1. Status of the housing allowance
The latest constitutional challenge to the clergy housing allowance brought by the Freedom From Religion Foundation (FFRF) cleared its first significant legal hurdle in October, when a federal district court judge ruled the valuable longtime tax benefit for ministers to be an unconstitutional preference for religion. The decision may now head to the Seventh Circuit Court of Appeals, the outcome of which will affect ministers in Illinois, Indiana, and Wisconsin—and may even have implications for clergy nationwide, depending on how an unfavorable ruling for the benefit would be treated by the Internal Revenue Service.
This case is several years in the making. FFRF challenged the housing allowance in 2013 through a lawsuit filed in the District Court for the Western District of Wisconsin. Judge Barbara Crabb at that time ruled the benefit was unconstitutional. Upon appeal, however, the Seventh Circuit said the FFRF lacked standing to pursue the challenge, meaning the FFRF’s officials hadn’t suffered a direct injury. The appeals court suggested that this deficiency could be overcome in a future challenge if the FFRF’s officers filed tax returns claiming a housing allowance that was later rejected by the IRS in an audit: “The plaintiffs could have sought the exemption by excluding their housing allowances from their reported income on their tax returns and then petitioning the United States Tax Court if the IRS were to disallow the exclusion. Alternatively, they could have … paid income tax on their housing allowance, claimed refunds from the IRS, and then sued if the IRS rejected or failed to act upon their claims.”
The FFRF responded to the appeals court’s ruling by designating a housing allowance for two of its officers. The officers reported their allowances as taxable income on their tax returns and thereafter filed amended tax returns seeking a refund of the income taxes paid on the amounts of their designated housing allowances. The FFRF claims that in 2015 the IRS denied the refunds sought by its officers (one of whom had died and was represented by her executor). Having endeavored to correct the standing problem, the FFRF renewed its legal challenge to the housing allowance in 2016 through the same federal district court in Wisconsin. Eight developments from this renewed challenge are noteworthy.
First, on October 6, 2017, Judge Crabb again ruled that the ministerial housing allowance is an unconstitutional preference for religion. Gaylor v. Mnuchin, (W.D. Wis. 2017). Judge Crabb observed:
[The housing allowance] violates the establishment clause because it does not have a secular purpose or effect and because a reasonable observer would view the statute as an endorsement of religion.
Although defendants try to characterize [the housing allowance] as an effort by Congress to treat ministers fairly and avoid religious entanglement, the plain language of the statute, its legislative history and its operation in practice all demonstrate a preference for ministers over secular employees. Ministers receive a unique benefit … that is not, as defendants suggest, part of a larger effort by Congress to provide assistance to employees with special housing needs. A desire to alleviate financial hardship on taxpayers is a legitimate purpose, but it is not a secular purpose when Congress eliminates the burden for a group made up of solely religious employees but maintains it for nearly everyone else. Under my view of the current law, that type of discriminatory treatment violates the establishment clause.
Judge Crabb acknowledged that “Congress could have enacted a number of alternative exemptions without running afoul of the First Amendment. For example, Congress could have accomplished a similar goal by allowing any of the following groups to exclude housing expenses from their gross income: (1) all taxpayers; (2) taxpayers with incomes less than a specified amount; (3) taxpayers who live in rental housing provided by the employer; (4) taxpayers whose employers impose housing-related requirements on them, such as living near the workplace, being on call or using the home for work-related purposes; or (5) taxpayers who work for nonprofit organizations, including churches.”
Key point. Perhaps of most interest was Judge Crabb’s suggestion that the tax code be amended to apply to taxpayers “who work for tax exempt organizations under § 501(c)(3) and are on call at all times.” Such an amendment would cover most clergy, but few enough employees of secular charities to be feasible as a matter of tax policy.
Second, Judge Crabb stayed the enforcement of her ruling so that the parties could submit briefs on appropriate remedies for the plaintiffs. It is likely, though not certain, that when the issue of remedies is resolved the judge will do what she did in her earlier decision in 2013 and stay enforcement of the ruling pending an appeal. But, this is not certain and so ministers and churches should be alert to developments, which will be addressed in this publication and on ChurchLawAndTax.com.
Third, a ruling by the Seventh Circuit would apply to ministers in that circuit, which includes only the states of Illinois, Indiana, and Wisconsin. It would become a national precedent binding on ministers in all states if affirmed by the United States Supreme Court—an unlikely outcome because the Supreme Court accepts less than 1 percent of all appeals. Note, however, that the IRS would have the discretion to follow or not follow such a ruling in other circuits and might be inclined to follow it to promote consistency in tax administration.
Fourth, churches everywhere should continue to designate housing allowances for their ministers for 2018 and future years until the housing allowance is conclusively declared unconstitutional. It could be declared unconstitutional in various ways, including the following: (1) Judge Crabb’s ruling is not appealed by the government, and the IRS applies it nationally; (2) Judge Crabb’s ruling is appealed to the Seventh Circuit, and the court affirms Judge Crabb’s ruling and the IRS elects to apply it nationally; or (3) the Supreme Court accepts an appeal of the appellate court’s ruling, and determines that the housing allowance is an unconstitutional preference for religion in violation of the First Amendment. Ministers should understand that claiming a housing allowance exclusion while this litigation is pending poses a risk that the exclusion may be disallowed and an amended tax return will need to be filed. Ministers should be prepared for this outcome, though it is unlikely that the housing allowance will be declared unconstitutional retroactively. Again, be alert to future developments.
Fifth, the US Department of Justice, which defends the constitutionality of federal legislation (such as the housing allowance), filed a brief with the court asking it to dismiss the FFRF’s challenge to the constitutionality of the parsonage exclusion (church-owned housing provided to qualifying ministers). The Department of Justice noted that section 107 of the tax code grants tax exclusions both for the rental value of parsonages provided to clergy as compensation for the performance of ministerial services and for housing allowances provided to clergy who own or rent their home. But since none of the FFRF’s officers were living in housing owned by the FFRF, they lacked standing to challenge the constitutionality of section 107’s exclusion of the rental value of church-owned parsonages.
The court, noting that FFRF had not opposed this argument, issued a summary judgment dismissing FFRF’s challenge to the constitutionality of the parsonage exclusion.
Sixth, the Department of Justice brief states that “the United States does not contest plaintiffs’ standing to sue under section 107(2)” (i.e., the housing allowance). This concession means that the appeals court will have the opportunity to address the merits of the FFRF’s constitutional challenge to the housing allowance. The appeals court ultimately may rule that the housing allowance is constitutional. Or it may decide that it is not. Either way, such a ruling likely would be appealed to the Supreme Court.
Seventh, ministers and churches should be aware that the housing allowance is under attack. Judge Crabb’s ruling may be affirmed on appeal and applied nationwide by the IRS. Should that occur, there are three actions that will need to be implemented quickly, as noted at the end of this article.
