IRS Inches Closer to Church Inquiry Criteria

Agency also issues guidance on disregarded SMLLCs.

Federal tax law permits the IRS to initiate a church inquiry or examination so long as certain criteria are carefully met. The criteria for a church tax inquiry include a requirement that a “high-level Treasury official” must determine, based on written evidence, that the church is not exempt, that it has a liability for unrelated business income tax, or that it has otherwise engaged in taxable activities.

Subsequent to a national restructuring of its operations, the IRS designated a particular official as its “high-level Treasury official” with authority to make the required determination. However, in litigation several years ago, a federal court ruled that the official designated by the IRS did not meet the statutory definition of a high-level Treasury official. The IRS has not yet rectified the issue and reports indicate that the IRS has ceased inquiries and examinations of churches until the matter is resolved. The IRS claims to be nearing completion of new regulations addressing the matter.

The IRS recently issued long-awaited guidance regarding the tax treatment of contributions made to disregarded single-member limited liability companies (DSMLLCs) owned and controlled by nonprofit 501(c)(3) organizations. Nonprofit organizations, including churches, sometimes use single-member limited liability companies (SMLLCs) to own property or conduct activities for risk management purposes. While generally treated as a separate legal entity under state law for liability purposes, a SMLLC may be “disregarded” under federal tax law—meaning that for federal income tax purposes, it is treated as if it were simply a division of its owner (the “single member”) and not a separate entity—hence, the term “disregarded.”

Given the federal tax treatment of DSMLLCs, logic would dictate that contributions to a DSMLLC whose single member is a church or other 501(c)(3) organization would be treated as contributions to the 501(c)(3) organization for federal tax purposes. However, the IRS has not issued formal guidance to that effect—until now. Notice 2012-52 states that charitable contributions made to a DSMLLC of a 501(c)(3) organization are treated as having been made to the 501(c)(3) organization, and the 501(c)(3) organization is considered the donee for purposes of acknowledgments (donor receipts) for contributions. The IRS also notes, “To avoid unnecessary inquiries by the Service, the charity is encouraged to disclose, in the acknowledgment or another statement, that the SMLLC is wholly owned by the U.S. charity and treated by the U.S. charity as a disregarded entity.”

In a recent information letter to a member of Congress, the IRS reaffirmed its longstanding position that gifts to a church earmarked for the benefit of a specific person are not deductible as charitable contributions. The facts addressed in the letter indicate that a donor wanted to make a contribution to a church’s scholarship fund and “suggest” that the church use the funds to pay tuition for the minister’s daughter. The IRS noted that, for contributions to be deductible, the donee organization must have “full control of the donated funds and discretion as to their use.”

The U.S. Supreme Court denied a petition in October to take up an appeal by a minister who claimed an income tax exclusion for two homes.

In late 2010, the U.S. Tax Court ruled that federal tax law does not limit the number of homes for which a minister can receive special, tax-free benefits. The federal government appealed the Tax Court decision, and the 11th Circuit Court of Appeals reversed the Tax Court earlier this year. The appeals court said the clergy housing exclusion is limited to a single home.

The minister, Philip Driscoll, then filed a petition to have the case considered by the U.S. Supreme Court. The denial issued in October by the Supreme Court leaves the issue where the IRS and the vast majority of clergy have understood it to be for decades—that the clergy housing exclusion is limited to a single home.

Michael (Mike) E. Batts is a CPA and the managing partner of Batts Morrison Wales & Lee, P.A., an accounting firm dedicated exclusively to serving nonprofit organizations across the United States.

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