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Do Former Employees Have a Legal Right to Accrued Vacation Pay?

Do churches have to pay accrued vacation to former employees? Here’s what the law says.

Richard R. Hammar, Attorney, CPA
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Yes, concluded a Louisiana court.

An employee retired, and their employer refused to pay out the accrued vacation time that had accumulated prior to retirement. The employer had an unwritten “use it or lose it” vacation policy and denied paying any accrued vacation time to employees following retirement, resignation, or dismissal.

The court ruled that in the absence of a clear, written policy stating that vacation time is a gratuity and not a vested right, accrued but unused vacation time must be compensated upon termination. This ruling emphasizes the importance of written vacation policies to define whether vacation time is a benefit or a legally protected right.

Understanding Accrued Vacation Pay Rights

Church treasurers and administrators should be aware that their church may be legally required to pay employees for accrued vacation time upon separation. While employers can enforce a policy requiring employees to use vacation time within the same calendar year, any vacation earned within that year is generally considered a vested right.

The case of Wyatt v. Avoyelles Parish School Board, (La. App. 2001) serves as a precedent, reinforcing that employers must clearly define vacation policies in writing to avoid potential legal disputes.
  • Churches should maintain a written vacation policy that explicitly states whether vacation time is accrued, carried over, or forfeited.
  • Some states require payout of accrued vacation upon termination, while others allow employers to set policies that prohibit rollover or payout. Check state labor laws here.
  • If no written policy exists, courts may rule in favor of employees, making accrued vacation a legally protected right.
  • Churches engaged in interstate employment may be subject to federal labor laws regarding vacation pay. Visit Department of Labor Wage and Hour Division for additional guidance.

FAQs About Accrued Vacation Pay Rights

1. Can churches implement a “use it or lose it” vacation policy?

Yes, but it must be clearly stated in a written policy. Without one, courts may rule that accrued vacation time is a vested right.

2. Are churches required to pay accrued vacation to terminated employees?

State laws vary. Some states require payout of accrued vacation upon termination, while others allow policies that prohibit it.

3. How can a church ensure compliance with vacation pay laws?

Churches should draft a written vacation policy, comply with state laws, and consult legal counsel for best practices.

The U.S. Department of Labor provides resources on wage and hour laws. Check their official website for more information.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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Can Bankrupt Debtors Make Contributions to Their Church?

Discover how the Religious Liberty and Charitable Donation Act ensures charitable contributions remain protected in bankruptcy cases.

Richard R. Hammar, Attorney, CPA
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Last Reviewed: January 23, 2025

In re Kirschner, 259 B.R. 416 (M.D. Fla. 2001)

Understanding the Case

A couple with $100,000 of debt filed for bankruptcy, but their petition was opposed by a bankruptcy trustee. The trustee argued that their plan, which included donating ten percent of their income to their church, was not “reasonably necessary for the debtors’ maintenance and support.” The trustee claimed these donations should be classified as disposable income and allocated to creditors instead.

The Court’s Decision

The federal bankruptcy court ruled that the couple’s plan could not be denied because of their proposed charitable contributions. Under the Religious Liberty and Charitable Donation Protection Act of 1998, bankruptcy plans cannot be rejected solely because they include charitable contributions, as long as these contributions meet specific conditions.
  • Contributions must not exceed 15 percent of the debtor’s gross annual income.
  • If contributions exceed 15 percent, they must align with the debtor’s regular practice of giving.

Congress intended this law to “protect the rights of debtors to continue to make religious and charitable contributions after they file for bankruptcy relief.”

Key Considerations

The court noted that the couple’s contributions to their church were less than 15 percent of their annual income. As a result, the bankruptcy plan could not be rejected solely on the basis of these donations, despite their significant debt. However, the court required the couple to provide proof of their contributions to prevent misuse of allocated funds.

Documentation Requirements
  • Debtors must provide documentation of charitable giving to the bankruptcy trustee.
  • Receipts or acknowledgments from the church can be used as proof.
  • This ensures transparency and prevents fraudulent claims.

Implications for Churches

Churches receiving charitable contributions from individuals in bankruptcy should issue clear receipts. These documents not only support tax deductions but also help donors comply with court requirements during bankruptcy proceedings.

FAQ Section

What is the Religious Liberty and Charitable Donation Protection Act?

The Act ensures that individuals in bankruptcy can continue making religious and charitable contributions up to 15 percent of their gross annual income.

Are charitable contributions always protected in bankruptcy cases?

Yes, as long as the contributions meet the conditions outlined in the Act, including the 15 percent income limit.

Do debtors need to prove their charitable contributions?

Yes, debtors must provide documentation, such as receipts, to demonstrate that contributions were made as stated in their bankruptcy plan.

How can churches support donors in bankruptcy?

Churches can help by providing detailed receipts and acknowledgments of contributions, ensuring compliance with legal and tax requirements.

This article first appeared in Church Treasurer Alert, June 2002.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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Reimbursing Lunch Expenses

Churches should refer to an important Tax Court decision when reimbursing lunch expenses.

Richard R. Hammar, Attorney, CPA
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There’s a right way churches should go about reimbursing lunch expenses.

In many churches, ministerial lunches are a weekly ritual. Since church matters are discussed, many church treasurers assume that the cost of the lunch can be reimbursed by the church under an accountable arrangement.

As a result, the cost of such lunches is not added to the employees’ taxable compensation for tax reporting purposes.

But is this the correct way to handle lunch expenses? If your church has an accountable reimbursement arrangement, can you reimburse lunch expenses? If so, under what circumstances? Always? Whenever church matters are discussed?

A Tax Court decision addresses this important question.

In Dugan v. Commissioner (T.C. Memo. 1998-373), a medical technician and a physician shared office space.

The two often met at lunchtime to discuss the treatment of their patients and the details of office administration and operations.

The two met at other times as well, but they found that lunchtime was often the best opportunity to meet. They alternated paying for their meals together.

On her federal income tax return, the technician deducted her share of these meal expenses (subject to the 50% reduction that applies to unreimbursed meal expenses).

The IRS disallowed any deduction for the meals on the ground that they were not a legitimate business expense. The technician appealed to the Tax Court.

Were the technician’s lunch expenses deductible?

After all, she discussed both treatment procedures and office operations during these lunches. Unfortunately, the court agreed with the IRS that the expenses were not deductible.

The court began its opinion by noting that “daily meals are an inherently personal expense, and a taxpayer bears a heavy burden in proving they are deductible” as a business expense.

Attorneys’ lunches

The court referred to a previous ruling involving attorneys.

Members of a law firm met every work day at a local restaurant to discuss work-related matters because the lawyers were all litigators and the court was not in session over the noon hour.

A federal appeals court conceded the business purpose for these lunch meetings, and that lawyers “did not dawdle over their lunch,” but it concluded that the meals represented nondeductible personal expenses rather than business expenses.

It observed:

[I]t is undeniable that eating together fosters camaraderie and makes business dealings friendlier and easier. It thus reduces the costs of transacting business, for these costs include the frictions and the failures of communication that are produced by suspicion and mutual misunderstanding, by differences in tastes and manners, and by lack of rapport. A meeting with a client or customer in an office is therefore not a perfect substitute for a lunch with him in a restaurant. But it is different when all the participants in the meal are coworkers, as essentially was the case here …. They know each other well already; they don’t need the social lubrication that a meal with an outsider provides–at least don’t need it daily. If a large firm had a monthly lunch to allow partners to get to know associates, the expense of the meal might well be necessary, and would be allowed by the Internal Revenue Service. But [the law firm in this case] never had more than eight lawyers and did not need a daily lunch to cement relationships among them ….

We may assume it was necessary for the [attorneys] to meet daily to coordinate the work of the firm, and also … that lunch was the most convenient time. But it does not follow that the expense of the lunch was a necessary business expense. The members of the firm had to eat somewhere … Although it saved time to combine lunch with work, the meal itself was not an organic part of the meeting …. Moss v. Commissioner, 758 F.2d 211 (7th Cir. 1985).

Example. The Tax Court ruled that lunch expenses incurred by a group of government attorneys who met for lunch one day each month were not business related despite the fact that business was discussed. The court did concede that “an occasional luncheon meeting with the staff to discuss the operation of the firm would be regarded as an ordinary and necessary expense,” as would “a luncheon to mark an anniversary, retirement or other occasion for an employee” since such expenses “aid in building morale and loyalty and serve as an inducement for others to work more efficiently.” Wells v. Commissioner, 36 T.C.M. 1690 (1977).

The court’s conclusion

Like the attorneys’ lunches, the lunches shared by the medical technician and the physician were not integral to the technician’s business objectives and have not been clearly linked to her production of income.

They met at lunchtime because that was the most convenient and feasible time to meet.

Their business relationship was well established and did not require “social lubrication,” at least not as often as [she and the physician] dined together.

Indeed, the frequency of their lunches together and the reciprocal nature of their meal arrangement belie the existence of any business purpose for the meals …. If taxpayers were permitted to deduct meal expenses in such circumstances then … only the unimaginative would dine at their own expense.

Why does this case matter to how church treasurers reimburse lunch expenses?

Consider the following checklist:

1. Entertainment expenses. Local lunch expenses incurred by church employees qualify as a business expense, and can be reimbursed by a church under an accountable expenses reimbursement arrangement, only if they qualify as entertainment expenses. The requirements for substantiating entertainment expenses are strict. You must demonstrate that the expenses are either (1) directly related to the active conduct of your ministry, or (2) associated with the active conduct of your ministry and the entertainment occurred directly before or after a substantial business discussion.

In order to show that entertainment was directly related to the active conduct of your business, you ordinarily must be able to demonstrate that (1) you had more than a general expectation of deriving income or some other specific business benefit at some indefinite future time; (2) you did engage in business during the entertainment period; and (3) the main purpose of the entertainment was the transaction of business.

In order to show that entertainment was associated with the active conduct of your ministry, you must be able to demonstrate that you had a clear business purpose in incurring the expense, and that the meal or entertainment directly preceded or followed a substantial business discussion.

2. Frequent staff lunches. Frequent lunches with the same members of the church staff are much less likely to qualify as a business expense, even if church business is discussed. For example, if the same three church staff members go out to lunch every Friday, it is very unlikely that any of these lunches will qualify as a business expense. After all, these persons work in the same office, and presumably have considerable interaction during the week. A shared lunch under these circumstances does not constitute an ordinary and necessary business expense.

Key point. It is worth noting that the Tax Court in the Wells case (summarized in an example in this article) met for lunch one day each month. This was considered too frequent to be business related.

3. Occasional lunches with non staff members. Such lunches are more likely to qualify as entertainment expenses, and as a result the costs of these lunches can be reimbursed by the church under an accountable expense reimbursement arrangement. To illustrate, a lunch arranged by a pastor with a local architect to discuss new building plans would qualify as a business expense.

4. Occasional employee lunches. The Tax Court, in a previous decision (the Wells case, summarized in an example in this article) addressing the deductibility of lunch expenses incurred by attorneys one day each month, conceded that “an occasional luncheon meeting with the staff to discuss the operation of the firm would be regarded as an ordinary and necessary expense,” as would “a luncheon to mark an anniversary, retirement or other occasion for an employee” since such expenses “aid in building morale and loyalty and serve as an inducement for others to work more efficiently.”

5. Lunch expenses while traveling. This article only addresses the reimbursement of local lunch expenses. Lunch expenses incurred while church employees are away from town on business travel are business related and can be reimbursed under an accountable arrangement.