Eighth, on January 19, 2017, the federal district court in Wisconsin granted a request by two pastors and the Diocese of Chicago and Mid-America of the Russian Orthodox Church (the “intervenors”) to intervene in the case in support of the constitutionality of the housing allowance. The intervenors filed a motion for summary judgment, and a brief in support of their motion, in which they made several arguments in support of the housing allowance, included the following. While these arguments were rejected by Judge Crabb, they may be deemed persuasive by the appeals court in the event of an appeal.
The intervenors noted that the Constitution limits the jurisdiction of the federal courts to “Cases” and “Controversies,” and “no Case or Controversy exists if the plaintiff lacks standing to challenge the defendant’s alleged misconduct.” To establish standing, the plaintiffs bear the burden of demonstrating a “concrete injury,” that is traceable to the challenged action of the defendant, and that is likely to be redressed by a favorable judicial decision.
In this case, the plaintiffs were seeking only prospective (forward-looking) relief. “They do not seek a refund of any taxes that they paid in the past; instead, they seek a nationwide injunction striking down [the housing allowance] prospectively.” To obtain this relief, it is not enough to show “past exposure to illegal conduct.” Instead, they must show “continuing, present adverse effects” that would be remedied by an injunction. The intervenors’ brief asserted that the plaintiffs have failed to demonstrate any continuing harm that would be remedied by an injunction. In fact, the available evidence suggests that they will not suffer continuing harm. According to an FFRF press release, although [the FFRF officers] were denied a refund in 2012, their request for a refund in 2013 was granted. They have produced no evidence suggesting that they will again be denied a refund in the future. Thus, absent a sufficient likelihood that [the FFRF officers] will again be wronged in a similar way, [they are] no more entitled to an injunction than any other citizen of [the United States]; and a federal court may not entertain a claim by any or all citizens who no more than assert that certain practices of [the IRS] are unconstitutional.
The housing allowance is consistent with the historical understanding of the First Amendment
The plaintiffs’ primary claim was that the housing allowance violated the “Establishment Clause” of the First Amendment, which provides that Congress shall make no law respecting an establishment of religion. The intervenors’ brief noted that in its most recent Establishment Clause decision, the Supreme Court reaffirmed that “the Establishment Clause must be interpreted by reference to historical practices and understandings.” Town of Greece v. Galloway, 134 S. Ct. 1811 (2014). The brief continues: So what does history have to say about the tax treatment of churches and ministers … ? While the Establishment Clause prohibits the types of direct financial support that prevailed in colonial establishments—land grants, direct grants from the treasury, and compulsory “tithes” to support churches and ministers—it does not bar the tax exemption at issue here. Such exemptions were common at the time of the Founding and actually further the core Establishment Clause goals of alleviating government burdens on religion, avoiding discrimination among churches, and avoiding entanglement between church and state.
The housing allowance is consistent with the Supreme Court’s Texas Monthly decision
In 1989, the Supreme Court, in a plurality decision, invalidated a sales tax exemption that applied exclusively to “periodicals … that consist wholly of writings promulgating the teaching of [a] faith” and “books that consist wholly of writings sacred to a religious faith.” Texas Monthly, Inc. v. Bullock, 489 U.S. 1 (1989). The Court concluded that the sales tax exemption violated the Establishment Clause because it constituted a “subsidy exclusively to religious organizations.” The Court’s central holding was that a religious tax exemption would be constitutional only if it were part of a broader scheme that provided benefits to “a large number of nonreligious groups as well.” The intervenors’ brief explains: “Here, the parsonage allowance is distinguishable from the tax exemption struck down in Texas Monthly in important ways. First, unlike Texas Monthly, where the tax exemption for religious literature stood alone, the parsonage allowance is coupled with numerous tax exemptions for nonreligious housing allowances.” These include: Exemptions for any nonreligious employee who receives lodging for the convenience of his employer [tax code § 119(a)]. Any nonreligious employee living in a foreign camp [tax code § 119(c)]. Any nonreligious employee of an educational institution [tax code § 119(d)]. Any nonreligious member of the uniformed services [tax code § 134]. Any nonreligious government employee living overseas [tax code § 912]. Any nonreligious citizen living abroad [tax code § 911]. Any nonreligious employee temporarily away from home on business [tax code §§ 162, 132].
The brief argues that “it is as if, in Texas Monthly, the state had coupled the tax exemption for religious literature with a tax exemption for business literature, scientific literature, educational literature, travel literature, and government literature. That would not be a form of preferential support for religious messages; it would be a form of putting religious messages on the same footing as many other secular messages.”
“In short,” the brief continues, “Congress has enacted a broad package of tax benefits designed to relieve workers who face unique, job-related housing requirements. The default rule is § 119(a)(2), which establishes a demanding, case-by-case test requiring all employees to demonstrate that their lodging is provided for the convenience of their employer. But Congress also relaxed this default rule in a variety of situations where the type of work, the burdens on housing, or a non-commercial working relationship make it likely that the lodging was intended to benefit the employer.”
Key point. FFRF suggested that these related exemptions for housing expenses apply only to a small number of secular groups. But according to Congressional estimates, the annual value of these exemptions vastly exceeds the benefit provided by the housing allowance to clergy.
The federal government suggested in a reply brief to the FFRF lawsuit in Wisconsin that it is conceivable that the FFRF officers could qualify for a housing allowance because “the IRS does not require that an individual maintain theistic beliefs in order to perform functions that may be considered the duties of a minister of the gospel.” This view finds support in a 1961 ruling by the Supreme Court. Torasco v. Watkins, 367 U.S. 488 (1961). In the Torasco case, the Court observed that “religions” need not be based on a belief in the existence of God: “[N]either [a state nor the federal government] can constitutionally pass laws or impose requirements which aid all religions as against nonbelievers, and neither can aid those religions based on a belief in the existence of God as against those religions founded on different beliefs.”
The Court in Torasco added that “among religions in this country which do not teach what would generally be considered as a belief in the existence of God are Buddhism, Taoism, Ethical Culture, Secular Humanism and others.” In United States v. Seeger, 380 U.S. 163 (1965), the Supreme Court interpreted the phrase “religious training and belief” to include a sincere and meaningful belief that “occupies a place in the life of its possessor parallel to that filled by the orthodox belief in God of one who clearly qualifies for the exemption. Where such beliefs have parallel positions in the lives of their respective holder we cannot say that one is ‘in relation to a Supreme Being’ and the other is not.” In Welsh v. United States, 398 U.S. 333 (1970), the Supreme Court equated purely moral or ethical convictions with “religious” belief.
The tax code’s special treatment of ministers and churches
The intervenors claimed that “in many cases, the First Amendment not only permits special solicitude for churches, but requires it. In particular, the First Amendment (1) restricts government interference in the relationship between churches and ministers; (2) forbids government entanglement in religious questions; and (3) prohibits government discrimination among denominations. These three values—church autonomy, non-entanglement, and non-discrimination—are reflected throughout the tax code in specific protections for churches, none of which are available to secular non-profits.”
