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Tax News for October 2023 . . .

Church Cybersecurity Starts With the Human Firewall – Part 3

Welcome back for part 3 concerning the cybersecurity threats and how Churches can protect themselves. – Posted 10/13/23

Setting solid standards

Meanwhile, established standards for good hardware, software, and security protocols are available through the National Institute of Standards and Technology (NIST). These are especially helpful for technical specifications related to firewalls, network security, virtual private networks, password management, and encryption.

Ward and Vaernhoej offer these best practices:

  • Take inventory of the devices and software your church uses. Take inventory of the people who possess them (as well as have access to networks).
  • Keep up on security patching released by hardware and software vendors.
  • Require regular password management and institute multifactor authentication (MFA) preferably through an app-based option from Okta, Microsoft, or Google. This cuts down on the multifactor workarounds that bad actors use with text- and email-based options.
  • Use an email filtering solution. Work to balance the sensitivity levels to screen out problem messages while still allowing legitimate ones. Microsoft’s Office365 and Gmail’s cloud email options, work well for small and large operations. Both offer in phishing and malware prevention techniques.
  • Use combinations of complementary tools to boost overall security. A good example? Pairing a content filtering firewall with antivirus software. This simple mix of foundational tools will stop many problems before they can cause any damage.

We hope you have enjoyed this 3 part series concerning cybersecurity threats. To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Church Cybersecurity Starts With the Human Firewall – Part 2

Welcome back for part 2 concerning cybersecurity threats and the ways Churches can protect themselves. – Posted 10/10/23

Attacks are on the rise

Several high-profile church cybersecurity breaches have made recent headlines.

  • The Florida Baptist Convention had $700,000 stolen in early 2023 after an email purporting to be from the Southern Baptist Church’s North American Mission Board instead proved to be fraudulent. The instructions in the email tricked convention employees into changing account information for routing funds.
  • In late 2022, a North Carolina church received an email containing a bill, along with new electronic payment instructions, from a party posing as its building contractor. Nearly $800,000 was lost.
  • Another email scam in 2019 cost an Ohio Catholic church $1.7 million after criminals accessed email accounts of parish employees and then sent emails instructing them to change payment information for a construction contractor.

Training and educating

Educating and training church pastors and staff members about these types of tactics—and how they continue to evolve—is critical, says Allison Ward, a partner with CapinTech, a division of church and nonprofit accounting firm CapinCrouse.

Repeating this training and education frequently is needed, too, adds Nick Vaernhoej, chief information security officer for Church Mutual Insurance Company, the largest insurer of US houses of worship. While criminal tactics mostly remain the same, the methods for accomplishing them rapidly shift.

The ways the tactics are adapted to trick recipients “change month by month,” Vaernhoej says.

‘Low-tech’ solutions

Building a strong human firewall is about getting people to:

  • Stop before they respond
  • Evaluate what’s happening
  • Take steps to verify what’s being requested through some other form of communication

“In my experience, the best methods for addressing ‘high-tech’ threats are typically ‘low-tech’ in nature,” Vaernhoej says. “For instance, some type of manual verification system, such as placing a phone call to the requester before releasing the funds requested.”

Smith agrees, adding a live confirmation before changing a payment method or process or releasing any funds is a must. Churches should adopt policies requiring live verifications, he adds, noting a live call, live video call, or in-person conversation should be used.

“AI can now mimic voices, so don’t rely on a voicemail left in tandem with an email,” Smith says.

At Faith Ministries, ongoing training comes multiple ways. The church partners with an outside vendor who sends about four test messages per week to staff members. These message are designed to trick an employee into clicking a link or opening an attachment. Those who fail get follow-up messages and tips.

Periodic staff wide training sessions also occur, Smith says.

KnowBe4—the vendor Faith Ministries uses—charges $3 per user per month. As Smith—who also consults for churches and ministries through his company, MBS Inc.—advises other churches to do the same, he frequently encounters resistance.

“How do we communicate the urgency for this? It’s such a simple thing to solve, it’s inexpensive to solve, and yet few are willing to do it,” Smith says.

Stay tuned for part 3 Friday where we will provide a list of recommended best practices to better protect you from cybersecurity threats. To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Church Cybersecurity Starts With the Human Firewall – Part 1

While external threats are real, church cybersecurity starts with strong internal processes and education, experts say. – Posted 10/9/23

An attack on church cybersecurity rarely comes at the right time, is rarely designed to be easily spotted, and is likely geared at exploiting human vulnerabilities, not firewalls or technological safeguards.

At Lafayette, Indiana-based Faith Ministries, the threat arrived in a staff member’s email inbox a few minutes before an early-morning worship service one Sunday this spring.

“I’m praying with some people,” the pastor wrote, adding he needed the staff member to send him several electronic gift cards for the people he was praying with.

Suspicious, the staff member flagged the email. He later learned the email really came from an outside party attempting to defraud the multisite church.

The human firewall

Jonathan Smith, Faith Ministry’s technology director and an advisor-at-large for Church Law & Tax, says the attack revealed just how well-versed some cybercriminals are in the normal routines and rhythms of the local church:

  • The sender knew the pastor’s name to pose as him.
  • The email described activities commonly occurring on a Sunday morning.
  • The email arrived just before the service started, a moment many church staff members might rush a response rather than verify it.

Thankfully, Smith’s colleague thought twice.

And that’s the key lesson in the never-ending fight against cyber fraud: people, not just technology, are the best defense.

While hardware and software defenses, technological best practices, and even cyberliability insurance, play important roles, training and education can go furthest toward minimizing susceptibilities at every church, technology and security experts say.

“The human firewall is our only hope,” Smith says.

Stay tuned for part 2 tomorrow where we will discuss ways to prevent cybersecurity threats before they begin. To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Tax News for September 2023 . . .

Q&A: Churches and Form 990

How do you know if your tax exemption status is still valid with the IRS? – Posted 9/29/23

How do you find out if your tax exemption is still valid? I was told the IRS is making changes and if you are not active in their system as of October 9, 2009, you won’t be able to operate as a church! This question probably arose from a misunderstanding related to filing a Form 990 series information return. Most types of nonprofit organizations are required by law to file either Form 990 (or the simpler Form 990-EZ for smaller organizations) if their “gross receipts” (revenues) normally exceed the threshold amounts published by the IRS in the instructions to the forms.

Organizations not required to file Form 990 or 990-EZ because their revenues are below the threshold amounts must still file an annual electronic Form 990-N with the IRS to advise the IRS that the organization still exists. Organizations that are required to file either Form 990, 990-EZ or 990-N and don’t do so will have their exempt status automatically revoked by the IRS after failing to file for three consecutive years. Churches, associations of churches, integrated auxiliaries of churches, certain foreign missions organizations and certain other specifically-listed types of nonprofit organizations are exempt from filing Form 990, 990-EZ or 990-N, regardless of their size.

Furthermore, churches, associations of churches, and integrated auxiliaries of churches are exempt from federal income tax as 501(c)(3) organizations whether they file an application for exemption with the IRS or not. Accordingly, while it is true that the IRS will revoke the exempt status of some nonprofits that fail to file Form 990, 990-EZ, or 990-N, that is not true with respect to churches.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Q&A: Can a For-Profit Food Truck Make Money on Church Property?

Receiving more than $1,000 from a vendor could be considered unrelated business income. – Posted 9/27/23

Q: We currently have our food service sell dinner for our congregation before services on Wednesday nights. We only have this option at one of our campuses. We’re wondering if we could allow food trucks to come to our other campuses to provide food before service. This would be for the convenience of our congregants, but could it be a problem to have a for-profit business making money on our nonprofit exempt property?

This is a practical question that comes up from time to time. The place to start is with the constitution and/or bylaws of your church. I’m going assume that your main purpose is something like, “to share the good news of Jesus, to bring religious education to our children, to reach our community.” Those may not be your exact words but most churches have the gist of it.

Having food trucks periodically serve your congregants doesn’t meaningfully impair or overshadow the religious purpose that is the basis of your exempt purpose. Rather, as you say, this is a service provided “for the convenience” of your congregants— a convenience that may make it possible for members and visitors to attend given the demands of today’s fast-paced society.

You would encounter a problem if you became “The First Church of Food Trucks.” If your purpose became “food trucks for profit for the city,” then you would no longer be a nonprofit entity, but a for-profit business.

It would be important to know if your church is receiving rental fees or a percentage of the sales. If so, there could be concerns about receiving unrelated business income. Keep in mind that if you receive more than $1,000 from any one vendor, this could be considered unrelated business taxable income (UBTI).