6. Other requirements of an accountable arrangement. In order for your church to reimburse expenses under an accountable expense reimbursement arrangement, you must have adopted a reimbursement arrangement that meets the following three requirements: (1) Only business expenses are reimbursed (expenses that would qualify for a business expense deduction on a taxpayer’s personal income tax return). (2) The church only reimburses an expense if the employee substantiates, with written records (including a receipt for expenses of $75 or more), the amount, date, location, and business connection of the expense. In addition, in the case of entertainment expenses (such as local lunch expenses) the employee must document the “occupation or other information relating to the person or persons entertained, including name, title, or other designation, sufficient to establish business relationship to the taxpayer.” (3) Employees must return to the church any reimbursements in excess of substantiated expenses. This article addresses only on the first of these three requirements. Even if a particular lunch qualifies as a business expense, the church may reimburse it under an accountable arrangement only if the other two requirements for an accountable arrangement are met.

If any of these three requirements is not satisfied, the church’s reimbursement of a lunch expense is nonaccountable, and the full amount of the reimbursement must be allocated to the employees’ W-2s.

7. Unreimbursed expenses. This article addresses the tax consequences of a church’s reimbursement of employee lunch expenses. In some cases, church employees pay for their own lunch expenses. Such “unreimbursed” expenses may be deducted as an employee business expense, but only if reimbursement from the church was not available. Further, church employees may deduct only 50% of business related entertainment expenses, including meals. This 50% limitation is incorporated directly into the tax returns (line 9 of Form 2106, and line 24c of Schedule C). Note however that the 50% limitation does not apply to expenses that are reimbursed by an employer under an accountable reimbursement plan. IRS Publication 463 states: “As an employee, you are not subject to the 50% limit if your employer reimburses you under an accountable plan and does not treat your reimbursement as wages.” Publication 463 states that the self employed persons also can avoid the 50% limitation through use of an accountable reimbursement arrangement.

Here are some examples that will illustrate the issues addressed in this article.

Example 1: A church has 3 pastors who for many years have gone out to lunch every Friday. Church business is almost always discussed at these lunches. The cost of these lunches is always charged to a church credit card, and the church treasurer has never reported the church’s reimbursements as taxable income to the pastors by including it on their W-2 forms. This is incorrect. According to the rulings summarized in this article, these lunches do not qualify as business expenses, and as a result they should not be charged to the church credit card. If the pastors continue to charge the lunches to the church credit card, the treasurer will need to allocate the reimbursed expenses to the pastors and report the reimbursements as taxable income on the pastors’ W-2 forms at the end of the year. The treasurer need not withhold additional income taxes because the pastors’ wages are exempt from income tax withholding.

Example 2: Same facts as the previous example, except that nonminister church employees rather than pastors are involved. The answer is the same, except that the church will need to withhold income taxes and FICA taxes from the value of the lunches.

Example 3: A pastor occasionally meets church members for lunch, and charges the cost of these lunches to the church credit card. The purpose of these lunches is for the pastor to become better acquainted with members, and to provide spiritual guidance as needed. These expenses qualify as an entertainment expense. As a result, the expenses reimbursed by the church are accountable so long as the requirements for an accountable reimbursement (summarized in this article) are satisfied.

Example 4: Same facts as the previous example, except that the pastor informs the church treasurer each month of the approximate amount he spent during the previous month on such lunches, and receives a reimbursement check. This arrangement is nonaccountable since the substantiation requirements for an accountable arrangement are not met. As a result, the treasurer will need to add the value of all lunch expense reimbursements to the pastor’s W-2 at the end of the year.

Example 5: A pastor takes the church staff out to lunch twice each year as a means of expressing appreciation for their hard work. The cost of these lunches is charged to the church credit card. These expenses represent a legitimate business expense, and as a result they can be reimbursed by the church under an accountable arrangement so long as they are adequately substantiated. As a result, the church treasurer would not report any of the reimbursements as taxable income. The Tax Court has noted that “an occasional luncheon meeting with the staff to discuss the operation of the firm would be regarded as an ordinary and necessary expense,” as would “a luncheon to mark an anniversary, retirement or other occasion for an employee” since such expenses “aid in building morale and loyalty and serve as an inducement for others to work more efficiently.” Wells v. Commissioner, 36 T.C.M. 1690 (1977).

Example 6: A church’s two pastors go out to lunch once each month. Church business is always discussed, and the cost of the lunches is charged to the church credit card. A federal appeals court has observed that monthly lunches by law firm members “might well be necessary, and would be allowed by the Internal Revenue Service.” Moss v. Commissioner, 758 F.2d 211 (7th Cir. 1985). On the other hand, the Tax Court has ruled that monthly lunch expenses incurred by government attorneys were not business related despite the fact that business was discussed. Wells v. Commissioner, 36 T.C.M. 1690 (1977). In summary, while there is legal support for treating monthly lunch expenses as business-related, but there is also support for the opposite conclusion. This suggests that the business nature of monthly lunch expenses may be challenged by the IRS, but that no penalties would be assessed.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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The Tax Consequences of Reclassifying an Employee as Self-Employed

Discover the tax implications of reclassifying an employee as self-employed, including IRS guidelines, potential penalties, and compliance strategies for churches.

Richard R. Hammar, Attorney, CPA
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Last Reviewed: January 8, 2025

Understanding the tax implications of reclassifying an employee as self-employed is crucial for church treasurers. This article explores the potential consequences for both the worker and the church when such a reclassification occurs.

Key Takeaways:
  • Workers remain liable for their income taxes, even if misclassified.
  • Churches may face penalties for incorrect worker classification.
  • Proper classification is essential to avoid financial liabilities.

What happens if a church reclassifies an employee as self-employed? The worker remains responsible for their own income taxes, and the church may incur penalties for failing to withhold the appropriate taxes.

Background

In Lucas v. Commissioner, T.C. Memo. 2000-14 (2000), the Tax Court examined a situation where a company treated a worker as self-employed, neglecting to withhold income and FICA taxes. The worker failed to pay the full amount of income taxes, leading to an IRS audit that reclassified him as an employee. The court determined that the worker was still liable for his income taxes, despite the employer’s misclassification.

Implications for Church Treasurers

Worker’s Liability

If a church misclassifies a worker as self-employed, the worker remains responsible for paying their income taxes. Failure to do so can result in personal tax deficiencies and potential penalties.

Church’s Liability

A church that incorrectly classifies an employee as self-employed may face several penalties:
  • Income Tax Penalty: 1.5% of the employee’s wages (3% if no Form 1099 was issued).
  • FICA Penalty: 20% of the employee’s share of FICA taxes (40% if no Form 1099 was issued).
  • Employer’s Share of FICA Taxes: The church is liable for the full employer’s portion.
  • Intentional Disregard: If the misclassification is intentional, the church may be liable for the full amount of the employee’s taxes.

Examples

Consider the following scenarios:

Example 1

Joan is a part-time secretary at her church, earning $10,000 annually. The church treats her as self-employed, and she pays her taxes through estimated payments. The IRS audits Joan and reclassifies her as an employee. Regardless of whether Joan paid the correct amount of taxes:
  • She remains responsible for any underpayment of income taxes.
  • The church faces an income tax penalty of $150 (1.5% of $10,000).
  • The church incurs a FICA penalty of $153 (20% of Joan’s share of FICA taxes).
  • The church owes the employer’s share of FICA taxes, totaling $765.

Example 2

In the same scenario, if the church failed to issue Joan a Form 1099, the penalties double:
  • Income tax penalty increases to $300.
  • FICA penalty rises to $306.

Example 3

If a church treasurer deliberately classifies all lay employees as self-employed to avoid withholding taxes, the church could be liable for all employees’ taxes due to intentional disregard of withholding requirements.

Conclusion

Proper classification of workers as employees or independent contractors is essential to avoid significant tax liabilities for both the worker and the church. Church treasurers should carefully assess worker classifications to ensure compliance with IRS regulations and prevent potential financial penalties.

FAQs

What criteria determine if a worker is an employee or self-employed? The IRS considers factors such as behavioral control, financial control, and the relationship between the parties. Detailed guidance is available on the IRS website.

Can a worker appeal an IRS reclassification? Yes, a worker can appeal an IRS determination by providing evidence supporting their classification. Consulting a tax professional is advisable in such cases.

What steps can a church take to ensure proper worker classification? Churches should review IRS guidelines, assess the nature of work relationships, and consider seeking legal or tax advice to ensure accurate classification.

Are there any safe harbor provisions for misclassification? Section 530 of the Revenue Act of 1978 provides relief for employers who have a reasonable basis for misclassifying workers. However, specific criteria must be met to qualify for this relief. More information can be found in this article.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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The Tax Consequences of Debt Forgiveness

Explore the IRS’s guidelines on debt forgiveness and learn how churches can navigate the tax implications effectively.

Richard R. Hammar, Attorney, CPA
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Last Reviewed: January 9, 2025

Explore the IRS’s guidelines on debt forgiveness and learn how churches can navigate the tax implications effectively.

Key Takeaways:
  • Debt forgiveness may result in taxable income for pastors.
  • Prearranged plans for forgiveness can impact IRS classification.
  • Adequate documentation is critical to compliance.

Debt forgiveness can lead to significant tax consequences, especially for churches assisting pastors with financial arrangements. This article examines IRS guidelines and offers insights to help church treasurers navigate these situations.

IRS Guidelines on Debt Forgiveness

The IRS provides clear guidance on the tax treatment of debt forgiveness. When a loan is made with a prearranged plan to forgive the debt, the IRS may classify the entire loan amount as taxable income at the time of the loan. Key points include:
  • Prearranged Plans: If forgiveness is part of a prearranged plan, the entire loan may be considered taxable income when issued.
  • No Prearranged Plan: If forgiveness arises later, the forgiven amount is taxable in the year forgiveness occurs.
  • Documentation: Adequate records and overt acts of forgiveness can affect tax treatment.

Examples of Debt Forgiveness Scenarios

The following examples illustrate how IRS guidelines apply in different debt forgiveness scenarios:

Example 1: No Documentation

A church gives a pastor $50,000 to assist with a home purchase but fails to document the arrangement. Later, the church decides informally to treat the amount as a loan and forgive annual installments. The IRS is likely to treat the entire $50,000 as taxable income in the year it was given, due to the lack of documentation and a prearranged plan.

Example 2: Adequate Documentation

A church provides a $50,000 loan secured by a promissory note, with annual installments of $5,000 to be forgiven each year. The board minutes explicitly state that forgiveness is not guaranteed. In this case, only the amount forgiven each year ($5,000) is taxable income for that year.

Lessons for Church Treasurers

Church treasurers must consider the following when addressing debt forgiveness:
  • Document all financial arrangements thoroughly to avoid IRS scrutiny.
  • Ensure that any forgiveness is not part of a prearranged plan unless the tax implications are understood.
  • Consult tax professionals to navigate complex scenarios and ensure compliance.

FAQs About Debt Forgiveness
  • Is forgiven debt always taxable?
    Forgiven debt is generally considered taxable income unless specific exclusions apply.
  • Can documentation reduce tax liability?
    Adequate documentation can help ensure that only forgiven amounts are taxed in the appropriate years.
  • What constitutes a prearranged plan?
    A prearranged plan exists if the intent to forgive the debt was established at the time the loan was made.
  • How should churches report forgiven debt?
    Forgiven amounts should be included in the pastor’s W-2 as taxable income for the applicable year.

