.” However, “wherecompensation is deemed necessary due to the complexity of the responsibility,the time commitment involved in board service, and the skills required”charities should base compensation on a review of the practices of comparableorganizations.||This recommendation is for voluntary action by charities, with noaction by Congress or the IRS.|
|57. Charities should make available to “peer organizations onrequest relevant information that would assist in reviewing thereasonableness of board compensation policies.”|
|58-62. Several recommendations for congressional and IRS actionpertaining to compensation paid to board members of charitable foundations,and revising Form 990 to disclose board compensation.|
|63. Congress should amend the tax code to require “disqualifiedpersons” (generally officers or directors, or their relatives) who arecharged with receiving excessive compensation to demonstrate that thecompensation they receive is reasonable.||Direct application to churches, if enacted. For more information seeChapter 4 (section A.3) in Richard Hammar’s Church &Clergy Tax Guide.|
|64. Congress should amend the tax code to impose penalties on boardmembers of charities for approving an “excess benefit transaction”involving any disqualified person not only if they knew the transaction wasimproper (this is current law), but also if they “should haveknown” it was improper-unless they qualify for a “rebuttable presumption” based on due diligence inbasing compensation on comparability data.|
|65. Congress should increase the collective penalty (intermediate sanctions) on board members who approve an excess benefit transaction forany disqualified person from ,000 to ,000.|
|66. Charities are urged to add to their bylaws or other governingdocument a requirement that the full board must approve, annually and inadvance, the compensation of the CEO unless there is no change incompensation other than a cost-of-living adjustment.||These recommendations identify a “best practice” that manychurches will want to follow voluntarily. Use of Richard Hammar’s annual CompensationHandbook for Church Staff is one way to comply with the secondrecommendation.|
|69. Governing boards or compensation committees should review thecharity’s staff compensation program periodically, including salary rangesfor particular positions.|
|70-72. Several recommendations for congressional and IRS actionpertaining to compensation paid to disqualified persons of charitablefoundations, and revising Form 990 to disclose more details regardingcompensation paid to the “CEO and other officers.”|
|73. “Charitable organizations that pay for or reimburse travelexpenses of board members, officers, employees, consultants, volunteers, orothers traveling to conduct the business of the organization should establishand implement policies that provide clear guidance on their travel rules,including the types of expenses that can be reimbursed and the documentationrequired to receive reimbursement. Such policies should require that travelon behalf of the charitable organization is to be undertaken in acost-effective manner. The travel policy should be provided to and adhered toby anyone traveling on behalf of the organization.”||These recommendations identify a “best practice” that manychurches will want to follow voluntarily.|
|74. “Charitable organizations should not pay for nor reimbursetravel expenditures (not including de minimisexpenses of those attending an activity such as a meal function of the organization) for spouses, dependents, or others who areaccompanying individuals conducting business for the organization unlessthey, too, are conducting business for the organization.”|
|75-76. The IRS should amend Form 990 to reflect whether or not apublic charity has a suitable travel policy.|
|13.Structure, Size, Composition and Independence of Governing Boards|
|77. Congress should amend the tax code to require public charities tohave at least three members of the board of directors as a requirement fortax-exempt status.||“Excluded from this requirement would be houses of worship.”However, note that the nonprofit corporation laws of some states specify aminimum number of directors, and such a provision may apply to anincorporated church.|
|78. Congress should amend the tax code to require at least one-thirdof a charity’s board to be “independent,” meaning individuals”(1) who have not been compensated by the organization within the pasttwelve months, including full-time and part-time compensation as an employeeor as an independent contractor, except for reasonable compensation for boardservice; (2) whose own compensation, except for board service, is notdetermined by individuals who are compensated by the organization; (3) who donot receive, directly or indirectly, material financial benefits (i.e.,service contracts, grants, or other payments) from the organization except asa member of the charitable class served by the organization; and (4) who arenot related to (as a spouse, sibling, parent, or child) any individualdescribed above.”||“Excluded from this requirement would be houses of worship.”|