For example, several provisions protect the relationship between churches and ministers by exempting churches from paying or withholding certain types of taxes. The brief cites the following:
Churches are not required to withhold federal income taxes from ministers in the exercise of ministry. IRC 3401(a)(9). Churches are exempt from Social Security and Medicare taxes for wages paid to ministers in the exercise of ministry; instead, ministers are uniformly treated as self-employed. IRC 1402(c)(4), 1402(e), 3121(b)(8). Churches are exempt from state unemployment insurance funds authorized by the Federal Unemployment Tax Act. IRC § 3309(b)(1).
Other provisions protect church autonomy by exempting churches from disclosing information: • Churches and certain related entities are not required to file Form 990, which discloses sensitive financial information. IRC 6033(a)(3).
Still others reduce entanglement by offering unique procedural protections: • Churches receive special procedural protections when subjected to a tax audit. IRC 7611. • Churches need not petition the IRS for recognition of their tax-exempt status under section 501(c)(3). IRC 508(a), (c)(1)(A).
Still others modify tax provisions so that they apply neutrally among various church polities:
Churches can maintain a single church benefits plan exempt from ERISA for employees of multiple church affiliates, regardless of common control, and for ministers, regardless of their employment status. IRC 414(e). Churches can include ministers in 403(b) contracts (a type of tax-deferred benefit), even if ministers do not qualify as employees. IRC 403(b)(1)(A)(iii). Churches can provide certain insurance to entities with common religious bonds, even if those entities are not structured to meet normal common control tests. Treas. Reg. § 1.502-1(b).
The intervenors’ brief concludes: “In short, the tax code does not treat churches and ministers as ordinary employers and employees. Rather, Congress has crafted numerous tax provisions that apply only to churches and ministers. These provisions, like [the housing allowance], reduce entanglement and prevent discrimination among religions.”
The housing allowance reduces entanglement
Any governmental law or policy that fosters excessive entanglement between church and state is suspect under the Establishment Clause. The intervenors’ brief argued that the housing allowance “is far less entangling than the next best alternative—which is applying the notoriously difficult [convenience of the employer] standard of section 119 to ministers.” Section 119 of the tax code exempts from tax lodging that is (1) furnished by an employer for an employee; (2) furnished in kind; (3) on the business premises of the employer; (4) for the convenience of the employer; and (5) is a condition of employment.
The brief explains: Section 119 is extremely difficult, if not impossible, to apply to ministers. First, it requires the minister to qualify as an “employee” under IRS rules. This, in turn, requires the government to tax differentially depending on internal matters of church polity. If the minister belongs to a denomination that gives him broad autonomy or exposes him to significant economic risk, he may fail this test and be considered self-employed. Some decisions suggest that United Methodist Council ministers would qualify as employees, but Assembly of God and various Pentecostal ministers would not. Even if a minister qualified as an employee, a section 119 exemption would be unavailable if one entity provided the housing (such as the congregation), but a different entity qualified as the “employer” (such as the diocese)—thus pressuring churches to make ministers answerable to those paying them. Once these threshold concerns are overcome, section 119 still requires the government to decide whether a minister’s housing was “furnished for the convenience of the employer” as “a condition of his employment.” This, in turn, requires the government to decide whether the lodging is truly necessary “to enable him properly to perform the duties of his employment.” Section 107 [the housing allowance] by contrast, recognizes that the government cannot decide which uses of a minister’s home are “necessary” to the mission of the church and which are not. It asks only whether the employee is functioning as a minister. This is an inquiry courts have been conducting for decades—not only in the tax context, but also under the First Amendment “ministerial exception.” Indeed, it is an inquiry that the Supreme Court itself said was constitutionally required just five years ago. Hosanna-Tabor Evangelical Lutheran Church & School v. E.E.O.C., 565 U.S. 171 (2012). To summarize, plaintiffs’ argument contradicts core Establishment Clause values. If the housing allowance is eliminated, “the taxation of ministers would no longer be governed by a bright-line rule; instead, it would be governed by the notoriously fact-intensive standard of section 119. The result would be deep, church-state entanglement—with IRS officials forced to answer religious questions about the relationship between churches and ministers and the way ministers use their homes.
The Lemon test
The intervenors claimed that the housing allowance satisfies the Supreme Court’s 1971 ruling in Lemon v. Kurtzman, 403 U.S. 602 (1971). In Lemon, the Supreme Court ruled that for a statute to survive an Establishment Clause challenge, it (1) “must have a secular legislative purpose,” (2) “its principal or primary effect must be one that neither advances nor inhibits religion,” and (3) it “must not foster an excessive government entanglement with religion.” The intervenors claimed that this test was satisfied: Section 107(2) has the valid secular purpose of ensuring fair treatment of ministers’ housing costs under the convenience of the employer doctrine, reducing government burdens on the exercise of religion, reducing entanglement between church and state, and eliminating discrimination among religions. Its primary effect is to accomplish precisely these goals. And applying section 107 reduces both enforcement and borderline entanglement. Furthermore, section 107 sends a message of neutrality with respect to religion, not endorsement. Just as Congress took the unique circumstances of many secular groups into account when it codified other applications of the convenience of the employer doctrine, so it did with ministers and section 107.
While not an argument for upholding the constitutionality of the housing allowance, the intervenors’ brief pointed out that a ruling in favor of the plaintiffs would produce widespread harm. Hardest hit would be small churches … which would be forced to curtail vital ministries and, in some cases, shut down. But the harm would not be limited to small churches. The illogic of plaintiffs’ argument threatens scores of longstanding federal and state tax provisions, all of which have been designed to protect the separation of church and state. Fortunately, none of this needs to happen. Plaintiffs lack standing to seek an injunction, because, despite any dispute over their 2012 taxes, the IRS has eliminated any continuing harm by granting their request for a refund of 2013 taxes. But even if the court reaches the merits, it should hold that section 107 is not only permissible under the Establishment Clause, but desirable. Accordingly, the Court should grant summary judgment to defendants on all of plaintiffs’ claims.
Should the FFRF and its two officers ultimately prevail in their quest to strike down the housing allowance as an unconstitutional preference for religion, what would be the impact? If Judge Crabb’s ruling is affirmed on appeal by the Seventh Circuit, this would only apply to ministers in that circuit, which includes Illinois, Indiana, and Wisconsin. It would become a national precedent binding on ministers in all states if affirmed by the Supreme Court—an unlikely outcome because the Supreme Court accepts less than 1 percent of all appeals. However, the IRS would have the discretion to follow or not follow such a ruling in other circuits and might be inclined to follow it nationwide to promote consistency in tax administration.
In conclusion, ministers and churches should be aware that the housing allowance remains under attack and one day may be invalidated. Should that occur, three actions will need to be implemented quickly: 1. Many ministers will experience an immediate increase in income taxes. As a result, they should be prepared to increase their quarterly estimated tax payments to reflect the increase in income taxes in order to avoid an underpayment penalty. Note that there will be no effect on self-employment taxes for which the housing allowance is not tax-exempt. 2. Many churches will want to increase ministers’ compensation to offset the adverse financial impact. Thousands of ministers have purchased a home, and obtained a mortgage loan, on the assumption that the housing allowance would continue to be available as it has for more than a half century. The sudden elimination of this tax benefit will immediately thrust many clergy into a dire financial position with a mortgage loan based on a tax benefit that no longer is available. Many church leaders will want to reduce the impact of such a predicament by increasing compensation. Such an increase could be phased in over a period of years to minimize the impact on the church. 3. Ministers who are considering the purchase of a new home should not base financing decisions on the availability of a housing allowance unless and until the courts conclusively rule in favor of the constitutionality of the allowance.
