Jury Finds Two Youth Workers Negligent—Assesses $7.1 Million

What churches should learn from a recent Oregon case.

Richard R. Hammar, Attorney, CPA
Bio
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.
Posted:

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
categorydocumentdescriptionhow long to keep (minimum)
corporatecharter (articles of incorporation), including amendmentsa legal document (usually issued by the secretary of state) confirming corporate statuspermanently
corporateconstitution or bylawsrules of internal church administrationpermanently
corporatecertificate of incorporationdocument issued by secretary of state confirming incorporationpermanently
corporatecertificate of good standingdocument issued by secretary of state confirming current corporate statuspermanently
corporateminutessummaries of membership and board meetingspermanently
corporateannual corporate reportsrequired annually by some state nonprofit corporation laws (in some states, a corporation can “lapse” for failure to submit this form)permanently
taxForm 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
taxForm W-4employees 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 form4 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
taxForm 941used 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
taxForm 941Echurches 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 withheld4 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
taxForm 990-Ttax return for exempt organizations, including churches, engaged in an unrelated trade or business3 years after the due date of the return
taxForm 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
taxForm 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
taxForm 5578used 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)
taxForm 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 revocablepermanently
taxForm 8282used 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 contribution6 years after the donor filed a tax return for the year in question, or the date the tax was due, whichever is later
taxoffering envelopesused 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
taxchurch’s contribution receiptschurch’s contribution receipts6 years after the donor filed a tax return for the year in question, or the date the tax was due, whichever is later
taxreceipts and other evidence substantiating employee business expense reimbursementsaccountable 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 entries6 years after the donor filed a tax return for the year in question, or the date the tax was due, whichever is later
taxhousing allowance designationsministers 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 expenses6 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.

Charitable Contribution Substantiation Rules

What church treasurers must know now.

Richard R. Hammar, Attorney, CPA
Bio

The rules for substantiating charitable contributions changed on January 1, 1994. For a donor to deduct a charitable contribution (of cash or property) of $250 or more, several new requirements apply. The important points are: (1) donors no longer will be able to substantiate individual cash contributions of $250 or more with canceled checks; (2) the current contribution receipts provided by your church probably do not satisfy the new requirements (summarized in the table); and (3) in order for a donor to deduct contributions of $250 or more made in 1994, the donor must receive a receipt from the church by the earlier of the following two dates: the date the donor files a tax return claiming a deduction for the contribution, or the due date (including extensions) for filing the return.

The substantiation requirements vary depending on the nature of the contribution. They are summarized in the following table. Because of the complexity of the substantiation requirements, they are presented in the form of 10 rules. Simply find the rules that apply to a particular contribution, and follow the substantiation requirements described. Keep this table handy so that you can refer to it as needed.

Key point. The substantiation requirements are complex, but they are very important. Your church could provide a significant benefit to its members by sharing the information contained in this article with donors—and especially those who make contributions of noncash property.

SUBSTANTIATION REQUIREMENTS FOR CHARITABLE CONTRIBUTIONS

Note: More than one rule may apply to a particular contribution. Apply each rule that applies.

ruleForm of contributionsubstantiation requirement
1individual cash contributions of less than $250new rules do not apply; substantiate with any one of the following: (1) a canceled check; (2) a receipt or letter from the donee church showing the church’s name and the amounts and dates of the contributions, or (3) any other reliable written record showing the name of the church
2individual cash contributions of $250 or morenew rules apply; donors will not be allowed a tax deduction for individual cash contributions of $250 or more unless they receive a written receipt from the church or charity that satisfies the following requirements: (1) The receipt must be in writing; (2) the receipt must identify the donor by name (a social security number is not required); (3) The receipt should list separately each individual contribution of $250 or more (do not lump all contributions together); (4) the receipt must state whether or not the church provided any goods or services to the donor in exchange for the contribution, and if so, the receipt must include a good faith estimate of the value of those goods or services; (5) 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; (6) the written acknowledgment must be received by the donor on or before the earlier of the following two dates: the date the donor files a tax return claiming a deduction for the contribution, or the due date (including extensions) for filing the return
3individual cash contributions of $75 or less that are part contribution and part payment for goods or services received in exchange (“quid pro quo” contributions)the new quid pro quo rules (Rule 4) do not apply to contributions of $75 or less, these contributions are still only deductible to the extent they exceed the value of the goods or services provided in exchange
4individual cash contributions of more than $75 that are part contribution and part payment for goods or services received in exchange (“quid pro quo” contributions)new rules apply (these are in addition to Rule 2); the church must 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 cash contributed by the donor over the value of any goods or services provided by the church in return; and (2) provides the donor with a good faith estimate of the value of the goods or services furnished to the donor