|79. Congress should amend the law “to prohibit individuals barredfrom service on boards of publicly traded companies or convicted of crimesdirectly related to breaches of fiduciary duty in their service as anemployee or board member of a charitable organization from serving on theboard of a charitable organization for five years following their convictionor removal.”||No application to churches, which are not publicly-traded companies.Some denominational foundations have established securities programs that maytrigger this requirement (if it is enacted by Congress).|
|80. The IRS should modify Form 990 to require public charities todisclose which of its board members are independent.|
|81. “Every charitable organization, as a matter of recommendedpractice, should review its board size periodically to determine the mostappropriate size to ensure effective governance and to meet the organization’s goals and objectives. All boards should establish strong andeffective mechanisms to ensure that the board carries out its oversight functions and that board members are aware of their legal and ethicalresponsibilities in ensuring that the organization is governedproperly.”||These recommendations identify a “best practice” that manychurches will want to follow voluntarily.|
|82. “A board of directors should ensure, as a matter ofrecommended practice, that the positions of chief executive officer, boardchair, and board treasurer are held by separate individuals. If the boarddeems it is in the best interests of the charitable organization to have theCEO serve as the board chair, the board should appoint a lead director tohandle issues that require a separation of responsibilities.”|
|83. “The charitable sector should undertake a vigorous effort toprovide information and education to its organizations regarding the rolesand responsibilities of board members and the factors that boards shouldconsider in evaluating the appropriate size and structure needed to ensurethe most effective and responsible governance.”|
|84. “Charitable organizations should include individuals withsome financial literacy on their board of directors in accordance with thelaws of their state or as a matter of recommended practice. Every charitableorganization that has its financial statements independently audited, whetherlegally required or not, should consider establishing a separate auditcommittee of the board. If the board does not have sufficient financialliteracy, and if state law permits, it may form an audit committee comprisedof non-voting, non-staff advisors rather than board members.”||These recommendations identify a “best practice” that manychurches will want to follow voluntarily.|
|85. “There should be a sector-wide effort to educate charitableorganizations about the importance of the auditing function.”|
|15.Conflict of Interest and Misconduct|
|86. The IRS should modify Form 990 to require public charities todisclose whether they have a conflict of interest policy.|
|87. “Adopt and enforce a conflict of interest policy consistentwith the laws of its state and tailored to its specific organizational needsand characteristics. This policy should define conflict of interest, identifythe classes of individuals within the organization covered by the policy,facilitate disclosure of information that may help identify conflicts ofinterest, and specify procedures to be followed in managing conflicts ofinterest. Special attention should be paid to any transactions between boardmembers and the organization.”||These recommendations identify a “best practice” that manychurches will want to follow voluntarily.|
It is important to stress once again that the Panel’s recommendations are just that-recommendations. Some urge Congress to enact legislation, others urge the IRS to modify forms or procedures, and several are directed at charities themselves and seek voluntary compliance with recommended practices without any additional action by Congress or the IRS. What impact would the Panel’s recommendations have on churches if they are adopted by Congress or the IRS? The following examples will illustrate how churches might be affected. But remember, these examples are assuming that the Panel’s recommendations are adopted.
• Example 1. A church rents a portion of its parking lot to employees and patrons of neighboring businesses. It files a Form 990-T with the IRS, reporting unrelated business income tax. If the Panel’s recommendations under Part 2 are adopted by the IRS, the church will not be required to file its annual Form 990-T electronically. The Panel’s recommendation applies only to filers of “all Form 990 series returns.” A glossary at the end of the Panel’s recommendation defines “Form 990 series” to encompass Form 990, Form 990-EZ and Form 9909-PF.” This definition does not mention Form 990-T. As a result, it is unlikely that the church in this example would be required to file a Form 990-T electronically, although it probably could do so voluntarily.
• Example 2. A church treasurer has heard about the Panel’s recommendations, and is wondering if the church needs to comply. The table summarizing the Panel’s recommendation shows that some of the recommendations would affect churches, if adopted. It is important to study the table, and be alert to which recommendations are adopted.