I will be monitoring all future developments and providing updates in this publication and on ChurchLawAndTax.com.
2. The effect of tax reform
Both the president and House Republicans offered proposals for tax reform in 2017 that may serve as a blueprint for future tax legislation. These proposals are summarized below:
The House Republicans’
“Tax Reform Blueprint”
In 2016, the House Republicans published a series of recommendations (the “Tax Reform Blueprint”) designed to fuel job creation, simplify the tax code, and transform the IRS into an agency focused on customer service.
The Blueprint calls for the following fundamental changes to the tax code: • Lower taxes at every income level Currently, there are seven different income tax brackets for individuals, with a top individual income tax rate of 39.6 percent. The Tax Reform Blueprint will consolidate the current seven tax brackets to three brackets and will lower the top individual income tax rate to 33 percent. Going forward, these income tax brackets will be indexed for inflation. See Table 1.
* As described below, the new standard deduction is larger than the current-law standard deduction and personal exemptions combined. This, in effect, creates a larger 0-percent bracket. As a result, taxpayers who are currently in the 10-percent bracket always will pay lower taxes than under current law.
• Alternative Minimum Tax (AMT)
The alternative minimum tax (AMT) requires families and individuals to compute both their regular income tax and their AMT, and then pay the greater of the two. In effect, the AMT is a second tax system. The requirement that taxpayers compute their income for purposes of both the regular income tax and the AMT is one of the complexities of the current tax code that is most far-reaching, with roughly 4 million American families subject to AMT in 2016, and millions more required to do the complex calculations to determine whether or not they are subject to it. The AMT is particularly burdensome for small business owners, who often do not know whether they will be affected by the AMT until they file their tax returns and therefore must maintain a reserve for potential AMT liability—funds not being used to create jobs or grow their businesses.
As the National Taxpayer Advocate, Nina Olson, said in her 2013 annual report to Congress: The AMT penalizes middle income taxpayers for having children, getting married, or paying state and local taxes. The AMT is also unnecessarily complicated and burdensome, even for those who are not subject to it. Many taxpayers must fill out a lengthy form only to find they owe little or no AMT after all.
Olson’s recommendation to Congress was simple: “Permanently repeal the AMT.” This echoed the recommendation to repeal the AMT that was included in a report on tax simplification issued by the Joint Committee on Taxation in 2001.
The Tax Reform Blueprint follows these recommendations and calls for the repeal of the individual AMT.
• Income from savings and investment
Under an income tax, income from savings and investment is subject to double taxation, with investments made out of after-tax earnings and the returns on those investments also subject to tax. Thus, an income tax creates a bias against savings. The current tax code only partially mitigates this double taxation by providing a special rate structure for certain types of investment income. This rate structure applies to adjusted net capital gain and qualified dividends, with a top statutory tax rate of 20 percent. When the 3.8-percent tax on net investment income and the effects of the so-called Pease limitation on itemized deductions are taken into account, the top effective tax rate on capital gains and dividends reaches roughly 25 percent (exclusive of corporate-level income taxes).
The Tax Reform Blueprint provides for reduced tax on investment income. If enacted, taxpayers will be able to deduct 50 percent of their net capital gains, dividends, and interest income, leading to basic rates of 6 percent, 12.5 percent, and 16.5 percent on such investment income depending on the individual’s tax bracket. This approach is similar to how relief from double taxation of savings and investment was structured for several years after the enactment of the first round of Reagan tax cuts in 1981. However, this Blueprint also includes interest income within the reduced tax on investment income, as part of the move in the direction of a cash-flow tax.
• Earned income credit
The Blueprint will continue the earned income tax credit (EITC), which rewards work by low-income individuals, encouraging them to enter the workforce and have the opportunity to move up the income scale. The Committee on Ways and Means agreed to continue to work to reform the EITC to reduce fraud and erroneous overpayments.
• Simplification of tax benefits for education
Under current law, there are over a dozen different overlapping tax benefits relating to education. These tax benefits are so complicated that many taxpayers cannot determine the tax benefits for which they are eligible. In fact, the IRS publication on tax benefits for education is almost 100 pages long. Streamlining education tax benefits will enable taxpayers to better understand the tax benefits for which they qualify.
The Blueprint simplifies the current array of tax benefits for families looking to make education more affordable for their children. The Committee on Ways and Means will work to simplify and consolidate the current-law provisions to provide a more effective and efficient package of higher education tax benefits that will cover both college and vocational training programs, including a savings incentive, such as 529 plans, and tax relief targeted at helping low- and middle-income families with the costs of higher education, such as the American Opportunity Tax Credit (which was made permanent in 2015).
• Individual exclusions and deductions
Under the Blueprint, the core component of the individual tax base will be compensation received. Families and individuals generally will include in income any compensation received related to employment or self-employment. Two pressing national priorities—quality health care and retirement security—require exceptions to this general rule. The exclusion for employer-provided health insurance and related health provisions in the tax code (such as health savings accounts and flexible spending arrangements) are major components of our nation’s health care system and therefore are being addressed in the context of the work of the Health Care Task Force. Second, the Blueprint will continue tax incentives for retirement savings. The Committee on Ways and Means will examine existing tax incentives for employer-based retirement and pension plans in developing options for an effective and efficient overall approach to retirement savings.
To simplify tax filings further for middle-income families, the Blueprint calls for the elimination of all itemized deductions except the mortgage interest deduction and the charitable contribution deduction. These two provisions help accomplish two important goals that strengthen civil society: homeownership and charitable giving.
• Home ownership
Historical data show that the strength of the nation’s housing market is tied more closely to the health of the overall economy than to any specific tax policies. The best way to promote a thriving housing market is to improve the overall economy, which is precisely what comprehensive tax reform will achieve.
Today, a taxpayer may claim an itemized deduction for mortgage interest paid with respect to a principal residence and one other residence of the taxpayer. A taxpayer who itemizes deductions may deduct interest payments on up to $1 million in acquisition indebtedness (for acquiring, constructing, or substantially improving a residence), and up to $100,000 in home equity indebtedness. Under the alternative minimum tax (AMT), however, the deduction for home equity indebtedness is disallowed.
The Blueprint preserves a mortgage interest deduction for homeowners. The Committee on Ways and Means will evaluate options for making the current-law mortgage interest provision a more effective and efficient incentive for helping families achieve the dream of homeownership. For those taxpayers who continue to itemize deductions, no existing mortgage will be affected by any changes in the tax code. Similarly, no changes will affect refinancings of existing mortgages.
But just as importantly, because of the other provisions included in the new tax system, far fewer taxpayers will choose to itemize deductions, with the vast majority of taxpayers finding they are better off by taking advantage of the larger, simpler standard deduction instead.
