Integrating Tax Reform for 2018—and Beyond

When President Trump signed the Tax Cuts and Jobs Act of 2017 into law, ministers and other church leaders wondered about the new law’s implications for ministry in 2018 and beyond. To help churches better understand key aspects of the law and its possible effects on ministry, Richard Hammar, senior editor of Church Law & Tax Report, gave an informative webinar titled “Tax Reform and Tax Law Changes: What Church Leaders Should Know for 2018.”

For this issue of Church Law & Tax Report, we combined portions of Hammar’s analysis with insights drawn from interviews with Frank Sommerville, an attorney, CPA, and editorial advisor, and Ted Batson, an attorney and CPA with the accounting firm CapinCrouse—all with the goal of giving leaders a better understanding of what the reform does—and doesn’t—mean for churches and their employees.

“The Tax Cuts and Jobs Act retains a deduction for charitable contributions, but the deduction will be available to a smaller number of donors because of a substantial increase in the standard deduction,” said Hammar. “The significantly increased standard deduction will reduce the number of persons who are able to itemize deductions on Schedule A (Form 1040) from 30 percent to as few as 5 percent of all taxpayers. The result will be a significant decrease in the number of taxpayers who can claim a tax deduction for contributions they make to churches and other charities” (see Table 1).

The Bottom line: 95 percent of taxpayers have lost the ability to receive a charitable deduction. Many speculate that this will negatively affect giving. Will it?

“By one estimate, the increase in the standard deduction will reduce charitable giving by $13 billion,” Batson said. Whether this decline will occur depends. On the one hand, those who give because they get a tax break will tend not to give, he said. On the other hand, “churches and other religious organizations whose donors give as part of their spiritual worship are less likely to be impacted,” he pointed out. “Donors who give because they are vested in the mission of an organization are much less likely to walk away just because they will receive less benefit at tax time.”

Batson added that churches with strong and consistent teaching on biblical tithing and stewardship encourage giving for reasons other than receiving a tax deduction.

Sommerville agreed, stressing that giving is about a connection between the donor and a church. “I think that all giving comes out of relationship, period,” he said. “It’s just more difficult to have that relationship in a secular charity. It can happen … but not as frequently.”

Sommerville also pointed out that giving regularly, consistently, and generously is not about how much money someone makes.

Most givers, he said, “are in the lower income category” and have not itemized in the past.

“You must remember that 70 percent of Americans haven’t itemized in the past,” he said. “So why would we think that raising that to 95 percent is going to change anything? It’s not.”

In other words, Sommerville believes the higher standard deduction will not significantly affect church giving. “I think it’s going to have an impact on secular giving,” he reiterated. “But I think that that is even overstated because you have to have an element of generosity before you even consider a gift.”

For example, said Sommerville, consider a person who has $100 to give to a charity. “If you itemize, you covered maybe 15 or 20 percent of that, but you’re still 85 percent or 80 percent out-of-pocket,” he said.

Sommerville also pointed out that a simplified tax code means that the IRS will no longer need to audit itemized deductions—a bonus savings for the government. “Ninety-five percent of Americans aren’t going to have deductions, so there’s nothing left to audit. And it greatly lessens the cost of checking compliance.”

Changes in the tax code will mean more take-home pay for many people. This could actually lead to greater giving. The seven new percentages for withholding are 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent, and 37 percent. The past percentages were 10 percent 15 percent, 25 percent, 28 percent, 33 percent, 35 percent, and 39.6 percent (see Table 2 on page 4 for a breakdown of 2018 withholdings by weekly, biweekly, semimonthly, and monthly payroll periods).

“Many of those in the lower-to-mid-income level will see an increase in their take-home pay,” Sommerville said. And remember, he added, that a lot of people tithe off of their take-home pay rather than their gross income.

Sommerville sees this an opportunity for churches to ask their congregants to increase their giving because they now have a larger paycheck. “Maybe a church needs to increase its offering or missions giving or children’s ministry or some other area,” he said.

For larger donors who want to receive a deduction, Hammar discussed the possibility of “bunching,” in which a donor could cover a couple of years of giving in a year’s time.

