Church Membership Directories and the Copyright Law

A federal appeals court ruling is instructive.

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Olan Mills, Inc. v. Linn Photo, Inc., 23 F.3d 1345 (8th Cir. 1994)

Background. Many churches prepare pictorial directories of church members. These directories are an excellent way for members to get to know other members, especially in larger congregations. Often, an outside company is used to make all the appointments and arrangements, take the photos, and prepare the directory—at no cost to the church. Individuals and families that show up for their photo session typically are given a free copy of the photo that the company selects for the church directory. The company is paid by additional orders it receives from individuals and families.

A potential problem. Some members attempt to save money by taking their free photo to a local film developer for additional copies. Other members purchase a package of photographs from the church directory company, but later (in some cases many years later) want additional copies. Not knowing how to contact the company, they take their photographs to a local film developer for additional copies. Do these common practices violate the copyright law? This question was addressed directly by a federal appeals court in a recent case.

The court’s ruling. Olan Mills operates more than 1,000 portrait studios throughout the United States. It took a number of family photographs of one client, and placed a copyright notice on each photograph. A local film developer was asked to make copies of some of these photos, and it agreed to do so despite the fact that the photos all contained a copyright notice showing Olan Mills as the owner of the copyright in the photos. However, the film developer had the customer sign the following statement:

This is to state that I am the owner of this photograph and have not given any one else permission to copyright this photograph. I am submitting it to [the film developer] for a copy at my request. This copy is for my personal use, and I agree to hold harmless [the film developer] or any of its agents from any liability arising from the copying of this photograph.

Olan Mills later sued the film developer for copyright infringement. A federal appeals court ruled that the film developer had violated the copyright law. It noted that Olan Mills retained the copyright in all of its photographs, and that one of the exclusive rights of a copyright owner is the right to make copies. The court further noted:

A purchaser may own a copy of a photograph, but absent specific arrangements to the contrary, the copyright remains vested in the author of the photograph, here Olan Mills. Because the photographs in this case were clearly marked with a copyright notice [the film developer] could not reasonably rely on its indemnification agreement.

Relevance of the case to church treasurers. Has your church ever used an outside company to prepare a church pictorial directory of your membership? Are you considering doing so in the near future? If so, here are some important points to keep in mind:

Copyright ownership. In many cases, the copyright in any photograph will belong to the photographer. Often, the photographs will contain a copyright notice—although this is not a legal requirement in order for the photographer to have copyright ownership of the photographs.
Notice to members. Members often do not understand that the copyright in their individual or family photograph belongs to the photographer. They fail to distinguish between ownership of the photograph and ownership of the copyright in the photograph. If the photographer retains copyright in the photographs, then members may not make copies without the photographer’s authorization. And this is true for the full duration of copyright protection—the life of the author plus 50 years! If the copyright is owned by a company, the copyright will last for 75 years from the date of publication.

Key point. If the photographer retains copyright ownership in the photographs, the church should consider informing church members of this fact at the time the directory is being produced. The photographer will also mention this fact, at least in the fine print of an “agreement” signed by members. But members often are not aware of this fact. The church can help to avoid misunderstandings, and potential copyright infringement, by informing members in clear language that they do not have the legal right to make copies of their photographs without the photographer’s permission.

Negotiation. Many church leaders, if they thought about it, would want members to retain greater control over their family pictures. The problem is that no one considers this issue when the church is contacted by a church directory company. The point to stress is this—the church is in the driver’s seat and need not enter into an agreement with anyone that is not desirable to itself or its members. Make this a point of negotiation. Tell the directory company that you do not want your members to be guilty of copyright infringement if they make duplicate copies of their photographs in the future. There are many church directory companies, and you have the right to use one that will work with you.

This article originally appeared in Church Treasurer Alert, February 1995.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Are Pastors Employees or Self-Employed?

The Tax Court Issues an Important Ruling—Weber v. Commissioner, 103 T.C. (1994)

Richard R. Hammar, Attorney, CPA

Bio

Background. Church treasurers often are not sure whether to treat pastors or some lay workers as employees or self-employed for federal tax reporting purposes. The distinction is important for several reasons, including the following:

• W-2 or 1099? Churches issue a W-2 to employees at the end of the year reporting wages paid and taxes withheld. Churches issue a 1099 form to self-employed persons who are paid at least $600 during the year. The 1099 form reports compensation paid.

• 941 forms. Churches that are subject to income tax withholding, FICA (social security) taxes, or both, must file Form 941 quarterly. Form 941 reports the number of employees and amount of FICA taxes and withheld income taxes that are payable. No entries are made for self-employed workers, since they are not subject to tax withholding and they do not pay FICA taxes (they pay the self-employment tax).

• Tax withholding. Churches must withhold federal income taxes and the employee’s share of FICA taxes from the wages of nonminister employees. However, churches should not withhold FICA taxes from the wages of nonminister employees if the church filed a timely Form 8274 exempting itself from paying the employer’s share of FICA taxes. Nonminister employees of such a church are treated as self-employed for social security purposes and pay self-employment taxes rather than FICA taxes. Self-employed workers are not subject to federal tax withholding (other than “backup withholding,” which applies if a self-employed worker fails to provide an employer with a social security number). Note that ministers are exempt from income tax withholding even if they are treated as employees–unless they request “voluntary withholding.”

• Treatment of fringe benefits. Some fringe benefits provided by a church to a minister or other church worker are not taxed if the person is an employee. Examples include medical insurance premiums paid by a church on behalf of its minister; group term life insurance (up to $50,000) provided by a church on behalf of a minister; amounts payable to employees on account of sickness, accident, or disability pursuant to an employer financed plan; and employer sponsored “cafeteria plans” which permit employees to choose between receiving cash payments or a variety of fringe benefits.

• Social security. Churches must withhold the employee’s share of FICA taxes from the wages of all nonminister employees (unless, as noted above, the church exempted itself from paying the employer’s share of FICA taxes by filing a Form 8274). Self-employed workers pay their own social security (self-employment) taxes.

Conclusions. Obviously, it is very important for church treasurers to decide if each minister and lay worker is an employee or self-employed. How is this decision made? The United States Tax Court issued an important decision in 1994 that addressed the issue of whether a Methodist minister was an employee or self-employed for federal income tax reporting purposes. Weber v. Commissioner, 104 T.C.—(1994). In reaching its decision that the minister was an employee, the Court announced a new “7-factor” test that church leaders can use to determine whether a worker is an employee or self-employed for federal income tax reporting purposes. The 7 factors are summarized in a table in this newsletter, along with the Court’s analysis of each. Church treasurers will find the table useful in quickly understanding the Court’s new test, and in applying the test to individual ministers and lay church workers.

THE WEBER CASE

TAX COURT’S 7 FACTOR TEST for
DETERMINING THE TAX STATUS OF MINISTERS

factor	facts suggesting employee status	facts suggesting self-employed	conclusion
#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 Church	employee
#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 library	employee
#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 loss	Rev. Weber could not be fired at will	employee
#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. Weber	none cited by the court	employee
#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 church	none cited by the court	employee
#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 court	employee
#7—the relationship the parties believe they are creating	Rev. 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 church	employee
Conclusions	these factors demonstrated that Rev. Weber was an employee for federal income tax reporting purposes	these 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.

Should Missions Offerings Be Reported as Taxable Income to Missionaries?

IRS rules that income need not be reported to agents acting on behalf of principals.

Richard R. Hammar, Attorney, CPA

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Church Finance Today

Should Missions Offerings Be Reported as Taxable Income to Missionaries?

IRS rules that income need not be reported to agents acting on behalf of principals.

Richard R. Hammar

Private Letter Ruling 9434008

Background. Many churches have missionaries conduct missions services during the course of the year. Often, an offering is collected. Church treasurers often ask if these offerings need to be reported to the missionary as taxable income on a Form 1099. In some cases this may be required. For example, if the offering will be turned over directly to the missionary and not to a missions board or agency, then a 1099 form ordinarily must be issued to the missionary.

The IRS ruling. A recent IRS ruling addressed a situation in which a 1099 would not need to be issued. While the ruling did not address missionaries directly, it is still instructive. The IRS noted that “as a general rule, income is taxed to the person who earns it” and that “a taxpayer who assigns or transfers compensation for personal services to another individual or entity fails to relieve himself of federal income tax liability, regardless of the motivation behind the transfer.” However, the IRS added that “amounts received by an agent on behalf of a principal, and turned over to the principal, are not taxable to the agent.”

Example. In 1958 the IRS ruled that fees paid to staff physicians and returned to a hospital were not included in the physicians’ taxable income. The physicians held salaried positions. Under a written agreement with the hospital, the physicians would receive no fees or compensation for their individual benefit from or on behalf of any patients admitted to the hospital. In situations in which patients made checks payable to physicians, the physicians would endorse the checks and turn them over to the hospital. The fees so received were used entirely in the operation of the hospital. The IRS held that the physicians were not required to include these amounts in gross income. The ruling noted that the physicians were an agent for the hospital, merely acting as a “conduit” for the fees collected.

Relevance to church treasurers. What is the relevance of this ruling to church treasurers? Simply this—it is not necessary for church treasurers to issue 1099 forms to missionaries who collect an offering if they are acting as “agents” of a missions board or agency. What factors indicate that a missionary is acting as an agent of missions board or agency? The IRS noted the following:

The missionary is required by contract or written policy to turn over all church offerings to the missions board or agency, and is forbidden to retain any portion of such offerings for his or her personal benefit.
The missionary has no control over the amount of the offering that will be collected.
The missionary is paid a salary by the missions board or agency.
A missionary who receives a 1099 from a church is required by official policy to attach a statement to his or her tax return explaining that the amounts were received as an agent for the missions board or agency.

This article originally appeared in Church Treasurer Alert, December 1994.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Complying with the New Charitable Contribution Rules

Take steps to ensure your church members will meet the new substantiation requirements.

Richard R. Hammar, Attorney, CPA

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Church Finance Today

Complying with the New Charitable Contribution Rules

Take steps to ensure your church members will meet the new substantiation requirements.

Richard R. Hammar

Background. New rules for substantiating charitable contributions took effect in 1994. Now is a good time for church treasurers to be sure that the church’s receipts reflect the new requirements. These requirements were summarized in a table in the December 1993 issue of Church Treasurer Alert! The important points are these:

Individual contributions of $250 or more. Donors no longer can substantiate individual contributions of $250 or more with canceled checks. They must have a receipt from the church that contains the following information:

Name. The donor’s name (a social security number is not required).
Itemization. Each individual contribution of $250 or more must be shown on the receipt. Do not lump all contributions together.
Value of any goods or services provided by charity. A statement indicating whether or not the church provided any goods or services to the donor in exchange for the contribution, and if so, a good faith estimate of the value of those goods or services.
If charity provides no goods or services, or only “intangible religious benefits.” If the church provides no goods or services to a donor in exchange for a contribution, or if the only goods or services the church provides are “intangible religious benefits,” then the receipt must contain a statement to that effect. The term “intangible religious benefit” is defined by the new law as “any intangible religious benefit which is provided by an organization organized exclusively for religious purposes and which generally is not sold in a commercial transaction outside the donative context.” The committee report to the new law states that the term intangible religious benefit includes “admission to a religious ceremony” or other insignificant “tangible benefits furnished to contributors that are incidental to a religious ceremony (such as wine).” However, the committee report clarifies that “this exception does apply, for example, to tuition for education leading to a recognized degree, travel services, or consumer goods.”
Receipt must be contemporaneous. The receipt must be “contemporaneous,” meaning that it must be received by the donor on or before the earlier of the following two dates: (1) the date the donor files a tax return claiming a deduction for the contribution, or (2) the due date (including extensions) for filing the return.

Quid pro quo contributions of more than $75. A church has additional requirements with respect to individual quid pro quo contributions of more than $75. A quid pro quo contribution is a payment “made partly as a contribution and partly in consideration for goods or services” provided to the donor by the church. For example, a donor contributes $100 to her church, but in return receives a dinner worth $30. Under the new rules a church or other charity is required to provide a written statement to the donor that (1) informs the donor that the amount of the contribution that is tax deductible is limited to the excess of the amount of any money (or the value of any property other than money) contributed by the donor over the value of any goods or services provided by the church or other charity in return, and (2) provides the donor with a good faith estimate of the value of the goods or services furnished to the donor.

A written statement need not be issued in either of the following situations: (1) only token goods or services (with a value not exceeding the lesser of $64 or 2% of the amount of the contribution) are provided to a donor; or (2) the donor receives only intangible religious benefits (as defined above) in exchange for his or her contributions.

What church treasurers should do now. There are a number of ways for church treasurers to comply with the new substantiation and quid pro quo reporting requirements. Here are some suggestions.