• Charitable giving
The Blueprint encourages charitable giving through a tax incentive.
Today, a taxpayer may claim an itemized deduction for charitable contributions. Because a taxpayer must itemize to claim a charitable deduction, however, only about 25 percent of taxpayers benefit from the current charitable contribution deduction. Moreover, historical data show that the total amount of charitable giving is tied more closely to the health of the overall economy than to any specific tax policies that might be in place. The best way to promote charitable giving is to improve the overall health of the American economy, which is precisely what this Blueprint will achieve.
Charitable organizations have presented many recommendations over the years for reforming the deduction for charitable contributions to make it more effective and efficient. The Committee on Ways and Means will develop options to ensure the tax code continues to encourage donations, while simplifying compliance and record-keeping and making the tax benefit effective and efficient.
• Retirement savings
Today, individuals may contribute to Individual Retirement Accounts (IRAs), including traditional IRAs and Roth IRAs, subject to a variety of rules providing for contribution limits and income phaseouts. Individuals who are covered by a 401(k) or another employer-based retirement plan may have options for traditional accounts or Roth accounts within the plan. These accounts are subject to maximum elective contribution amounts.
The Committee on Ways and Means will explore the creation of more general savings vehicles, using as a model the retirement accounts. Universal Savings Accounts have been proposed by many people over the years as a way to eliminate the double taxation of savings and investment for families, most recently by Rep. Dave Brat of Virginia (H.R. 4094). These are accounts to which individuals could contribute cash and over which they would have full control of investment decisions. Account holders could withdraw both contributions and earnings at any time, and for any reason, without penalty. The Blueprint continues the current tax incentives for savings. The Committee on Ways and Means will work to consolidate and reform the multiple different retirement savings provisions in the current tax code to provide effective and efficient incentives for savings and investment.
• Estate taxes
Under current law, the estate tax applies under specified circumstances to transfers of wealth when a person dies. An additional tax may apply to generation-skipping transfers, which generally involve a person making a gift that skips one or more generations—for example, a gift from a grandfather to a grandchild or great-grandchild.
The Blueprint calls for the repeal of the estate and generation-skipping transfer taxes. This would eliminate the Death Tax, which can result in double, and potentially even triple, taxation on small businesses and family farms.
• Tax simplification
The tax code currently includes five basic family tax deductions and credits, each with its own rules, eligibility criteria, and calculations. Three benefits—the basic standard deduction, additional standard deduction, and personal exemption for taxpayer and spouse—are intended to protect a minimum level of income from federal income taxation, with the level depending on whether the taxpayer is single or married. The other two—the personal exemptions for children and dependents and the child tax credit—are intended to deliver additional tax benefits to households with children and dependents. Consolidating these five benefits into two simpler benefits—a larger standard deduction and an enhanced child and dependent tax credit—will achieve the same policy and distributional goals as current law while making the tax code much simpler for low- and middle-income families.
Under current law, an individual determines taxable income by reducing adjusted gross income (AGI) by any personal exemption deductions and either the applicable standard deduction or his or her itemized deductions. For 2017, the amount of the standard deduction was $6,350 for single individuals, $9,350 for heads of households, and $12,700 for married individuals filing a joint return. An additional standard deduction ($1,250 in 2017) was allowed with respect to any individual who was elderly or blind. In addition, a taxpayer generally may claim personal exemptions for the taxpayer, the taxpayer’s spouse, and any dependents. For 2017, taxpayers could deduct $4,050 for each personal exemption.
In addition, under the current-law child tax credit, an individual may claim a $1,000 tax credit for each qualifying child under the age of 17. The credit starts phasing out for single filers earning over $75,000 and for joint filers earning over $110,000. To the extent the child credit exceeds the taxpayer’s tax liability, the taxpayer is eligible for a refundable credit (equal to 15 percent of earned income in excess of $3,000). The taxpayer is not required to provide a Social Security number to claim the refundable portion of the credit (unlike the earned income tax credit today), which has led to substantial fraud and erroneous overpayments.
The Tax Reform Blueprint proposes to consolidate the basic standard deduction, the additional standard deduction, and the personal exemptions for families and individuals. The new larger standard deduction will be $24,000 for married individuals filing jointly, $18,000 for single individuals with a child in the household, and $12,000 for other individuals. These amounts will be adjusted annually for inflation. See Table 2.
In addition, the Blueprint consolidates the child credit and personal exemptions for dependents into an increased child credit of $1,500. The first $1,000 will be refundable as under current law. A nonrefundable credit of $500 also will be allowed for non-child dependents.
The marriage penalty that exists in the current-law phaseout of the child credit will be eliminated, so that married couples will be able to earn up to $150,000 before their child credits start phasing out. To reduce waste, fraud, and abuse, a taxpayer will be required to provide his or her Social Security number to claim the refundable portion of the child credit.
3. Tax status of “love gifts” to clergy
The United States Tax Court ruled that “love gifts” made by a church to its pastor represented taxable compensation. A church had 25 to 30 active members and as many as 7 ministers, and offered services 3 days each week. The lead pastor had informed the church’s board of directors that he did not want to be paid a salary for his pastoral services but that he would not be opposed to receiving “love offerings,” gifts, or loans from the church.
The pastor and his wife managed the church’s checking account, and jointly signed all of the church’s checks. They signed numerous checks in 2012, made payable to the pastor, with handwritten notations such as “Love Offering” or “Love Gift” on the memo line. The church transferred “love offerings” to other members of the church, including the pastor’s wife.
In 2012, the church’s bookkeeper prepared and sent to the pastor a Form 1099-MISC reporting that he had received nonemployee compensation of $4,815 from the church. When the bookkeeper left the church in late 2015, the pastor’s daughter became the church’s bookkeeper.
The pastor filed a joint federal income tax return for 2012, claiming a deduction for a charitable contribution of $6,478 to the church. He did not, however, include as an item of income the $4,815 of nonemployee compensation reported on Form 1099-MISC. Although the pastor did not dispute that he had received $4,815 from the church, he insisted that the amounts transferred to him were improperly reported as nonemployee compensation when in fact they were nontaxable “love offerings,” gifts, or loans.
The IRS audited the pastor’s 2012 tax return, and determined that the $4,815 represented taxable income, and not a nontaxable love gift. The IRS also ruled that none of this amount could be characterized as a tax-free loan since neither the church nor the pastor was able to produce objective evidence, such as bank records or a promissory note, showing that the church made any loans to the pastor.
The pastor appealed to the Tax Court, which affirmed the decision of the IRS. The court concluded:
In Commissioner v. Duberstein, 363 U.S. at 284-285, the United States Supreme Court stated that the problem of distinguishing gifts from taxable income “does not lend itself to any more definitive statement that would produce a talisman for the solution of concrete cases.” The Supreme Court concluded that, in cases such as this one, the transferor’s intention is the most critical consideration, and there must be an objective inquiry into the transferor’s intent. In other words, rather than relying on a taxpayer’s subjective characterization of the transfers, a court must focus on the objective facts and circumstances.