“Some tax advisors are recommending that donors consider ‘bunching’ their contributions to charity, making no contributions in one year, and doubling contributions in the next so that the augmented amount will exceed the standard deduction and allow persons to deduct their contributions as an itemized deduction,” Hammar said. “Whether this strategy will gain traction with church members remains to be seen.”

Sommerville thinks this strategy could work for a church that takes pledges from its members and then creates a budget based on those pledges. He offered this example:

Batson recalled a donor who actually let his church know in December of 2017 that he was going to write a check that would fulfill his donations for 2018 and 2019. While donating a large amount in this manner would receive the benefits of a tax deduction ahead of time, Batson said the situation poses a theological question.

“Is it possible to prepay the ‘first fruits’ of your giving ahead of time or must you receive your first fruits and pay it?” Batson asked.

Theological questions aside, there is also the issue of creating a budget around this type of contribution strategy. “In terms of managing cash flow, the approach might not be very favorable for many churches,” he said. That is, it would be difficult for a lot of churches to work bunching into their year-to-year budgeting plans.

Then there is simply the fact that bunching is not an option for most givers. Hammar stressed that such an approach “would only be appealing to the 5 percent of taxpayers whose contributions exceed their standard deduction.”

“Some very wealthy people do this,” Sommerville said. “But I don’t think there’s going to be many that do this. Typical members in the pew aren’t going to be able to do that.”

WEEKLY PAYROLL PERIOD(a) Single person (including head of household)—(b) Married person—If the amount of wages (after subtracting withholding allowances) is:The amount of income tax to withhold is:If the amount of wages (after subtracting withholding allowances) is:The amount of income tax to withhold is:Not over $71 … … . .$0Not over $222 … … . .$0Over—But not over—Of excess over—Over—But not over—Of excess over—$71$254$0.00 plus 10%$71$222$588$0.00 plus 10%$222$254$815$18.30 plus 12%$254$588$1,711$36.60 plus 12%$588$815$1,658$85.62 plus 22%$815$1,711$3,395$171.36 plus 22%$1,711$1,658$3,100$271.08 plus 24%$1,658$3,395$6,280$541.84 plus 24%$3,395$3,100$3,917$617.16 plus 32%$3,100$6,280$7,914$1,234.24 plus 32%$6,280$3,917$9,687$878.60 plus 35%$3,917$7,914$11,761$1,757.12 plus 35%$7,914$9,687… … … …$2,898.10 plus 37%$9,687$11,761… … … . .$3,103.57 plus 37%$11,761

BIWEEKLY PAYROLL PERIOD(a) Single person (including head of household)—(b) Married person—If the amount of wages (after subtracting withholding allowances) is:The amount of income tax to withhold is:If the amount of wages (after subtracting withholding allowances) is:The amount of income tax to withhold is:Not over $142 … … . .$0Not over $444 … … . .$0Over—But not over—Of excess over—Over—But not over—Of excess over—$142$509$0.00 plus 10%$142$444$1,177$0.00 plus 10%$444$509$1631$36.70 plus 12%$509$1,177$3,421$73.30 plus 12%$1,177$1631$3351$171.34 plus 22%$1,631$3,421$6,790$342.58 plus 22%$3,421$3,315$6200$541.82 plus 24%$3,315$6,790$12,560$1,083.76 plus 24%$6,790$6,200$7,835$1,234.22 plus 32%$6,200$12,560$15,829$2,468.56 plus 32%$12,560$7,835$19,373$1,757.42 plus 35%$7,835$15,829$23,521$3,514.64 plus 35%$15,829$19,373… … … …$5,795.72 plus 37%$19,373$23,521… … … . .$6,206.84 plus 37%$23,521