• Example 3. A church board member has heard that every church is now required to have a CPA audit its financial statements annually. Is this information correct? The answer is no. The Panel recommended that the tax code be amended to require a CPA audit for any charity required to file Form 990 that has annual revenue of $1 million or more (and a CPA review if annual revenue is $250,000 to $1 million). Since churches are not required to file Form 990, this recommendation would not apply to a church even if Congress adopts it. Some religious organizations are not exempt from the Form 990 filing requirement (such as some parachurch ministries), and these organizations may be affected. Note that some church leaders will consider a CPA audit to be a “best practice” that churches should voluntarily follow.
• Example 4. A church member informs the pastor that she is considering a donation of her house to the church. Will the Panel’s recommendations apply to such a transaction? Yes they may, if Congress adopts the Panel’s recommendations regarding donations of noncash property. These recommendations contain no exemption for churches. Among other things, these recommendations will strengthen the definition of a qualified appraisal and a qualified appraiser, to make it less likely that donors will inflate the value of donated noncash property. Church leaders should remain alert to any developments (which will be addressed fully in future issues of this newsletter).
• Example 5. A church member donates a tract of undeveloped property to his church. The donor obtains a qualified appraisal, and claims a charitable contribution deduction of $15,000 (the appraised value). The church resells the property within 6 months. If the Panel’s recommendations are adopted by Congress, then the church will need to file a Form 8282 (donee information return) with the IRS electronically.
• Example 6. Same facts as the previous example. The donor asks the church treasurer to sign the “donee acknowledgment” in Section B of Form 8283 before filling in the rest of the form. If the Panel’s recommendations are adopted by Congress, then the church treasurer must not sign the Form 8283 until after the donor has completed the section of the form listing the name of the qualified appraiser and the appraised value of the donated property.
• Example 7. A church frequently receives donations of clothing and household items. Will it be affected by the Panel’s recommendations? Yes, if the IRS adopts the Panel’s recommendation regarding valuation of donations of such items. Of course, churches are not appraisers and are not required to provide a cash value for these donated items in a receipt. A receipt simply describes the donated items and their condition (additional requirements apply if the combined value of a donor’s contribution of such items is $250 or more). If this recommendation is adopted, the IRS will publish a “value guide” to assist taxpayers in valuing gifts of clothing and household goods to charity. This can be used by a church to assist the donor in establishing a value for the donated items.
• Example 8. A church pays an honorarium to board members each year. Is this practice prohibited by the Panel’s recommendations? The answer is no. The Panel did not recommend that Congress or the IRS take any action to prohibit this practice, but it did “discourage payment of compensation to board members of charitable organizations.” As a result, compliance with this “best practice” is purely voluntary. Further, the Panel’s recommendations state that “where compensation is deemed necessary due to the complexity of the responsibility, the time commitment involved in board service, and the skills required” charities should base compensation on a review of the practices of comparable organizations.
• Example 9. A church board votes to “give” a church-owned parsonage to its senior pastor at his retirement. The value of the parsonage is $150,000. The church did not report the value of the parsonage as taxable income on the pastor’s Form W-2, and the pastor did not report the value as income on his Form 1040. This is an excess benefit transaction since the value of this benefit was not reported as taxable income. Generally, the IRS can assess an excise tax (called “intermediate sanctions”) against board members who authorize an excess benefit transaction. However, the board members in this case insist that they cannot be liable for this tax since they did not know that giving the parsonage to the pastor was an excess benefit transaction. The Panel recommended that this tax be assessed against board members if they “should have known” that a transaction was improper (actual knowledge would not be required).
• Example 10. A church board approves excessive compensation for the senior pastor that the IRS later determines to be an excess benefit transaction. Under current law, board members of a public charity who approve an excess benefit transaction may be subject to an excise tax (“intermediate sanctions”) of up to 10% of the amount of the excess, up to a maximum of $10,000 for the entire board. The Panel recommended that the maximum collective liability of board members for such a transaction be increased from $10,000 to $20,000.