1. A “2 form” approach. The simplest way for church treasurers to respond to the new substantiation rules will be to use the church’s current receipt form for all contributions not subject to the new substantiation rules, and then use a second form to report contributions that are covered by the new rules. The receipt form used by the church in 1993 (before the new rules took effect) can be used for all individual contributions of cash or property of less than $250, assuming that the new quid pro quo reporting rules do not apply. If this option is selected, the church’s customary receipt must enable multiple contributions on the same day to be recorded separately. If this is not possible, and multiple contributions made on the same day must be aggregated, then this will jeopardize the deductibility of contributions totaling $250 or more on the same day, unless the church’s customary receipt is modified to include the language required by the new rules.

For contributions of property valued by the donor at less than $250, a church’s receipt must comply with “Rule 5” (explained in the December 1993 issue of Church Treasurer Alert!).

2. The modified 2 form approach. The next easiest way for church treasurers to respond to the new substantiation requirements will be for a simplified receipt to be used that separately lists each cash contribution (date and amount), and contains the language required by the new rules. Illustration 1 represents such a form. Illustration 1 satisfies all of the new substantiation rules with the minimal complexity. However, it makes three very important assumptions: (1) the church provided no goods or services in connection with any individual contribution of $250 or more other than intangible religious benefits; (2) no donor made any quid pro quo contribution; and (3) only cash contributions were made (and not property). Obviously, these assumptions will hold true for many if not most donors. However, if any one or more assumptions is not met, then appropriate adjustments will be required. For example, if a donor did make a quid pro quo contribution, then an appropriate statement would need to be issued separately by the church. And, if the church provides goods or services or more than insubstantial value in exchange for a contribution of $250 or more, it would need to adapt this form or include a separate statement with the form describing and valuing the goods or services that were provided.

3. Keep donors informed. To avoid jeopardizing the tax deductibility of charitable contributions, churches should advise donors at the end of 1994 not to file their 1994 income tax returns until they have received a written acknowledgement of their contributions from the church. This communication should be in writing. To illustrate, the following statement could be placed in the church bulletin or newsletter for the last few weeks of 1994, or included in a letter to all donors:

IMPORTANT NOTICE: To ensure the deductibility of your church contributions, please do not file your 1994 income tax return until you have received a written acknowledgment of your contributions from the church. Under new rules that took effect this year, you may lose a deduction for some contributions if you file your tax return before receiving a written acknowledgement of your contributions from the church.

ILLUSTRATION

First Church
Chicago, Illinois
December 31, 1994

Cash Contributions Statement for October through December of 1994
John A. Doe

Codes:

10 = general fund –––30 = missions
20 = building fund –––40 = other

For the calendar quarter October through December of 1994, our records indicate that you made the following cash contributions. Should you have any questions about any amount reported or not reported on this statement, please notify the church treasurer within 90 days of the date of this statement. Statements that are not questioned within 90 days will be assumed to be accurate, and any supporting documentation (such as offering envelopes) retained by the church may be discarded. No goods or services were provided to you by the church in connection with any contribution, or their value was insignificant or consisted entirely of intangible religious benefits.

code	date	amount	code	date	amount	code	date	amount
10	Oct 2	30.00	10	Nov 6	30.00	10	Dec 18	30.00
10	Oct 9	30.00	10	Nov 13	30.00	10	Dec 25	100.00
10	Oct 16	30.00	10	Nov 20	30.00	30	Dec 25	200.00
30	Oct 23	500.00	10	Nov 27	30.00
10	Oct 23	30.00	10	Dec 4	30.00
10	Oct 30	30.00	10	Dec 11	30.00
TOTAL								1160.00

This article originally appeared in Church Treasurer Alert, November 1994.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Court Finds Minister Filed a Timely Application for Exemption from Social Security

What church treasurers should know about this ruling.

Richard R. Hammar, Attorney, CPA

Bio

Church Finance Today

Court Finds Minister Filed a Timely Application for Exemption from Social Security

What church treasurers should know about this ruling.

Richard R. Hammar

Hall v. Commissioner, 94-2 USTC ¶ 50,392 (10th Cir. 1994)

Background. Federal law treats ministers in a very unique way for purposes of social security coverage. Consider the following 2 special rules:

Self-employed status. All ministers are treated as self-employed for social security purposes with respect to services performed in the exercise of their ministry. There are no exceptions. This is an absolute rule. As a result, ministers pay the “self-employment tax” (the social security tax on self-employed persons) not “FICA taxes” (the social security tax on employers and employees).
Exemption. Ministers may apply for exemption from self-employment (social security) taxes with respect to service performed in the exercise of their ministry if they are opposed on the basis of religious convictions to the acceptance of social security benefits and file a timely exemption application (Form 4361) that is approved by the IRS. The due date for the exemption application is the deadline for the federal tax return (Form 1040) for the second year in which the minister has net self-employment earnings of $400 or more, any part of which comes from ministerial services.

Can ministers ever again be eligible to exempt themselves from self-employment taxes after the deadline for filing the exemption application has expired? That was the question addressed by a federal appeals court in a recent decision.

Facts of the case. A Methodist minister was not opposed to accepting social security benefits on the basis of his religious convictions, and did not submit an application for exemption from self-employment taxes before the deadline for doing so. He later left the Methodist church, entered into secular employment for 5 years, was reordained by another church and became a pastor in his new faith. He then submitted an exemption application which was denied by the IRS on the ground that it was filed too late. The minister appealed.

The court’s decision. A federal appeals court ruled that the period of time during which the minister had to file an application for exemption from social security started all over when he

left the ministry for 5 years
converted to another faith
was reordained by his new church
developed religious-based opposition to accepting social security benefits based on his new faith, and
filed a timely exemption application after being reordained

The federal court’s recent decision will not open the floodgates to other ministers, except in rare cases. The decision applies only to those few ministers who change their church affiliation, are reordained, and develop an opposition, based on their new religious convictions, to the acceptance of social security benefits. Few ministers will satisfy these requirements. The ruling will not apply to ministers who do not change their church affiliation or doctrine. Ministers who did not file an exemption application within the prescribed period, and who have served a local church for several years, are not given a second chance to opt out of social security by this ruling.

Relevance to church treasurers. What is the significance of this ruling to church treasurers? Consider the following:

Self-employed status. The ruling confirms that ministers are always treated as self-employed for social security with respect to their ministerial services. This means that they pay the self-employment tax. Church treasurers should not withhold FICA taxes from the wages of a minister. This is incorrect and can lead to problems.

Example. First Church treats its minister as an employee for federal income tax purposes. The church treasurer assumes that FICA taxes must be taken out of the minister’s wages since the minister is treated as an employee for income tax purposes. This is incorrect. Ministers always are treated as self-employed for social security with respect to their ministerial services—even if they report their income taxes as an employee. As a result, they never pay FICA taxes on church compensation. They pay the “self-employment tax,” which is the social security tax (15.3%) imposed on self-employed persons.

Counseling the younger minister. It is helpful for church treasurers to be informed as to the basis for the ministerial exemption from social security, and the deadline for filing an exemption application. This information will enable church treasurers to counsel younger ministers who may be considering opting out of social security. Many younger ministers decide to exempt themselves solely for financial reasons (to avoid paying the 15.3% self-employment tax). Many receive erroneous advice from financial planners or insurance agents. Church treasurers are in a unique position to counsel younger ministers. Here are the points that should be made:

• Basis for exemption. Ministers are eligible for exemption from self-employment taxes, but only if they satisfy several conditions. One condition is that the minister is opposed on the basis of religious convictions to the acceptance of social security benefits based on ministerial services. Very few ministers satisfy this extraordinary requirement. Many may be opposed to paying excessive taxes, but how many can say they are opposed on the basis of religious convictions to accepting social security benefits?

• Deadline for filing the exemption application (Form 4361). An application for exemption must be submitted by the due date of the federal tax return (Form 1040) for the second year in which the minister has net self-employment earnings of $400 or more, any part of which come from ministerial services. This deadline is not extended because a minister belatedly develops religious-based opposition to accepting social security benefits. There is only one possible exception that was addressed in this article—the deadline may start all over if a minister experiences a change of faiths, is reordained in another church, develops a religious-based opposition to accepting social security benefits, and files a timely exemption application after being reordained.

• Exemption is irrevocable. Church treasurers should advise younger ministers that an exemption from social security is irrevocable. Ministers who opt out of social security cannot assume that they will someday be able to re-enter the system.

• Insurance coverages. The church treasurer should inform the younger minister of the many advantages of social security coverage, including retirement benefits, survivor benefits, disability benefits, and Medicare (hospital and medical benefits at age 65). These are significant benefits that are forfeited by a minister who opts out of social security (unless the minister has enough years of secular employment to be fully covered). If the church does not make some or all of these coverages available through private insurance, the treasurer should so inform the minister.

This article originally appeared in Church Treasurer Alert, November 1994.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Can a Pastor’s Club Dues Be Treated as a Business Expense?

According to new IRS regulations, most likely not.

Richard R. Hammar, Attorney, CPA

Bio

Church Finance Today

Can a Pastor’s Club Dues Be Treated as a Business Expense?

According to new IRS regulations, most likely not.

Richard R. Hammar

Background. Many ministers belong to local clubs, including fitness and golf clubs. Some churches agree to pay the annual dues or fees to these clubs as a fringe benefit. In some cases, the church treats the club dues as a business expense because a minister’s membership in the club will either contribute to his or her health or expose the minister and church to the community.

New IRS regulations. The issue of club dues was addressed by last year’s tax reform law, and by proposed regulations released by the IRS last month. Under the new tax law and IRS regulations dues paid for membership in any club organized for business, pleasure, recreation, or other social purposes cannot be claimed as a business expense—other than dues paid to professional organizations such as bar associations and medical associations, and civic or public service organizations such as Kiwanis, Lions, and Rotary. As a result, dues paid to health and fitness clubs, golf clubs, airline and hotel clubs, and dinner clubs are no longer deductible as a business expense.

Key point. The fact that membership in a club may enhance a minister’s health or length of ministry, or provide positive exposure of the church in the community, does not matter. These dues are not business expenses.

There are two points to emphasize:

• Reimbursements. Since most club dues no longer can be treated as a business expense, a church cannot pay for or reimburse such dues under an accountable expense reimbursement arrangement. If a church pays for a minister’s club dues, then the full amount must be added to the minister’s W-2 or 1099 form as additional taxable compensation. It is not a business expense that is reimbursable under an accountable arrangement.

• Deductions. Second, ministers cannot claim a business expense deduction for unreimbursed club dues that they pay themselves.

Significance to church treasurers. What is the significance of the new law and regulations to church treasurers? Consider the following:

• Re-evaluate current practices. If your church pays a pastor’s dues to one or more local clubs, now is the time to re-evaluate your practice in light of the new IRS regulations.

• If you have an accountable reimbursement arrangement. If your church has an accountable business expense reimbursement arrangement, it cannot pay for or reimburse (under such an arrangement) dues it pays on behalf of a pastor to clubs organized for pleasure, recreation, or other social purposes. This includes dues paid to health and fitness clubs, golf clubs, airline and hotel clubs, and dinner clubs. If the church pays or reimburses these dues, then the full amount paid by the church must be reported as additional income on the pastor’s W-2 or 1099.

• Some dues may be treated as a business expense. Dues paid to professional organizations and civic or public service organizations (such as Kiwanis, Lions, and Rotary) can be treated as a business expense if they otherwise qualify.

• Examples. Consider the following examples:

Example. A church board adopts an accountable business expense reimbursement arrangement. The board agrees to pay its pastor’s club dues at a local fitness club. These dues are $1,500 each year. Since the dues cannot be treated as a business expense, they cannot be reimbursed under an accountable expense reimbursement arrangement. As a result, the church must include the full $1,500 as additional income on the minister’s W-2 at the end of the year, and the minister must report the full amount as additional income on Form 1040.

Example. Same facts as the previous example, except that the minister’s club dues were not reimbursed by the church. The key point to note here is that the minister will not be able to deduct any part of the dues as a business expense. They are a nondeductible personal expense.

• Final thought. Since fitness and recreational club dues no longer are treated as a business expense, some churches may elect to discontinue paying them. While churches no longer can reimburse such expenses under an accountable expense reimbursement arrangement, there is no reason why a church cannot continue to pay these kinds of dues so long as it properly reports the full amount as additional taxable income. Payment of these dues by the church becomes a taxable fringe benefit.

This article originally appeared in Church Treasurer Alert, October 1994.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Tax Court Addresses Clergy Housing Allowances

Court reaffirms IRS stance on home loans.

Richard R. Hammar, Attorney, CPA

Bio

Rasmussen v. Commissioner, T.C. Memo. 1994-311.

Background. Ministers are able to exclude from their income (for federal income tax reporting purposes) that portion of their compensation that is designated by the church as a housing allowance—to the extent they in fact use the allowance “to provide a home.” The biggest expense for most ministers who own their homes is their monthly mortgage payment. When ministers who own their homes pay off their mortgage loan they lose a big housing expense and reduce the value of the housing allowance. Many of these ministers have obtained home equity loans, or a conventional loan secured by mortgage on their otherwise debt-free home, in order to include their loan repayments as a housing expense. The argument is this—since these loans are secured by a mortgage on the minister’s home they are a legitimate housing expense since the minister will lose the home if the loan is not paid. The IRS issued a ruling in 1991 that disallowed this practice. The Tax Court recently addressed the same issue and agreed with the IRS position.