SEMIMONTHLY PAYROLL PERIOD (a) Single person (including head of household)—(b) Married person—If the amount of wages (after subtracting withholding allowances) is:The amount of income tax to withhold is:If the amount of wages (after subtracting withholding allowances) is:The amount of income tax to withhold is:Not over $154 … … . .$0Not over $481 … … . .$0Over—But not over—Of excess over—Over—But not over—Of excess over—$154$551$0.00 plus 10%$154$481$1,275$0.00 plus 10%$481$551$1,761$39.70 plus 12%$551$1,275$3,706$79.40 plus 12%$1,275$1,761$3,592$185.62 plus 22%$1,767$3,706$7,356$371.12 plus 22%$3,706$3,592$6,717$587.12 plus 24%$3,592$7,356$13,606$1,174.12 plus 24%$7,356$6,717$8,488$1,337.12 plus 32%$6,717$13,606$17,148$2,674.12 plus 32%$13,606$8,488$20,988$1,903.84 plus 35%$8,488$17,148$25,481$3,807.56 plus 35%$17,148$20,988… … … …$6,278.84 plus 37%$20,988$25,481… … … . .$6,724.11 plus 37%$25,481

MONTHLY PAYROLL PERIOD(a) Single person (including head of household)—(b) Married person—If the amount of wages (after subtracting withholding allowances) is:The amount of income tax to withhold is:If the amount of wages (after subtracting withholding allowances) is:The amount of income tax to withhold is:Not over $308 … … . .$0Not over $963 … … . .$0Over—But not over—Of excess over—Over—But not over—Of excess over—$308$1,102$0.00 plus 10%$308$963$2,550$0.00 plus 10%$963$1,102$3,533$79.40 plus 12%$1,102$2,550$7,413$158.70 plus 12%$2,550$3,533$7,183$371.12 plus 22%$3,533$7,413$14,713$742.26 plus 22%$7,413$7,183$13,433$1,174.12 plus 24%$7,183$14,713$27,213$2,348.26 plus 24%$14,713$13,433$16,975$2,674.12 plus 32%$13,433$27,213$34,296$5,348.26 plus 32%$27,213$16,975$41,975$3,807.56 plus 35%$16,975$34,296$50,963$7,614.82 plus 35%$34,296$41,975… … … …$12,557.56 plus 37%$41,975$50,963… … … . .$13,448.27 plus 37%$50,963

Source: IRS.gov

The new tax reform expands the section 529 plans to now incorporate primary and secondary schools—including religiously affiliated ones.

“A ‘section 529 plan’ (also known as a ‘qualified tuition plan’) is a plan operated by a state or educational institution with tax advantages and potentially other incentives to make it easier to save for college and other post-secondary training for a designated beneficiary, such as a child or grandchild,” Hammar said. “The main tax advantage of a 529 plan is that earnings are not subject to federal tax and generally are not subject to state tax when used for the qualified education expenses of the designated beneficiary, such as tuition, fees, books, as well as room and board. Contributions to a 529 plan, however, are not deductible.”

These plans previously only applied to college savings. But the tax reform “modifies section 529 plans to allow such plans to distribute not more than $10,000 in expenses for tuition incurred during the taxable year in connection with the enrollment or attendance of the designated beneficiary at a public, private, or religious elementary or secondary school,” Hammar said.

The $10,000 “limit applies on a per-student basis, rather than a per-account basis,” Hammar explained. “Thus, although an individual may be the designated beneficiary of multiple accounts, that individual may receive a maximum of $10,000 in distributions free of tax, regardless of whether the funds are distributed from multiple accounts. Any excess distributions received by the individual would be treated as a distribution subject to tax under the general rules of section 529.”

“I think that’s a huge benefit to those churches that are operating a K through 12 school,” said Sommerville. Churches will want to let families in their congregations and communities know about this, he added.

Batson agreed that 529 plans are a good way to save for a child or grandchild’s college and precollege education. Yet Batson said there is a possible “wrinkle”: while the federal government has modified the plan, those modifications might not apply in every state.

“Many states have complementary state laws that provide a state-level tax benefit that may be tied specifically to the funds being used for college education only,” he said. “So, state laws may not permit the use of 529 funds for primary and secondary education. Because these plans are administered by the states or third-parties hired by the states, there will be a period of adjustment before these administrative bodies are able to honor a request for such a distribution.” Until states act to remedy this plan discrepancy, Batson added, this is a “limiting factor on the usefulness of the federal law change.”