Conclusion

Debt forgiveness arrangements can have significant tax consequences for churches and pastors. Proper documentation and an understanding of IRS guidelines are essential to avoid complications. Consult with a tax professional to ensure compliance and minimize risks.

For further information, visit the IRS website or explore resources on Church Law & Tax.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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Returning Excess Salary: Navigating Excess Salary Taxes

Explore the essential steps for managing excess salary taxes, including repayments and payroll adjustments for churches and employees.

Richard R. Hammar, Attorney, CPA
Bio

Last Reviewed: January 9, 2025

Explore the essential steps for managing excess salary taxes, including repayments and payroll adjustments for churches and employees.

Key Takeaways:
  • IRS guidelines govern the repayment of excess salary received in a prior year.
  • Repayments affect FICA taxes, taxable income, and payroll reporting.
  • Proper documentation is essential for compliance and record-keeping.

Excess salary payments can create complex tax and payroll scenarios. This article explains IRS guidance for addressing these situations, ensuring compliance for both employers and employees.

Background: What Are Excess Salary Taxes?

Occasionally, a church treasurer may overpay an employee due to an innocent mistake. If discovered, the employee may wish to return the excess to the church. Understanding the tax and payroll implications is critical for handling these scenarios appropriately.

IRS Guidance on Excess Salary Repayments

According to the IRS, here are the key tax consequences for employees who repay excess salary:
  • No FICA or Federal Income Tax Adjustments in Year 2: The employer does not adjust FICA taxes or federal income tax withholding for year 2.
  • No Year 1 Taxable Income Adjustments: The employee’s taxable income and income taxes withheld for year 1 remain unchanged.
  • Receipts for Repayment: The employer should provide the employee with a receipt for the repayment, which the employee should keep for their records.
  • FICA Tax Overpayments: Repayment of excess salary in year 2 creates an overpayment of FICA taxes for year 1. Employers may claim a credit for this overpayment.
  • Itemized Deduction for Employees: Employees may claim a miscellaneous itemized deduction on Schedule A in year 2 for the amount repaid.
  • Corrected Forms W-2: Employers must issue corrected Forms W-2 for year 1, reflecting adjusted social security and Medicare wages and taxes. However, no changes should be made to Box 1 (“Wages, tips, other compensation”) or Box 2 (“Federal income tax withheld”).

Source: IRS SCA 1998-026

Example:

Assume a church treasurer overpays an employee in year 1, and the error is discovered in year 2:
  • The employee repays the excess salary to the church in year 2.
  • The employer must provide a receipt for the repayment.
  • Corrected Forms W-2 must be issued for year 1, adjusting social security and Medicare wages.

FAQs About Excess Salary Taxes
  • Can employees adjust their taxable income for prior years?
    No, taxable income for prior years remains unchanged when repaying excess salary.
  • What documentation is required for repayments?
    Employers should issue a receipt for the repayment and provide corrected Forms W-2 for the affected year.
  • Can employers recover overpaid FICA taxes?
    Yes, employers can claim a credit for FICA tax overpayments from the prior year.
  • How do repayments affect Schedule A deductions?
    Employees may claim a miscellaneous itemized deduction for the repayment in the year it is made.

Conclusion

Managing excess salary taxes requires careful attention to IRS guidance. Churches and employees should document repayments accurately and ensure compliance with payroll reporting rules to avoid complications. Consulting a tax professional can help navigate complex scenarios effectively.

For further details, consult the IRS website or explore resources on Church Law & Tax.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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What Churches Should Know About Works Made for Hire

Legal implications of works created by a church employee.

Richard R. Hammar, Attorney, CPA
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Checklist of important points

Here are the points to keep in mind:
  • a “work made for hire” is any book, article, or piece of music created by an employee in the course of employment
  • a work is created in the course of employment if it is written or composed during office hours, on church property, using church equipment
  • the employer owns the copyright in a work made for hire
  • an employer, by a signed writing, can transfer copyright in a work made for hire to the employee who created it
  • a church that transfers the copyright in a work made for hire to the employee who created it is jeopardizing its tax-exempt status, since this may constitute “inurement” of its assets to a private individual
  • a church that transfers the copyright in a work made for hire to the employee who created it may be exposing the employee to intermediate sanctions
  • sermons may not constitute a work made for hire, even if they are created in the course of employment

Background

It is common for church employees to compose music or write books or articles in their church office during office hours.

What is often not understood is that such persons do not necessarily own the copyright in the works they create. While the one who creates a work generally is its author and the initial owner of the copyright in the work, section 201(b) of the Copyright Act specifies that “[i]n the case of a work made for hire, the employer or other person for whom the work was prepared is considered the author … and, unless the parties have expressly agreed otherwise in a written instrument signed by them, owns all of the rights comprised in the copyright.”

Two requirements for ‘work made for hire’

The copyright law defines “work made for hire” as “a work prepared by an employee within the scope of his or her employment.”

There are two requirements that must be met: (1) the person creating the work is an employee, and (2) the employee created the work within the scope of his or her employment.

Whether or not one is an employee will depend on the same factors used in determining whether one is an employee or self-employed for federal income tax reporting purposes (see chapter 2 of Richard Hammar’s Church & Clergy Tax Guide). However, the courts have been very liberal in finding employee status in this context, so it is possible that a court would conclude that a work is a work made for hire even though the author reports his or her federal income taxes as a self-employed person.

The second requirement is that the work must have been created within the scope of employment.

This requirement generally means that the work was created during regular working hours, on the employer’s premises, using the employer’s staff and equipment. This is often a difficult standard to apply. As a result, it is desirable for church employees to discuss this issue with the church leadership to avoid any potential misunderstandings. Section 201(a), quoted above, allows an employer and employee to agree in writing that copyright ownership in works created by the employee within the scope of employment belongs to the employee. This should be a matter for consideration by any church having a minister or other staff member who creates literary or musical works during office hours, on church premises, using church staff and church equipment (e.g., computers, printers, paper, library, secretaries, dictation equipment).


Example. Rev. B is senior minister of his church. He is in the process of writing a devotional book. Most of the writing is done during regular church office hours, in his office in the church, using church equipment and a church secretary. Rev. B’s contract of employment does not address the issue of copyright ownership in the book, and no written agreement has ever been executed by the church that addresses the matter. Under these facts, it is likely that the book is a “work made for hire.” The result is that the church is the “author” of the book, it is the copyright owner, and it has the sole legal right to assign or transfer the copyright in the book.


Example. Rev. T is minister of music at her church. She has composed several songs and choruses, all of which were written during regular office hours at the church, using church equipment (piano, paper, etc.). The church has never addressed the issue of copyright ownership in a signed writing. It is likely that the songs and choruses are “works made for hire.” The result is that the church is the “author” of these materials, it is the copyright owner, and it has the sole legal right to assign or transfer the copyright in these works.


Example. Same facts as the preceding example, except that Rev. T composes the music in the evening and on weekends in her home. While she is an employee, she did not compose the music “within the scope of her employment,” and therefore the music cannot be characterized as “works made for hire.” The legal effect of this conclusion is that Rev. W owns the copyright in the music, and is free to sell or transfer such works in any manner she chooses without church approval.


Example. Same facts as the previous example, except that Rev. T composes many of her works both at home and at the church office. Whether or not a particular work is a work made for hire is a difficult question under these circumstances. The answer will depend upon the following factors: (1) the portion of the work that is composed at the church office, compared to the portion composed at home; (2) the portion of the work created with church equipment, compared to the portion created with Rev. T’s personal equipment; (3) the portion of the work created during regular office hours, compared to the portion created after hours; and (4) the adequacy of Rev. T’s personal records to document each of these factors. Unfortunately, a staff member’s records may be inadequate. In such a case, work made for hire status will depend upon the staff member’s own testimony, and the testimony of other witnesses (such as other staff members).

Church’s tax-exempt status may be a concern

If a church transfers the copyright in a work made for hire to an employee, this may be viewed by the IRS as “private inurement” of the church’s resources to an individual. If so, this could jeopardize the church’s tax-exempt status. Neither the IRS nor any court has addressed the tax consequences of such an arrangement to a church. Here are some options:

1. The church transfers copyright ownership to the staff member. This may constitute private inurement. The IRS construes this requirement as follows:

An organization’s trustees, officers, members, founders, or contributors may not, by reason of their position, acquire any of its funds. They may, of course, receive reasonable compensation for goods or services or other expenditures in furtherance of exempt purposes. If funds are diverted from exempt purposes to private purposes, however, exemption is in jeopardy. The Code specifically forbids the inurement of earnings to the benefit of private shareholders or individuals …. The prohibition of inurement, in its simplest terms, means that a private shareholder or individual cannot pocket the organization’s funds except as reasonable payment for goods or services.

When a church employee writes a book during office hours at the church, using church equipment, supplies, and personnel, the copyright in the work belongs to the church. If the church chooses to renounce its legal rights in the book, and transfers the copyright back to the employee, then it is relinquishing a potentially valuable asset that may produce royalty income for several years. Few if any churches would attempt to “value” the copyright and report it as additional taxable compensation to the employee, and as a result it is hard to avoid the conclusion that such arrangements result in inurement of the church’s assets to a private individual. The legal effect is to jeopardize the church’s tax-exempt status. This risk must not be overstated, since only a few churches have had their exempt status revoked by the IRS in the last fifty years, and none because of a transfer of copyright to an employee who created a work made for hire. But the consequences would be so undesirable that the risk should be taken seriously.

2. The church retains the copyright. The risk of inurement can be minimized if not avoided if the church retains the copyright in works made for hire, and pays a “bonus” or some other form of compensation to the author.


Example. Rev. G is senior pastor of his church. He writes a devotional book in his office at the church during office hours and using church equipment. He reads an article about works made for hire, and is concerned about the legal implications. He discusses the matter with the church board. In order to eliminate any risk to the church’s tax-exempt status, the church board decides that the church will retain the copyright in Rev. G’s book. The publisher is contacted, and agrees to list the church as the copyright owner on the title page and to pay royalties from sales of the book directly to the church. The church board agrees to pay Rev. T a “bonus” in consideration of his additional services in writing the book. The bonus is added to Rev. T’s W-2 at the end of the year. This arrangement will not jeopardize the church’s tax-exempt status.

3. The church urges employees to do “outside work” at home. Do you have a writer or composer on staff at your church? If so, it is possible that this person is doing some writing or composing on church premises, using church equipment, during office hours. One way to avoid the problems associated with work made for hire status is to encourage staff members to do all their writing and composing at home. Tell staff members that (1) if they do any writing or composing at church during office hours, their works may be works made for hire; (2) the church owns the copyright in such works; and (3) the church can transfer copyright to the writer or composer, but this may constitute “inurement” of the church’s assets to a private individual, jeopardizing the church’s tax-exempt status. By urging staff members to do all their personal writing and composing at home, the church also will avoid the difficult question of whether works that are written partly at home and partly at the office are works made for hire.

