To maintain tax-exempt status under section 501(c)(3) of the Internal Revenue Code, churches must meet several requirements.
Two critical ones are:
- No part of a church’s net earnings can inure to the benefit of an insider.
- A church cannot provide substantial private benefit to anyone.
Violating either rule can jeopardize a church’s exemption.
This article explains these rules using recent IRS guidance and court precedents.
What Is an Excess Benefit Transaction?
Section 4958 of the tax code imposes an excise tax—called intermediate sanctions—on excess benefit transactions.
- Disqualified persons are individuals who exercise substantial influence over the organization’s affairs during the past five years.
This includes their family members and related entities. - An excess benefit transaction occurs when a disqualified person receives an economic benefit that exceeds the value of what they provided in return.
(Treas. Reg. § 53.4958-4)
Examples of compensation or benefits considered include:
- Salary
- Fringe benefits
- Loans
- Nonaccountable expense reimbursements
Penalties:
- Disqualified persons may face excise taxes up to 225% of the excess benefit.
- Organizational managers (like board members) who approve excess benefit transactions can face a tax of up to 10%, capped at $20,000 total.
Important:
In 2004, the IRS ruled that any unreported fringe benefit—even small—automatically counts as an excess benefit.
Defining Inurement
Section 501(c)(3) states that no part of a church’s net earnings can inure to the benefit of a private individual.
According to the IRS (Publication 1828):
- Insiders include ministers, board members, officers, and sometimes employees.
- Prohibited inurement includes:
- Paying unreasonable compensation
- Transferring property to insiders below fair market value
- Paying dividends
- The prohibition is absolute—any amount of inurement can jeopardize tax-exempt status.
Note:
Reasonable payments for services rendered are not considered inurement.
Three Types of Inurement
The IRS and courts recognize three main categories of private inurement:
1. Personal Use of Organizational Assets
- Insiders freely use the organization’s funds or assets for personal benefit.
- Example cases:
- John Marshall Law School v. U.S. — Personal expenses paid by the school for its founder’s family.
- Founding Church of Scientology v. U.S. — Unexplained payments beyond a reasonable salary.
2. Overpayment or Undervaluation in Transactions
- The organization pays too much or receives too little value in return.
- Example case:
- Anclote Psychiatric Center v. Commissioner — Sale of assets for far below fair market value.
3. Organizational Structure That Benefits Insiders
- Even if transactions seem reasonable, closely linked entities can funnel financial benefits to insiders.
Real-World Examples of Inurement
The IRS and courts have found private inurement in many cases, including:
- Riemers v. Commissioner — Church paid personal expenses of family members.
- Church in Boston v. Commissioner — Unstructured cash grants to officers.
- New Life Tabernacle v. Commissioner — Salaries based on a percentage of church receipts.
- Founding Church of Scientology v. U.S. — Founder received 10% of gross income, residence, loans.
Key Point: Charitable Contribution Implications
Inurement can also disqualify a church from receiving tax-deductible charitable contributions.
Example:
Whittington v. Commissioner — A minister’s personal expenses were paid by his ministry, nullifying his ability to deduct contributions made to the ministry.
Additional Court Cases
- Triplett v. Commissioner — Publishing activities for personal benefit precluded tax-exempt status.
- IRS Private Letter Rulings (PLRs 200926037, 201517014, 201533022, 201534014) — All examples where personal use of organizational assets led to denial or revocation of exempt status.
Private Benefit vs. Inurement
Private benefit and inurement are related but distinct:
| Inurement | Private Benefit |
|---|---|
| Benefits insiders only | Can benefit anyone (insiders or outsiders) |
| Any amount triggers loss of exemption | Only substantial private benefit triggers loss |
(IRS Publication 1828)
Important:
- Private benefit must be incidental to an exempt purpose to be acceptable.
- Otherwise, it can threaten a church’s 501(c)(3) status.
Conclusion
Church leaders must understand and strictly avoid both private inurement and substantial private benefit.
To protect tax-exempt status:
- Ensure all transactions with insiders are reasonable and properly documented.
- Avoid personal use of church funds or assets.
- Structure activities clearly for public—not private—benefit.
When in doubt, seek legal or tax counsel to avoid costly mistakes.