On top of that, there is a reason a state might be reluctant about including K through 12 on its 529 plan. Such an inclusion would mean that “states are going to have a whole lot of dollars taken off the tax rolls,” Batson said. “This will maybe take tens of millions of dollars of tax revenue—if not a couple of hundred million dollars—off the table for a given state,” said Batson.

The bottom line: Churches with schools should check with their state plan sponsors to see if 529 plans include precollege savings.

One final note: The House bill originally proposed extending 529 plans to homeschooled students, however, the final legislation did not include homeschooling.

Prior to tax reform, a pastor’s reasonable moving expenses could be deducted—with certain restrictions. Meals, for instance, could not be deducted. And the move had to meet both a distance test and a time test. The current law, however, no longer allows pastors and other employees to deduct moving expenses.

“The Tax Cuts and Jobs Act repeals both the moving expense deduction, and the exclusion of employer reimbursements of moving expenses under an accountable arrangement—except in the case of a member of the Armed Forces of the United States on active duty who moves pursuant to a military order,” Hammar explained.

Sommerville and Batson said that this exclusion has generated a lot of questions from church leaders. Specifically, churches want to know if pastors and staff members will be taxed for travel expenses the church covers.

“The answer is yes,” Batson said.

Pastors now must pay their moving expenses “out-of-pocket” and “with no tax benefit,” he explained. If a church pays for moving expenses, he added, it must be considered taxable income.

Handling taxable moving expenses won’t be a problem for more prosperous churches, said Batson, but less prosperous churches will probably have a tough decision to make about whether or not to hire someone who would have “substantial moving expenses.”

A case could possibly be made for paying a new employee’s travel costs to his or her new place of employment—but not the expenses of the spouse or children—as a nontaxable business expense. Still, Batson admitted, opinions about this kind of scenario would undoubtedly vary greatly among CPAs and tax attorneys who work with churches and other nonprofits.

Batson recalled a conversation he had recently with one of his mission clients in which he was asked, “What about relocating a missionary and his family from the US to their station of foreign service? Are you telling us that we cannot reimburse the moving expenses for the husband, the wife—who’s also an employee—and the children and their household furnishings?”

“You probably could make the argument that moving the husband and the wife, who are employees, to their foreign station is a business expense,” Batson said. “But not the kids, not their household furnishings.”

Of course, no decisions should be made without receiving guidance from a tax professional. Yet, as Batson pointed out, opinions vary greatly among even tax experts. Churches should err on the side of caution.

As Batson reflected on the effect of the travel exclusion on churches, he said that this is an area where a for-profit business will fare better than nonprofits.

“Corporate tax rates were lowered dramatically, so they have the money to pay for moving expenses,” he said. “But nonprofit organizations, including churches, don’t have any kind of benefit like that. Mission organizations where people raise their own support, are going to have to raise more money to handle moving expenses.”

Prior to the tax reform, employees could deduct educational expenses—with certain restrictions and limitations.

“The Tax Cuts and Jobs Act eliminates any deduction for unreimbursed employee business expenses, including education,” Hammar said.

“While this is true for an individual employee with educational expenses that are not reimbursed by an employer, it does not apply where an employer pays for educational expenses as a working-condition fringe benefit,” clarified Batson. This includes educational expenses that may be deducted by the employer as a business expense.

Eligibility for this fringe benefit is subject to these conditions:

Hammar also offered this clarification: “Self-employed taxpayers may continue to deduct work-related educational expenses.”

Prior to the new law, certain business expenses were deductible if, in aggregate, they exceeded 2 percent of the taxpayer’s adjusted gross income (AGI), Hammar said.

Some expenses subject to the 2 percent AGI floor included:

The Tax Cuts and Jobs Act, however, “suspends all miscellaneous itemized deductions that are subject to the 2 percent floor,” Hammar said.

The inability to itemize and deduct business expenses “will hit some clergy hard,” Hammar said. He suggested this possible workaround: “Churches could reimburse employees’ business expenses under an accountable expense reimbursement arrangement.”