4. Sermons. Are a minister’s sermons “works made for hire” that are owned by the employing church? To the extent that sermons are written in a church office, during regular church hours, using church secretaries and equipment, it is possible that sermons would be considered works made for hire. However, this issue has never been addressed directly by any court, and so it is difficult to predict how a court would rule. A professor’s lecture notes provide a comparable example. College professors often prepare their lecture notes in their office on campus, using campus equipment. Are these notes, and the lectures themselves, works made for hire? If so, the college owns the copyright in the notes and lectures, unless it has transferred the copyright back to the professor in a signed writing. One court has ruled that a professor’s lectures were not works made for hire, and did not belong to the university. Williams v. Weisser, 78 Cal. Rptr. 542 (1969). This case certainly can be used to support the position that a minister’s sermons are not works made for hire.

Don’t forget compensation limits

Staff members who retain ownership of a work made for hire because of a written transfer signed by the church may be subject to intermediate sanctions. Intermediate sanctions are excise taxes the IRS can assess against persons who receive excessive compensation from a church or other charity. The point is this—since the church is the legal owner of the copyright in a work made for hire, it is legally entitled to any income generated from sales of the work. By letting the writer or composer retain the copyright, and all rights to royalties, the church in effect is paying compensation to him or her in this amount. If the work generates substantial income, then this may trigger intermediate sanctions. This would expose the writer or composer to an initial excise tax of 25 percent of the amount of taxable compensation that exceeds what the IRS deems to be reasonable. There is an additional 200 percent tax that can be assessed against the writer or composer if he or she does not return the excess amount to the church. Board members who authorized a transfer of the copyright to the writer or composer may be collectively assessed a tax of 10 percent of the excessive compensation up to a maximum of $10,000.


Key point. Intermediate sanctions can be imposed only against “disqualified persons” and “managers.” IRS regulations define a disqualified person as any person who was in a position to exercise substantial influence over the affairs of the organization at any time during the five-year period ending on the date of the transaction. While a senior pastor ordinarily will meet this definition, other staff members may not. As a result, in many churches the risk of intermediate sanctions will be limited to senior pastors who create works made for hire and are allowed by their church to retain the copyright.


Key point. Church board members are exposed to an excise tax if they authorize a transfer of copyright in a work made for hire to the employee who created it, if the work generates substantial income.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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Understanding Clergy Taxes: Key Insights for Churches

The essentials of clergy taxes, including IRS reclassifications, deductions, and tax impacts for churches and clergy members.

Richard R. Hammar, Attorney, CPA
Bio

Last Reviewed: January 9, 2025

The essentials of clergy taxes, including IRS reclassifications, deductions, and tax impacts for churches and clergy members.

Key Takeaways:
  • IRS reclassification can impact clergy taxes significantly.
  • Self-employment deductions may no longer apply if reclassified as an employee.
  • Social security tax liabilities change based on classification.

Clergy taxes can be complex, especially when the IRS reclassifies self-employed clergy as employees. This article outlines what clergy members and church leaders need to know about these tax implications.

How IRS Reclassification Affects Clergy Taxes

When the IRS reclassifies a clergy member from self-employed to employee, several tax consequences arise:
  • Income Tax Increases: Clergy lose access to certain “above the line” deductions available to self-employed individuals. These include:
    • Deductions for half of self-employment tax.
    • Health insurance premium deductions.
    • Keogh retirement plan contributions.
  • Expense Deduction Changes: Business expenses, if unreimbursed or reimbursed under a “nonaccountable” arrangement, are no longer fully deductible.
  • Social Security Tax Decrease: Employees pay a 7.65% tax rate, compared to the 15.3% self-employment tax rate.

Refunds and Offsets: IRS Policies

If a clergy member is reclassified, the IRS has policies regarding refunds and offsets:

For example, if a church treats a clergy member as self-employed and issues a 1099, the IRS may later reclassify them as an employee. In such cases:
  • The IRS refunds the excess social security taxes paid as a self-employed person.
  • However, this refund may be offset by the additional income tax liability resulting from the reclassification.

Source: FSA 1992-116.1

Example:

Assume a church treats its full-time custodian as self-employed, issuing a 1099. If the IRS reclassifies the custodian as an employee:
  • The custodian is entitled to a refund of excess social security taxes.
  • The IRS may offset this refund by the custodian’s increased income tax liability.

FAQs About Clergy Taxes
  • What deductions are clergy members eligible for?
    Clergy may claim deductions for housing allowances, travel expenses, and professional costs, depending on their classification.
  • What happens if a clergy member’s tax status changes?
    Reclassification impacts deductions, income taxes, and social security obligations.
  • Are clergy members considered employees or self-employed?
    It depends on their role and the church’s treatment of their tax status.
  • How can churches avoid tax misclassification?
    Consult a tax professional and ensure proper documentation for clergy roles and responsibilities.

Conclusion

Understanding clergy taxes is essential for churches to remain compliant and for clergy members to optimize their tax strategies. Be proactive in reviewing IRS classifications and consult a tax professional to ensure accuracy and compliance.

For more information, consult the IRS guidelines or explore resources on Church Law & Tax.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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The Assignment of Income Doctrine

A tax ruling sheds light on how churches and church treasurers should handle certain accounting processes.

Richard R. Hammar, Attorney, CPA
Bio

Last Reviewed: January 21, 2025

Ferguson v. Commissioner, 108 T.C. 244 (1997)

Background.

Donors occasionally attempt to “assign” their right to receive income to a church, assuming that they are avoiding any receipt of taxable income.

Example. Rev. T is senior pastor of First Church. He conducts a service at Second Church, and is offered compensation of $500. Rev. T refuses to accept any compensation, and asks the pastor of Second Church to put the $500 in the church’s building fund. Rev. T, and the treasurer at Second Church, assume that there is no income to report. Unfortunately, they may be wrong.

The United States Supreme Court addressed this issue in a landmark ruling in 1940. Helvering v. Horst, 311 U.S. 112 (1940). The Horst case addressed the question of whether or not a father could avoid taxation on bond interest coupons that he transferred to his son prior to the maturity date. The Supreme Court ruled that the father had to pay tax on the interest income even though he assigned all of his interest in the income to his son. It observed: “The power to dispose of income is the equivalent of ownership of it. The exercise of that power to procure the payment of income to another is the enjoyment and hence the realization of the income by him who exercises it.” The Supreme Court reached the same conclusion in two other landmark cases. Helvering v. Eubank, 311 U.S. 122 (1940), Lucas v. Earl, 281 U.S. 111 (1930).

Example. A taxpayer earned an honorarium of $2,500 for speaking at a convention. He requested that the honorarium be distributed to a college. This request was honored, and the taxpayer assumed that he did not have to report the $2,500 as taxable income since he never received it. The IRS ruled that the taxpayer should have reported the $2,500 as taxable income. It noted that “the amount of the honorarium transferred to the educational institution at the taxpayer’s request … is includible in the taxpayer’s gross income [for tax purposes]. However, the taxpayer is entitled to a charitable contribution deduction ….” The IRS further noted that “the Supreme Court of the United States has held that a taxpayer who assigns or transfers compensation for personal services to another individual or entity fails to be relieved of federal income tax liability, regardless of the motivation behind the transfer” (citing the Horst case discussed above). Revenue Ruling 79 121.

A recent Tax Court ruling.

The Tax Court has issued an important ruling addressing the assignment of income to a church. Don owned several shares of stock in Company A. On July 28, Company A agreed to merge with Company B. Pursuant to the merger agreement, Company B offered to purchase all outstanding shares of Company A for $22.50 per share (an 1,100% increase over book value). On August 15, Don informed his stockbroker that he wanted to donate 30,000 shares of Company A to his church. On September 8 Don deposited 30,000 shares in his brokerage account and on September 9 signed an authorization directing his broker to transfer the shares to his church. A few days later the church issued Don a receipt acknowledging the contribution. The receipt listed the “date of donation” as September 9. The church sold all of the shares to Company B for $22.50 per share. Don claimed a charitable contribution deduction for $675,000 (30,000 shares at $22.50 per share). He did not report any taxable income in connection with the transaction..

Audit findings

The IRS audited Don, and conceded that a gift of stock had been made to the church. It insisted, however, that Don should have reported the “gain” in the value of his stock that was transferred to the church. Not so, said Don. After all, he never realized or “enjoyed” the gain, but rather transferred the shares to the church to enjoy.

The IRS asserted that Don had a legal right to redeem his Company A shares at $22.50 per share at the time he transferred the shares to the church. As a result, Don had “assigned income” to the church, and could not avoid being taxed on it.

Tax Court gets involved

The Tax Court agreed with the IRS. It began its opinion by addressing the date of Don’s gift. Did the gift to the church occur before he had a legal right to receive $22.50 per share for his Company A stock? If so, there was no income that had been assigned and no tax to be paid. Or, did Don’s gift occur after he had a legal right to receive $22.50 per share? If so, Don had “assigned income” to the church and he would have to pay tax on the gain. The court concluded that Don’s gift occurred after he had a legal right to receive $22.50 per share. It quoted the following income tax regulation addressing the timing of gifts of stock:

Ordinarily, a contribution is made at the time delivery is effected …. If a taxpayer unconditionally delivers or mails a properly endorsed stock certificate to a charitable donee or the donee’s agent, the gift is completed on the date of delivery or, if such certificate is received in the ordinary course of the mails, on the date of mailing. If the donor delivers the stock certificate to his bank or broker as the donor’s agent, or to the issuing corporation or its agent, for transfer into the name of the donee, the gift is completed on the date the stock is transferred on the books of the corporation.

The critical issue was whether Don’s broker was acting as Don’s agent or the church’s agent in handling the transaction. The court concluded that the broker had acted as Don’s agent. The broker “facilitated” Don’s gift of stock to the church, and was acting on the basis of Don’s instructions. The court concluded:

[Don has] failed to persuade us that depositing stock in his brokerage account with instructions to [the stockbroker] to transfer some of the stock to the [church] constituted the unconditional delivery of stock to a charitable donee’s agent …. [Don] has failed to persuade us that depositing stock in [his] brokerage account with instructions to [his stockbroker] to transfer some of the stock to the [church] constituted the unconditional delivery of stock to a charitable donee’s agent pursuant to [the regulations] …. Based on the circumstances surrounding the gift … we believe that [the stockbroker] acted as [Don’s] agent in the transfer of the stock and that [he] relinquished control of the stock on September 9 when the letters of authorization were executed, and we so find. The gift to the [church], therefore, was complete on September 9.

Court’s conclusions

The court decided that on the date of the gift (September 9) Don had a legal right to receive $22.50 per share for all his shares of Company A, and therefore his gift to the church was a fully taxable “assignment of income.” The court observed:

It is a well-established principle of the tax law that the person who earns or otherwise creates the right to receive income is taxed. When ]the right to income has matured at the time of a transfer of property, the transferor will be taxed despite the technical transfer of that property …. An examination of the cases that discuss the anticipatory assignment of income doctrine reveals settled principles. A transfer of property that is a fixed right to income does not shift the incidence of taxation to the transferee …. [T]he ultimate question is whether the transferor, considering the reality and substance of all the circumstances, had a fixed right to income in the property at the time of transfer.

It also concluded that Don did have a “fixed right to income” at the time he donated the 30,000 shares to his church. According to the terms of the merger agreement between Company A and Company B, each outstanding share of Company A was “converted” into a right to receive $22.50 per share in cash. In essence, the stock in Company A “was converted from an interest in a viable corporation to a fixed right to receive cash.”

Conclusions.

Here are a few principles for church treasurers to consider:

* Charitable contribution reporting.

Note that the “assignment of income” doctrine does not bar recognition of a charitable contribution. Both the Tax Court and IRS conceded that Don was eligible for a charitable contribution deduction as a result of his gift of stock.