The record shows that the transfers were made to compensate [the pastor] for his services as pastor. As the pastor candidly explained at trial, he had informed the board of directors that he would accept “love offerings” and gifts as substitutes for a salary. The church’s bookkeeper at the time considered the payments to be compensation as is reflected in the Form 1099-MISC that she issued to him. In the light of these facts, the pastor’s subjective characterization of the transfers as nontaxable “love offerings” and “love gifts” is misguided.
The pastor did not offer the testimony of any members of the congregation (including the other directors) or [the former bookkeeper] that would allow the court to conclude that the transfers were anything other than compensation for services. The frequency of the transfers and the fact that they purport to have been made on behalf of the entire congregation is further objective evidence that the transfers represented a form of compensation.
In conclusion, we hold that the amounts that the pastor received from the church in 2012 represented compensation for services and, thus, constituted taxable income to him.
This case addresses the recurring question of the distinction between nontaxable gifts and taxable compensation for the performance of services. Note the following points:
1. Ministers often receive “love gifts” from their employing church, or directly from individuals. Love gifts from a church typically are funded by a “love offering” collected by the church from members. Whether collected in an offering, or paid directly by members to their minister, the question is whether such payments represent taxable compensation, or tax-free gifts. The tax code excludes “gifts” from taxable income. IRC 102. But it also broadly defines taxable income as “all income from whatever source derived, including (but not limited to) the following items … compensation for services, including fees, commissions, fringe benefits, and similar items.” IRC 61. This means that any “love gift” provided to a minister, whether from individuals or a church, constitutes taxable income if the transferor’s intent was to more fully compensate the pastor for services rendered.
2. The Tax Court stressed that a donor’s intent must be assessed in light of objective facts and circumstances. The court concluded that in this case the facts unequivocally demonstrated that the intent of donors and the church itself was to compensate the pastor for services he performed. The court pointed to the following facts:
The pastor informed the board of directors that he would accept “love offerings” and gifts as substitutes for a salary. The church’s bookkeeper at the time considered the payments to be compensation as is reflected in the Form 1099-MISC that she issued to him. The pastor did not offer the testimony of any members of the congregation (including the other directors) that would allow the court to conclude that the transfers were anything other than compensation for services. The frequency of the transfers and the fact that they purported to have been made on behalf of the entire congregation is further objective evidence that the transfers represented a form of compensation.
3. The court referenced section 102(c) of the tax code, which specifies that the definition of the term gift does not include “any amount transferred by or for an employer to, or for the benefit of, an employee.” However, it noted that the IRS did not raise this issue or contend that the pastor was an employee of the church.
4. Love gifts almost always will constitute taxable income rather than tax-free gifts because the donor’s intent is to more fully compensate the pastor for services performed. There is a significant risk of getting this wrong. If a love gift is not reported as taxable income by the church or the recipient in the year it is provided, the IRS may be able to assess intermediate sanctions in the form of substantial excise taxes against the recipient, and possibly members of the church board, regardless of the amount of the benefit, under section 4958 of the tax code. Jackson v. Commissioner of Internal Revenue, T.C. Summ. 2016-69 (2016).
4. Substantiating charitable contributions
The United States Tax Court upheld the IRS’s denial of a $65 million charitable contribution deduction because the written acknowledgment issued by the donee charity was not “contemporaneous” as required by the tax code. On its 2007 tax return, a partnership claimed a charitable contribution deduction of $65 million. In order to substantiate a charitable contribution deduction of $250 or more, a taxpayer must secure and maintain in its files a “contemporaneous written acknowledgment” (CWA) from the donee organization. IRC 170(f)(8)(A). The CWA must state (among other things) whether the donee provided the donor with any goods or services in exchange for the gift. IRC 170(f)(8)(B)(ii).
The IRS audited the partnership’s tax return and disallowed the charitable contribution deduction in its entirety. The partnership thereafter submitted an amended return that included the information specified in subparagraph (B), including whether the donee provided the donor with any goods or services in exchange for the gift. The IRS ruled that these belated acts did not cure the partnership’s noncompliance with the contemporaneous requirement. The partnership appealed to the Tax Court. The partnership asked the court to dismiss the case on the ground that the substantiation requirements had been met. The court declined to do so.
The court began its opinion by stressing that “the requirement that a CWA be obtained for charitable contributions of $250 or more is a strict one. In the absence of a CWA meeting the statute’s demands, no deduction shall be allowed.” If a taxpayer fails to meet the strict substantiation requirements of section 170(f)(8), “the entire deduction is disallowed.”
Further, the doctrine of “substantial compliance” does not excuse a failure to obtain a CWA meeting the statutory requirements. In other words, a taxpayer’s substantial compliance with the tax code’s substantiation requirements is no defense to noncompliance. The court explained:
Section 170(f)(8)(B) [of the tax code] provides that a CWA must include the following information:
(i) The amount of cash and a description (but not value) of any property other than cash contributed.
(ii) Whether the donee organization provided any goods or services in consideration, in whole or in part, for any property described in clause (i).
(iii) A description and good faith estimate of the value of any goods or services referred to in clause (ii)… .
An acknowledgment qualifies as “contemporaneous” only if the donee provides it to the taxpayer on or before the earlier of “the date on which the taxpayer files a return for the taxable year in which the contribution was made” or “the due date (including extensions) for filing such return.”
The court concluded that the partnership failed to comply with the tax code’s requirement of a “contemporaneous” written acknowledgement, despite its attempt to rectify the mistake by filing an updated form after the deadline had expired.
This case illustrates the consequences that can result from a church’s failure to comply with the substantiation requirements for charitable contributions. Those requirements are stricter for contributions of $250 or more, and, as this case demonstrates, require the written acknowledgment (receipt) provided by a charity to donors to be contemporaneous and include a statement indicating whether the charity provided goods or services to the donor in consideration of the contribution. If goods or services were provided, the church’s written acknowledgment must provide a description and good-faith estimate of the value of those goods or services, or, if only intangible religious benefits were provided, a statement to that effect.
Churches that fail to provide donors with a proper acknowledgment are jeopardizing the deductibility of donors’ contributions. In this case, that meant the loss of a $65 million contribution deduction for the donor.
Both the IRS and the Tax Court stressed that whether or not the donor actually made the donation was irrelevant. Even assuming that the donor made the $65 million contribution, it was not entitled to a charitable contribution deduction because it was unable to meet the strict substantiation requirements that apply to contributions of $250 or more. When it comes to the substantiation of charitable contributions, it is form over substance. And, “substantial compliance” with the law is no excuse or defense. 15 West 17th Street LLC v. Commissioner, 147 T.C. 19 (2016).
TIP To avoid jeopardizing the tax deductibility of charitable contributions, churches should advise donors at the end of 2017 and early 2018 not to file their 2017 income tax returns until they have received a written acknowledgment of their contributions from the church. This communication should be in writing. To illustrate, the following statement could be placed in the church bulletin, church newsletter, or letter to members in the last few weeks of 2017 and/or the first few weeks of 2018: “IMPORTANT NOTICE: To ensure the deductibility of your church contributions, please do not file your 2017 income tax return until you have received a written acknowledgment of your contributions from the church. You may lose a deduction for some contributions if you file your tax return before receiving a written acknowledgment of your contributions from the church.”
TIP Be alert to any donation of noncash property that may be valued by the donor at more than $500. Be sure the donor is aware of the need to complete Section A of Form 8283 for donations of property valued at more than $500 but not more than $5,000, and Section B of Form 8283 for donations of property (other than publicly traded stock) valued at more than $5,000. The instructions to Form 8283 contain a helpful summary of the substantiation requirements that apply to these kinds of gifts. Different rules apply to donations of vehicles. Failure to comply with these rules may lead to a loss of a deduction. It is a good practice for churches to have some of these forms on hand to give to donors who make contributions of noncash property.
5. Tax implications of “coffee shops” operated by churches
The IRS ruled that a “coffee shop” established by a church for personal evangelism in an urban area did not qualify for tax-exempt status since it was indistinguishable in operation from secular, for-profit coffee shops. A nonprofit corporation (the “Corporation”) was formed for the following four purposes:
- Proclaim earnestly the gospel message and to urge its personal acceptance.
- Promote prayer, Bible study, missions, Christian fellowship, evangelism, Christian service and
- encouraging, in every possible way, a lifetime commitment to Christ.
- Provide a forum in which the Gospel of Jesus Christ can be discussed with non-believers outside of a formal church setting.
- Generously extend the grace of God by giving away 100 percent of all profits (except those retained for capital expenditures) to community ministries, other local, national, or international non-profits or organizations, or those in financial need.
The founder of the Corporation came up with the vision to form a coffee shop where believers could interact with nonbelievers in a safe and friendly environment to convey the gospel in a nonconfrontational manner in word and deed. The founder served as pastor of a local church, but he elected to form the Corporation as a separate entity from his church in order to encourage other Christian churches and organizations to participate in his vision. The founder’s church granted funding for the Corporation’s startup, and the Corporation’s bylaws specified that a majority of its board members had to be members of the church.
The Corporation applied to the IRS for recognition of tax-exempt status as a ministry organized and operated exclusively for religious purposes. Its application for exemption described its purposes and activities as follows:
- Once formed, the Corporation opened a coffee shop and obtained tradename protection for its name.
- It sold coffee locally and planned to eventually sell it online as well.
- The Corporation’s coffee shop was open Monday through Friday from 6 a.m. to 8 p.m. and Saturday from 7 a.m. to 8 p.m.
- It had free Wi-Fi and power outlets for customer use. It used coffee that was sourced directly from coffee farmers. The Corporation believed that its coffee benefited coffee farmers 50 percent to 100 percent over the price paid for “Fair Trade” coffee. Its drink selection included coffee, tea, smoothies, frappes, soft drinks, and juices. Food items included baked goods, soups, sandwiches, salads, and desserts.
- The coffee shop provided a location for both formal and informal Bible study, church group meetings, and meetings for other organizations. The coffee shop was used for a women’s Bible study, a men’s Bible ministry, meetings of the church’s elders, book signings, birthday parties, baby and bridal showers, community business meetings, game nights, live music, and similar events.
- The Corporation stated that its promotion of the Gospel of Jesus Christ was subtle and indirect. Several times a year the Gospel was promoted through a program consisting of a donor paying for a certain amount of coffee in advance. Then, when a customer came in, they were told by the staff that the coffee had already been paid for and, “that the coffee is not free but that the price has already been paid, just like Jesus already paid the price for all of our sins by dying on the cross for us.”
- The Corporation had a “Monthly Mission” in which it partnered with other ministries, missionaries, and nonprofit organizations by highlighting their activities to help raise funds, supplies, and recognition for them. The Corporation selected a “partner” and provided information about the person or organization to customers. It also collected donations for the partner.
- The Corporation gave away meals and drinks to the homeless and helped connect them with local ministries for lodging and jobs.
- The Corporation took part in a training program that helped train underserved youth by placing them in a local business for a six-week internship so they could gain firsthand experience.
- The coffee shop’s activities are run by compensated staff as well as volunteers.
- Almost all of the coffee shop’s revenue was from the sale of food items. Its largest expense was for salaries and wages. It also had occupancy expenses and expenses for cost of goods sold, advertising, licenses and permits, insurance, supplies, payroll, and repairs and maintenance.
- The coffee shop had not earned profits that would have allowed it to give away any substantial amount of money but it hoped to be able to do so in the future.
In rejecting the Corporation’s application for tax-exempt status, the IRS noted that one of the requirements for exemption enumerated in section 501(c)(3) of the tax code is that the organization seeking exempt status must be “organized and operated exclusively for charitable, religious or educational purposes, no part of the net earnings of which inures to the benefit of any private shareholder or individual.” This essential requirement was not met in this case, the IRS concluded:
You are not described in Section 501(c)(3) of the Code … because you fail the operational test. Specifically, the facts show you are not operated exclusively for Section 501(c)(3) purposes because a substantial portion of your activities consists of the operation of a coffee shop in a commercial manner.
While donating funds to other non-profit community organizations is charitable … your main focus is the operation of a coffee shop. Additionally, while some of the activities that take place in the coffee shop … advance religion, more than an insubstantial portion of your activities serve a commercial purpose … . You are not regarded as “operated exclusively” for one or more exempt purposes because you do not engage primarily in activities which accomplish one or more of such exempt purposes specified in section 501(c)(3) of the Code. Your primary activity is the operation of a coffee shop in a commercial manner. You are open to the public Monday through Friday from 6 a.m. to 8 p.m. and Saturday from 7 a.m. to 8 p.m. You have free Wi-Fi and power outlets throughout for customer use. You have space that can be used for gatherings such as meetings and parties. You have a selection of food and beverage items that can be purchased at the coffee shop… . You believe the location of the coffee house is ideal because there are no other similar businesses downtown. Therefore, the operation of your coffee shop to raise funds is a commercial activity, not a charitable activity… .
The operation of the coffee shop and your programs to further the Gospel of Jesus Christ, partner with other organizations, and participate in community activities are separate and distinct activities. Since the operation of the coffee shop is a substantial part of your activities and is not a recognized charitable purpose, you are not organized and operated exclusively for 501(c)(3) purposes… .
You are operating a coffee shop that is open to the public six days a week in competition with other commercial markets. This is indicative of a business. Your primary sources of revenues are from coffee shop sales. Your expenses are mainly for salaries, cost of goods sold, and occupancy expenses to support the operation of the coffee shop. Taken in totality, the operation of your coffee shop constitutes a significant non-exempt commercial activity.
The IRS concluded: “You do not qualify for recognition of exemption from federal income tax as an organization described in Section 501(c)(3) of the Code. Your coffee shop activities are indistinguishable from similar activities of an ordinary commercial enterprise.”
This case is instructive for any church that is considering the creation of a commercial venture in furtherance of its religious mission. A predominantly commercial enterprise will not qualify for tax-exempt status if its principal activities are indistinguishable from competing for-profit entities, even if it engages in occasional or insignificant activities in furtherance of its religious mission.
Churches that operate coffee shops on or off of the church premises should be aware of the following legal and tax considerations:
- Income tax exemption for separate facilities. As this ruling demonstrates, a church cannot assume that a coffee shop will be exempt from federal income taxes, even if it has a religious purpose, if its commercial functions and purposes are significant. In such cases, the facility may fail the “operational test” of tax-exempt status described in section 501(c)(3) of the Internal Revenue Code.
- The federal unrelated business income tax, which subjects tax-exempt entities to the corporate income tax. There are exceptions, including facilities that are operated by volunteer labor.
- The potential impact on a church’s property tax exemption.
- The potential impact of an applicable state sales tax law.
- Compliance with local zoning laws.
- Compliance with health department regulations.
- Liability issues for injuries occurring at the facility.
The least regulatory burden will apply to church-operated coffee facilities that:
- Are located on church property.
- Are operated solely for the convenience of members.
- Are operated by volunteers.
- Are not advertised to the general public by exterior signage, newspaper ads, and so on.
- Are open only during (or immediately before and after) church services.
- Do not charge a fee for coffee or snacks.
IRS Private Letter Ruling 201645017 (2017).
6. Revoking an exemption from Social Security
Will Congress give ministers another opportunity to revoke an exemption from Social Security? It does not seem likely, at least for now. No bills were introduced in Congress in 2017 that would have authorized ministers to revoke an exemption from Social Security.
7. IRS not addressing several issues in private letter rulings
The IRS announced early in 2017 (Rev. Proc. 2017-3) that it will no longer issue private letter rulings addressing the following issues:
- “Whether an individual is a minister of the gospel for federal tax purposes.” This means taxpayers will not be able to obtain clarification from the IRS in a letter ruling on their status as a minister for any one or more of the following matters: (1) eligibility for a parsonage exclusion or housing allowance; (2) eligibility for exemption from self-employment taxes; (3) self-employed status for Social Security; or (4) exemption of wages from income tax withholding.
- “Whether amounts distributed to a retired minister from a pension or annuity plan should be excludible from the minister’s gross income as a parsonage allowance.”
- “Whether a taxpayer who advances funds to a charitable organization and receives therefore a promissory note may deduct as contributions, in one taxable year or in each of several years, amounts forgiven by the taxpayer in each of several years by endorsement on the note.” To illustrate, a church member transfers $5,000 to her church and receives in return a promissory note from the church promising to pay back the note in annual installments over the next five years. Each year, on the due date of the annual installment, the note holder “forgives” the payment. Can the note holder treat the forgiven installment as a charitable contribution deduction? This is a question the IRS will no longer address in private letter rulings.
- “Whether a transfer is a gift within the meaning of section 102” of the tax code. To illustrate, a pastor retires after many years of service to the same church. The church presents him with a check in the amount of $10,000. Is this check taxable compensation or a tax-free gift? This is a question the IRS will no longer address in private letter rulings.
- “Whether a compensation or property transaction satisfies the rebuttable presumption that the transaction is not an excess benefit transaction as described in § 53.4958-6 of the Excess Benefit Transactions Excise Tax Regulations.”
- Generally, tax-exempt organizations are required by the tax code to inform the IRS of material changes in their activities or operations. The IRS has announced that it no longer will issue private letter rulings informing exempt organizations if changes in their activities or operations jeopardize their exempt status.
8. Limited relief from the employer payment plan penalty
Sections 105(h) and 106 of the tax code specify that an employee may exclude from taxable income amounts provided through an arrangement under which
(1) an employer pays or reimburses premiums for health insurance for the employee and family members purchased in the individual insurance market (referred to as an employer payment plan or EPP) or (2) an employer reimburses the employee for medical expenses generally of the employee and family members (referred to as a health reimbursement arrangement or HRA).
In the final days of 2016, Congress enacted the 400-page 21st Century Cures Act, with massive bipartisan support. The Act addressed several health-related issues and, perhaps of most interest to church leaders, included a provision relieving many small employers of one of the most feared provisions in the Affordable Care Act (ACA): the infamous $100 per day per employee penalty that the IRS could impose upon any employer that continued to pay or reimburse employees’ medical insurance under a private plan.
The relief from the $100 per day penalty will not benefit all churches. A church may be subject to the penalty if, for example, it offers an employer payment plan or health reimbursement arrangement (defined above) and: (1) it is a large employer with an average of 50 full-time and “full-time equivalents” (FTEs) employees during the previous calendar year; (2) it offers a group health plan to any of its employees; (3) it contributes more than $5,130 ($10,260 for a family) to an employer payment plan or health reimbursement arrangement (defined above), adjusted for inflation; or (4) the arrangement fails to satisfy one or more of the other requirements for a “qualified small employer health reimbursement arrangement” (referred to as a QSEHRA).
The Act is effective retroactively.
9. Increase in uninsured penalty
One of the most important and divisive provisions in the ACA is a requirement that, beginning in 2014, “applicable individuals” are required to maintain “minimum essential” health care coverage or pay a penalty. A requirement that persons failing to provide such coverage would be subject to imprisonment was dropped during final consideration.
For 2016 and 2017, failure to maintain minimum essential health care coverage resulted in a penalty of the greater of 2.5 percent of household income, or $695 per adult and $347.50 per child under 18, up to a maximum of $2,085 per family. After 2017, dollar amounts increased by an annual cost of living adjustment.
The penalty applies to any period in which an individual does not maintain minimum essential coverage and is determined monthly. It is assessed through the tax code and accounted for as an additional amount of federal tax owed. However, use by the IRS of liens and seizures of property otherwise authorized by the tax code for the collection of taxes does not apply to the collection of this penalty.
The penalty is reported on line 61 of IRS Form 1040. IRS Commissioner John Koskinen has stated: “For most people, filing their returns … is going to be fairly simple with regard to this issue … they’ll simply check a box indicating that they have qualifying insurance or they’ll indicate that they’re eligible for an exemption. Otherwise, they’ll calculate their shared responsibility payment and add it to their tax return.” Please see an important related update, “IRS: Tax Returns Must Address Health Coverage” in the In Brief section appearing on page 28 of this issue.
10. CHARITY Act introduced in Congress
In 2017, U.S. Senators John Thune (R-S.D.) and Ron Wyden (D-Ore.) introduced the Charities Helping Americans Regularly Throughout the Year (CHARITY) Act (S.2750), a bill that would encourage charitable giving and make it easier for foundations and other tax-exempt organizations to conduct their charitable mission. The CHARITY Act would, if enacted:
- Express the sense of the Senate that the promotion of charitable giving be one of the goals of comprehensive tax reform.
- Authorize the Treasury Department to adopt regulations that align the simplified standard mileage tax deduction rate for personal vehicle use for volunteer charitable services with that for medical/moving purposes. This would mean elevating the mileage rate from its current 14 cents per mile. Currently, the IRS has the authority to regulate mileage rates for business and medical/moving purposes, but not for charitable activities. The charitable rate is set by statute and has remained unchanged since 1997.