Several recent developments affect tax reporting by ministers, church staff, and churches in 2022 and beyond. Ten of them are addressed here and are also found in the 2023 Church & Clergy Tax Guide (order yours today – it will ship in January)which covers other key developments.
Tip: The 2023 Church & Clergy Tax Guide is also available for download in .pdf form.
1. Status of the housing allowance
In March 2019, a federal appeals court rejected an atheist group’s challenge to the constitutionality of the ministers housing allowance. Gaylor v. Mnuchin, 919 F.3d 420 (7th Cir. 2019). The atheist group did not appeal this ruling, and there have been no further legal challenges.
Tip: Be sure and check out Church Law & Tax’s update on Designating a House Allowance for 2023 to include recommendations for a variety of situations.
2. Revoking an exemption from Social Security
Once a minister seeks and receives an exemption from Social Security, it is generally irrevocable. 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 2022 that would have authorized ministers to revoke an exemption from Social Security.
However, in 2020 the Internal Revenue Service (IRS) amended its Internal Revenue Manual (the “Manual”) by adding a section addressing the revocation of an exemption from self-employment taxes that was obtained for economic rather than religious reasons. The section notes that applications “made solely for economic considerations rather than religious opposition” mean the “taxpayer wasn’t qualified for the exemption from self-employment tax ... effectively allow[ing] for revocation.”
The Manual then says a minister who notifies the agency about his or her wish to revoke a previously granted exemption because the application was solely based upon economic considerations will be advised the exemption has been revoked. The agency then will notify the Social Security Administration and it will note the change in the minister’s permanent file, along with including copies of all relevant material related to the change.
The section also notes that a minister who sought and received an exemption based on more than economic considerations will not be able to receive a revocation.
3. Charitable contribution deduction for non-itemizers
The CARES Act (2020) encouraged Americans to contribute to churches and charitable organizations by permitting them to deduct up to $300 of cash contributions, whether they itemize their deductions or not. Congress extended this deduction through 2021 and increased it to $600 for married couples filing a joint return. However, the deduction expired at the end of 2021 and Congress has not extended it, meaning it is unavailable for 2022 federal income tax returns.
4. No further private letter rulings on certain matters
According to the IRS, a “private letter ruling (“PLR”) is a written statement issued by the IRS to a taxpayer that interprets and applies tax laws to the taxpayer’s specific set of facts.” The IRS will issue a PLR “to establish with certainty the federal tax consequences of a particular transaction before the transaction is consummated or before the taxpayer's return is filed.” The taxpayer must request a PLR in writing, and if the IRS responds with a PLR, it is binding on the agency—assuming the taxpayer does not deviate from the facts and circumstances described about the transaction in the request.
A PLR may not be relied on as precedent by other taxpayers or IRS personnel. However, the information can be helpful for understanding how the IRS views different issues, especially when taxpayers may face situations with similar facts and circumstances.
In 2022, the IRS announced that it will no longer issue PLRs under any of the following circumstances involving churches, clergy, and charities:
- “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. Revenue Procedure 2022-3.
- “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.” Revenue Procedure 2022-3.
- “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 in return receives 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? The IRS will no longer address such a question in a PLR. Revenue Procedure 2022-3.
- “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 PLRs. Revenue Procedure 2022-3.
- “Whether a compensation of property transaction satisfied 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.” Revenue Procedure 2022-3.
- Whether material changes will affect an organization’s tax-exempt status. Generally, tax-exempt organizations are required by the tax code to inform the IRS of “material changes” in their activities or operations. The IRS will no longer send PLRs to exempt organizations to address whether changes in activities or operations will jeopardize their exempt statuses. Revenue Procedure 2022-3.
Whether a compensation or property transaction satisfies the rebuttable presumption that the transaction is not an excess benefit transaction as described in section 4958 of the tax code. Revenue Procedure 2022-3.
5. Simplified definition of a “highly compensated employee”
A number of tax-favored provisions in the tax code do not apply to “highly compensated employees” if they are treated more favorably than other employees. These include:
- simplified employee pensions (SEPs),
- 403(b) tax-sheltered annuities (churches and qualified church-controlled organizations are exempt from this nondiscrimination rule),
- qualified employee discounts,
- cafeteria plans,
- flexible spending arrangements,
- qualified tuition reductions,
- employer-provided educational assistance, and
- dependent-care assistance.
A highly compensated employee in 2022 was one who (1) was a 5 percent owner of the employer at any time during the current or prior year (this definition will not apply to churches) or (2) had compensation for the previous year (2021) in excess of $135,000 and, if an employer elects, was in the top 20 percent of employees by compensation.
6. Large drop in audit rates
On May 17, 2022, the U.S. Government Accountability Office (GAO) reported that the audit rate declined 44 percent between fiscal years 2015 and 2019, including a drop in the audit rate of 75 percent for individuals with incomes of $1 million or more, raising concerns about the potential for a decline in taxpayers accurately reporting their tax liability. (GAO-22-104960.)
The GAO Report found that, from tax years 2010 to 2019, audit rates of individual income tax returns decreased for all income levels. On average, the audit rate for these returns decreased from 0.9 percent to 0.25 percent. IRS officials attributed this trend primarily to reduced staffing caused by decreased funding.
Audit rates decreased the most for taxpayers with incomes of $200,000 and above. According to IRS officials, these audits are generally more complex and require a staff's review. Lower-income audits are generally more automated, allowing the IRS to continue these audits even with fewer staff.
The report noted that, although there was a sharper decrease in audit rates for higher-income taxpayers, the IRS generally audited such taxpayers at higher rates compared to lower-income taxpayers. However, the audit rate for lower-income taxpayers claiming the earned income tax credit (EITC) was higher than average.
According to IRS officials, EITC audits require relatively few resources and prevent ineligible taxpayers from receiving the EITC.
With the passage of the Inflation Reduction Act (IRA) in August of 2022, the IRS and related agencies will receive nearly $80 billion through 2031 for tax enforcement activities, such as hiring more enforcement agents, providing legal support, and investing in “investigative technology.”
7. A trio of noteworthy court cases involving tax fraud, tax liens, and tax bills
- The Tax Court rejected a minister’s tax arguments, subjecting him to back taxes, interest, and a penalty for filing a frivolous return.
- A Florida case underscored the power of the IRS to impose tax liens on ministries.
- The Virginia Supreme Court sided with a church in a local tax delinquency case.
8. Inflation adjustments relevant for 2022 tax-filing season
Some tax benefits were adjusted for inflation for 2022. Key changes affecting 2022 returns include the following:
- The mileage rate for miles driven for business increased to 65.5 cents per mile on January 1, 2023.
- The mileage rate for miles driven for medical purposes, and for moving, remained 22 cents per mile on January 1, 2023.
- The charitable mileage rate remains at 14 cents for all of 2023.
- The Alternative Minimum Tax exemption amount for tax year 2022 increases to $75,900 for single taxpayers and $118,100 for married persons filing jointly. The exemption amount for single persons (and heads of household and married persons filing separately) begins to phase out at $539,900 and the exemption amount for married couples filing jointly begins to phase out at $1,079,800.
- For estates of any decedent passing away in calendar year 2022, the basic exclusion amount is $12,06,000.
- For 2022, the foreign earned income exclusion will be $112,000.
- The maximum earned income credit amount will be $6,935 for taxpayers with three or more qualifying children for 2022.
9. Working after retirement
Many churches employ retired persons who are receiving Social Security benefits. Persons younger than full retirement age may have their Social Security retirement benefits cut if they earn more than a specified amount.
Full retirement age (the age at which you are entitled to full retirement benefits) for persons born in 1943 to 1954 is 66 years. If you are under full retirement age for the entire year, $1 is deducted from your benefit payments for every $2 you earn above the annual limit. For 2023, that limit is $19,560.
In the year you reach full retirement age, your monthly benefit payments are reduced by $1 for every $3 you earn above a different limit. For 2023, that limit is $51,960, but only earnings before the month you reach full retirement age are counted.
10. New per diem rates for substantiating the amount of travel expenses
The IRS allows taxpayers to substantiate the amount of their business expenses by using per diem (daily) rates. Taxpayers still must have records substantiating the date, place, and business purpose of each expense. Separate rates are set for meals and lodging, with separate rates for high-cost localities and all other communities. See the IRS website for applicable rates.
In some cases, using the per diem rates will simplify the substantiation of meals and lodging expenses incurred while engaged in business travel. However, a number of restrictions apply, and these are explained further in the latest Church & Clergy Tax Guide.