* Timing of a gift of stock.

This case will provide helpful guidance to church treasurers in determining the date of a gift of stock. The income tax regulations (quoted above) contain the following three rules:
(1) Hand delivery.

If a donor unconditionally delivers an endorsed stock certificate to a charity or an agent of a charity, the gift is completed on the date of delivery.
(2) Mail.

If a donor mails an endorsed stock certificate to a charity or an agent of a charity, the gift is completed on the date of mailing
(3) Delivery to an agent.

If a donor delivers a stock certificate to his or her bank or stockbroker as the donor’s agent (or to the issuing corporation or its agent) for transfer into the name of a charity, the gift is completed on the date the stock is transferred on the books of the corporation
* Notification of income consequences.

While certainly not required, church treasurers may want to inform some donors about the assignment of income doctrine. It often comes as a shock to donors (such as Don) to discover that their charitable contribution is “offset” by the taxable income recognized under the assignment of income doctrine. Assignments of income most often occur in connection with donations of stock rights or compensation for services already performed.
* Gifts of appreciated stock not affected.

Many donors give stock that has appreciated in value to their church. Such transactions are not affected by the court’s ruling or by the assignment of income doctrine because the donor ordinarily has no “fixed right to income” at the time of transfer. Don’s case was much different. He had a contractual right to receive $22.50 per share for all of his shares of Company A stock as a result of the merger.

Key point. Persons who donate stock often can deduct the fair market value of the stock as a charitable contribution (there are some important limitations to this rule) and they have no “assigned income” to report.

Example.

Jill is employed by a local business. Her company declares a $1,000 Christmas bonus. Jill asks her supervisor to send the bonus directly to her church. The supervisor does so. The church treasurer should be aware of the following: (1) Jill will be taxed on the bonus under the assignment of income doctrine. The church treasurer may want to point this out to Jill, although this is not required. There is no need for the church to report this income, or issue Jill a W-2 or 1099. (2) Jill should be given credit for a charitable contribution in the amount of the bonus. Since the bonus was in excess of $250 the receipt issued by the church should comply with the charitable contribution substantiation rules that apply to contributions of $250 or more.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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Inurement Definition: Safeguarding Your Church’s Tax-Exempt Status

Understand the inurement definition and how it affects a church’s tax-exempt status, with examples and compliance tips for treasurers.

Richard R. Hammar, Attorney, CPA
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Last Reviewed: January 8, 2025

Church treasurers and board members must understand the concept of inurement to protect their church’s tax-exempt status under section 501(c)(3) of the tax code.

Key Takeaways:
  • Inurement occurs when a church’s net earnings benefit private individuals or insiders beyond reasonable compensation.
  • Any inurement can jeopardize a church’s 501(c)(3) tax-exempt status.
  • Compliance requires transparency, governance policies, and adherence to IRS guidelines.

What Is Inurement?

According to the IRS, inurement occurs when trustees, officers, or insiders use a nonprofit’s funds for personal benefit beyond reasonable compensation. This strict prohibition ensures that tax-exempt organizations operate solely for their exempt purposes and not for the private benefit of individuals.

IRS Clarification: “An organization’s trustees, officers, or members may not acquire funds beyond reasonable compensation for services rendered. Any diversion of funds from exempt purposes puts the exemption in jeopardy.”

Case Law: Variety Club Tent No. 6 Charities, Inc. v. Commissioner

In Variety Club Tent No. 6 Charities, Inc. v. Commissioner, T.C. Memo. 1997-575 (1997), the IRS revoked a charity’s tax-exempt status after identifying prohibited inurement, including:
  • Excessive rent paid to insiders for property use.
  • Misappropriation of funds by officers.
  • Payment of legal fees for personal criminal defense.

The Tax Court upheld the IRS ruling, emphasizing that transactions benefiting private individuals beyond fair compensation constitute inurement.

Examples of Inurement Risks

1. Excessive Compensation

Salaries or benefits exceeding fair market value may be considered inurement. Regular reviews and benchmarking are essential to ensure compliance.

2. Personal Use of Church Assets

If a church-owned vehicle or property is used for personal purposes without proper compensation, it may violate inurement rules.

3. Preferential Transactions

Entering into business arrangements with insiders at above-market rates can trigger IRS scrutiny.

Steps to Avoid Inurement
  • Ensure compensation aligns with fair market value through regular evaluations.
  • Implement conflict of interest policies and require board approval for insider transactions.
  • Maintain transparent financial records and documentation of all transactions.
  • Consult with tax professionals for complex situations or concerns.

FAQs on Inurement
  • What is inurement?
    Inurement refers to the improper use of nonprofit funds to benefit insiders beyond reasonable compensation.
  • What happens if inurement occurs?
    The IRS may revoke a church’s tax-exempt status and impose penalties for prohibited inurement.
  • How can churches prevent inurement?
    Adopt clear governance policies, regularly evaluate compensation, and maintain financial transparency.
  • Can churches pay legal fees for an officer?
    Only if the expenses meet indemnification provisions in the church’s bylaws and are related to official duties.

By understanding and adhering to IRS rules, churches can protect their tax-exempt status and avoid costly penalties or revocations.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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Eminent Domain and Churches: Understanding Your Rights

Discover how eminent domain impacts churches, with key legal insights and guidance for negotiating fair compensation.

Richard R. Hammar, Attorney, CPA
Bio

Last Reviewed: January 8, 2025

Church treasurers must understand how eminent domain works and what compensation churches are entitled to when property is taken for public purposes.

Key Takeaways:
  • Governments can take private property for public purposes under eminent domain laws.
  • “Just compensation” must be provided to property owners, including churches.
  • Churches are typically not entitled to “business damages.”

Eminent domain allows governments to take private property for public use, provided they pay “just compensation.” Churches, like other property owners, are subject to this law. However, determining what constitutes “just compensation” can be complex, as illustrated in the case of Trinity Temple Church of God in Christ v. Orange County.

What Is Eminent Domain?

Eminent domain, also known as condemnation, is the government’s power to take private property for public use, such as building roads, schools, or utilities. Under the Fifth Amendment to the U.S. Constitution, property owners are entitled to “just compensation” when their property is taken.

Did You Know? “Just compensation” typically equals the fair market value of the property but does not always include additional damages like lost profits.

The Trinity Temple Case

In Trinity Temple Church of God in Christ v. Orange County, 681 So.2d 765 (Fla. App. 1996), a Florida county used eminent domain to take part of a church parking lot for a street expansion project. The county compensated the church for the land taken, but the church argued it was entitled to additional “business damages,” claiming reduced parking would decrease attendance and donations.

The Florida appeals court disagreed, ruling that business damages apply only to businesses, not churches. The court stated, “Because the promotion of religion, not its own livelihood, is the primary purpose of a church … we conclude that a church is not a business as that term is used [in the statute].”

What Churches Should Know

When facing eminent domain, churches should consider the following:

1. Understand Your Rights

Governments must provide “just compensation” for any property taken. This compensation usually reflects the property’s fair market value.

2. Assess Impacts Beyond Land Value

While churches are not entitled to “business damages,” they may negotiate for compensation covering specific impacts on their operations, such as parking or accessibility.

3. Review Local Laws

Eminent domain laws vary by state. Consult with a local attorney familiar with eminent domain to understand your church’s rights and options.

If your church is approached with an eminent domain claim, work with legal counsel to ensure fair compensation and address any unique concerns about church operations.

FAQs About Eminent Domain and Churches
  • What is eminent domain?
    Eminent domain is the government’s power to take private property for public purposes, provided “just compensation” is paid.
  • Are churches subject to eminent domain?
    Yes, churches are subject to eminent domain like any other property owners.
  • What is “just compensation”?
    “Just compensation” usually reflects the fair market value of the property taken by the government.
  • Can churches claim business damages?
    No, churches are typically not entitled to business damages as they are not classified as businesses under most state laws.

By understanding your rights under eminent domain laws, churches can navigate property takings more effectively and advocate for fair compensation.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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Sales Tax Exemption for Church Construction Projects: Understanding Roles & Responsibilities

Understanding sales tax exemptions in church construction projects is crucial for contractors and suppliers. This guide outlines key responsibilities and precautions to ensure compliance with state regulations.

Richard R. Hammar, Attorney, CPA
Bio

Last Reviewed: January 8, 2025

In many states, construction materials purchased for church projects are exempt from sales tax.
To qualify for the exemption, contractors usually must:
  • Obtain an exemption certificate or number from the church
  • Present the certificate to the supplier when purchasing materials

Case Study: Hess, Inc. v. Department of Revenue

In Hess, Inc. v. Department of Revenue, 663 N.E.2d 123 (Ill. App. 1996), the court addressed this exact situation.

What happened:
  • A contractor bought construction materials for a church project.
  • The contractor presented the church’s exemption certificate to the supplier.
  • The supplier did not charge sales tax.

Later, during an audit, the Illinois Department of Revenue claimed the supplier still owed sales tax.
Their argument: suppliers cannot rely solely on exemption certificates; they must verify how the materials were actually used.

The Court’s decision:
The Illinois Appellate Court rejected the state’s claim.
It ruled that suppliers are entitled to rely on valid exemption certificates without conducting further verification.

(Source: Leagle)

Proper planning protects your church from unexpected tax liabilities.

Key Takeaways for Church Treasurers

To properly manage sales tax exemptions during construction projects:
  • Maintain Current Exemptions:
    Make sure your church’s sales tax exemption certificate is valid, active, and renewed as required by state law.
  • Clarify Contractual Obligations:
    When signing contracts for goods or services:
    • Clearly state the church’s tax-exempt status.
    • Outline who is responsible for any sales tax if issues arise later due to non-compliance.

Conclusion

Properly managing sales tax exemptions in church construction projects is critical for legal compliance and good financial stewardship.
By:
  • Keeping exemption certificates up to date
  • Defining tax responsibilities clearly in contracts

churches, contractors, and suppliers can protect themselves and confidently navigate these important tax rules.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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The Importance of IRS Form 8283 for Churches and Donors

Key considerations for churches and donors about IRS Form 8283 and noncash contribution documentation.

Richard R. Hammar, Attorney, CPA
Bio

Last Reviewed: January 17, 2025

Hewitt v. Commissioner, 109 T.C. 12 (1997)

Understanding IRS Form 8283

IRS Form 8283 plays a crucial role for donors who claim charitable contribution deductions exceeding $5,000 for noncash property. The form ensures accurate valuation and prevents inflated deductions. Here’s what donors and churches need to know to comply with the regulations.

What Donors Must Do
  • Obtain a Qualified Appraisal: Donors must secure an appraisal from a qualified appraiser no earlier than 60 days before the donation. The appraisal must include detailed information, such as the description of the property, appraised value, and appraiser qualifications.
  • Complete IRS Form 8283: Donors must include a summary of the appraisal (Section B) with their tax return. Publicly traded stock is exempt from these requirements, but nonpublicly traded stock valued over $10,000 is not.
  • Maintain Records: Donors should retain detailed documentation, including the church’s name, the property’s fair market value, and a description of the property.

Why Compliance Matters

Failure to comply with the substantiation requirements can lead to denied deductions. In the case of Hewitt v. Commissioner, the Tax Court disallowed deductions due to a lack of qualified appraisal and Form 8283 submission, despite the donations’ fair market value.