To be considered accountable, a church’s reimbursement arrangement must comply with the following four rules:

“I have advocated for years that churches need to get on board with an accountable expense reimbursement plan,” said Sommerville. He then added, “Frankly, I applaud the elimination of the deduction for the unreimbursed employee business expenses,” explaining that far too many churches simply do not properly review and report taxable employee business expense reimbursements. “I’m handling an IRS exam right now on a pastor who didn’t do it right,” he said. “Pastors just don’t do it right. It’s a complicated process.”

Batson, however, is not convinced that an accountable expense reimbursement plan is practical or affordable for many smaller churches.

Churches would need to carefully consider whether or not they can afford reimbursing a pastor’s business expenses, Batson explained, because it would mean more out-of-pocket expenses for the church. Prior to the new law, he said, pastors could claim a “tax benefit,” but now that is no longer the case.

Paying for a pastor’s business expenses could be very difficult for a small church on a tight budget. To emphasize his point, Batson gave this scenario:

Reimbursing a travel expense like that, Batson said, would greatly stretch or even break the budget of a small church and also create a system that’s difficult for a smaller church to manage. Unlike larger churches, smaller churches often lack the staff size and well-defined financial systems that allow them to make use of such a plan. “This will create a quandary for small churches: they will either need to find a way to accommodate an accountable expense plan, perhaps with a cap, or the pastor will suffer the brunt of the tax law change,” Batson explained.

Sommerville feels that setting a cap could make such an accountable plan work for smaller churches. They would just need to establish and adhere to certain stipulations on spending, which includes setting a reasonable and affordable cap. “You let the pastor know that you are going to reimburse his or her expenses up to $4,000, $5,000, or whatever the church can afford.”

Along with that, Sommerville said that the church treasurer or financial manager must commit to reviewing and approving the expense for which the pastor is seeking reimbursement. And that can sometimes create a problem. Nobody wants to get on the pastor’s bad side, he said. Even so, it’s a financial manager’s job to hold a pastor and all church staff accountable for the use of the church’s funds—and an accountable reimbursement plan would help a church financial manager do just that.

“Under the … tax reform bill, Section 274(a) of the Internal Revenue Code will include a new provision that expressly disallows deductions for ‘the expense of any qualified transportation fringe (as defined in section 132(f)) provided to the employee of the taxpayer.’ Further, the newly-added Section 274(l) generally disallows deductions for any expense incurred for providing transportation, payment, or reimbursement to an employee relating to travel between the employee’s residence and workplace,” reported National Benefit Services.

The loss of this tax deductible fringe benefit may negatively affect urban churches where employees must pay for parking, Sommerville said.

In the past, he explained, a church would pay for parking or the cost of a transit pass “as a tax free fringe benefit for employees.” With the current tax law, a church will now have to file an “Exempt Organization Business Income Tax Return” (990-T) and pay taxes on any employee’s transportation expense.

Batson sees the potential negative effect on urban churches as well.

“One nonprofit I work with has provided a ‘qualified transportation expense’ to employees,” said Batson. “With the changes in the tax law, this employer can no longer claim a deduction for this fringe benefit. While the employee won’t be taxed on this benefit, the nonprofit organization, and this includes churches, will have to treat the benefit as taxable unrelated business income.”

Batson stressed that this will be especially burdensome for churches and employees in urban settings where parking and transportation are expensive.

As mentioned earlier in this article, the tax bill reduced the percentages of the seven income tax brackets to 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent, and 37 percent. (In 2017, the seven brackets were 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, 35 percent, and 39.6 percent.)

The 2017 and 2018 rates, and income ranges, for both single and married taxpayers, are summarized in Table 3 through 6 (see below and page 8).

Hammar explained that an employee’s “tax liability is not computed by taking the top marginal tax rate times total income. Rather, tax is computed by multiplying income in each bracket times the applicable percentage.” To illustrate, he gave this example:

Hammar explained, however, that the computation of tax savings may be more complex because of other factors such as dependent children.

One other point: The new rates are repealed for tax years beginning after December 31, 2025. At that time, the rates revert back to those in effect in 2017 unless extended by Congress.