The IRS ruling. In 1991 the IRS ruled that ministers cannot take into account home equity loan payments or payments on a personal loan secured by a mortgage on a home that is otherwise owned debt-free as legitimate housing-related expenses in computing the housing allowance.

Example. Rev. C is paid salary of $30,000 for 1994 plus a housing allowance of $10,000. Rev. C has housing expenses of $10,000, consisting of mortgage payments on a conventional home loan of $6,000, utilities of $2,500, and property taxes and insurance of $1,500. Rev. C can claim the full church-designated housing allowance as an exclusion from taxable income for income tax reporting purposes since he has housing-related expenses of at least this amount.

Example. Same facts as the previous example, except that Rev. C pays off his home mortgage loan. Rev. C is still eligible for a housing allowance, but it is excludable only to the extent of his actual housing-related expenses of $4,000. As a result, $6,000 of the housing allowance represents taxable income.

Example. Same facts as the previous example, except that Rev. C obtains a loan, secured by mortgage on his home, to pay for various personal expenses (a car, a vacation, a child’s college education, and various medical bills). The loan payments amount to $6,000 in 1994. Rev. C cannot include any portion of the $6,000 in computing his housing allowance exclusion for the year, since these are not an expense of providing a home. Rev. C’s housing allowance exclusion (the amount by which he can reduce his taxable income) is $4,000 (utilities, property taxes and insurance). The “excess housing allowance” of $6,000 must be reported as taxable income.

Example. Same facts as the previous example, except that Rev. C obtains a loan, secured by a mortgage on his home, to pay for remodeling expenses and furnishings. The full amount of these loan payments can be considered in computing Rev. C’s housing allowance for the year.

The IRS ruling was predictable, but its reasoning was questionable. After all, if a minister defaults on a home equity loan, or on a personal loan secured by a mortgage on his or her home (that is otherwise debt-free), the lender has the legal authority to sell the home in a foreclosure sale. For this reason it has been difficult to understand the IRS position that the threat of foreclosure does not make such loan payments an expense of “providing a home” as required by federal tax law. More clarification was needed, and the Tax Court responded in a recent ruling.

The Tax Court’s decision. The facts in the recent Tax Court ruling are simple. A Baptist minister bought a home in 1970 for $50,000. He financed the purchase through a mortgage loan, and had annual loan payments of $3,000. Between 1982 and 1986 the minister received $108,000 in personal loans from his church to assist him in paying various personal expenses (including medical bills, education expenses, and taxes). The church loans provided for interest rates “equal to current Treasury Bill rates.” Each year the church loan committee prepared a written acknowledgement stating that the loans were “deemed by the parties to be secured by a non-recorded deed of trust on the [pastor’s home].” Other than these acknowledgments, there were no documents purporting to be a mortgage held by the church on the pastor’s property. The church did not receive an appraisal of the property nor did it make any inquiry regarding title to the property. The church board designated large housing allowances for the pastor each year. The allowances were large enough to cover not only the pastor’s annual home mortgage loan payments of $3,000, but also miscellaneous housing expenses and repayments of the personal loans from the church. The IRS audited the minister and refused to let him count the loan repayments to the church in computing his housing allowance exclusion. The minister appealed to the Tax Court.

The minister claimed that he was entitled to include the loan repayments to the church in computing his housing allowance. He pointed out that the church loans were secured by a mortgage on his home and accordingly the repayments were payments to provide a home. The IRS countered by insisting that there was insufficient proof that the church loans in fact were secured by a mortgage on the pastor’s home. And, even if there were, the payments on the church loans were not used to “provide a home” as required by federal law.

Key point. The IRS relied on a 1984 Tax Court ruling in which the Court observed: “Congress intended to exclude from the minister’s income only that portion of his compensation paid by the church which was actually used by the minister for the purposes of renting or otherwise providing a home for himself.”

The Tax Court, in rejecting the pastor’s position, concluded:

Exemptions from gross income are to be construed narrowly … and [federal law does not] provide for the exclusion of payments on loans secured by a home if they are not used to “provide a home.” The proceeds of the church loans were used to pay personal expenses of [the pastor and his wife] unrelated to their home. Thus, even assuming that the loans were secured by the [pastor’s home, he has] not shown that the portion of the parsonage allowance used to repay the church loans was used for the maintenance or purchase of the home. On the record before us, we hold that [the pastor and his wife] have not proven that the portion of the parsonage allowance used to repay the church loans was used to provide a home as required by [federal law].

Significance to church treasurers. What is the significance of this ruling to church treasurers? Consider the following:

• Housing allowance designations. Church treasurers should alert ministers that they should not include loan payments in computing their housing allowance exclusion for 1994, even if the loan is secured by a mortgage on the minister’s home, unless the loan is “to provide a home.” According to the Tax Court, this refers to housing-related expenses. Ministers also should be advised not to take into account these kinds of loan repayments when estimating their housing allowance for 1995. If your church has developed a form for ministers to use in estimating their housing expenses each year, be sure to modify the form to clarify that these kinds of payments are not to be considered.

Key point. Ministers who have paid off their home mortgage loan and who later obtain a loan secured by a mortgage on their otherwise debt-free home may include their loan repayments in computing their housing allowance so long as the loan is used for housing expenses. The Tax Court conceded as much. Any form used by ministers to estimate their housing allowance should make this important distinction.

• Amending a housing allowance. If your minister has been treating repayments of personal loans as “housing expenses” for purposes of computing the housing allowance exclusion, you may want to consider amending the church’s housing allowance designation for 1994. While this is not necessary, it may result in a much more realistic amount. This in turn may reduce the “excess housing allowance” (the amount by which the church designated housing allowance exceeds actual housing expenses) that the minister must report as additional income on Form 1040.

• Gardening expenses. There is one additional aspect of the court’s decision that is worth mentioning. The court noted that the IRS had conceded on appeal that the minister was able to include, in computing his housing allowance exclusion, “other payments for providing a home such as maintenance, utilities, and gardening services.” In the past it has been unclear whether or not ministers can consider gardening services as housing expenses for purposes of computing their housing allowance exclusion. While this reference by the court to the IRS position on appeal does not constitute an authoritative pronouncement on this issue, it provides some support for this position. Once again, churches that use forms for computing a minister’s estimated housing expenses may want to add this item to the list of expenses.

This article originally appeared in Church Treasurer Alert, October 1994.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Unreimbursed Business Expenses—An Important Clarification

What treasurers should know.

Richard R. Hammar, Attorney, CPA

Bio

Church Finance Today

Unreimbursed Business Expenses—An Important Clarification

What treasurers should know.

Richard R. Hammar

The Tax Court recently affirmed an important rule—employees who are entitled to be reimbursed by an employer for their business expenses, but who fail to request reimbursement, cannot claim a deduction for their unreimbursed business expenses. Gravett v. Commissioner, T.C. Memo. 1994-156.

Example. A church agrees to reimburse a minister’s business expenses up to $5,000 for 1994. The minister receives reimbursements of business expenses totaling $3,000 and claims a deduction for an additional $1,500 of business expenses for which no reimbursement was sought or received. The minister cannot deduct the $1,500 in expenses for which a reimbursement was available from the church.

However, if a church agrees to reimburse business expenses up to a specified amount, a minister or lay employee can claim a deduction for unreimbursed expenses in excess of this amount.

Example. A church agrees to reimburse a minister’s business use of a car at a rate of 19 cents per mile for 1994. The minister is reimbursed $1,900 for 10,000 miles of business travel. The IRS allows taxpayers to use a standard mileage rate of 29 cents per mile in 1994 to compute the business use of a vehicle. The minister can claim an unreimbursed business expense deduction for the amount by which the IRS approved rate (29 cents per mile) exceeds the amount reimbursed by the church (19 cents per mile), or $1,000.

Caution! Church treasurers who are authorized to reimburse a minister’s (or lay employee’s) business expenses, but who fail to do so, may be precluding any business expense deduction.

This article originally appeared in Church Treasurer Alert, September 1994.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Can Clergy Claim Church Contributions as a Professional Expense?

US Tax Court issues a surprise decision.

Richard R. Hammar, Attorney, CPA

Bio

Forbes v. Commissioner, T.C. Sum. Op. 1992-167 (unpublished)

background

Most ministers support their church with regular contributions. Some also make regular contributions to a denominational agency. Must this financial support be treated as a charitable contribution? Or, is it possible to treat it as “professional dues”? This question was addressed directly in an unpublished Tax Court decision that will be summarized in this article. The court’s decision, and its significance to church treasurers, will be summarized in this article.

facts of the case

A local church adopted a “tithing policy” requiring every employee to pay a tithe of ten percent of total compensation back to the church. The church strictly enforces the tithing policy. Tithing records are maintained on a computer and are periodically examined for all employees. Employees found to be delinquent in their tithes are required to become current. The church has dismissed several employees for failing to comply with the tithing requirement.

The church views its tithing policy as both moral and managerial. Morally, the church believes that “a church member whose wages are paid from the tithes of the parishioners, but refuses to participate in the support of the ministry, is dishonest and hypocritical.” From a management standpoint, the church believes that an employee who disagrees with its basic tenets and is unwilling to comply with its policies is not fulfilling his or her employment commitment.

One of the church’s ministers received $24,600 in wages from the church in one year, which consisted of salary, housing allowance, and miscellaneous amounts received for services performed at weddings, funerals, and other occasions. She paid a tithe of $2,460 back to the church, as required by the tithing policy. In computing her self-employment (social security) taxes for the year she deducted this tithe as a “business expense.”

the IRS position

The IRS audited the minister’s tax return and claimed that she could only claim her tithe as a charitable contribution deduction and not as a business expense. As a result, the IRS concluded that it was improper for the minister to deduct the tithe in computing her social security taxes. While taxpayers can deduct business expenses in computing self-employment taxes, they cannot deduct charitable contributions. The minister appealed the IRS ruling to the Tax Court, claiming that her tithe was a business expense that she was entitled to deduct in computing her self-employment taxes.

the court’s decision

The Tax Court concluded that the minister’s tithes to the church represented a business or professional expense rather than a charitable contribution under the facts of this case. As a result, the minister properly deducted her tithes in computing her social security taxes. The court observed:

Under consideration of the record in this case, we agree with [the minister]. Tithing is required by [the church] as a matter of employment policy, and [the minister] must annually tithe ten percent of the income she receives as a result of her position as a minister. Since [the church’s] tithing policy is rigorously enforced, [the minister’s] employment is, in a very real sense, dependent upon her willingness to give. The fact that she is tithing to a charitable organization to which she belongs and to which she might tithe ten percent anyway is of little consequence given the facts in this case. Accordingly … we hold that [the minister] is entitled to compute her net earnings from self-employment by reducing her gross income from self-employment by the $2,460 she paid to [the church] during the year in issue as a tithe.

Federal tax law permits taxpayers to deduct business and professional expenses, which are defined as “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business”. The court concluded that the minister’s tithes satisfied this definition and accordingly could be deducted as a business expense. It is significant that the IRS conceded that the minister’s tithes could be deducted as a business or professional expense, except for a provision in federal law preventing taxpayers from claiming a business expense deduction for an item that could be claimed as a charitable contribution. The IRS claimed that this provision prevented the minister from deducting her tithes as a business expense—since she could have claimed them as a charitable contribution. Not so, said the court. It concluded that “payments made as an integral part of a taxpayer’s trade or business” are deductible as business or professional expenses even if “the recipient of the payment is a charitable organization.” That is, the critical question to ask is whether or not a payment satisfies the definition of a business expense. Is it an ordinary and necessary expense paid or incurred in carrying on a trade or business? If so, it is deductible as a business expense even though it may be possible to characterize it as a charitable contribution.

Further, the court suggested that it would be unrealistic to treat the minister’s tithe to the church as a voluntary charitable contribution, since in no sense was it a voluntary transfer of funds to the church. Rather, it was a mandatory payment, and as such it could not be characterized as a charitable contribution.

Key point. The United States Supreme Court has observed that a gift or charitable contribution “proceeds from a detached and disinterested generosity … out of affection, respect, admiration, charity, or like impulses.” Surely, it would be inappropriate to classify mandatory financial support paid to a church by a minister or lay employee as a gift or contribution under this test, since in no sense does such support “proceed from a detached and disinterested generosity.”

importance to church treasurers

What is the relevance of this case to church treasurers? Consider the following:

1. The case suggests that mandatory contributions made by ministers and lay employees to a church can be treated as business expenses. What is the practical effect of this result? Most importantly, it means that ministers may be able to deduct such contributions as a business expense in computing their self-employment (social security) tax on Schedule SE (of Form 1040). Remember, ministers always are considered to be self-employed for social security purposes with respect to their ministerial income. Consider the following examples:

Example. Rev. D receives compensation of $40,000 for 1994 from his church (of which $10,000 is designated as a housing allowance). Rev. D makes mandatory contributions of $4,000 to his church, and has other business expenses of $3,000. If the $4,000 in contributions to the church are mandatory, the Tax Court’s ruling suggests that these can be deducted as a business expense in computing both income taxes and self-employment taxes. Rev. D would pay self-employment taxes on $33,000 (total compensation including housing allowance less the mandatory contributions and business expenses). Without taking into account any other facts or deductions (for the sake of simplicity) this would result in a tax of $5,049.

Example. Same facts as the previous example, except that Rev. D’s contributions to the church do not meet the Tax Court’s definition of “mandatory”. Rev. D would pay self-employment taxes on $37,000 (total compensation including housing allowance less business expenses but not less contributions). Without taking into account any other facts or deductions (for the sake of simplicity) this would result in a tax of $5,661. By not treating his contributions as a business expense Rev. D will pay $612 in additional self-employment taxes.

2. Income tax deduction. The Tax Court concluded that mandatory contributions to a church by a church employee can be claimed as a business expense. As a result, such expenses can be deducted as a miscellaneous itemized deduction on Schedule A (by church employees) or as a deduction on Schedule C (for self-employed workers). One problem—employees who do not have enough deductions to itemize on Schedule A (this is true of nearly 70%) cannot claim any deduction for income tax purposes. This is true whether the contribution is treated as a charitable contribution or as a business expense. Note however that a mandatory contribution can still be deducted in computing self-employment taxes, even if the taxpayer cannot itemize income tax deductions on Schedule A. This is the primary reason why some ministers want to treat their church contributions as a business expense.

3. Reimbursing mandatory contributions. Many church treasurers reimburse their minister’s business expenses. If mandatory contributions to the church are considered to be business expenses for purposes of self-employment taxes, can a church treasurer reimburse them? This is a difficult question that the Tax Court’s ruling did not address. Logically, if mandatory contributions are considered to be business expenses for self-employment tax purposes, they can be reimbursed under either an accountable or nonaccountable business expense reimbursement arrangement. There are two considerations to note: (1) Neither the IRS nor any court has directly addressed this issue. There is no clear precedent that can be cited in support of such a conclusion. This does not mean that the reimbursement of mandatory contributions would be wrong or illegal. It simply means that there is no direct precedent to support such a position. (2) Some would say there is a logical or theological inconsistency in a church reimbursing a minister’s contributions. To illustrate, David refused to make a burnt offering to the Lord using donated oxen (“will I offer burnt offerings unto the Lord my God of that which cost me nothing?”)

4. Contributions must be mandatory. For contributions to a church to be treated by ministers and lay employees as a business expense rather than as a charitable contribution, they must be “mandatory” under the Tax Court’s rigid definition. Note the following elements that were noted by the court:

• the church adopted a formal “tithing policy” that required every employee to pay a tithe (ten percent) of gross income to the church

• the church maintained tithing records on every employee

• the church periodically reviewed the tithing records of all employees and required delinquent employees to become current

• the church dismissed several employees for failing to comply with the tithing requirement

• the church clearly articulated both a theological and managerial basis for its tithing policy

Example. Rev. K would like to reduce the amount of social security taxes that he pays. He decides to deduct his church contributions as a business expense in computing his self-employment taxes. He claims that if he does not set an example to his congregation by making contributions to the church, he may be asked to resign. The church has never adopted a formal “tithing policy,” and has never dismissed (or even suggested dismissing) a minister for inadequate contributions. These contributions are not mandatory, and are not deductible (for income tax or social security tax purposes) as a business expense.

5. The IRS conceded that mandatory contributions could be treated as business expenses. As noted above, it is important to recognize that the IRS conceded that the minister’s tithes could be deducted as a business or professional expense except for a provision in federal law preventing taxpayers from claiming a business expense deduction for an item that could be claimed as a charitable contribution. Since the court concluded that this provision did not apply, the contributions were deductible as a business expense.

6. Denominational support. Some denominations require ministers to make contributions for their support. If these contributions are mandatory, they can be treated as business expenses and deducted in computing self-employment taxes according to the Tax Court’s decision. Once again, it is important to emphasize that the contributions must in fact be mandatory. For example, the denomination’s governing documents specify that ministers can lose their ordained status for failure to pay the required support.

Key point. Ministers can elect to treat their mandatory contributions as a charitable contribution rather than as a business or professional expense. Why would they choose to do so? Some will do so for theological reasons. Others will do so to reduce their audit risk (since it is possible that the IRS will not accept the reasoning of the Tax Court in other cases).

7. Effect of a “small Tax Court case”. The Tax Court’s decision was a “small tax court case,” meaning that it involved less than $10,000 and the taxpayer elected to pursue an expedited and simplified procedure authorized by section 7463 of the Internal Revenue Code. While small tax court cases are more quickly resolved, there is a trade off—section 7463 specifies that “a decision entered in any case in which the proceedings are conducted under this section shall not be reviewed by any other court and shall not be treated as precedent for any other case.” In other words, the decision of the Tax Court was final, and it cannot be cited as precedent in other cases. Obviously, this greatly limits the impact of the case. The IRS is free to completely ignore the decision in future cases.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

29 Percent of All Taxpayers Can Itemize Deductions on Schedule A

Why treasurers should be aware of this little-known statistic.

Richard R. Hammar, Attorney, CPA

Bio

Church Finance Today

29 Percent of All Taxpayers Can Itemize Deductions on Schedule A

Why treasurers should be aware of this little-known statistic.

Richard R. Hammar

Background. Only 29 percent (about 3 out of 10) taxpayers are able to itemize deductions on Schedule A. This interesting statistic is buried in the Spring 1994 Statistics of Income Bulletin issued by the IRS in June. What is the relevance of this to church treasurers? It demonstrates that 7 out of 10 ministers and lay church workers who report their federal income taxes as employees (or who are reclassified as employees by the IRS) will be unable to deduct either their unreimbursed business expenses or business expenses reimbursed under a nonaccountable arrangement. Here’s why. Employees can claim unreimbursed business expenses (including travel and transportation expenses), and business expenses reimbursed by their church under a nonaccountable arrangement, only as miscellaneous itemized deductions on Schedule A. Employees who cannot itemize deductions will not be able to deduct any of these expenses. This is particularly unfortunate for employees whose business expenses are reimbursed under a nonaccountable plan, since they must include the full amount of all the expense reimbursements as taxable income but they are denied any deduction of their expenses. Reimbursed expenses are nonaccountable if the employee was not required to or did not “account” to the employer for the expenses or was not required to or did not return any “excess reimbursements” (employer reimbursements in excess of substantiated expenses) to the employer. The most common form of nonaccountable reimbursement is a monthly car allowance paid to a church employee without any requirement that actual business expenses be substantiated.

In addition, most miscellaneous expenses (including unreimbursed and unsubstantiated reimbursed employee business expenses) are deductible on Schedule A only to the extent they exceed 2% of adjusted gross income (only 50% of business meals and entertainment are counted).

Planning tip. Ministers reporting their income taxes as employees can minimize if not eliminate the adverse effect of these rules by having their employing church adopt an accountable reimbursement policy.

Planning tip. Ministers who report their income taxes as employees (or who would be classified as employees by the IRS) cannot deduct any of their unreimbursed business expenses if they have insufficient itemized deductions to use Schedule A. However, these ministers are placed in an even worse position if their church reimburses some or all of their expenses under a nonaccountable arrangement, since all of the reimbursements are includable on the minister’s W-2 as taxable income while the minister is unable to claim any offsetting deduction. This makes it critical for churches to avoid nonaccountable reimbursement arrangements. Here are some examples of nonaccountable reimbursement arrangements that should be avoided. Our recommendation—if you currently have any of these arrangements, immediately convert it to an accountable arrangement.

Your church pays a monthly “car allowance” to clergy or lay staff members, without requiring any accounting or substantiation.
Your church reimburses business expenses without requiring adequate written substantiation (with receipts for all expenses of $25 or more) of the amount, date, place, and business purpose of each expense.
Your church only reimburses business expenses once each year. Business expenses must be accounted for within a “reasonable time” under an accountable arrangement. Generally, this means within 60 days or less.
Your church provides clergy or lay staff with travel advances and requires no accounting for the use of these funds.

Many ministers assume they can avoid these limitations simply by reporting their income taxes as self employed. This is a very dangerous assumption, since the IRS and the courts would consider most pastoral ministers to be employees for income tax reporting purposes (of course, ministers are self-employed for social security purposes with respect to ministerial services).

Conclusion. According to the recent IRS Statistics of Income Bulletin, 7 out of 10 taxpayers do not have enough deductions to itemize on Schedule A. Among other things, this means that 7 out of 10 taxpayers cannot deduct unreimbursed business expenses or business expenses reimbursed by an employer under a nonaccountable arrangement. This harsh result can be reduced if not eliminated if an employing church simply adopts an accountable reimbursement policy that requires an adequate accounting prior to the reimbursement of any business expense and the return of any excess reimbursements to the church. Failure to do so will needlessly result in the payment of additional taxes.

Example. Rev. B serves a senior minister of a church and reports his federal income taxes as an employee. The church expects Rev. B to pay business expenses out of his own salary, so it reimburses none of Rev. B’s business expenses. In other words, all of Rev. B’s business expenses are “unreimbursed.” For 1994, Rev. B has total church compensation of $35,000, and incurs unreimbursed business expenses of $3,000. He does not have enough itemized deductions to use Schedule A. As an employee, the only way for Rev. B to deduct his unreimbursed business expenses is as an itemized deduction on Schedule A (to the extent that such expenses exceed 2% of his adjusted gross income). Since Rev. B does not have enough deductions to itemize on Schedule A, he cannot deduct any portion of his unreimbursed business expenses. According to the recent IRS report, 70% of all taxpayers cannot use Schedule A. This suggests that 7 out of 10 ministers who report their income taxes as employees (or who would be classified as employees by the IRS in an audit) will be unable to deduct their unreimbursed business expenses. This unfortunate result can be avoided completely if a church simply adopts an accountable business expense reimbursement arrangement.

Example. Rev. H receives a monthly “car allowance” of $300. Rev. H is not required to account for the use of any of these funds. This is an example of a nonaccountable reimbursement arrangement. The church is reimbursing business expenses (through a monthly car allowance) without requiring any accounting or substantiation. If Rev. H reports her income taxes as an employee (or as self employed, but is reclassified as an employee by the IRS in an audit), and has insufficient itemized deductions to use Schedule A, the following reporting requirements apply: (1) the church must report all of the monthly allowances ($3,600) on Rev. H’s W 2 form; (2) Rev. H must report all of the monthly allowances ($3,600) as income on her Form 1040; (3) Rev. H cannot deduct any of her car expenses since these are deductible only as itemized deductions on Schedule A. This result is even worse than the previous example, since in this case all of the monthly car allowances are includable on Rev. H’s W-2 though she is unable to claim any offsetting deduction for her car expenses. As noted before, it can be assumed that 7 out of 10 clergy are not able to use Schedule A, and cannot deduct either unreimbursed business expenses or business expenses reimbursed under a nonaccountable arrangement. This harsh rule can be avoided if a church adopts an accountable reimbursement arrangement. This is especially critical if a church uses a nonaccountable reimbursement arrangement, since not only are all of the expenses nondeductible under such an arrangement but all of the church’s reimbursements are includable as taxable income on the minister’s W-2.

Planning tip. If your church has not yet adopted an accountable reimbursement arrangement, helpful guidance is available in chapter 6 of Richard Hammar’s annual Church and Clergy Tax Guide. This chapter includes a sample resolution that can be adopted by the governing board of your church to implement an accountable reimbursement arrangement.

This article originally appeared in Church Treasurer Alert, August 1994.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Tax Implications of Clergy Discretionary Funds

Different fund setups mean different tax policies.

Richard R. Hammar, Attorney, CPA

Bio

Background. It is a fairly common practice for a congregation to set aside a sum of money in a “discretionary fund” and give a minister the sole authority to distribute the money in the fund. In some cases, the minister has no instructions regarding permissible distributions. In other cases, the congregation establishes some guidelines, but these often are oral and ambiguous. Consider the following examples.

Example. A congregation at an annual business meeting authorizes the creation of a “pastor’s fund” in the amount of $10,000, with the understanding that Rev. T, the congregation’s senior minister, will have the authority to distribute the fund for any purpose. Rev. T is not required to account to the congregation or church board for any distribution, and he is not prohibited from making distributions to himself. During 1994, Rev. T distributes the entire fund to members of the congregation who were in need. He did not distribute any portion of the fund to himself or to any family member.

Example. Same facts as the previous example, except that Rev. T distributed $5,000 to himself in 1994.

Example. The governing board of First Church sets aside $5,000 in a discretionary fund, and authorizes Rev. D, its senior minister, to distribute the funds for “benevolent purposes.” Rev. D is required to account to the church board for all distributions and is prohibited from making any distributions to himself or to any family member.

Many church treasurers are unaware of the potential tax consequences of these arrangements. The tax consequences of some of the more common arrangements are summarized in this article.

Situation 1. The congregation (or governing board) establishes a discretionary fund and gives a cleric full and unfettered discretion to distribute it.

To the extent the minister has the authority to distribute any portion of the discretionary fund for any purpose, including a distribution to him or herself, without any oversight or control by the governing board, then the following consequences ensue:

• The entire fund must be reported as taxable income to the minister in the year it is funded. This is so even if the minister in fact does not personally benefit from the fund. The mere fact that the minister could personally benefit from the fund is enough for the fund to constitute taxable income. The basis for this result is the “constructive receipt” rule, which is set forth in income tax regulation 1.451 2(a):

Income although not actually reduced to a taxpayer’s possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions.

For a discretionary fund to constitute taxable income to a minister, it is essential that the minister have the authority to “draw upon it at any time” for his or her own personal use. This means that the fund was established without any express prohibition against personal distributions.

• Donations by members of the congregation to the fund would not be tax-deductible as charitable contributions since the fund is not subject to the full control of the congregation or its governing board. For a charitable contribution to be tax-deductible, it must be subject to the full control of the church or other charity. The IRS stated the rule as follows in an important ruling: “The test in each case is whether the organization has full control of the donated funds, and discretion as to their use, so as to insure that they will be used to carry out its functions and purposes.” If a church sets up a discretionary fund and authorizes a minister to make distributions from the fund for any purpose without any oversight or control by the church, this fundamental test is not met.

Situation 2.The congregation establishes a discretionary fund and gives a minister the discretion to distribute it for any purpose, but the congregation’s governing board retains administrative control over the fund.

Under this scenario the fund would still constitute taxable income to the minister, but the donations of congregational members to the fund probably would be tax-deductible as charitable contributions since the congregational board exercises control over the funds. Board “control” could be established if the board simply reviewed all distributions to ensure consistency with the congregation’s exempt purposes.

Situation 3.The congregation establishes a discretionary fund and gives a minister the discretion to distribute it only for specified purposes (such as relief of the needy) that are consistent with the congregation’s exempt purposes. The minister does not qualify for distributions and in fact is prohibited from making distributions to him or herself. The congregation’s governing board retains administrative control over the fund.

If a discretionary fund is set up by a resolution of a congregation’s governing board that absolutely prohibits any distribution of the fund for the minister’s personal use, then the constructive receipt rule is avoided and no portion of the fund represents taxable income to the minister. In the words of the income tax regulations, “income is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions.” Accordingly, in order to avoid the reporting of the entire discretionary fund as taxable income to the minister, it is essential that the fund be established by means of a congregational or board resolution that absolutely prohibits any use of the fund by the minister for personal purposes.

In order to provide a reasonable basis for assuring donors that their contributions to the fund are deductible, the following steps should be taken: (1) The board resolution should specify that the fund may be distributed by the minister only for needs or projects that are consistent with the congregation’s exempt purposes (as set forth in the congregation’s charter); and (2) the congregational board must exercise control over the funds. As noted above, board “control” could be established if the board simply reviewed all distributions to ensure consistency with the congregation’s exempt purposes.

Planning tip. Ministers can avoid the constructive receipt of taxable income and donors can be given reasonable assurance of the deductibility of their contributions if a discretionary fund:

Gives a minister the discretion to distribute the fund only for specified purposes (such as relief of the needy) that are consistent with the congregation’s exempt purposes.
Prohibits (in writing) the minister from distributing any portion of the fund for him or herself or any family member.
The congregation or its governing board retains administrative control over the fund to ensure that all distributions further the church’s exempt purposes.

What is “charity”? Ministers who are authorized to distribute discretionary funds for benevolent purposes must recognize that the IRS interprets the term “charity” very strictly. More is required than a temporary financial setback or difficulty paying bills. Ministers should keep this important point in mind when making distributions from a discretionary fund. And, the church board should carefully scrutinize every distribution to ensure that this strict test is satisfied.

Should recipients receive a 1099? In general, a 1099-MISC form is issued only to self-employed workers who are paid compensation. Since most recipients of a minister’s discretionary fund do not perform any services for their distribution, no 1099-MISC is required.

This article originally appeared in Church Treasurer Alert, August 1994.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Returning Contributions to Donors

How to address donors who want their money back.

Richard R. Hammar, Attorney, CPA

Bio

Church Finance Today

Returning Contributions to Donors

How to address donors who want their money back.

Richard R. Hammar

The problem. Should church treasurers ever return a contribution to a donor? This is a question that nearly every church treasurer faces eventually. Such requests can arise in a variety of ways. Consider the following:

Example. A church member donates $1,000 to the church building fund in 1992. In 1994, the church abandons its plans to construct a new building. The member asks the church treasurer to return her $1,000 contribution.

Example. A church member donates $2,500 to his church during the first six months of 1994. In July of 1994 he experiences a financial crisis and asks the church treasurer for a refund of his contributions.

Example. A church member donates $2,000 to First Church during the first six months of 1994. In July of 1994 she becomes upset with First Church and begins attending Second church. She later asks the treasurer of First Church for a refund of her contributions.

General rule. A charitable contribution is a gift of money or property to a charitable organization. Like any gift, a charitable contribution is an irrevocable transfer of a donor’s entire interest in the donated cash or property. Since the donor’s entire interest in the donated property is transferred, it generally is impossible for the donor to recover the donated property. As we will see, there are a few exceptions to this general rule.

Undesignated contributions. Most charitable contributions are undesignated, meaning that the donor does not specify how the contribution is to be spent. An example would be a church member’s weekly contributions to a church’s general fund. Undesignated contributions are unconditional gifts. A church has absolutely no legal obligation to return undesignated contributions to a donor under any circumstances. In fact, there are a number of problems associated with the return of undesignated contributions to a donor. These include:

Inconsistency. As noted above, a return of a donor’s contributions would be completely inconsistent with the church’s prior characterization of the transfers as charitable contributions. As already noted, a charitable contribution is tax-deductible since it is an irrevocable gift to a charity. If a church complies with enough donors’ requests to refund their contributions, then this raises a serious question as to the deductibility of any contribution made to the church. Contributions under these circumstances might be viewed as no-interest “demand loans”—that is, temporary transfers of funds that are recallable by donors at will. As such they would not be tax-deductible as charitable contributions.
Amended tax returns. Donors who receive a “refund” of their contributions would have to be informed that they will need to file amended federal tax returns if they previously claimed a charitable contribution deduction for their “contributions”. This would mean that donors would have to file a Form 1040X with the IRS. In most states, donors also would have to file amended state income tax returns.
Church liability. In order to avoid the potential penalty for “aiding and abetting” a taxpayer in the substantial understatement of tax, the church would need to notify the IRS of the return of the contribution. This notification would need to include the donor’s name, address, social security number, the date and amount of the earlier contribution, and the date the contribution was returned. Failure by the church to notify the IRS of the return of the contribution could result in a penalty under section 6701(b) of the Internal Revenue Code of $1,000 for aiding and abetting in the substantial understatement of tax. The church should inform the donor if it plans to notify the IRS of the returned contribution.
“Refund department”. Compliance with a donor’s demand for the return of a contribution would morally compel a church to honor the demands of anyone wanting a return of a contribution. This would establish a terrible precedent.

Conclusion. Churches should resist appeals from donors to return their undesignated contributions. There is no legal basis for doing so, even in “emergencies”. Honoring such requests can create serious problems, as noted above. Our recommendation—do not honor such requests without the recommendation of an attorney.

Designated contributions. Often a donor will make a “designated” contribution to a church. That is, the donor designates how the contribution is to be spent. For example, a donor contributes a check in the amount of $500 and specifies that it be used for missions, or the building fund, or some other specific project. Designated contributions are held by the church “in trust” for the designated purpose. So long as the church honors the designation, or plans to do so in the foreseeable future, it has no legal obligation to return a donor’s designated contribution. Quite to the contrary, returning a donor’s designated contribution under these circumstances would create the same problems associated with the return of undesignated contributions (summarized above). Those problems should be reviewed again.

What if a donor contributes money to a church’s building fund and the church later abandons its plans to construct a new facility? Such contributions are conditioned on the church pursuing its building program. When the condition fails, the contribution is revocable at the option of the donor. Should the church refund designated contributions to donors under these circumstances? There are a number of possibilities, including the following:

• Donors can be identified. If donors can be identified, they should be asked if they want their contributions returned or retained by the church and used for some other purpose. Ideally, donors should communicate their decision in writing to avoid any misunderstandings. Churches must provide donors with this option in order to avoid violating their legal duty to use “trust funds” only for the purposes specified. Of course, churches should advise these donors that they will need to file amended tax returns if they claimed a charitable contribution deduction for their contributions in a prior year. As noted above, the church may want to inform donors that it must notify the IRS of any return of a charitable contribution in order to avoid the potential penalty for “aiding and abetting” a taxpayer in the substantial understatement of tax.

Key point. Often, donors prefer to let the church retain their designated contributions rather than go through the inconvenience of filing an amended tax return.

• Donors cannot be identified. A church may not be able to identify all donors who contributed to the building fund. This is often true of donors who contributed small amounts, or donors who made anonymous cash offerings to the building fund. In some cases, designated contributions were made many years before the church abandoned its building plans, and there are no records that identify donors. Under these circumstances the church has a variety of options. One option would be to address the matter in a meeting of church members. Inform the membership of the amount of designated contributions in the church building fund that cannot be associated with individual donors, and ask the church members to take an official action with regard to the disposition of the building fund. In most cases, the church membership will authorize the transfer of the funds to the general fund. Note that this procedure is appropriate only for that portion of the building fund that cannot be traced to specific donors. If donors can be identified, then use the procedure described above. Another option is to ask a court for authorization to transfer the building fund to another church fund. Many states have adopted the Uniform Management of Institutional Funds Act, and this Act permits churches to ask a civil court for authorization to remove a restriction on charitable contributions. The Act provides:

If written consent of the donor cannot be obtained by reason of his death, disability, unavailability, or impossibility of identification, the governing board may apply in the name of the institution to the [appropriate] court for release of a restriction imposed by the applicable gift instrument on the use or investment of an institutional fund …. If the court finds that the restriction is obsolete, inappropriate, or impracticable, it may by order release the restriction in whole or in part.

Other options are available. Churches should be sure to consult with a local attorney when deciding how to dispose of designated funds if the specified purpose has been abandoned.

• Some donors can be identified, and some cannot. In most cases, some of the building fund can be traced to specific donors, but some of it cannot. Both of the procedures summarized above would have to be used.

Key point. This article has focused on building funds. The same analysis is relevant to contributions that designate any other specific purpose or activity. Other examples include contributions designating a new organ, a missions activity, or a new vehicle.

This article originally appeared in Church Treasurer Alert, July 1994.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Should Churches Be Concerned About an IRS Audit?

Recent statistics suggest no.

Richard R. Hammar, Attorney, CPA

Bio

Church Finance Today

Should Churches Be Concerned About an IRS Audit?

Recent statistics suggest no.

Richard R. Hammar

In May the House Ways and Means Committee released a report on ways to increase compliance by exempt organizations with federal tax law. The report contains some interesting information about the likelihood and probable results of an IRS audit. Consider the following:

IRS’s staffing for examinations of exempt organizations has remained relatively constant over the past six years. In 1990, there were 501 examination employees; in 1991 there were 486 employees; in 1992 there were 509 employees; in 1993 there were 501 employees; in 1994 there are 508 employees (planned); and in 1995 497 employees have been requested.
Funding for IRS oversight of exempt organizations was $47.8 million in fiscal year 1990; $47.6 million in 1991; $50.7 million in 1992; $52.9 million in 1993; $48.4 million in 1994 (planned); and $49.2 million in 1995 (requested).
At the end of 1993, there were 1,450,265 tax-exempt organizations, including an estimated 340,000 churches (23 percent of all exempt organizations are churches). How many of these organizations are audited by the IRS? In 1988, the IRS examined 6,708 exempt organizations; in 1989, 7,541; in 1990, 7,232; in 1991, 6,011; in 1992, 5,132; and in 1993, 5,472, or less than one-half of one percent of all tax-exempt organizations.
In 1991 and 1992, IRS revoked the tax-exempt status of 60 section 501(c)(3) organizations—that is, about 30 per year or 2 out of every 100,000!

Warning! There are a few unscrupulous individuals who are attempting to frighten church leaders into attending worthless seminars and purchasing questionable accounting or “compliance” services by citing the “thousands” of churches that are audited each year. One individual claims that 6,000 churches lost their exempt status last year, and that the IRS is hiring thousands of new agents to audit churches! Don’t be fooled by such hype. Our recommendation—if you receive a seminar advertisement that attempts to frighten you with such stories, throw it out.

This article originally appeared in Church Treasurer Alert, July 1994.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Handling Designated Missions Contributions

The Tax Court issues an important ruling.

Richard R. Hammar, Attorney, CPA

Bio

Hubert v. Commissioner, T.C. Memo. 1993-482 (1993)

Background. How should church treasurers handle contributions that are made to the church for specific missionaries? For example, John issues a check in the amount of $500 to First Church with the stipulation that it be used for a named missionary. Should this contribution be treated as tax-deductible? Or, should it be returned to the donor as non-deductible? This was the issue addressed by the Tax Court in a recent case.

Facts of the case. A member attended an inner-city Baptist church for many years. Due to a lack of funds, the church asked the member to sponsor two missionaries from the church. The member did so for a number of years. One of the missionaries worked in Peru, and was responsible for beginning 15 Baptist churches there. The other missionary worked in a variety of assignments overseas in missionary radio. The member was not related to either missionary or personally associated with them in any way other than the fact that he had taught one of them in his Sunday School class many years before.

In 1982 the member executed a last will and testament that created two trusts funded with $100,000 each. The income of each trust was to be paid to two missions organizations for the missionary work of the two missionaries during their lives, including support during retirement. The member died in 1986, and his estate claimed a charitable contribution deduction for the two $100,000 trusts. The IRS denied a deduction, arguing that the member intended to benefit the missionaries personally and that the missions organizations lacked full control over the use of the funds. The IRS relied in part on a Supreme Court decision denying a charitable contribution deduction to Mormon parents for contributions made directly to their missionary sons.

The court’s ruling. The court ruled that the estate could claim a charitable contribution deduction for the money placed in the two trusts despite the fact that the church member specified that the trusts were for the benefit of the two missionaries. The court noted that a charitable contribution, to be deductible, must be “to or for the use of” a charity. A contribution is “for the use of” a charity if it is transferred to a legally enforceable trust for the charity:

Under [the Supreme Court’s decision in the Mormon missionary case] the test is not whether the charitable organization has full control of the funds, but rather is whether the charitable organization has a legally enforceable right to the funds. In [the Mormon missionary case] the charitable organization [did not] actually receive the funds, either directly or in trust. In the case before us, the income and later the principal are held in a legally enforceable trust for [the two missions] organizations which have control over the funds.

The court rejected the IRS argument that the charitable purpose failed because the intent and the actual effect of the gifts was to benefit the two missionaries rather than the church. The court acknowledged that the trusts focused on two specific missionaries. However, it concluded that “we are satisfied, on the facts before us, that decedent intended the bequests to be used to implement the missionary work of the [missions organizations] through the named missionaries, as well as through the building of foreign mission field medical clinics.” The court explained:

The charities have complete discretion to use the funds in any manner which fits the stated purpose, including choosing the amounts of the funds to be used and the methods of using those funds …. On these facts, we conclude that decedent intended to benefit the general public, not the two named missionaries. Moreover, we find that the charitable organizations have substantial control over the use of the funds and were not meant to be mere conduits to funnel money to the missionaries. The fact that decedent directed the [missions organizations] to use the funds for specific purposes does not defeat the charitable nature of the bequests. Under general trust principles, the [missions organizations] have a fiduciary duty to use the funds as directed; however, they have complete discretion to determine the most appropriate ways to implement the directed purposes. We conclude that the charitable organizations had sufficient control and enforceable rights over the bequests to ensure that the funds were used for charitable purposes, as is required by [law]. The charitable nature of the bequests is further protected by the Attorneys General of Georgia and the State or States in which the charitable organizations are located. The Attorneys General are charged with ensuring that the charitable purposes of the trust are carried out.

The fact that the trusts were to continue distributing funds to the two missionaries following their retirements did not matter to the court. It observed:

The retirement provisions further decedent’s charitable purpose by ensuring that the missionaries will be able to continue their work without concern for what will happen to them when the time comes to retire. During the retirement period, the [missions organizations] will continue to control the funds and may provide for the retirement of the missionaries as they see fit. Under the provisions of the will, upon retirement of the missionaries, the income and principal of the trusts are to be given to the charities “to provide for” the retirement of the missionaries and their wives.

The court did caution that “on different facts we might conclude that the charitable organization was a mere conduit to funnel money to an individual and, therefore, lacked sufficient control over the funds. In such a circumstance, because the bequest was intended to benefit one individual rather than the general public, the bequest would not qualify for a charitable deduction.”

Relevance of this decision to church treasurers.

What is the relevance of this ruling to church treasurers? Consider the following:

Contributions made directly to a church or missions organization without any designation of a specific recipient are tax-deductible.
Contributions made directly to a missionary are not tax-deductible. This was the conclusion of the Supreme Court in the Mormon missionary case. The reason is that a deductible contribution must be “to or for the use of” a charitable organization, not directly to an individual.
Contributions to a church or missions organization may be tax-deductible even though they designate a specific missionary in either of two situations:

Situation 1. In 1962, the IRS ruled that contributions to a church or missions organization are tax-deductible even though they designate a particular missionary so long as the church or missions organization “has full control of the donated funds, and discretion as to their use, so as to insure that they will be used to carry out its functions and purposes.” In other words, if a donor contributes funds to a church missions board and designates a particular missionary, the contribution will be deductible so long as the church or missions board retains full administrative and accounting control over the funds.

Situation 2. Contributions “for the use of” a church or missions organization are tax-deductible even though they designate a particular missionary. The phrase “for the use of” means that a contribution is given to a trustee pursuant to a trust or similar legal arrangement for the benefit of a charitable organization. If this test is met, it does not matter that the trustee is directed to distribute funds to a church or missions organization for a specified individual. A contribution is deductible under these circumstances because the trustee has a legal duty to ensure that trust funds are used by the named beneficiary for religious or charitable purposes. This conclusion is reinforced by two additional considerations: (1) Churches and missions organizations have a “fiduciary duty” to distribute funds only for religious or charitable purposes. As a result, if a trust distributes funds to a church or missions organization for the missionary work of a specified individual, the church or missions organization has a fiduciary duty to ensure that trust distributions are used by the missionary for such purposes. Accordingly, such contributions are “for the use of” the church or missions organization even though they designate a specific recipient. (2) State attorneys general are empowered to ensure that the charitable purposes of charitable trusts are carried out.

Persons may still make direct contributions to individual missionaries or religious workers. Such contributions are not “illegal”—they merely are not tax deductible as charitable contributions.

Tip. For more information on designated contributions (including contributions designating specific projects, students, pastors, missionaries, and benevolence fund recipients) see chapter 7 of Richard Hammar’s Church and Clergy Tax Guide.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Filing Form 5578

One of the most neglected federal reporting requirements.

Richard R. Hammar, Attorney, CPA

Bio

Church Finance Today

Filing Form 5578

One of the most neglected federal reporting requirements.

Richard R. Hammar

Key point. If your church operates a private school or preschool, you must be familiar with IRS Form 5578.

Churches and other religious organizations that operate, supervise, or control a private school (or schools) must file a certificate of racial nondiscrimination (Form 5578) each year with the IRS. The certificate is due by the 15th day of the fifth month following the end of the organization’s fiscal year. This is May 15th of the following year for organizations that operate on a calendar year basis.

For purposes of this requirement, a “private school” is defined as an educational organization that normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly conducted. The term includes primary, secondary, preparatory, or high schools, and colleges and universities, whether operated as a separate legal entity or an activity of a church. The term also includes preschools, and this is what makes the reporting requirement relevant for many churches. As many as 25 percent of all churches operate a preschool program. Private religious schools that are not affiliated with or controlled by a church also must file the form.

The form is very simple to complete. A church official simply identifies the church and the school, and certifies that the school has “satisfied the applicable requirements of section 4.01 through 4.05 of Revenue Procedure 75-50.” This reference is to the following requirements:

The school has a statement in its charter, bylaws, or other governing instrument, or in a resolution of its governing body, that it has a racially nondiscriminatory policy toward students.
The school has a statement of its racially nondiscriminatory policy toward students in all its brochures and catalogs dealing with student admissions, programs, and scholarships.
The school makes its racially nondiscriminatory policy known to all segments of the general community served by the school through the publication of a notice of its racially nondiscriminatory policy at least annually in a newspaper of general circulation or through utilization of the broadcast media. However, such notice is not required if one or more exceptions apply. These include: (1) During the preceding three years the enrollment consists of students at least 75 percent of whom are members of the sponsoring church or religious denomination and the school publicizes its nondiscriminatory policy in religious periodicals distributed in the community; (2) the school draws its students from local communities and follows a racially nondiscriminatory policy toward students and demonstrates that it follows a racially nondiscriminatory policy by showing that it currently enrolls students of racial minority groups in meaningful numbers.
The school can demonstrate that all scholarships or other comparable benefits are offered on a racially nondiscriminatory basis.

Filing the certificate of racial nondiscrimination is one of most commonly ignored federal reporting requirements. Churches that operate a private school (including a preschool), as well as independent schools, may obtain copies of Form 5578 by calling the IRS forms number (1-800-829-3676).

This article originally appeared in Church Treasurer Alert, May 1994.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Retirement Planning for Clergy Without a Denominational Pension Plan

Three retirement options for pastors.

Richard R. Hammar, Attorney, CPA

Bio

Church Finance Today

Retirement Planning for Clergy Without a Denominational Pension Plan

Three retirement options for pastors.

Richard R. Hammar

Many ministers and church lay workers are not associated with a denomination that sponsors a pension plan. What retirement options are available to these individuals? Consider the following:

Individual retirement accounts (IRAs). An annual IRA contribution is an excellent idea for most ministers and church staff. Employees who do not participate in an employer’s retirement plan may deduct annual IRA contributions of up to $2,000 (or 100% of compensation, whichever is less). The amount of this deduction is reduced for single employees earning over $25,000 and married employees earning over $40,000, if either the employee or the employee’s spouse participates in an employer-sponsored retirement plan. The interest earnings on all IRAs continues to be tax-deferred whether or not the annual IRA contribution deduction is reduced or eliminated. Most IRAs are set up with a bank, or with a mutual fund company. IRAs are perhaps the ideal retirement plan for ministers and church staff who (1) are not associated with a church or denomination that sponsors a retirement plan, and (2) cannot afford to contribute more than $2,000 per year into a retirement plan.
Tax-sheltered annuities (TSAs or “403(b)” plans). Churches that are not associated with a denomination that sponsors a pension plan should consider creating a tax-sheltered annuity plan for their ministers and lay workers. Unfortunately, the rules associated with TSAs are complex, and often require professional assistance. However, the benefits provided under these plans are significant, and merit serious consideration. Most employees are able to make annual contributions far above the IRA limits (discussed in the previous paragraph). Many mutual fund companies will help you establish your own TSA.
Rabbi trusts. A rabbi trust is an arrangement that can provide tax sheltered retirement income for clergy and church workers. Generally, rabbi trusts are used only for those ministers and church workers who would like to contribute more to a retirement plan that is permissible under either an IRA or TSA. Churches can adopt a model rabbi trust published by the IRS in 1992. The model IRS rabbi trust is reproduced in chapter 9 of Richard Hammar’s annual Church and Clergy Tax Guide, along with a discussion of the advantages of this type of retirement plan.

This article originally appeared in Church Treasurer Alert, May 1994.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Jury Finds Two Youth Workers Negligent—Assesses $7.1 Million

What churches should learn from a recent Oregon case.

Richard R. Hammar, Attorney, CPA

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Church Finance Today

Jury Finds Two Youth Workers Negligent—Assesses $7.1 Million

What churches should learn from a recent Oregon case.

Richard R. Hammar

An Oregon jury awarded $7.1 million in damages to a boy who became a quadriplegic as a result of injuries he suffered during a touch football game at a scouting activity. The boy, who was 16 at the time of the injury, was returning a kickoff when he was tackled and broke his neck. He sued national and regional scouting organizations, claiming that they were responsible for his injuries on the basis of negligent supervision and negligent training of volunteer workers. A court dismissed the lawsuit, and the victim then sued two adult volunteers who were present at the event. A jury awarded $7.1 million in damages against the two volunteers on the basis of negligence. The case is being appealed.