Lessons for Church Treasurers

Churches should assist donors to ensure compliance with IRS regulations. Here are best practices for treasurers:
  • Educate Donors: Provide copies of Form 8283 to donors making noncash contributions.
  • Verify Appraisals: Follow up with donors by year-end to confirm they’ve obtained a qualified appraisal for donations exceeding $5,000.
  • Keep Records: Document communications and retain copies of donor-related forms for your records.

A Limited Exception

The Tax Court allows deductions in cases of “substantial compliance,” as seen in Bond v. Commissioner. However, donors should aim for strict compliance to avoid risking their deductions.

Conclusion

IRS Form 8283 ensures accountability and accurate valuation of noncash contributions. By understanding and following these requirements, donors and churches can prevent denied deductions and maintain compliance.

FAQs on IRS Form 8283

What is IRS Form 8283? It’s a form used to report noncash charitable contributions exceeding $500, with additional requirements for amounts over $5,000. Who needs a qualified appraisal? Donors claiming deductions for noncash contributions valued above $5,000 must obtain a qualified appraisal. Are publicly traded stocks subject to these rules? No, publicly traded stocks are exempt from the appraisal and Form 8283 requirements. How can churches help donors comply? Churches can provide Form 8283, educate donors on the requirements, and remind them to obtain appraisals if necessary.

This article first appeared in Church Treasurer Alert, June 2002.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
Image: AdobeStock/ Andrey Popov

Church Bank Account Authority: Key Lessons from First Born Church of the Living God v. Bank South

Discover crucial lessons on church bank account management from the First Born Church case, emphasizing compliance with constitutions and bylaws.

Richard R. Hammar, Attorney, CPA
Bio

Last Reviewed: January 26, 2025

Case

First Born Church of the Living God v. Bank South, 472 S.E.2d 469 (Ga. App. 1996).

Background

Is a bank required to honor a change in signature authority on church accounts if the change failed to comply with the church’s constitution? This Georgia case tackled that issue.

A church’s bank accounts stated that all checks and withdrawals had to be approved by the senior pastor.

A dispute arose in the church, and the congregation split over the issue of whether or not to retain their pastor. The church board held an “emergency meeting” at which it removed the pastor and replaced him with another pastor. The board also amended its bank accounts to require that all checks and withdrawals be approved by the new pastor. The former pastor claimed that the board’s actions were invalid because they violated the church constitution.

The constitution required that the senior pastor approve any actions adopted by the board. The former pastor claimed that he had not been asked to approve the board’s attempt to change the church bank accounts, and therefore the board’s action was legally invalid. The bank asked a court to determine who controlled the church’s accounts.

The board’s actions were invalid.

The court ruled that the board failed to follow the church constitution in attempting to change the bank accounts. The effect of this failure? The board’s attempt to substitute the new pastor on the bank accounts failed. Such a substitution required the former pastor’s approval—according to the church constitution.

The court concluded that it was not barred by the first amendment’s guaranty of religious freedom from resolving this lawsuit. It observed that “the sole issue is not of a religious nature but is secular—whether the board at its emergency meeting duly complied with the provisions of the written constitution. The court’s involvement does not call for the resolution of any ecclesiastical or theological dispute.”

What this means for churches

Every church with a bank account has completed a card or resolution identifying those persons with signature authority. If such a person is removed from office in a manner that violates the church’s constitution or bylaws, then a bank may question the validity of such an action. This can result in unfortunate delays in accessing church funds, which may result in delays in meeting payroll obligations or in paying church debts. This is one of the consequences of attempting to take action in violation of the church’s constitution or bylaws.

Key point. Any attempt by a church to remove a person from office who has signature authority over church bank accounts must be in strict compliance with the church’s constitution or bylaws.

Checklist

Now is a good time to review your records to see who has signature authority over your church bank accounts. Use this checklist as a guide.

(1) In which banks does the church maintain accounts?

(2) Which persons have signature authority to write checks or make withdrawals?

(3) Are the persons with authority to write checks and make withdrawals the persons duly authorized by the church’s constitution, bylaws, or pertinent board or congregational resolution? If not, this discrepancy should be addressed immediately.

(4) Does your church require the signature of two persons on all checks and withdrawals? If not, this is a serious weakness in your church’s internal control that should be addressed immediately.

This article originally appeared in Church Treasurer Alert, November 1997.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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The Pitfalls of Borrowing Funds from Church Members

A Tennessee court issues a helpful ruling.

Richard R. Hammar, Attorney, CPA
Bio
Church Finance Today

The Pitfalls of Borrowing Funds from Church Members

A Tennessee court issues a helpful ruling.

Richard R. Hammar

Whitehaven Community Baptist Church v. Halloway, 1997 WL 147529 (Tenn. App. 1997)

Background. A church purchased vacant land as the site of a new building. The church signed a $120,000 note, which was secured by a first mortgage on the land. When the church was unable to obtain a commercial loan to finance construction of the new building, it borrowed $100,000 from two of its members. The church signed a promissory note agreeing to pay the members in full within seven months, at ten percent interest. To secure this loan the church conveyed title to this property to the two members, subject to the first mortgage. With the financing in hand, construction of the new facility began. Unfortunately, the church defaulted on both loans. To protect against a foreclosure (and loss of its security) the two members paid off the church’s debt under the first mortgage. By now the members had invested more than $200,000 in the project. A court later ruled that the two members were entitled to exclusive possession of the church property. The church appealed. A state appeals court agreed with the trial court’s eviction of the church from the property.

Relevance to church treasurers. There are a couple of important points to note. First, churches that seek to raise funds by borrowing from their own members may be creating a significant problem. Church leaders sometimes assume that borrowing from members is an attractive option because it is convenient and members will be more “forgiving” than a bank if the church is late with a payment or defaults. As this case illustrates, borrowing from church members can create unforeseen legal complications. Some members cannot afford to be “forgiving” when the church fails to repay them their loans. This case illustrates another important point—failure to pay promissory notes ultimately may lead to a congregation’s eviction from church property. Promissory notes that are secured by mortgages on church property must be honored in order to avoid foreclosure.

This article originally appeared in Church Treasurer Alert, June 1997.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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How Churches Should Handle Suspected Embezzlement

Discover essential steps for handling embezzlement in churches, including audits, legal actions, and restoring accountability within your congregation.

Richard R. Hammar, Attorney, CPA
Bio

Last Reviewed: January 26, 2025

Sometimes a person who has embezzled church funds will voluntarily confess.

This is often done out of a fear that he or she is about to be “caught.”

But in many cases the embezzler does not confess—at least initially. Discrepancies or irregularities may occur which cause church leaders to suspect this person.

A few examples:
  • The same person has counted church offerings for many years. The pastor inadvertently notices that offerings are always higher when this person is absent (due to illness, business, or vacation).
  • Church officials noticed that a church bookkeeper was living a higher standard of living than was realistic given her income. Among other things, she purchased an expensive home and a luxury car.
  • Church offerings have remained constant, or increased slightly, despite the fact that attendance has increased.
  • A church treasurer notices several undocumented and expensive purchases from the church’s checking account.

Church leaders often are unsure how to address suspected cases of embezzlement. The suspected embezzler is almost always a trusted member or employee. Because of this, church leaders are reluctant to accuse such a person without irrefutable evidence of guilt.

Seldom does such evidence exist. The pastor may confront the person about the suspicion. However, the individual often denies wrongdoing even when they’re clearly guilty. This compounds the frustration of church officials, who do not know how to proceed.

Here is a list of steps that church leaders can take to resolve such difficult cases:

Confront the suspected embezzler

The pastor and at least one other church leader should confront the suspected embezzler. Inform the person that the church has evidence indicating that he or she has embezzled church funds. Seek a confession. Inform the person that if no one confesses, the church will be forced to call in a CPA firm to confirm that embezzlement has occurred, and to identify the probable embezzler.

Tip. Embezzlement is a criminal offense. Depending on the amount of funds or property taken, it may be a felony that can result in a sentence in the state penitentiary. This obviously would have a devastating impact on the embezzler, and his or her family.

If the evidence clearly indicates that a particular member or employee has embezzled church funds, but this person denies any wrongdoing, inform him or her that the church may be forced to turn the matter over to the police for investigation and prosecution.

Tip. Embezzlers never report their illegally obtained “income” on their tax returns. Nor do they suspect that failure to do so may subject them to criminal tax evasion charges! In fact, in some cases it is actually more likely that the IRS will prosecute the embezzler for tax evasion than the local prosecutor will prosecute for the crime of embezzlement.

If the evidence clearly indicates that a particular member or employee has embezzled church funds, but this person denies any wrongdoing, inform him or her that the church may be forced to turn the matter over to the IRS for investigation and possible prosecution.

Conduct an audit

Have a local CPA conduct an audit to establish that embezzlement has occurred, and provide an estimate of how much was embezzled.

If the suspected embezzler denies any wrongdoing (or if embezzlement is suspected but it is not clear who is guilty), church leaders should consider hiring a local CPA firm to look for evidence of embezzlement. There is a good possibility that the embezzlement will be detected, and that the perpetrator will be identified.

Tip. CPAs can also help the church establish a strong system of internal control to reduce the risk of embezzlement in the future.

Many church leaders have found that turning the investigation over to a CPA firm is much more acceptable than conducting the investigation internally. The CPA firm is completely objective, and ordinarily will not know the suspected embezzler. Further, few church members will object to the church hiring a CPA firm to detect wrongdoing and help establish a sound system of internal control.

Contact the police or local prosecutor

If the suspected embezzler does not confess, or if embezzlement is suspected but it is not clear who is guilty, church leaders must consider turning the matter over to the police or local prosecutor. This is a very difficult decision, since it may result in the prosecution and incarceration of a member of the congregation.

Respond to a confession

In some cases the embezzler eventually confesses. Often, this is to prevent the church from turning the case over to the IRS or the police, or to a CPA firm. Embezzlers believe they will receive “better treatment” from their own church than from the government. In many cases they are correct.

It often is astonishing how quickly church members will rally in support of the embezzler once he or she confesses—no matter how much money was stolen from the church. This is especially true when the embezzler used the embezzled funds for a “noble” purpose, such as medical bills for a sick child. Many church members demand that the embezzler be forgiven.

They are shocked and repulsed by the suggestion that the embezzler—their friend and fellow church member—be turned over to the IRS or the police! But is it this simple? Should church leaders join in the outpouring of sympathy? Should the matter be dropped once the embezzler confesses?

Some questions demand answers

These are questions that each church will have to answer for itself, depending on the circumstances of each case. Before forgiving the embezzler and dropping the matter, church leaders should consider the following points:

A serious crime has been committed, and the embezzler has breached a sacred trust. The church should insist, at a minimum, that the embezzler must:
  • disclose how much money was embezzled
  • make full restitution by paying back all embezzled funds within a specified period of time, and
  • immediately and permanently be removed from any position within the church involving access to church funds

Tip. Closely scrutinize and question the amount of funds the embezzler claims to have taken. Remember, you are relying on the word of an admitted thief. Is it a realistic amount? Is it consistent with the irregularities or discrepancies that caused church leaders to suspect embezzlement in the first place? If in doubt, consider hiring a local CPA to review the amount the embezzler claims to have stolen.

In many cases the embezzler will insist that he or she is not able to pay back the embezzled funds.