• Example 11. A church pays its senior pastor an annual salary of $45,000 this year. In addition, it reimburses expenses the pastor incurs for the use of his car, out of town travel, entertainment, and cell phone use, but does not require substantiation of the amount, date, location, or business purpose of reimbursed expenses. Instead, the pastor provides the church treasurer with a written statement each month that lists the expenses incurred for the previous month. The treasurer then issues a check to the pastor for this amount. This is an example of a nonaccountable reimbursement arrangement. Assume that the church reimburses $5,000 under this arrangement this year, and that the amount is not reported as taxable income by the church on the pastor’s Form W-2 for this year. Since the amount was not reported as taxable compensation by the church in the year the benefit was paid, it is an “automatic” excess benefit resulting in intermediate sanctions. An “excess benefit” is defined by section 4958 of the tax code as any compensation or benefit provided to a “disqualified person” (generally an officer or director, or relative of an officer or director) in excess of the reasonable value of his or her services. It includes nonaccountable reimbursements of business and personal expenses—unless the reimbursements are reported as taxable compensation by the church or pastor in the year they are paid. Since the church did not “clearly indicate its intent to treat the benefit as compensation for services when the benefit was paid” (i.e., the benefit was not reported on the pastor’s W-2 or Form 1040), the benefit constitutes an “automatic” excess benefit resulting in intermediate sanctions, regardless of the amount of the benefit. So, even though the total amount would not have constituted an excess benefit had the church reported it as taxable income, the fact that it did not do so makes the transaction an “automatic” excess benefit. An excess benefit transaction exposes not only the pastor to intermediate sanctions, but also members of the church board who approved the transaction. The Panel recommended that the liability of board members for approving an excess benefit transaction be modified in two ways: (1) the board members are liable if they “should have known” that a transaction was improper (whether they had actual knowledge or not); and (2) maximum liability for a board is increased from the lesser of 10% of the amount of the excess or $10,000, to the lesser of 10% of the amount of the excess or $20,000.
Resource. Excess benefit transactions, and intermediate sanctions, are addressed fully in Chapter 4, Section A.3, in Richard Hammar’s 2005 Church & Clergy Tax Guide.
• Example 12. Same facts as the previous example except that the pastor is a church’s youth pastor. Assuming that the youth pastor is not an officer of the church, a member of the governing board, or a relative of someone who is, he is not a disqualified person and therefore is not subject to intermediate sanctions. While the nonaccountable reimbursements constitute taxable compensation, and the failure by the church and pastor to report them as such exposes the pastor to back taxes plus penalties and interest, they are not an “automatic” excess benefit resulting in intermediate sanctions since the youth pastor is not a disqualified person.
• Example 13. Same facts as the previous example except that the youth pastor is the senior pastor’s son. Assuming the senior pastor is president of the church corporation or a member of the governing board, he is a disqualified person and so is his son. As a result, the nonaccountable reimbursements that were not reported as taxable compensation are an “automatic” excess benefit exposing the youth pastor, his father, and members of the church board (who approved the transaction) to intermediate sanctions. The Panel recommended that the liability of board members for approving an excess benefit transaction be modified in two ways: (1) the board members are liable if they “should have known” that a transaction was improper (whether they had actual knowledge or not); and (2) maximum liability for a board is increased from the lesser of 10% of the amount of the excess or $10,000, to the lesser of 10% of the amount of the excess or $20,000.
• Example 14. A church sends its pastor and his wife on an all-expense-paid trip to Hawaii in honor of their 25th wedding anniversary. The total cost of the trip is $8,000. The church treasurer assumes that this amount is a nontaxable fringe benefit, and so she does not report any of the $8,000 on the pastor’s W-2. The pastor likewise assumes that the cost of the trip is a nontaxable benefit. The church’s payment of these travel expenses constitutes an automatic excess benefit exposing the pastor and members of the church board (who approved the transaction) to intermediate sanctions. The Panel recommended that the liability of board members for approving an excess benefit transaction be modified in two ways: (1) the board members are liable if they “should have known” that a transaction was improper (whether they had actual knowledge or not); and (2) maximum liability for a board is increased from the lesser of 10% of the amount of the excess or $10,000, to the lesser of 10% of the amount of the excess or $20,000.
