Key point 6-04.02. A church may have a number of reporting obligations under federal law, including annual information returns to employees and self-employed workers (W-2 and 1099 forms), the quarterly employer’s tax return (Form 941), the unrelated business income tax return (Form 990-T), and the annual certification of racial nondiscrimination (Form 5578).
Federal law imposes several reporting requirements on charitable organizations. Among them are the following:
1. APPLICATION FOR RECOGNITION OF TAX-EXEMPT STATUS
Most organizations seeking recognition of exemption from federal income tax must file an application with the IRS. This is done either on IRS Form 1023 or 1024, depending on the nature of the applicant. Churches, their integrated auxiliaries, and conventions or associations of churches are exempted by law from payment of federal income tax and therefore they are not required to file an application with the IRS.141 I.R.C. § 508(c)(1)(A).Such organizations nevertheless may find it advantageous to obtain IRS recognition of exempt status since this would avoid the need of substantiating their tax-exempt status each time the IRS questions the deductibility of contributions made by a member or adherent. A church may obtain recognition of exemption in either of two ways: (1) by filing a Form 1023 with the IRS, or (2) by being a member of a convention or association of churches that has obtained a “group-exemption ruling” from the IRS.
If a church independently applies for and receives IRS recognition of exemption, it must notify the IRS of any material changes in its sources of support, purposes, character, or methods of operation. Churches that are included in the group exemption ruling of a convention or association of churches must annually notify their convention or association of any changes in their purposes, character, or methods of operation.142 The procedures for obtaining an exemption from federal income taxes are discussed in R. HAMMAR, CHURCH AND CLERGY TAX GUIDE (published annually by the publisher of this text).
2. ANNUAL INFORMATION RETURNS
Section 6033 of the Internal Revenue Code requires most tax-exempt organizations to file an annual information return with the IRS. The annual information return is IRS Form 990. This form sets forth an exempt organization’s gross income, expenses, disbursements for exempt purposes, assets and liabilities, net worth, contributions received (including the names and addresses of substantial contributors), and compensation paid to certain employees. Section 6033 provides a “mandatory exemption” for (1) “churches, their integrated auxiliaries, and conventions and associations of churches”; (2) certain religious and charitable organizations whose annual gross receipts normally do not exceed $5,000; and (3) the “exclusively religious activities of any religious order.”
Form 990 itself specifies that the following organizations are exempt from the annual information return requirement:
- “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, mission society, or youth group)”;
- “a school below college level affiliated with a church or operated by a religious order”;
- “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”;
- “an exclusively religious activity of any religious order”;
- “an organization whose annual gross receipts are normally $25,000 or less.”
3. TAX ON UNRELATED BUSINESS INCOME
Even though a church is recognized as tax-exempt by the IRS, it still may be liable for tax on its unrelated business income, that is, income from a regularly carried on trade or business that is not substantially related to the purposes constituting the basis for the church’s exemption. A church that has $1,000 or more in gross income from an unrelated trade or business must file an IRS Form 990-T. In computing unrelated business taxable income, churches are entitled to deduct all reasonable and necessary expenses directly associated with the unrelated business.143 The tax on unrelated business income is addressed in R. HAMMAR, CHURCH AND CLERGY TAX GUIDE (published annually by the publisher of this text).
4. EMPLOYMENT TAXES
Every employer, including organizations exempt from federal income tax, that pays taxable wages to employees is responsible for withholding, depositing, paying, and reporting federal income tax, and Medicare tax, and federal unemployment tax unless specifically exempted by law. Churches are exempted from paying federal and state unemployment taxes on their employees.144 I.R.C. § 3306(c)(6). The application of unemployment taxes to churches and other religious organizations is addressed in R. HAMMAR, CHURCH AND CLERGY TAX GUIDE (published annually by the publisher of this text).
A church’s obligation to withhold federal income tax and (and Medicare) tax from employees’ wages, and to deposit such withheld taxes and periodically report the amounts withheld to the IRS, generally are referred to as a church’s “payroll tax obligations.”
Compliance with the various payroll tax obligations represents the most significant reporting obligation for most churches. This is so for two very important reasons. First, the payroll reporting obligations apply to most churches. Second, there are substantial penalties for failing to comply with these requirements. For example, the church, and possibly some church board members individually, may be responsible for the payment of these taxes if they are not withheld from employee wages. As a result, it is essential for church board members to familiarize themselves with their church’s payroll tax reporting obligations, and to be certain that these obligations are being properly discharged. This is not as easy as it sounds, for several reasons.
First, churches often use volunteer treasurers or bookkeepers who serve for limited terms and are unable to devote their full time and attention to such matters. This has a tendency of making church accounting practices sloppy.
Second, a surprisingly large number of church leaders continue to assume that they are immune from legal obligations that apply to everyone else because they represent the church.
Third, the payroll tax reporting procedures are complex. In fact, one private organization presented its annual “most incomprehensible government regulation” award to tax code provisions dealing with payroll tax reporting requirements. These rules are complex, and they are even more complex in the context of church reporting—since special rules apply.
All of a church’s payroll tax reporting obligations are addressed in a companion text.145 R. HAMMAR, CHURCH AND CLERGY TAX GUIDE.
5. INFORMATION RETURNS
Churches must issue annual “information returns” to (1) all employees who were paid wages, and (2) any self-employed person to whom the church paid annual compensation of at least $600. These information returns are referred to as the W-2 and 1099-MISC forms, respectively. In addition, churches are required to issue a 1099-INT form to each person who was paid $600 or more in interest income during any one year (a $10 rule applies to certain forms of interest payments). These rules are considered fully in a companion text.146 Id.
6. ANNUAL CERTIFICATION OF RACIAL NONDISCRIMINATION
No doubt one of the most widely disregarded federal reporting obligations applicable to churches is the annual certification of racial nondiscrimination (IRS Form 5578). Any church that operates, supervises, or controls a “private school” must submit a Form 5578 each year to the IRS certifying that it operates its school in a racially nondiscriminatory manner.
The term private school is defined in the instructions to Form 5578 to include “an educational organization which 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 carried on. The term includes primary, secondary, preparatory, or high schools, and colleges and universities, whether operated as a separate legal entity or as an activity of a church. … The term also includes preschools. …” This important reporting obligation is discussed fully in a companion text.147 Id.
7. RETURNS REGARDING DISSOLUTION OR TERMINATION
Section 6043 of the Internal Revenue Code requires a corporation to file a return (Form 966) within 30 days after the adoption of any resolution or plan concerning the dissolution of the corporation. Churches, their integrated auxiliaries, and conventions and associations of churches, however, are exempted by section 6043 from this reporting requirement.
8. EEOC REPORTS
Title VII of the Civil Rights Act of 1964 prohibits employers from discriminating in any employment decision—including hiring, discharge, compensation, and the terms, conditions, or privileges of employment—on the basis of race, color, religion, sex, or national origin.148 42 U.S.C. § 2000e-2(a). See generally chapter 8, infra. Title VII applies to every employer, including churches, having 15 or more employees for at least 20 weeks in a year. Part-time employees are to be included in making the calculation. The Act does exempt religious organizations, including churches, from the prohibition against discrimination based on religion, and the United States Supreme Court upheld the constitutionality of this provision in 1987.149 Corporation of Presiding Bishop of the Church of Jesus Christ of Latter Day Saints v. Amos, 483 U.S. 327 (1987).
The Equal Employment Opportunity Commission (EEOC), an agency created by Congress to enforce Title VII of the Civil Rights Act of 1964, requires all employers, including religious organizations, having 100 or more employees to submit annually an Employer Information Report. This report is prepared on Standard Form 100, which is also known as Employer Information Report EEO-1. Among other things, this report provides the EEOC with the racial composition of the employer’s work force.