For specifics on dependent children and possible tax credits, see the sidebar “Enhancement of Child Tax Credit and New Family Credit” (below).

The Tax Cuts and Jobs Act temporarily increases the child tax credit from $1,000 to $2,000 per qualifying child. The credit is further modified to temporarily provide for a $500 nonrefundable credit for qualifying dependents other than qualifying children (such as aging parents). The provision generally retains the present-law definition of dependent.

Under the conference agreement, the maximum amount refundable may not exceed $1,400 per qualifying child. Additionally, the conference agreement provides that, in order to receive the child tax credit (i.e., both the refundable and nonrefundable portion) a taxpayer must include a Social Security number for each qualifying child for whom the credit is claimed on the tax return. For these purposes, a Social Security number must be issued before the due date for the filing of the return for the taxable year. This requirement does not apply to a non-child dependent for whom the $500 nonrefundable credit is claimed.

Further, the tax conference agreement retains the age limit for a qualifying child. As a result, a qualifying child is an individual who has not attained age 17 during the taxable year.

Lastly, the conference agreement modifies the adjusted gross income phaseout thresholds for the credit, starting with taxpayers with adjusted gross income in excess of $400,000 (in the case of married taxpayers filing a joint return) and $200,000 (for all other taxpayers). These phaseout thresholds are not indexed for inflation.

Prior law allowed taxpayers to claim an itemized deduction for property losses arising from fires, storms, or other casualty or theft if they exceeded $100 per casualty or theft. “In addition, aggregate net casualty and theft losses were deductible only to the extent they exceeded 10 percent of an individual taxpayer’s adjusted gross income,” said Hammar.

The tax act modified that law. “Under the provision, a taxpayer may claim a personal casualty loss [subject to previous limitations] only if such loss was attributable to a disaster declared by the President under the Disaster Relief and Emergency Assistance Act,” said Hammar.

He offered this scenario:

Sommerville explained, however, that such a scenario is extremely rare. “The $5,000 had to be reduced by $100 plus 10 percent of the adjusted gross income of the pastor. If the pastor had $50,000-worth of taxable income, he or she still would not have received a deduction in 2017. This change in the tax law is just not going to affect that many pastors or other taxpayers.”

On top of that, Sommerville said that any loss could be remedied with the right kind of insurance coverage.

“You either buy the insurance or you don’t,” Sommerville said. “In fact, the major losses I have seen in my 40 years of involvement with nonprofits came about because pastors chose not to buy coverage for this or that. A pastor played the odds and lost … . For instance, a pastor thought that there was no need for flood insurance because it couldn’t happen to him, because he’s not in a flood plain.”

The bottom line, said Sommerville, is this: Get proper coverage.

Churches and other charitable organizations described in section 501(c)(3) of the tax code generally are exempt from federal income tax and are eligible to receive tax-deductible contributions so long as they are organized and operated exclusively for one or more tax-exempt purposes constituting the basis of their tax exemption. These purposes include religious, charitable, and educational.

In addition, charitable organizations may not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of or in opposition to any candidate for public office. The prohibition on such political campaign activity is absolute and, in general, includes activities, such as making contributions to a candidate’s political campaign, endorsements of a candidate, lending employees to work in a political campaign, or providing facilities for use by a candidate. The absolute prohibition on campaign activities was added in 1954 by the so-called “Johnson amendment” (named for then-Senate majority leader Lyndon Baines Johnson).

Many other activities may constitute political campaign activity, depending on the facts and circumstances. The sanction for a violation of the prohibition is loss of the organization’s tax-exempt status, although the tax code provides three other possible penalties: an excise tax on political expenditures, termination assessment of all taxes due, and an injunction against further political expenditures.

An early version of the tax reform bill provided that an exempt organization would not lose its exempt status solely because of the content of any statement that:

However, the Senate did not include this provision in its version of the tax bill, and a joint House-Senate conference committee did not adopt the House bill provision in the final text of the new law. As a result, the prohibition of political campaign activity by churches remains intact and unchanged.

The following resources are available on ChurchLawAndTaxStore.com: