On July 28, 1995, the IRS issued its audit guidelines for ministers under its “market segment specialization program” (MSSP). These guidelines will be used by IRS agents who audit ministers. Most of the information contained in the audit guidelines is a restatement of existing law. Here are some of the key provisions that will be interest to church treasurers:
- Ministers “are generally considered employees” for income tax reporting purposes (although they are self-employed for social security with respect to their ministerial income).
- The guidelines do not provide specific guidance in answering the sometimes troublesome question of who is a “minister” for federal tax purposes. Rather, they summarize some of the leading court decisions that have addressed this issue. Significantly, these cases include the Tax Court’s decision in Knight v. Commissioner, a case that has perhaps the most liberal definition of the term “minister.” See chapter 2 of Richard Hammar’s Church and Clergy Tax Guide for a full discussion of the Knight case.
- “Special gifts” received by ministers from their employing church are includable in gross income for tax purposes.
- “If the church or church agency pays amounts in addition to salary to cover the minister’s self-employment tax or income tax, these are also includable in gross income.”
- “An accountable plan is an arrangement that meets all the [following] requirements: business connection, substantiation within a reasonable period of time, and return of amounts in excess of substantiated expenses within a reasonable period of time …. If an arrangement meets all the requirements for an accountable plan, the amounts paid under the arrangement are excluded from the minister’s gross income and are not required to be reported on his or her Form W 2. If, however, the arrangement does not meet one or more of the requirements, all payments under the arrangement are included in the minister’s gross income and are reported as wages on the Form W 2, even though no withholding at the source is required.”
- If the church has a salary reduction arrangement which “reimburses” the minister for employee business expenses by reducing his or her salary, the arrangement will be treated as a nonaccountable plan because it does not meet the reimbursement requirement …. This is the result regardless of whether a specific portion of the minister’s compensation is designated for employee expenses or whether the portion of the compensation to be treated as the expense allowance varies from pay period to pay period depending on the minister’s expenses. As long as the minister is entitled to receive the full amount of annual compensation, regardless of whether or not any employee business expenses are incurred during the taxable year, the arrangement does not meet the reimbursement requirement.”
- Ministers often pay a small annual renewal fee to maintain their credentials, which constitutes a deductible expense. However, ministers’ contributions to the church are not deductible as business expenses. They may argue that they are expected to donate generously to the church as part of their employment. This is not sufficient to convert charitable contributions to business expenses.”
Key point. The audit guidelines rely heavily on Richard Hammar’s annual Church and Clergy Tax Guide.
This article originally appeared in Church Treasurer Alert, September 1995.