Note: a written statement need not be issued if only token goods or services are provided to the donor (generally, with a value of $62 or 2% of the amount of the contribution, whichever is less) or if the donor receives solely an intangible religious benefit that generally is not sold in a commercial context outside the donative context

5individual contributions of noncash property valued at less than $250new rules do not apply; substantiate with a receipt that lists the donor’s name, the church’s name, and date and location of the contribution, and description (but not value) of the property
6individual contributions of noncash property valued at $250 or morenew rules apply; donors will not be allowed a tax deduction for individual contributions of property valued at $250 or more unless they receive a written receipt from the church or charity that satisfies the requirements of Rule 2 (above) and that describes the property (no value needs to be stated)
7individual contributions of noncash property valued by the donor at $500 to $5,000the income tax regulations require that all donors of noncash property valued at $5,000 or less maintain reliable written records with respect to each item of donated property; the reliable written records must include the following information: (1) the name and address of the church; (2) the date and location of the contribution; (3) a detailed description of the property; (4) the fair market value of the property at the time of the contribution, including a description of how the value was determined; (5) the cost or other basis of the property; (6) if less than the donor’s entire interest in property is donated during the current year, an explanation of the total amount claimed as a deduction in the current year; (7) the terms of any agreement between the donor and church relating to the use, sale, or other disposition of the property

Note: in addition to complying with Rule 6 (above), a donor must complete the front side (Section A, Part I, and Part II if applicable) of IRS Form 8283 and enclose the completed form with the Form 1040 on which the charitable contribution deduction is claimed

8individual contributions of noncash property valued at more than $500if the donated property is valued by the donor in excess of $500, the following additional written records must be maintained by the donor: (1) an explanation of the manner of acquisition by the donor (such as by purchase, gift, inheritance, or exchange), and (2) the cost or other basis of the property immediately preceding the date on which the contribution was made; these records are in addition to the requirements discussed above in connection with individual contributions of property valued by the donor at $250 or more
9individual contributions of noncash property valued at more than $5,000in addition to complying with Rule 6 (above), a donor must obtain a qualified appraisal of the donated property from a qualified appraiser, and complete a qualified appraisal summary (the back side of Form 8283), and has the summary signed by the appraiser and a church representative; the completed Form 8283 is then enclosed with the Form 1040 on which the charitable contribution deduction is claimed
10quid pro quo contributions of noncash propertynew rules apply (these are in addition to Rule 2); see Rules 3 and 4 (above)

This article originally appeared in Church Treasurer Alert, December 1993.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

How To Handle Commuting Expenses

Helpful tips to understand this expense.

Richard R. Hammar, Attorney, CPA
Bio

Church treasurers often are confused over the proper handling of commuting expenses of church staff. What is commuting? What if a pastor stops at the hospital to visit a member on the way home? Is this commuting? What if a staff member makes more than one round-trip between home and the church in one day? Are both trips commuting? Are commuting expenses business expenses? Can they be reimbursed by the church? What is the best way for a church to treat these kinds of expenses? How should the church report reimbursements of commuting expenses?

Commuting—what is it?

Commuting refers to travel between one’s home and regular place of work. The income tax regulations state that commuting expenses are personal expenses and do not qualify as business expenses. This is so even if a worker is required to make more than one round-trip between home and work in one day. For example, if a minister must return to the church in the evening for a board meeting, this trip is commuting. A commuting trip does not become a business expense just because work is done in the car.

Trips between church and a second “business location”

Clergy and other church staff often travel between church and another business location in the community. For example, a pastor leaves the church to visit someone in a local hospital. Or, a church staff member travels from the church to a local store to purchase church supplies. These trips, from the church to a second business location, are business-related. This means that the expenses incurred in making such trips may be deductible as a business expense by the worker, or may be reimbursed by the church if it has established a business expense reimbursement arrangement.

Tip.The most desirable arrangement is for a church to establish an accountable business expense reimbursement arrangement. A reimbursement arrangement is accountable if

  1. workers are reimbursed only for those expenses that they properly substantiate (as to amount, place, location, and business nature), and
  2. workers are required to return excess reimbursements to the church.

  3. Under such an arrangement, the reimbursements are not reportable as taxable income to the workers (on their W-2 forms), and the workers have no deductions to claim. They are reporting to the church rather than to the IRS. But remember, unsubstantiated statements as to the amount of their business expenses is not enough. They must not be reimbursed unless they have sufficient substantiation as to support a deduction on their tax return. For a copy of a board resolution adopting an accountable reimbursement arrangement, see chapter 6 of Richard Hammar’s Church and Clergy Tax Guide (available from the publisher of this newsletter).

  4. Trips between a second business location and home
  5. What happens if a minister travels from church to a hospital to make a call, and then goes directly home from the hospital? Is this entire trip commuting, or simply a part of it? The miles from the church to the hospital are business-related, but the miles from the hospital to the minister’s home are non-deductible commuting expenses.

  6. Example. Rev. C is an associate minister at her church. Her home is 5 miles from church. Her round-trip commutes between her home and the church are personal commuting miles, and are never deductible. If the church has adopted an accountable business expense reimbursement arrangement, these expenses are not reimbursable since they are not business-related. If the church reimburses these expenses anyway, the full amount of the reimbursements must be included on Rev. C’s W-2 (or 1099) as taxable income. In the future, reimbursement of personal miles should be discouraged, even if the reimbursements are reported as taxable income.

  7. Example. Same facts as the previous example. Assume that Rev. C leaves work early one afternoon to call on several persons in a local hospital that is 3 miles from the church, and only 2 miles from Rev. C’s home (the hospital is between Rev. C’s home and the church). The miles between the church and hospital are business miles, and may be reimbursed by the church under a business expense reimbursement arrangement even though Rev. C has travelled 3 miles closer to her home. However, the remaining 2 miles between the hospital and Rev. C’s home are personal miles and are not reimbursable as business expenses.

  8. Example. Same facts as the previous example, except that the hospital is 3 miles from the church and 8 miles from Rev. C’s home. The entire 8 miles in travelling home from the hospital represent personal miles. On the other hand, if Rev. C returns to the church following her visit at the hospital, then these 3 miles would be business-related, and the only the remaining 5 miles to Rev. C’s home would be personal.

  9. Church reporting
  10. If the church has adopted an accountable business expense reimbursement arrangement, then it can reimburse business miles incurred by church staff at the current IRS-approved standard mileage rate of 28 cents per mile, or at any other rate the church chooses. However, if your church reimburses a staff member at a higher rate than the IRS-approved rate (28 cents per mile for 1993), then the amount of the reimbursements in excess of the 28 cent rate must be reported as taxable income in box 10 of the workers’ W-2 forms (and in boxes 12 and 14 for non-minister employees).
  11. In addition, box 17 of the W-2 form must report code “L” followed by the amount of reimbursements up to the 28-cent approved limit. Churches that reimburse mileage without adequate substantiation (a “nonaccountable” arrangement) must report all of their reimbursements as income on the workers’ W-2 forms. Workers who have unreimbursed transportation expenses, or expenses reimbursed under a nonaccountable arrangement, may be able to deduct some or all of their expenses on Schedule A (if an employee) or on Schedule C (if self-employed).
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Tax Court Narrows Definition of “Minister”

New definition requires pastors to meet three factors to qualify for tax benefits.

Richard R. Hammar, Attorney, CPA
Bio

In an unfortunate ruling, the Tax Court narrowed the definition of the term “minister” for federal tax purposes. This ruling will have an immediate impact on church treasurers and bookkeepers, since special tax and reporting rules apply to “ministers” under federal tax law. These rules include:
  • eligibility for housing allowances
  • self-employed status for social security purposes
  • exemption of wages from income tax withholding (ministers use the quarterly estimated tax procedure to pay their taxes, unless they elect voluntary withholding)
  • eligibility under very limited circumstances to exempt themselves from self-employment taxes

The Tax Court ruled that a “minister” for tax purposes is someone who is ordained, licensed, or commissioned, and who satisfies all 3 of the following factors: (1) administers sacerdotal functions (such as marriages, funerals, baptisms, communion); (2) conducts religious worship; and (3) is engaged in the “control, conduct, and maintenance” of a church or church-controlled organization (this refers to directing, managing, or promoting the activities of the church or organization).

There are many ministers who do not satisfy all three factors. Common examples include some associate pastors, youth pastors, and clergy serving in parachurch ministries. The impact of the Court’s narrow definition is illustrated in the following examples.


Example. Rev. G is youth minister at First Church. He conducts a weekly worship service for the youth of the church, and occasionally performs weddings, baptisms, and communion. Rev. G is not affected by the Court’s ruling, and remains a “minister” for federal tax purposes. As such, he is eligible for the housing allowance, his wages are exempt from income tax withholding, and he is self-employed for social security purposes with respect to his church compensation.


Example. K is the full-time music minister at her church. While her official title is “minister of music” she has never been ordained, commissioned, or licensed as a minister. She does not qualify as a minister for federal tax purposes. This is so even if she leads worship and engages in pastoral duties, since she is not ordained, commissioned, or licensed. She is not eligible for a housing allowance, she is an employee for social security purposes (the church should withhold FICA taxes from her wages), her wages are subject to income tax withholding, and she is not eligible for an exemption from self-employment taxes.


Tip. Church treasurers should never treat a minister as an employee for social security purposes. Why? Because federal law states that ministers are always self-employed for social security purposes with respect to their ministerial services. So, do not withhold FICA taxes from a minister’s wages, or report a minister’s wages as subject to FICA taxes on the W-2 form. Ministers pay the self-employment tax (the social security tax for the self-employed). This is very confusing, since most ministers are employees for federal income tax purposes. In other words, ministers have a dual tax status. Church treasurers must keep this important point in mind.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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Q&A: Will Our Tax-Exempt Status Be Jeopardized if We Encourage a Senate Confirmation of a Federal Judge?

The answer revolves around whether your church’s actions were substantial in nature and constituted an attempt to influence legislation.

Richard R. Hammar, Attorney, CPA
Bio
Will a church jeopardize its tax-exempt status by encouraging Senate confirmation of federal judicial candidates?
Possibly, concluded the IRS chief counsel’s office in a General Counsel Memorandum (GCM).
Churches jeopardize their tax-exempt status under section 501(c)(3) of the Internal Revenue Code by either (1) engaging in substantial efforts to influence legislation, or (2) intervening or participating in a political campaign on behalf of or in opposition to any candidate for public office.
But do efforts to encourage Senate confirmation of federal judicial candidates fall under either of these restrictions? The IRS concluded that such efforts cannot be characterized as intervention or participation in a political campaign on behalf of or in opposition to a candidate for public office, since the income tax regulations define a “candidate for public office” as a contestant for elective public office. Federal judges, by comparison, are not elected but rather are appointed for life by the President with the consent of the Senate.
However, the IRS concluded that efforts to encourage Senate confirmation of federal judicial candidates did constitute an attempt to influence legislation, since Senate confirmation of judicial candidates constituted “legislation” for purposes of section 501(c)(3) of the Code. The IRS reasoned that Senate confirmation is a “final action by Congress,” much like any other legislation that is enacted. Accordingly, efforts to encourage the Senate to confirm judicial candidates constitute legislative activity, and jeopardize an organization’s tax-exempt status if the efforts are substantial in nature (GCM 39694).
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Is a Minister an Employee or a Self-employed Person for Income Tax Reporting Purposes?

A recent tax court ruling addresses this issue

Richard R. Hammar, Attorney, CPA
Bio

The question of whether a minister should report his or her federal income taxes as an employee or as a self-employed person is one that has generated a good deal of controversy. It is a significant question for many reasons, including the following:
  1. Employees report their compensation directly on Form 1040, and claim unreimbursed business expenses on Schedule A only if they itemize deductions and only to the extent that such expenses (together with most other miscellaneous expenses) exceed 2% of adjusted gross income (only 80% of travel and entertainment expenses are counted). Self-employed persons report compensation and business expenses on Schedule C. Business expenses are in effect deductible whether or not the minister itemizes deductions, and are not subject to the 2% floor.
  2. Adjusted gross income ordinarily will be higher if a minister reports as an employee, since business expenses are deductions from adjusted gross income. Self-employed persons deduct business expenses in computing adjusted gross income. Adjusted gross income is a figure that is important for many reasons. For example, the percentage limitations applicable to charitable contributions and medical expense deductions are tied to adjusted gross income.
  3. Ministers working for a church or church agency should receive a Form W-2 each year if they are employees, and a Form 1099-MISC if they are self-employed (and receive at least $600 in compensation).
  4. Favorable tax-deferred annuities offered by nonprofit organizations (including churches) may only be available to employees.
  5. The disability pay exclusion generally is available only to employees.
  6. For many years, most ministers reported their income taxes as self-employed persons. This was consistent with the treatment of all ministers as self-employed for social security purposes (with respect to services performed in the exercise of ministry). However, beginning in 1978, the IRS began making statements that were interpreted by some to require ministers to report their income taxes as employees. For example, in Revenue Ruling 80-110, the IRS held that a minister who is “an employee of a church’ may not deduct unreimbursed business expenses on Schedule C but rather must use Schedule A. See also Rev. Rul. 79-78. In Publication 517 (“Social Security for Members of the Clergy and Religious Workers”), the IRS lists a comprehensive example demonstrating how a minister who is “an employee of the church” should report his income and business deductions. These pronouncements led some tax advisors to conclude that the IRS now views all ministers serving local churches as employees rather than as self-employed. Reliance has also been placed on section 3401 (a) (9) of the Internal Revenue Code which states that ministers who are employees of a church are exempt from tax withholding.
  7. Your editor has always taken the position that the IRS pronouncements mentioned above merely stated the appropriate manner of reporting income and deductions if employee status was assumed, and were not IRS directives requiring all ministers to report their taxes as employees. Publication 517 itself recognizes that it is possible for ministers who are employees of their churches to be self-employed with respect to certain services (baptisms, marriages, funerals, etc.). And, no one seriously questions that full-time evangelists are self-employed for income tax purposes. It is therefore difficult to support sweeping generalizations that all ministers are employees for income tax purposes.
  8. The best approach to this issue is to treat ministers as employees only if they satisfy the common law employee test adopted by the Treasury Department:

  9. Generally the relationship of employer and employee exists when the person for whom services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done but how it shall be done. In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if he has the right to do so. The right to discharge is also an important factor indicating that the person possessing that right is an employer. Other factors characteristic of an employer, but not necessarily present in every case, are the furnishing of tools and the furnishing of a place to work to the individual who performs the services. In general, if an individual is subject to the control or direction of another merely as to the result to be accomplished by the work and not as to the means and methods for accomplishing the result, he is not an employee. Treas. Reg. sec. 31.3401(c)-1(b). See also Publication 517.

  10. Determining a particular minister’s status under this somewhat ambiguous test is often difficult. The following additional criteria, contained in the Social Security Handbook, are intended to clarify the common law employee test. They are accompanied by the qualification that “all facts must be weighed and the conclusion must be based on careful evaluation of all the facts and the presence or absence of factors which point to an independent contractor status,” and “any single fact or small group of facts is not conclusive evidence of the presence or absence of control.”
  11. (1) A person who is required to comply with instructions about when, where, and how to work is ordinarily an employee.
  12. (2) Training of a person by an experienced employee or by other means is a factor of control and indicates that the worker is an employee.
  13. (3) Integration of a person’s services into the business operations generally shows that the person is subject to direction and control and accordingly is an employee.
  14. (4) If the services must be rendered personally by the individual employed, it suggests an employer-employee relationship. Self-employed status is indicated when an individual has the right to hire a substitute without the employer’s knowledge.
  15. (5) Hiring, supervising, and payment of assistants by the employer generally indicates that all workers on the job are employees. Self-employed persons generally hire, supervise, and pay their own assistants.
  16. (6) The existence of a continuing relationship between an individual and the person for whom the individual performs services is a factor tending to indicate the existence of an employer-employee relationship.
  17. (7) The establishment of set hours of work by the employer is a factor indicating control and accordingly the existence of an employer-employee relationship. Self-employed persons are “masters of their own time.”
  18. (8) If the worker must devote full time to the business of the employer, he or she ordinarily will be an employee. A self-employed person on the other hand may choose for whom and when to work.
  19. (9) Doing the work on the employer’s premises may indicate that the worker is an employee if the work could be done elsewhere.
  20. (10) Persons who must follow established routines and schedules of the employer ordinarily are employees.
  21. (11) A requirement that workers submit regular oral or written reports to the employer is indicative of an employer-employee relationship.
  22. (12) An employee usually is paid by the hour, week, or month, whereas a self-employed person usually is paid by the job on a lump sum basis (although the lump sum may be paid in intervals in some cases).
  23. (13) Payment by the employer of the worker’s business or travel expenses suggests that the worker is an employee. Self-employed persons usually are paid on a job basis and take care of their own incidental and business expenses.
  24. (14) The furnishing of tools and materials by the employer indicates an employer-employee relationship. Self-employed persons ordinarily provide their own tools and materials.
  25. (15) The furnishing of all necessary facilities (equipment and premises) by the employer suggests that the worker is an employee.
  26. (16) Workers who are in a position to realize a profit or suffer a loss as a result of their services generally are self-employed, while employees ordinarily are not in such a position.
  27. (17) A person who works for a number of persons or organizations at the same time is usually self-employed.
  28. (18) Workers who make their services available to the general public are usually self-employed. Individuals ordinarily hold their services out to the public by having their own offices and assistants, hanging out a “shingle” in front of their office, holding a business license, and by advertising in newspapers and telephone directories.
  29. (19) The right to discharge is an important factor in indicating that the person possessing the right is an employer. Self-employed persons ordinarily cannot be fired as long as they produce results which measure up to their contract specifications.
  30. (20) An employee ordinarily has the right to end the relationship with the employer at any time he or she wishes without incurring liability. A self-employed person usually agrees to complete a specific job and is responsible for its satisfactory completion or is legally obligated to make good for failure to complete the job.
  31. Another important factor, not mentioned in the above list, is the parties’ own characterization of their relationship. For example, if a church and its minister enter into a written contract that specifically characterizes the minister as self-employed, this would be an additional factor to consider. The accompanying illustration is a clause that may be used by a church wishing to characterize its minister as self-employed rather than as an employee. The clause could be inserted in the contract of employment, or simply adopted as a resolution by the church board and included in the board’s official minutes. Keep in mind that such a clause by itself will have little, if any, relevance. It is merely one factor that will be considered, but one that could be given considerable weight in a close case. Of course, a church will offset the effect of such a clause by issuing its minister a W-2 instead of a 1099 form at the end of each year.
  32. Sample Clause Characterizing A Minister As Self-Employed
  33. The church board and Rev. Lang agree and intend that Rev. Lang’s status shall be that of a self-employed person rather than that of an employee in view of the board’s determination, based on its review and consideration of all the facts and circumstances, that Rev. Lang does not satisfy the ‘common law employee” test. In particular, it is the board’s conclusion that it does not have the authority to control the methods or means by which Rev. Lang conducts his services on behalf of the church.
  34. There is no doubt that most ministers will be employees under “common law employee test” discussed above. However, such a conclusion is not automatic. As has already been indicated, traveling evangelists ordinarily are self-employed, as are ministers of local congregations with respect to certain personal services rendered directly to church members (baptisms, marriages, funerals, etc.). Ministers of local congregations may be self-employed with respect to their services on behalf of the church as well, provided that they are not “employees” under the common law employee test. The fact that such a conclusion is entirely possible is illustrated by a recent Tax Court ruling. In Cosby v. Commissioner, T.C. Sum. Op. 1987-141, the Tax Court concluded that a Methodist minister was not an employee of his local church but rather was self-employed, and accordingly could report his church income and all business expenses on Schedule C. The court acknowledged that the common law employee test” had to be applied in reaching a determination as to the minister’s status, and referred to most of the twenty criteria discussed above as helpful guidelines. The court relied upon the following considerations in reaching its conclusion: (1) the minister was “free to use his own methods and style in the day-to-day conduct of his activities” and was clearly ‘his own man and operated free from any substantial control”; (2) the procedures that existed for terminating the minister’s services did “not at all approximate the type of day-to-day supervision and control which is characteristic of an employer-employee relationship” and did not enable the church to “control or direct the details and means by which the desired result was to be accomplished”; (3) the minister’s seminary education represented a substantial capital investment in his profession; (4) the minister’s profession requires considerable skill; and (5) the minister and his church regarded him as self-employed rather than as an employee. The court observed that its conclusion was “bolstered by the fact that neither party, nor our own research, disclosed a single case in which a member of the clergy.., was held to be an employee of either his or her local congregation or of the hierarchical structure of his or her denomination.”
  35. In summary, a minister’s reporting status for federal income tax purposes will be determined on the basis of the common law employee test. Ministers wanting to report as self-employed persons should have their church so characterize them in their work agreement or contract, and should have the church issue them a Form 1099 rather than a Form W-2 at the end of each calendar year.
  36. Example. Rev. Perez is a retired minister who serves as an interim minister for churches in a given geographical region that are temporarily in need of ministerial services. Rev. Perez typically spends no more than three months with any particular congregation, is given great freedom with respect to the duties he performs and the manner or method of performance, and its issued a 1099 form by each church. These facts suggest that Rev. Perez could report his income and business expenses as a self-employed person on Schedule C.
  37. Example. Rev. Linn is a minister of education at First Church. She has a specific job description, her services are under the direct supervision and control of her senior pastor, she is issued a W-2 form each year, and is required to follow prescribed methods in the performance of her duties. These facts strongly suggest that Rev. Linn is an employee for income tax reporting purposes.
  38. Example. Rev. Green is senior minister at First Church. The church exercise no control over the methods, means, or results of Rev. Green’s services. Much of his work is performed off of church premises. He is issued a 1099 form each year, and his work agreement with the church characterizes him as self-employed. Under these facts, the Tax Court’s ruling in Crosby v. Commissioner (discussed above) suggests that Rev. Green is free to report his income taxes as a self-employed person.
  39. Example. Rev. Mayfield works in an administrative capacity for a church agency. Ordinarily, ministers who work in such a capacity will satisfy the definition of a common law employee since they are subject to a greater degree of control and supervision with respect to the details and performance of their duties, and accordingly should report their income taxes as employees.
  40. Example. Rev. Hoyle is a youth minister at First church. Ordinarily, ministers who work in such a capacity will satisfy the definition of a common law employee since they are subject to a greater degree of control and supervision with respect to the details and performance of their duties, and accordingly should report their income taxes as employees.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Q&A: Do Pastorial Exemptions from Social Security Hurt My Ability to Obtain Life Insurance?

The impact of opting out of Social Security

Richard R. Hammar, Attorney, CPA
Bio
I am exempt from social security coverage on the basis of my religious convictions. For many years, I have wondered if my exemption from social security prevents me from obtaining life insurance or participating in an IRA or other retirement program. Can you help?
An exemption from social security coverage requires that the applicant be opposed on the basis of religious convictions to the acceptance (with respect to services performed in the exercise of ministry) of benefits under any public insurance system (including the social security program). Income tax regulation 1.1402(e)-2A(2) provides that “the term ‘public insurance’ … refers to governmental, as distinguished from private, insurance, and does not include insurance carried with a commercial insurance carrier …” Accordingly, you are free to obtain life insurance, or invest in an IRA or most other retirement programs, despite the fact that you are exempt from social security coverage.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Q&A: When Should Our Church File a Form 990?

Six guidelines to help you file.

Richard R. Hammar, Attorney, CPA
Bio
Must our church file a Form 990 with the federal government? We have received conflicting opinions.
Your church is not required to file a Form 990 with the federal government. Section 6033 of the Internal Revenue Code requires every organization that is exempt from federal income taxes to file an annual return (Form 990) with the IRS. Form 990 consists of 89 questions requesting detailed information about the finances, service, and administration of the exempt organization. However, section 6033 exempts several organizations from the reporting requirements, including:

(1) a church, an interchurch organization of local units of a church, a convention or association of churches, an integrated auxiliary of a church (such as a men’s or women’s organization, religious school, missions society, or youth group), and certain church-controlled organizations (see Rev. Proc. 86-23)

(2) a school below college level affiliated with a church (or operated by a religious order)

(3) a mission society sponsored by or affiliated with one or more churches or church denominations, if more than one-half of the society’s activities are conducted in, or directed at persons in foreign countries

(4) an exclusively religious activity or any religious order

(5) a religious or apostolic organization described in section 501(d) of the Code

(6) and exempt organization whose annual gross receipts are normally $25,000 or less

Efforts are underway in Washington to require all religious organizations (including churches) to file an annual Form 990. You will be fully apprised of any developments in future newsletters.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Should a Minister Revoke an Exemption from Social Security Coverage?

An ethical question.

Richard R. Hammar, Attorney, CPA
Bio

Many ministers exempted themselves from social security coverage because of the advice of a consultant that they would be “better off financially” if they did not enter the system. In other words, the basis for their exemption was purely financial. Should such a minister take advantage of a provision in the Tax Reform Act of 1986 that gives ministers a limited opportunity to revoke an exemption? This is a question that I have been asked repeatedly over the past several months.

It is my opinion that a minister who claimed an exemption for which he or she was not eligible has an ethical duty to re-enter the system. This is the very reason that Congress has given ministers a limited opportunity to revoke an exemption. Congress recognized that the vast majority of ministers who obtained an exemption were in fact not eligible. To be eligible for the exemption, a minister must be conscientiously opposed, because of religious principles, to accepting social security benefits for services performed as a minister. The opposition is not to the payment of the tax, or to the perceived inadequacy of social security benefits. Opposition to receiving benefit checks upon one’s retirement or disability, and not to paying taxes to finance those benefits, is indeed an extraordinary position.

Ministers may revoke an exemption by filing a Form 2031 (revised) by April 15, 1988. Ministers electing to revoke their exemption will not be liable for back taxes and will not be asked to explain the basis for their action. One final thought—ministers should decide as early as possible whether or not to revoke an exemption from social security coverage, since they will be liable for the self-employment tax for all of 1987 if they do elect to revoke the exemption. Many ministers who put off the decision until late 1987 or early 1988 may be forced to maintain their exemption because of an inability to pay the substantial accumulated tax for all of 1987.

Ministers approaching retirement must consider an additional factor. They will not be eligible for most social security benefits unless they have ten years (forty quarters) of covered employment. Revoking an exemption within a few years of retirement therefore makes little sense. Such a minister would be paying into a system from which he or she ordinarily will receive no benefits, Ministers who plan to work at least ten more years must also recognize that under current law their benefits generally are computed on the basis of their thirty-five highest years of taxable wages. Ministers who revoke an exemption and then work only ten or twenty years prior to retirement will find their benefits reduced accordingly.

Ministers who worked at least ten years in secular employment do not lose social security benefits based on their secular earnings, even if they continue to be exempt from coverage as a clergyman. Again, however, they should recognize that each year of exempt wages will have the effect of reducing their benefits.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Computing Your Housing Allowance Exclusion

How to estimate accurately.

Richard R. Hammar, Attorney, CPA
Bio

The housing allowance is one of the most valuable tax benefits available to ministers. Yet, many ministers either fail to claim it or do not claim enough. In some cases, this results from tax advisors who are unfamiliar with ministers’ taxes. In this article, I will summarize the requirements for obtaining the full benefit available to ministers who live in a church-owned parsonage. In the next issue, I will discuss the rules that apply to ministers who rent or own their homes. Section 107 of the Internal Revenue Code says simply that “in the case of a minister of the gospel, gross income does not include—(1) the rental value of a home furnished to him as part of his compensation, to the extent used by him to rent or provide a home.” There are four important considerations to note in this section, First, the housing allowance is available only to a minister of the gospel. The income tax regulations (drafted by the Treasury Department and interpreting the Code) define a minister of the gospel to include any minister who has been ordained, commissioned, or licensed by a church or church organization that qualifies as a tax-exempt religious organization. Ministers who have been licensed by a religious organization that both licenses and ordains clergy must perform substantially all the religious functions of an ordained minister in order to qualify for the exemption.

Second, the housing allowance is an exclusion from gross income, rather than a deduction in computing or reducing adjusted gross income. As a result, it is not reported anywhere on Form 1040. In effect, the housing allowance is “claimed by not reporting it as income.

Third, section 107 excludes the fair rental value of a parsonage provided rent-free to a minister as well as an allowance paid to a minister to the extent used by him or her to pay expenses incurred in maintaining the parsonage (e.g., utilities, repairs, furnishings). Ministers who live in a church-owned parsonage do not report the fair rental value of the parsonage as income (as they ordinarily would do if they were allowed to live rent-free in a home provided by any other employer). The church is not required to declare an allowance in the amount of the fair rental value of the parsonage. The exclusion is automatic. However, if the minister incurs any expenses in living in the parsonage, then he or she may exclude them only to the extent that they do not exceed a “parsonage allowance” declared in writing and in advance by the church board.

Example. Rev. White lives rent-free at a church owned parsonage having a fair rental value of $6000 in 1986k The church expects Rev. White to incur some expenses in living in the parson age, and accordingly provides him with an allowance of $100 each month. His salary (not including the monthly allowance,) is $20,000 in 1986. On his 1986 federal income tax return Rev. White would not report the fair rental value of the parsonage ($6000) as income, even though the church never designated that amount as a housing allowance. However, he would have to report the total monthly allowances ($1200) as income unless the church board declared a parsonage allowance” in writing and in advance of at least $1200.

Suggestion. Ministers living in parsonages should be sure to have the church board declare a “parsonage allowance” in advice of each calendar year to cover any miscellaneous expenses the minister may incur in living in the parsonage. The allowance should be declared in writing and be incorporated into the board’s minutes.. The allowance can be a portion of the minister’s salary. For example, in the previous example, the church could have declared $1200 of Rev. White’s annual salary of $20,000 to be a parsonage allowance. The effect of this would have been to exclude the $1200 from gross income (to the extent Rev. White incurred expenses of at least that amount).

Churches failing to declare a parsonage allowance before January 1 should not wait until the following year to act. The declaration is effective from the date of its enactment on. Therefore, a church failing to declare a parsonage allowance until Match can still provide its minister with an important tax benefit for the remainder of the year.

Finally, section 107 requires that the parsonage be furnished to the minister as part of his or her compensation for services performed in the exercise of ministry. The regulations define “services performed in the exercise of ministry” to include (1) the performance of sacerdotal functions, (2) the conduct of religious worship, (3) direction, managing or promoting the activities of a religious organization under the authority of a church or church denomination, or (4) teaching or administrative duties at a theological seminary under the authority of a church or church denomination. A parsonage must be provided to a minister as compensation for one or more of these categories of employment in order for the minister to exclude the parsonage’s rental value from gross income.

The housing allowance is an exclusion for federal income tax purposes only. It cannot under any circumstances be excluded in computing a minister’s social security (self-employment) tax liability. Therefore, in computing the social security tax on Schedule SE of Form 1040, a minister must include the fair rental value of his or her parsonage as income on line 2 of Part 1. A minister must also include any parsonage allowance paid by his or her church to cover miscellaneous expenses in maintaining the parsonage. The rental value of a parsonage is a question of fact to be determined in each case on the basis of its particular circumstances.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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