They have been spent. This presents church leaders with a difficult decision, since the embezzler has received unreported taxable income from the church. The embezzler should be informed that the embezzled funds must either be returned within a specified time, or a promissory note must be signed promising to pay back the embezzled funds within a specified period of time.

The embezzler should be informed that failure to agree to either alternative will force the church to issue him or her a 1099 (or a corrected W-2 if the embezzler is an employee) reporting the embezzled funds as taxable income. Failure to do so will subject the church to a potential penalty (up to $10,000) for aiding and abetting in the substantial understatement of taxable income under section 6701 of the tax code.

Tip. An embezzler’s biggest problem ordinarily will not be with the church or even with the local prosecutor. It will be with the IRS for failure to report taxable income. There are only two ways to avoid trouble with the IRS: (1) the embezzler pays back the embezzled funds, or (2) the church reports the embezzled funds as taxable income on a 1099 or corrected W-2.

Church leaders must also remember that they owe a fiduciary obligation to the church and that they are stewards of the church’s resources.

Viewing the offender with mercy does not necessarily mean that the debt must be forgiven and a criminal act ignored. Churches are public charities that exist to serve religious purposes, and they are funded entirely out of charitable contributions from persons who justifiably assume that their contributions will be used to further the church’s mission. These purposes may not be served when a church forgives and ignores cases of embezzlement.

Tip. The federal Employee Polygraph Protection Act prohibits most employers from requiring or even suggesting that an employee submit to a polygraph exam. Employers also are prevented from dismissing or disciplining an employee for refusing to take a polygraph exam.

There is an exception that may apply in some cases—an employer may require that an employee take a polygraph exam if the employee is suspected of a specific act of theft or other economic loss and the employer has reported the matter to the police. However, the employer must follow very strict requirements to avoid liability.

A church should never suggest or require that an employee submit to a polygraph exam, even in cases of suspected embezzlement, without first contacting a local attorney for legal advice.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
Image: AdobeStock/wollertz

Preventing and Addressing Embezzlement in Churches

Discover how to prevent church embezzlement through practical steps, real examples, and a focus on accountability and transparency.

Richard R. Hammar, Attorney, CPA
Bio

Last Reviewed: January 26, 2025

The definition of embezzlement varies slightly from state to state, but in general it refers to the wrongful conversion of property that is lawfully in your possession. The idea is that someone has legal control or custody of property or funds, and then decides to convert the property or funds to his or her own personal use.

Most people who embezzle funds insist that they intended to pay the money back and were simply “borrowing” the funds temporarily. An intent to pay back embezzled funds is not a defense to the crime of embezzlement. Most church employees who embezzle funds plan on repaying the church fully before anyone suspects what has happened. One can only imagine how many such schemes actually work without anyone knowing about it. The courts are not persuaded by the claims of embezzlers that they intended to fully pay back the funds they misappropriated. The crime is complete when the embezzler misappropriates the church’s funds to his or her own personal use. As one court has noted:

The act of embezzlement is complete the moment the official converts the money to his own use even though he then has the intent to restore it. Few embezzlements are committed except with the full belief upon the part of the guilty person that he can and will restore the property before the day of accounting occurs. There is where the danger lies and the statute prohibiting embezzlement is passed in order to protect the public against such venturesome enterprises by people who have money in their control.

In short, it does not matter that someone intended to pay back embezzled funds. This intent in no way justifies or excuses the crime. The crime is complete when the funds are converted to one’s own use—whether or not there was an intent to pay them back.

What if the embezzled funds are returned?

Giving stolen money back does not mean it was not stolen and a crime has not been committed.

Of course, it may be less likely that a prosecutor will prosecute a case under these circumstances. And even if the embezzler is prosecuted, this evidence may lessen the punishment. But the courts have consistently ruled that an actual return of embezzled funds does not purge the offense of its criminal nature or absolve the embezzler from punishment.


Key point. Even if an embezzler is caught or confesses, and then agrees to “pay back” the embezzled funds, church officials seldom know if all embezzled funds are being returned. They are relying almost entirely on the word of the embezzler.

Why churches often are vulnerable to embezzlement.

Many churches refuse to adopt measures to reduce the risk of embezzlement out of a fear of that such measures will reflect a lack of trust in those persons who handle church funds.


Example. Tom has counted the church offering at his church for 25 years. The church board has discussed this arrangement several times, but fails to stop it out of a fear of offending Tom.

Why should church leaders take this risk seriously?

For several reasons, including the following:
  • Survey data. Our survey data (mentioned above) demonstrates that embezzlement is a risk that every church should take seriously.
  • Removing temptation. Churches that take steps to prevent embezzlement remove a source of possible temptation from church employees and volunteers who work with money.
  • Protecting reputations. By taking steps to prevent embezzlement a church protects the reputation of innocent employees and volunteers who otherwise might be suspected of financial wrongdoing when financial irregularities occur.
  • Avoiding confrontations. By taking steps to prevent embezzlement a church avoids the unpleasant task of confronting individuals who are suspected of embezzlement.
  • Avoiding church division. By taking steps to prevent embezzlement a church avoids the risk of congregational division that often is associated with cases of embezzlement—w ith some members wanting to show mercy to the offender and others demanding justice.
  • Avoiding the need to inform donors. By taking steps to prevent embezzlement a church reduces the risk of having to tell donors that some of their contributions have been misappropriated by a church employee or volunteer.
  • Protecting the reputation of church leaders. By taking steps to prevent embezzlement a church reduces the damage to the reputation and stature of its leaders who otherwise may be blamed for allowing embezzlement to occur.
  • Preserving accountability. Churches that take steps to prevent embezzlement help to create a “culture of accountability” with regard to church funds.

These are powerful motivations for addressing the issue of embezzlement.

How it happens.

Let’s look at a few cases of actual embezzlement of church funds to see how it can occur.


Example. An usher collected offerings each week in the church balcony, and pocketed all loose bills while carrying the offering plates down a stairway to the main floor. Church officials later estimated that he embezzled several thousands of dollars over a number of years, before being caught.


Example. The same two persons counted church offerings for many years. Each week they removed all loose coins and currency (not in offering envelopes) and split it between them. This practice went on for several years, and church officials later estimated that the two had embezzled several tens of thousands of dollars.


Example. A church left its Sunday offering, along with the official count, in a safe in the church office until Monday. On Monday morning a church employee deposited the offering. The employee ignored the official counts, and deposited the offering less loose coins and currency (which she retained). The deposits were never checked against the offering counts.


Example. A church child care director embezzled church funds by issuing herself paychecks for the gross amount of her pay (before deductions for tax withholding). The church withheld taxes and paid them to the government, but her paychecks reflected the gross amount of her pay.


Example. A pastor had the sole authority to write checks on the church’s checking account. He used church funds to pay for several personal expenses, amounting to thousands of dollars each year, until his actions were discovered.


Example. A church bookkeeper embezzled several thousand dollars by issuing checks to a fictitious company. He opened an account in the name of a fictitious company, issued church checks to the company for services that were never performed, and then deposited the checks in the fictitious company’s account. He later withdrew the funds and purchased two automobiles which he gave to a friend. A court ruled that the friend had to give the cars back to the church, since they had been purchased with embezzled church funds. The point here, as noted by the court, is that one who acquires property that was purchased with embezzled church funds may be required to transfer the property to the church.


Example. A minister received an unauthorized kickback of 5% of all funds paid by a church to a contractor who had been hired to build a new church facility. The minister received over $80,000 from this arrangement, in exchange for which he persuaded the church to use the contractor. The minister’s claim that the $80,000 represented a legal and nontaxable “love offering” was rejected by a federal court that found the minister guilty of several felony counts. This arrangement was not disclosed to the church board, and obviously amounted to an unauthorized diversion of church funds back to the minister.


Example. A church accountant embezzled $212,000 in church funds. This person’s scheme was to divert to his own use several designated offerings, and to inflate the cost of equipment that he paid for with his own funds and that the church later reimbursed at the inflated amounts. The interesting aspect of this case was that the accountant was not only found guilty of embezzlement, but he was also convicted for tax evasion because he had failed to report any of the embezzled money as taxable income, and was sentenced to prison.


Example. A court ruled that an insurance company that paid out $26,000 to a charity because of an act of embezzlement could sue the embezzler for the full amount that it paid. This is an important case, for it demonstrates that a church employee who embezzles church funds may be sued by the church insurance company if it pays out a claim based on the embezzlement. In other words, the fact that the church decides not to sue the embezzler does not mean that the person will be free from any personal liability. If the church has insurance to cover the loss, the insurance company can go after the embezzler for a full recovery of the amount that it paid out on account of the embezzlement.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
Image: AdobeStock/lembergvector

Clergy Taxable Income: Understanding Taxable Income and Gifts

Key insights into taxable income for ministers, including handling of bonuses, love gifts, and fringe benefits.

Richard R. Hammar, Attorney, CPA
Bio

Last Reviewed: January 8, 2025

Church treasurers must accurately report the clergy taxable income paid to ministers on W-2 or 1099 forms. This ensures compliance with IRS regulations and minimizes errors that could lead to audits or penalties.

Key Taxable Income Categories for Ministers

Bonuses

Any “bonus” paid by a church to a minister is taxable income and must be included on the minister’s W-2 or 1099 form.

“Love Gifts”

Churches often pay ministers “love gifts” for occasions like Christmas or anniversaries. If the purpose of the gift is to compensate a minister for services rendered, it is taxable income and must be reported. This is true even if the payment is called a “love gift.”

Important: Since 1987, federal law specifies that the term “gift” does not include “any amount transferred by or for an employer to, or for the benefit of, an employee.” Traditional holiday gifts of low fair market value, like a turkey or fruitcake, are an exception and are nontaxable.

Retirement Gifts

Most retirement gifts presented to ministers by a church are taxable compensation and must be included on the minister’s W-2 or 1099. Federal law prohibits employers from making tax-free gifts to employees since 1987. Self-employed ministers may qualify for tax-free retirement gifts under strict conditions, such as demonstrating the gift was not intended as compensation.

Property Purchased Below Market Value

When a church sells property to a minister at less than fair market value, the difference must be reported as taxable income on the minister’s W-2 or 1099. For example, if a church sells a parsonage valued at $100,000 for $25,000, the $75,000 difference is taxable.

Social Security Assistance

Ministers pay self-employment taxes for social security. If a church provides financial assistance to cover this tax, the amount must be reported as taxable income on the minister’s W-2 or 1099 form.

Moving Expenses

Employer reimbursements of moving expenses are taxable unless they meet specific IRS criteria. Substantiated moving expenses reimbursed by the employer are not reported in box 1 of the W-2 but must be noted in box 13 using code “P.” Unsubstantiated reimbursements are taxable income.

Personal Use of a Church-Provided Car

If a church provides a car to its minister, the personal use of the vehicle is a taxable noncash fringe benefit. The church must calculate the taxable value and include it on the minister’s W-2 or 1099.

Below Market Interest Loans

Loans offered by a church to a minister below prevailing interest rates may generate taxable income. The church treasurer must report the foregone interest as compensation. However, loans under $10,000 may be exempt under certain conditions.

General Guidelines for Church Treasurers
  • Special occasion gifts from the church’s general fund are taxable income and must be reported.
  • Direct personal gifts from members, such as checks or cash given personally to a minister, are typically tax-free and not deductible for donors.
  • Special offerings collected through the church for a minister are generally taxable income, depending on the intent of the donors and the church’s involvement.