Relevance to church treasurers. While this case involved a scouting organization, it is directly relevant to churches. Churches often engage in sporting activities for both youth and adults. Church treasurers should note the following:

Negligent selection, supervision, or training. While the lawsuit against the scouting organizations was dismissed in the Oregon case, it is possible for a church to be sued as a result of an injury occurring during a youth activity on the basis of negligent selection, negligent supervision, or negligent training. Negligent selection means that a church failed to exercise reasonable care in the selection of workers. Negligent supervision means that a church failed to exercise reasonable care in the supervision of workers. Negligent training means that a church failed to exercise reasonable care in the training of workers. It is critical for church treasurers, along with other church leaders, to evaluate their procedures (if any) for selecting, supervising, and training youth workers. Are such procedures adequate? If a child is injured during a church activity, would a jury conclude that your procedures for selecting, supervising, or training workers (whether paid or volunteer) are sufficient? Is it possible that a jury would conclude that your church failed to exercise proper care? If so, you should immediately address this concern.
Unpaid volunteer workers who are in charge of youth activities may be personally liable for injuries that occur. Ordinarily, liability will be based on negligent supervision. This means that the volunteers failed to exercise reasonable care in the supervision of the activity.
Insurance. Do you know whether or not your church liability insurance policy covers volunteers? You should. If you are unsure, review your policy and discuss it with your agent.
Limited immunity. Some states provide limited immunity to unpaid volunteers who assist nonprofit organizations. Such laws generally provide that a volunteer cannot be legally responsible for injuries that are caused by his or her ordinary negligence. You may want to find out if your state has enacted such a law. If so, it will provide some protection for volunteer workers. Note, however, that such laws ordinarily do not protect against gross negligence, and it is possible that a jury would conclude that some injuries are caused by a volunteer’s gross negligence.
Parental consent forms. Does your church require that a form be signed by parents or legal guardians of all minors that (1) consents to their child participating in the customary activities of the youth group (such activities should be described); (2) certifies that their child is able to swim; (3) lists those activities that their child is not permitted to participate in; (4) lists any medical condition or allergy that may be relevant to a health care professional in the event of an injury; and (5) authorizes a designated adult worker to make emergency medical decisions on behalf of the child in the event the parents or guardians cannot be located. Have a local attorney prepare such a form for you if you do not already have one.

This article originally appeared in Church Treasurer Alert, April 1994.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Purchase of a Personal Computer as a Business Expense

Recent ruling clarifies business expense requirements.

Richard R. Hammar, Attorney, CPA

Bio

Church Finance Today

Purchase of a Personal Computer as a Business Expense

Recent ruling clarifies business expense requirements.

Richard R. Hammar

Bryant v. Commissioner, T.C. Memo. 1993-597

Many ministers have purchased a personal computer. Is the cost of a computer a deductible business expense? Can a church reimburse such a purchase under an accountable expense reimbursement arrangement? These are important questions that many church treasurers have asked. A recent Tax Court ruling provides some helpful guidance.

Facts. A public school required that all teachers prepare report cards in a new computerized format. The school purchased several personal computers and made them available to teachers. One teacher purchased her own personal computer (at a cost of $3,200) so that she could prepare report cards and evaluations at home. She deducted the full cost of the computer as a business expense. The IRS audited the teacher and denied the deduction. The IRS pointed out that the cost of a personal computer cannot be deducted by an employee as a business expense unless the computer is required “as a condition of employment” and is “for the convenience of the employer.” The teacher claimed that she satisfied these requirements since the school had not purchased an adequate number of computers and that the only time she could use school computers was after hours (when it was unsafe to remain on school premises). Further, the school had encouraged teachers to buy their own computers.

The court’s ruling. The Tax Court agreed with the IRS that the teacher was not entitled to deduct the cost of her computer as a business expense. For an employee’s purchase of a personal computer to be a deductible business expense, both of the following tests must be met:

Use of the computer in your home must be “for the convenience of your employer”. This means that you can clearly demonstrate that you cannot perform your job without the home computer. The fact that the computer enables you to perform your work more easily and efficiently is not enough. Further, you must prove that the computers available at your place of employment are insufficient to enable you to properly perform your job.
Use of the computer in your home is required as a “condition of your employment”. This means that you must not be able to properly perform your duties without the computer. It is not necessary that your employer explicitly requires you to use the computer. On the other hand, it is not enough that your employer merely states that your use of the home computer is a condition of your employment.

If you are an employee and you meet both tests described above then you can claim a “section 179” deduction in the year of purchase for the cost of the computer (up to $17,500) attributable to business use if you use your home computer more than 50% of the time during the year in your work.

The Tax Court concluded that the teacher did not satisfy these tests. It observed: “Although a computer was needed for [the teacher] to file her reports and evaluations, the school had computers which could be used for this purpose. Furthermore, we note that … there were several … teachers who did not own personal computers and, nonetheless, they were able to file timely reports and evaluations. In short, it is amply clear on this record that a personal computer was not required for the proper performance by lower school teachers of their employment duties. Although it may have been more convenient for [the teacher] to use her own personal computer, we must, as the statute requires, focus on the convenience of the employer and not the convenience of the employee.”

Application to churches and clergy. Ministers who purchase a personal computer for in-home use will not be able to deduct any of the cost as a business expense unless they meet both the “condition of employment” and “convenience of the employer” tests summarized above. The Tax Court cautioned that these tests cannot be met by a self-serving statement from a church. It noted that “a mere statement by the employer that the use of the property is a condition of employment is not sufficient.” On the other hand, if both tests are met, then that portion of the cost of the computer attributable to business use is a legitimate business expense. If it is paid by a minister, then this cost can be reimbursed by the church. If the church has an accountable expense reimbursement arrangement (it only reimburses business expenses that are adequately substantiated within a reasonable time) then the amount of the reimbursement need not appear on the minister’s W-2 form and the minister will not claim any deduction on Schedule A. The minister is reporting to the church rather than to the IRS. If the church reimburses the cost of the computer without adequate substantiation, then the reimbursement is nonaccountable and the full amount must be added to the minister’s W-2. The minister can deduct the cost of the computer as a miscellaneous employee business expense on Schedule A (to the extent such expenses exceed 2 percent of adjusted gross income). If a minister receives no reimbursement from the church for the cost of the computer, then a deduction is available only as a miscellaneous employee business expense on Schedule A. Similar rules apply to self-employed ministers (except that they deduct nonaccountable expenses and unreimbursed expenses directly on Schedule C).

Section 179 of the Internal Revenue Code permits the full cost of a computer (up to $17,500) to be deducted in the year of purchase, but only if the computer is used more than 50 percent of the time for business use. Obviously, it is essential for ministers to keep records (such as a time log) documenting the percentage of business use if they plan to claim a section 179 deduction.

If the purchase of a personal computer satisfies the “condition of employment” and “convenience of the employer” tests summarized above, then the business expense deduction is limited to the actual business use of the computer. It is essential for the minister to maintain records substantiating the percentage of time the computer is used for business as opposed to personal purposes. A business expense deduction is limited to the business use percentage. For example, if the computer costs $3,000, and it is used 70 percent of the time for business use, a deduction (or business expense reimbursement) is limited to $2,100 ($3,000 x 70 percent). Obviously, for a church to reimburse a minister’s purchase of a personal computer under an accountable arrangement, it will need substantiation of the business use percentage.

Key point. Church treasurers should be familiar with the following rules:

If your church has an accountable expense reimbursement arrangement (you only reimburse those business expenses that are adequately substantiated), do not reimburse a minister’s purchase of a personal computer unless the “condition of employment” and “convenience of the employer” tests are satisfied, and the minister substantiates the business use percentage with written records. Reimburse only the cost of the computer (up to $17,500) multiplied times the substantiated business use percentage. This amount is not included on the minister’s W-2 or Form 1040.
If your church does not require adequate substantiation of reimbursed business expenses (a “nonaccountable” reimbursement arrangement), then any reimbursement of the cost of a minister’s personal computer must be added to his or her W-2 (1099 if self-employed) as taxable income. A deduction is available only as a miscellaneous business expense on Schedule A (or Schedule C for self-employed clergy).
If both the “condition of employment” and “convenience of the employer” tests are not satisfied, then any reimbursement of the cost of a personal computer is taxable income and must be added to the minister’s W-2 (or 1099 if self-employed). The minister will not be eligible for any business expense deduction.

This article originally appeared in Church Treasurer Alert, April 1994.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Designated Contributions to a Scholarship Fund

Potential tax pitfalls can impact gifts designated to specific individuals.

Richard R. Hammar, Attorney, CPA

Bio

Church Finance Today

Designated Contributions to a Scholarship Fund

Potential tax pitfalls can impact gifts designated to specific individuals.

Richard R. Hammar

IRS Letter Ruling 9405003

The IRS has issued a private letter ruling that provides helpful guidance to churches on a controversial and confusing issue—designated contributions.

The problem. Churches receive a variety of designated contributions during the year. Common examples—contributions that designate a specific project or activity (such as the building fund, or a new van), or a particular missionary, student, or needy family. Are these contributions fully deductible by donors? Should the church issue donors a receipt or list the contributions on the donors’ annual contributions statements? These are questions that many church treasurers have asked.

Background. A religious organization solicits contributions from family members and other interested persons to apply toward the tuition expenses of seminary students. Interested parents and family members send in contributions to the organization on behalf of a designated seminary student, and the organization transfers the funds to the student for his or her seminary expenses (less a nominal administrative fee). Most donors give a certain amount every month for the support of a particular student. Literature published by organization states that:

As with all Christian corporations for which donations qualify for tax-exempt status with the Internal Revenue Service, contributions must be directed to [the organization]. A check should not contain the name of the [student] for whose ministry it is given; instead the student’s name should be designated on the envelope or a separate paper. Although the disposition of all contributions rests with the board of directors, [the organization] honors the donor’s designation whenever possible. If it is not possible, [the organization] notifies the donor about the situation.

The organization’s policy manual states that “because of the nonprofit status of [the organization] the distribution of all contributions rests with the board of directors. However, [the organization] takes donors’ designations into account as a matter of accountability and integrity.”

The organization claimed that donors’ contributions for specified seminary students were fully deductible since the organizations’ board of directors reserved the final authority to distribute all contributed funds.

The IRS ruling. The IRS disagreed, noting that “an individual taxpayer is entitled to a deduction for charitable contributions or gifts to or for the use of qualified charitable organizations, payment of which is made during the taxable year.” It added, “[i]n addition, a gift is not considered a contribution ‘to’ a charity if the facts show that the charity is merely a conduit to a particular person.” The IRS then quoted from a 1962 ruling in which it observed:

If contributions to the fund are earmarked by the donor for a particular individual, they are treated, in effect, as being gifts to the designated individual and are not deductible. However, a deduction will be allowable where it is established that a gift is intended by a donor for the use of the organization and not as a gift to an individual. The test in each case is whether the organization has full control of the donated funds, and discretion as to their use, so as to insure that they will be used to carry out its functions and purposes. In the instant case, the son’s receipt of reimbursements from the fund is alone insufficient to require holding that this test is not met. Accordingly, unless the taxpayer’s contributions to the fund are distinctly marked by him so that they may be used only for his son or are received by the fund pursuant to a commitment or understanding that they will be so used, they may be deducted by the taxpayer in computing his taxable income. Revenue Ruling 62 113.

The IRS concluded that contributions designating seminary students did not satisfy this test:

In the present case, the taxpayers’ contributions to [the organization] were earmarked for the student not only through the use of account numbers which link donors to seminarians, but also by indicating the student’s name on the contribution envelopes. Further, the organization’s literature indicates that it will make every effort to use the contributions as the donor requests “as a matter of accountability and integrity.” These facts indicate that the program is set up so that donors would expect that their contributions will go to the designated seminarian. Thus, the donor reasonably intends to benefit the individual recipient. In addition, taxpayers in this case have stated that they would not have made donations to this particular organization if their son had not been associated with it. Taxpayers’ intended their donations to support their son and expected that their son would receive the contributions they made to the organization. It follows from these facts that the organization does not have full control of the donated funds. Thus, under the standard enunciated by Revenue Ruling 62 113 … the contributions made by taxpayers to the organization are not deductible … because they not only are earmarked but also are received subject to an understanding that the organization will use the funds as the donors designate and because the taxpayers intended to benefit the designated individual rather than the organization.

The IRS rejected the organization’s claim that the parents’ donations were deductible since the organization exercised “control” over their distribution. The IRS observed: “[T]he organization’s statement in their literature that the disposition of all contributions rests with the board of directors is not sufficient to demonstrate control. In fact, the organization in this case refutes its own statement of control by going on to say that it considers designations by donors as a matter of accountability.”

Key point. The IRS concluded that “contributions” on behalf of specific seminary students were not deductible because: (1) the contributions designated a specific student; (2) donors understood that their contributions would benefit the students they designated; and (3) the parents intended to benefit designated children rather than the school. This is a useful test for evaluating the deductibility of contributions to churches and schools that earmark a specific student.

In conclusion, contributions by parents and others that designate a particular student are not deductible even if the school (or other organization) purports to retain full control over the distribution of those contributions. A mere statement that the school exercises control is not enough.

Key point. To be tax-deductible, a charitable contribution must be to (or for the use of) a charitable organization. Contributions that designate a specific project or fund (building fund, new organ) are tax-deductible since they clearly are made to a church.