• Example 15. A church collects a “love offering” from the congregation during the Christmas season last year. The congregation was informed that donations would be tax-deductible, and donations were reported on the annual contribution summary provided to each member. Last year the pastor’s love offering was $4,000. Both the pastor and church treasurer assumed that this amount was a nontaxable gift, and so neither reported it as taxable income (on Form W-2 or Form 1040). The love offering constitutes an automatic excess benefit resulting in intermediate sanctions since it was not reported as taxable compensation by either the church or pastor in the year the benefit was provided. This is so even though the amount of the benefit by itself, or when added to the pastor’s other church compensation, is reasonable in amount. This will expose the pastor and members of the church board (who approved the transaction) to intermediate sanctions. The Panel recommended that the liability of board members for approving an excess benefit transaction be modified in two ways: (1) the board members are liable if they “should have known” that a transaction was improper (whether they had actual knowledge or not); and (2) maximum liability for a board is increased from the lesser of 10% of the amount of the excess or $10,000, to the lesser of 10% of the amount of the excess or $20,000.
• Example 16. A pastor determines his own salary without any input from the board or congregation. Is this practice prohibited by the Panel’s recommendations? The answer is no. However, the Panel urged charities, as a “best practice,” to amend their bylaws or other governing document to require full board approval (annually, and in advance) of the compensation paid to the CEO.
• Example 17. A pastor determines the salary of all staff members without any input from the board or congregation. Is this practice prohibited by the Panel’s recommendations? The answer is no. However, the Panel urged charities, as a “best practice,” to have their governing board review staff compensation periodically, “including salary ranges for particular positions.” One way to comply with this “best practice” is to use Richard Hammar’s annual Compensation Handbook for Church Staff, which contains salary ranges for 9 different staff positions.
• Example 18. A pastor travels to a church in another city to conduct worship services. Since the city is 1,500 miles away, the church purchases a first class airline ticket for the pastor. Is it an appropriate use of church funds to pay for a premium class airline ticket? The tax code permits public charities to pay for or reimburse the “ordinary and necessary expenses” incurred in carrying out its activities, including the cost of travel. However, the code requires that these expenses not be “lavish or extravagant.” The Panel recommended that charities, as a “best practice,” should “establish and implement clear travel policies that will guide individuals who may incur travel expenditures while conducting the business of the organization and that will reflect the standards of the organization as to what it considers reasonable expenditures. Travel policies should include procedures for properly documenting expenses incurred and their organizational purpose.” The Panel noted that “while there are occasions on which travel may require the purchase of tickets and accommodations at the last moment and necessitate paying premium prices, as a matter of general practice travel policies should ensure that the business of the organization is carried out in a cost-effective and efficient manner.” Further, “as a general practice, charitable funds should not be used for premium or first-class travel.”
• Example 19. Same facts as the previous example, except that the pastor is traveling to another country to conduct worship services, and his flight will be longer than 6 hours. The Panel’s recommendations state, “Boards should retain the flexibility to permit first-class or premium accommodations or travel when it is in the best interest of the organization. Such a policy should be consistently applied and transparent to board members and others associated with the organization. Many organizations have developed policies that allow for such travel if the flight is longer than six hours or if an overnight flight (red-eye) enables the traveler to sleep during the flight and thereby save time and cost of an overnight stay.”
• Example 20. A church allows staff members to occasionally drive church-owned vehicles for personal purposes. The value of this travel is not reported as taxable income. The Panel’s recommendations specify, “An organization’s travel policies should reflect the requirements and restrictions on travel expenditures imposed under current law. For example, policies should make clear that personal use of the organization’s vehicles or accommodations is prohibited, unless the expenditure is treated as compensation. Public charities may permit individuals to reimburse the organization for the fair market value of the personal use of its property.” Personal use of church-owned vehicles must be valued and reported as taxable income under current law. The Panel recommends, as a “best practice,” that public charities adopt travel policies that specifically inform staff of this requirement.
• Example 21. A church board member has heard that churches are legally required by the federal tax code to have at least three board members. Is this true? The answer is no. The Panel did recommend that Congress amend the tax code to require charities to have at least three board members, but “houses of worship” were exempted from this recommendation.
© Copyright 2005 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: m46 c0505