Accurate reporting of taxable income ensures compliance with IRS regulations and protects both churches and ministers from legal and financial risks.

FAQs
  • Are bonuses taxable for ministers?
    Yes, all bonuses are taxable and must be reported on W-2 or 1099 forms.
  • What qualifies as a tax-free gift to a minister?
    Personal gifts from members directly to a minister, without church involvement, are usually tax-free.
  • How should a church report social security assistance?
    Any assistance provided to cover self-employment taxes must be included as taxable income.
  • Are retirement gifts taxable?
    In most cases, retirement gifts from the church are taxable unless specific conditions for self-employed ministers are met.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
Image: AdobeStock/Zamrznuti tonovi

Clergy Taxes: Employee vs. Self-Employed Status

Learn the key factors that determine whether clergy are classified as employees or self-employed for tax purposes, and how this affects tax reporting.

Richard R. Hammar, Attorney, CPA
Bio

Last Reviewed: January 8, 2025

Church treasurers often wonder whether to treat pastors and certain lay workers as employees or self-employed for federal tax purposes.
This distinction matters for several key reasons, including:
  • Which forms to file (W-2 or 1099)
  • How to handle tax withholding
  • Which social security taxes apply
  • The treatment of fringe benefits

Below is a clear breakdown to help churches make the right decisions.

W-2 or 1099?
  • Employees receive a W-2 form at the end of the year, reporting wages paid and taxes withheld.
  • Self-employed individuals that are paid at least $600 during the year receive a 1099 form. The 1099 reports total compensation but no tax withholding.

Filing Form 941

Churches subject to income tax withholding, FICA (Social Security and Medicare taxes), or both must file Form 941 quarterly.
This form reports:
  • The number of employees
  • The amount of FICA taxes and withheld income taxes owed

Important:
Self-employed workers are not included on Form 941. They are responsible for paying their own self-employment taxes directly and are not subject to withholding.

Tax Withholding Rules
  • Nonminister employees:
    Churches must withhold federal income taxes and the employee’s share of FICA taxes from their wages.
  • Churches with a Form 8274 exemption:
    If a church has filed a timely Form 8274, it does not withhold FICA taxes from nonminister employees. These employees pay self-employment taxes. This is because they are self-employed for Social Security purposes.
  • Self-employed workers:
    Federal tax withholding does not apply unless backup withholding is required (for instance, if the worker fails to provide a Social Security number).
  • Ministers:
    Ministers are exempt from mandatory income tax withholding, even when treated as employees, unless they opt into voluntary withholding.

Handling Fringe Benefits

Fringe benefits may be tax-free if provided to an employee.
Examples include:
  • Medical insurance premiums paid by the church
  • Group term life insurance (up to $50,000)
  • Disability or accident payments under an employer-financed plan
  • Employer-sponsored cafeteria plans (allowing employees to choose between cash and benefits)

Self-employed workers generally do not qualify for the same tax-free treatment.

Social Security Responsibilities
  • For employees:
    Churches must withhold the employee’s share of FICA taxes, unless they filed a Form 8274 exemption.
  • For self-employed workers:
    They pay their own Social Security taxes through self-employment tax filings.

Why Proper Classification Matters

It is critical for church treasurers to determine correctly whether each pastor and lay worker is an employee or self-employed.
This impacts:
  • Tax reporting
  • Tax withholding
  • Eligibility for fringe benefits
  • Liability for social security taxes

How to Decide: The 7-Factor Test

In 1994, the United States Tax Court ruled on this issue in a case involving a Methodist minister.
(Weber v. Commissioner, 104 T.C.—(1994).)

The Court concluded the minister was an employee and introduced a new 7-factor test to help make this determination.

The table below summarizes the 7-factor test. Church treasurers will find the table useful for:
  • Applying the test to individual pastors and lay workers
  • Understanding the Court’s criteria

THE WEBER CASE

TAX COURT’S 7 FACTOR TEST for ETERMINING THE TAX STATUS OF MINISTERS:
FactorFacts suggesting employee statusFacts suggesting self-employedConclusion
#1—the degree of control exercised by the employer over the details of the work(1) less control required over a professional; (2) Methodist ministers are required to perform numerous duties set forth in the Discipline; (3) had to explain the position of the Discipline on any topic he chose to present in his sermons; (4) followed United Methodist theology in his sermons; (5) could not unilaterally discontinue the regular services of a local church; (6) under the itinerant system of the United Methodist Church ministers are appointed by a bishop to their pastoral positions; (7) Methodist ministers cannot establish their own churches; (8) Methodist ministers are bound by the rules stated in the Discipline regarding mandatory retirement at age 70 and involuntary retirement; (9) Methodist ministers cannot transfer to another Annual Conference without permission of a bishop; (10) the Annual Conference limits the amount of leave ministers can take during a year; (11) Methodist ministers are required by the Discipline to be “amenable” to the Annual Conference in the performance of their duties(1) Rev. Weber scheduled his own activities from day to day and took vacation days without obtaining prior approval; (2) ministers generally do not need day-to-day supervision; (3) Rev. Weber had the right to explain his personal beliefs to his congregation in addition to the position of the Discipline and the United Methodist Churchemployee
#2—which party invests in the facilities used in the work(1) local churches provided a home, office, and work facilities for Rev. Weber; (2) local churches bought religious materials used by Rev. Weber in his ministry(1) Rev. Weber prepared church bulletins at home; (2) Rev. Weber used his own computer for church work; (3) Rev. Weber purchased some of his own vestments; (4) Rev. Weber purchased his own libraryemployee
#3—the opportunity of the individual for profit or loss(1) Rev. Weber was paid a salary, and provided with a parsonage, a utility expense allowance, and a travel expense allowance from each local church; (2) if Rev. Weber was not assigned to a local church, the Annual Conference would pay him a minimum guaranteed salary, or if he were in special need, the Annual Conference could give him special support; (3) aside from minimal amounts earned for weddings and funerals and amounts spent on utilities and travel, Rev. Weber was not in a position to increase his profit, nor was he at risk for lossRev. Weber could not be fired at willemployee
#4—whether or not the employer has the right to discharge the individual(1) the Annual Conference had the right to “try, reprove, suspend, deprive of ministerial office and credentials, expel or acquit, or locate [Rev. Weber] for unacceptability or inefficiency”; (2) the clergy members of the executive session of the Annual Conference had the authority to discipline and fire Rev. Webernone cited by the courtemployee
#5—whether the work is part of the employer’s regular business(1) Rev. Weber’s work is an integral part of the United Methodist Church; (2) a Methodist minister has the responsibility to lead a local church in conformance with the beliefs of the United Methodist Church, to give an account of his or her pastoral ministries to the Annual Conference according to prescribed forms, and to act as the administrative officer for that churchnone cited by the courtemployee
#6—the permanency of the relationship(1) the relationship between Methodist ministers and the United Methodist Church is “intended to be permanent as opposed to transitory”; (2) Rev. Weber had been ordained since 1978; (3) Rev. Weber is likely to remain a Methodist minister for the remainder of his professional career; (4) the Annual Conference will pay a salary to a minister even when there are no positions with a local church available; (5) ministers are provided with retirement benefits; (6) Rev. Weber did not make his services available to the general public, as would an independent contractor; (7) Rev. Weber works at the local church by the year and not for individuals “by the job”none cited by the courtemployee
#7—the relationship the parties believe they are creatingRev. Weber received many benefits typical of those provided to employees rather than independent contractors, including (1) local church contributions to his pension fund, (2) continuation of salary while on vacation, (3) disability leave and paternity leave, (4) a guaranteed salary if no pastoral position was available, (4) life insurance paid by the local churches, (5) local churches paid 75% of health insurance premiums(1) Rev. Weber and his employing churches believed that he was self-employed rather than an employee; (2) Rev. Weber received a 1099 rather than a W-2 from the churchemployee
ConclusionsThese factors demonstrated that Rev. Weber was an employee for federal income tax reporting purposesThese factors did not overcome the conclusion that Rev. Weber was an employee for federal income tax reporting purposes
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
Image: AdobeStock/Bildwerk

Clergy Taxes: IRS Rules on Club Dues and Business Expenses

Understand how clergy taxes impact club dues and IRS rules for reporting and deductions to maintain compliance.

Richard R. Hammar, Attorney, CPA
Bio

Last Reviewed: January 8, 2025

Key takeaway:
  • Club dues for recreation or fitness are not deductible as business expenses under current IRS regulations.
  • Churches must report these dues as taxable income if paid on behalf of ministers.
  • Dues to professional or civic organizations may still qualify as business expenses.

Under the current tax laws, many clergy members face specific rules about how certain expenses, such as club dues, are handled. Can clergy deduct or have churches reimburse dues for local clubs like fitness centers or golf courses? Here’s the answer:

Dues paid to clubs organized for recreation, pleasure, or other social purposes are not deductible as business expenses under IRS regulations. However, dues paid to professional or civic organizations may qualify as business expenses.

What the IRS Says About Club Dues

The IRS regulations, updated after the most recent tax reform, clarify the treatment of club dues:
  • Dues for fitness clubs, golf clubs, airline lounges, or social clubs are not deductible as business expenses.
  • Dues to professional organizations (e.g., bar or medical associations) or civic organizations (e.g., Rotary, Lions) may qualify as business expenses.

The IRS makes no exceptions for club memberships that enhance health or provide community exposure for clergy or churches.

Key Points for Churches and Clergy

IRS rules mandate that church-paid club dues for recreation must be reported as taxable income. Learn more about clergy tax compliance on the IRS website.

Here’s how the rules apply in practice:

Reimbursements
  • Churches cannot reimburse club dues under an accountable expense arrangement.
  • Such reimbursements must be reported as additional taxable income on the minister’s W-2 or 1099 form.

Deductions
  • Clergy cannot deduct unreimbursed club dues for recreation or social purposes.

Implications for Church Treasurers

Church treasurers need to adjust their practices to comply with the IRS regulations. Here are the key steps to take:

Re-Evaluate Practices
  • If your church pays club dues for clergy, reassess this policy in light of IRS guidelines.

Accountable Reimbursement Arrangements
  • Do not include recreational club dues in an accountable expense arrangement.
  • Report any paid dues as taxable income on W-2s or 1099s.

Allowable Business Expenses
  • Dues for professional or civic organizations, such as Rotary or Kiwanis, can still qualify as business expenses if they meet IRS requirements.

Examples to Clarify the Rules

Example 1: A church pays $1,500 annually for a minister’s fitness club membership. These dues cannot be reimbursed as a business expense. Instead, the full amount must be reported as taxable income on the minister’s W-2, and the minister must report it as additional income on Form 1040.

Example 2: A minister personally pays for a golf club membership. Since the dues are for recreational purposes, they are nondeductible personal expenses.

Final Considerations for Churches

While churches may continue paying such dues, it’s essential to report them accurately as taxable fringe benefits. Failing to do so could lead to compliance issues.

The following has been added to the original content to maintain accuracy and relevancy:

FAQ on Clergy Taxes
  • Can clergy deduct club dues?
    No, club dues for recreational or social purposes are not deductible under IRS rules.
  • Can a church pay for a minister’s club dues?
    Yes, but the amount must be reported as taxable income on the minister’s W-2 or 1099.
  • What types of dues qualify as business expenses?
    Dues for professional or civic organizations may qualify if they meet IRS requirements.
  • How should churches report paid dues?
    Churches must include paid dues for recreation in the minister’s taxable income.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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