Missionaries. What is the impact of the IRS ruling on other kinds of designated contributions? Are contributions that designate a specific missionary tax-deductible? What about contributions that designate a needy family? Several courts have ruled that contributions to churches and missions boards that designate a specific missionary will be tax-deductible so long as the church or mission maintains full administrative and accounting control over the donated funds. As the IRS said in its 1962 ruling (quoted above) “[t]he test in each case is whether the organization has full control of the donated funds, and discretion as to their use, so as to insure that they will be used to carry out its functions and purposes.” The IRS acknowledged in its recent ruling such designated missions offerings generally are deductible.

Benevolence funds. What about benevolence funds? Many churches have established benevolence funds and solicit designated contributions with the understanding that the church maintains full control over the distribution of the contributions. The recent IRS ruling makes the deductibility of such designated benevolence contributions more questionable. Recall that the IRS concluded that “contributions” on behalf of specific seminary students were not deductible because: (1) the contributions designated a specific student; (2) donors understood that their contributions would benefit the students they designated; and (3) the parents intended to benefit designated children rather than the school. If this test were applied to designated benevolence contributions, they ordinarily would be non-deductible even if the church claimed to exercise full control over the contributions.

Examples. The relevance of the IRS ruling is illustrated by the following examples.

Example. A church operates a school and charges annual tuition of $2,000. A parent contributes $2,000 to the school’s scholarship fund, and specifies that the contribution be used for his child’s tuition (who attends the school). This “contribution” is not deductible. The church or school should so inform the parent at the time of the contribution, and should decline the check.

Example. Same facts as the previous example, except that the donor is a neighbor rather than the student’s parent. The result is the same.

Example. A church establishes a scholarship fund to assist members who are attending seminary. A parent of a seminary student contributes $5,000 to the fund, with the stipulation that the contribution be applied toward her son’s seminary tuition. Based on the recent IRS ruling, this contribution would not be deductible if the parent understood that her contribution would benefit her son and the parent intended to benefit her son rather than the school (this can be established by asking the donor whether or not she would have contributed to the scholarship fund if her son were not a seminary student).

Example. A taxpayer made a contribution to a college and identified the individual student that he wished to benefit from the funds. The taxpayer stated, “I am aware that a donation to a scholarship fund is only deductible if it is unspecified, however, if in your opinion and that of the authorities, it could be applied to the advantage of Mr. Robert F. Roble, I think it would be constructive.” A federal appeals court held that the intent to benefit a particular person prevented a charitable contribution deduction, even though the person was unrelated to the taxpayer, and the person might have been an appropriate scholarship recipient had the college used its own funds. The IRS referred to this decision in its recent ruling. Tripp v. Commissioner, 337 F.2d 432 (7th Cir. 1964).

Example. A member contributes $2,000 to a scholarship fund. The donor does not designate any student, but rather leaves the distribution of her contribution to the discretion of the school’s scholarship committee. This contribution is tax-deductible.

Example. A member contributes $1,000 to a church building fund. This contribution is tax-deductible since it is to a church rather than to a specific individual.

How church treasurers should respond. What should you do when a member attempts to contribute a check for a specified missionary, student, staff member, or benevolence recipient and you know (on the basis of the above information) that the “contribution” is not tax-deductible? There are a number of alternatives, including the following:

Simply refuse to accept the check. This is appropriate when the donor does not indicate on the face of the check that it is for the specified recipient (e.g., the designation is made orally or in an accompanying note or letter). The possibility in such cases is that the donor will deduct the “contribution,” and that the IRS would not be able to question the deduction because the check is made payable to the church (without any reference to the designation). In order to prevent such potential abuse it is essential for church treasurers not to accept such checks.
Accept the check but stamp it “NONDEDUCTIBLE” on its face in red ink. This would prevent the donor from claiming a charitable contribution deduction. Churches that choose this alternative should have an appropriate stamp made by a local printing company.
Place an asterisk on the contribution summaries provided to church members by all contributions that are not deductible. This alternative is not sufficient, since a donor can substantiate a charitable contribution (of less than $250) with a canceled check. If a donor’s designation does not appear on a check, and the check is accepted by the church and not stamped “NONDEDUCTIBLE,” it is possible for the donor to claim a deduction with little risk of it being disallowed. The church would be contributing to the possibility of an impermissible charitable contribution deduction in such cases by adopting the third alternative.

The effect of a private letter ruling. A private letter ruling is addressed only to the party who requests it, and it is of no legal value in other cases. In fact, it cannot even be cited as precedent in other cases. However, such rulings are issued by the IRS national office and often are viewed as indicators of how the IRS would rule in similar cases.

IRS Offers Further Guidance on Designated Contributions

In another recent pronouncement, the IRS provided the following guidance with regard to charitable contributions designated by donors for earthquake assistance: “The IRS has received questions regarding the tax consequences of private efforts to provide relief to victims of the earthquake [in Los Angeles] including related disasters such as fires resulting from earthquake damage …. Contributions earmarked for Los Angeles earthquake relief that are made to organizations currently recognized by the IRS as tax exempt under section 501(c)(3) of the Internal Revenue Code are fully deductible as charitable contributions. However, the tax law does not allow taxpayers to deduct contributions earmarked for relief of any particular individual or family.” This announcement illustrates an important principle—to be deductible, a charitable contribution must be made to (or for the use of) a charity, and not to a private individual.

This article originally appeared in Church Treasurer Alert, March 1994.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Keeping Church Records (Part 1)

When to keep and when to toss your church’s records.

Richard R. Hammar, Attorney, CPA

Bio

Church Finance Today

Keeping Church Records (Part 1)

When to keep and when to toss your church’s records.

Richard R. Hammar

If you are like most church treasurers, you probably have asked yourself a number of times how long you should keep church records. After all, church offices can become overwhelmed by records and forms. Unfortunately, there is no easy answer to this question. This article is the first in a series of articles in Church Treasurer Alert! that will summarize recordkeeping rules for several kinds of church records. In this article, we will be addressing corporate and tax recordkeeping rules. In future articles we will addressing recordkeeping recommendations for several other categories of records including employment, insurance, correspondence, contracts, property, financial, vehicles, members, investments, and legal.

Churches approach recordkeeping in a number of ways. Some retain records “forever” just in case they may be needed even though some records have not been looked at in years. Others react to growing piles of clutter by going on occasional “search and destroy” missions. Some churches have adopted the rule that “if it hasn’t been touched in one year, then throw it out.” None of these rules is either appropriate or desirable. It is possible to keep some records too long—well beyond what is required by law. In some cases this can result in the retention of records that might be harmful in future litigation. On the other hand, disposing of records too soon can lead to unanticipated problems—both with various state and federal government agencies and in future lawsuits.

What is needed is a records retention policy based on applicable legal considerations and your church’s needs that will make records retention and disposal decisions systematic and rational. The “guesswork” and arbitrary nature of record retention decisions must be replaced with a sound and consistent policy. The table reproduced in this newsletter will assist you in developing such a policy with regard to corporate and tax records.

Tip. You can use the chart as a quick glossary of commonly used terms.

Tip. In establishing a records retention policy you should consider a number of factors in addition to how long to keep records. These include: (1) when to make copies of records, (2) maintaining the security of records (especially records you plan to keep permanently), including backups of computer records, and (3) developing a record retention schedule (a document that summarizes records, lists how long you plan to keep them, and indicates where they are kept).

Here are some additional factors to consider in developing a records retention policy for your church:

Make an inventory of existing records.
The church board should develop and approve your records retention policy.
Your records retention policy should be reviewed by a local attorney (who can check local and state requirements), a CPA, and your insurance agent.
There are many reasons to keep church records. These include legal requirements, potential relevance in future litigation, the needs of the organization, and historical importance. The table reproduced in this article suggests minimum periods of time for retaining various church records. Some of the suggested retention periods are based on legal requirements, while others are based on practical considerations. You may want to keep some records longer than the table suggests.
Some organizations maintain a “destruction of records journal”. When the period of time for keeping a record has expired, the record is described in the journal before being destroyed.
Do not destroy records, even when the period for keeping them has expired, if they may be relevant in pending or threatened litigation or in pending or threatened government (including IRS) investigations.
Generally, the period for keeping tax records corresponds to the period of time that the IRS can conduct an audit and assess back taxes. Note however that there is no limit on how far back the IRS can assess taxes in cases of fraud, filing a false return, willfully attempting to evade tax, or failing to file a return. Each church must review this list carefully. If there is any possibility that you are guilty of any of the conditions that trigger the “unlimited” assessment period, then you should keep relevant records permanently.

CHURCH RECORDS—HOW LONG TO KEEP THEM

CORPORATE AND TAX RECORDS

category	document	description	how long to keep (minimum)
corporate	charter (articles of incorporation), including amendments	a legal document (usually issued by the secretary of state) confirming corporate status	permanently
corporate	constitution or bylaws	rules of internal church administration	permanently
corporate	certificate of incorporation	document issued by secretary of state confirming incorporation	permanently
corporate	certificate of good standing	document issued by secretary of state confirming current corporate status	permanently
corporate	minutes	summaries of membership and board meetings	permanently
corporate	annual corporate reports	required annually by some state nonprofit corporation laws (in some states, a corporation can “lapse” for failure to submit this form)	permanently
tax	Form W-2 (the employer’s copy of forms issued to employees)	reports wages paid and taxes withheld	4 years after the due date of the tax for the return period to which the records relate, or the date such tax is paid, whichever is later
tax	Form W-4	employees report withholding allowances on this form, to assist their employer in determining the amount of taxes to be withheld (wages of minister-employees are exempt from withholding, but clergy can elect voluntary withholding by submitting a completed W-4 form to their employing church); all nonminister employees should complete this form	4 years after the due date of the tax for the return period to which the records relate, or the date such tax is paid, whichever is later
tax	Form 941	used by employers to report to the IRS wages paid to employees each quarter, and both income taxes and FICA taxes withheld; churches must file this form quarterly with the IRS if they have at least one employee (the amounts reported on a church’s W-2 forms at year-end must reconcile with the 941 forms filed during the year)	4 years after the due date of the tax for the return period to which the records relate, or the date such tax is paid, whichever is later
tax	Form 941E	churches that have filed a timely election to exempt themselves from employer FICA taxes (Form 8274) use this form to report to the IRS wages paid to employees each quarter, and income taxes withheld	4 years after the due date of the tax for the return period to which the records relate, or the date such tax is paid, whichever is later
tax	Form 990-T	tax return for exempt organizations, including churches, engaged in an unrelated trade or business	3 years after the due date of the return
tax	Form 1023	(1) application for IRS recognition of exemption from federal income taxes; (2) your church may not have this form since churches are not required to file it (although doing so is helpful in confirming the deductibility of members’ donations), and it is unnecessary if you are covered by a denomination’s “group exemption”	permanently
tax	Form 1099-MISC	used to report payment of nonemployee compensation of $600 or more during any one year to the same individual; churches use this form to report compensation of $600 or more paid to self-employed clergy or any other self-employed worker, including itinerant evangelists and guest speakers (some exceptions apply)	4 years after the due date of the tax for the return period to which the records relate, or the date such tax is paid, whichever is later
tax	Form 5578	used by private schools (including preschools, elementary and secondary schools, and colleges), even if church-affiliated, to certify compliance with federal nondiscrimination requirements (due by the 15th day of the 5th month following the close of each fiscal year)
tax	Form 8274	(1) used by churches, and some other religious organizations, to elect exemption from the employer’s share of FICA taxes; (2) electing organization must be opposed, on the basis of religious convictions, to payment of the employer’s share of FICA taxes; (3) the form was due by October 30, 1984 for any employer having at least one nonminister employee as of July of 1984; for other employers, the due date is one day before the due date of the first 941 reporting nonminister wages; (4) effect of the form is to convert all nonminister employees into self-employed persons for social security purposes (they pay the self-employment tax); (5) the form is revocable	permanently
tax	Form 8282	used by churches to report to the IRS the sale, consumption, or other disposal of donated property originally valued by the donor in excess of $5,000; must be filed if the donated property was sold, consumed, or otherwise disposed of within 2 years of the contribution	6 years after the donor filed a tax return for the year in question, or the date the tax was due, whichever is later
tax	offering envelopes	used by many church members to substantiate their contributions of cash and checks (for individual contributions of less than $250)	6 years after the donor filed a tax return for the year in question, or the date the tax was due, whichever is later
tax	church’s contribution receipts	church’s contribution receipts	6 years after the donor filed a tax return for the year in question, or the date the tax was due, whichever is later
tax	receipts and other evidence substantiating employee business expense reimbursements	accountable business expense reimbursement arrangements require a church to reimburse only those worker business expenses that are properly substantiated with adequate records; such records include receipts, logs, and diary entries	6 years after the donor filed a tax return for the year in question, or the date the tax was due, whichever is later
tax	housing allowance designations	ministers are able to exclude from taxable income (for federal income tax reporting purposes) the portion of their church compensation that is designated in advance by the church as a housing allowance, to the extent the allowance is used to pay for housing expenses	6 years after the minister filed a tax return for the year in question, or the date the tax was due, whichever is later

This article originally appeared in Church Treasurer Alert, February 1994.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.