UBTI can be a tricky and complex topic. For a professional’s insights, we reached out to CPA and tax attorney Ted Batson. Here is what he had to say:

If the church is receiving a fee from the food truck operators, then the analysis must consider whether this has become an unrelated business activity. I think that the real property rental exception could come into play so long as the church isn’t providing substantial services—such as utilities, bathrooms, and security. But even then, since this activity occurs at the same time and place as a church function, the exception for trade or business services provided as a convenience for our members should preclude any amount you receive from being UBTI. This is the same exception we use to argue that a church’s café that operates around church services doesn’t generate UBTI. This scenario could conceivably create a more heightened degree of concern about the church’s property tax exemption if it is receiving a rental fee, percentage of sales, or both. But even then, I suspect that a conversation with the county property tax authority about the occasional, transient use of the property by the food trucks—coupled with the food trucks serving food during church events—would result in no change to the property tax status. If the church isn’t receiving any remuneration, then I would say that having food trucks on the property is comparable to catering a meal. Under this condition, there would be no UBTI because the church isn’t receiving remuneration. I think in most states the transient use of the church property (and perhaps utilities) during these limited time periods that are attached to church functions should not infringe on the church’s property tax exemption either.

I would like to add one other thought—and a caution: If anyone on your church staff has a personal or family interest in the food trucks, they should disclose that information. That person cannot take part in deciding what trucks will sell food. That would be a conflict of interest.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

IRS Again Alerts Employers to Improper ERC Claims

Third parties are using aggressive tactics and lucrative promises related to ERC claims. – Posted 9/26/23

Editor’s Note: On September 14, 2023, the Internal Revenue Service (IRS) announced it has immediately stopped processing new Employee Retention Credit (ERC) claims “amid [a] surge of questionable claims.”

Concerns raised by tax professionals, coupled with aggressive marketing to ineligible applicants, “highlights unacceptable risk to businesses and the tax system,” the agency said.

The IRS will continue processing previously filed claims and pay out claims it approves, it said, but processing times will take longer as the agency applies more scrutiny to address fraud concerns.

The IRS also said it is finalizing details to help entities victimized by “aggressive promoters” who have used repeated advertising and direct-contact methods to entice claim applications without carefully evaluating whether an entity truly qualifies for the credit.

Taxpayers who already have a claim submitted, but fear they were misled–including churches and small businesses–will be eligible for a special withdrawal option as well, the IRS said. It plans to announce details for the option soon.

The IRS said more than 600,000 claims remain unprocessed.

Church Law & Tax will continue to monitor developments.

The Internal Revenue Service (IRS) is again warning employers, including churches, to exercise caution if they’re contacted by a third party regarding the Employee Retention Credit (ERC).

The ERC is legitimate. However, third parties are using aggressive tactics to try and entice employers to seek it, and sometimes, the third parties aren’t carefully evaluating an employer’s eligibility, putting the employer in jeopardy with the IRS.

In other instances, the third parties have fraudulent intentions altogether.

Many churches may be eligible for the ERC, a provision providing employers relief due to hardships experienced in the early days of the COVID-19 pandemic. Specific criteria must be met, however.

“The aggressive marketing of the Employee Retention Credit continues preying on innocent businesses and others,” said IRS Commissioner Danny Werfel, in the agency’s latest alert. “Aggressive promoters present wildly misleading claims about this credit. They can pocket handsome fees while leaving those claiming the credit at risk of having the claims denied or facing scenarios where they need to repay the credit.”

The IRS provided a list of “warning signs” that employers should look for when dealing with a third party about the ERC, including:

  • Unsolicited calls or advertisements mentioning an “easy application process.”
  • Statements that the promoter or company can determine ERC eligibility within minutes.
  • Large upfront fees to claim the credit.
  • Fees based on a percentage of the refund amount claimed. This is a similar warning sign for everyday taxpayers, who should always avoid a tax preparer basing their fee on the size of the refund.
  • Aggressive claims from the promoter that the business receiving the solicitation qualifies before any discussion of the group’s tax situation. The ERC is a complex credit that requires careful review before applying.
  • Wildly aggressive suggestions from marketers urging businesses to submit the claim because there is nothing to lose. Those improperly receiving the credit could have to repay the credit—along with substantial interest and penalties.

“These promoters may lie about eligibility requirements,” the IRS added. “In addition, those using these companies could be at risk of someone using the credit as a ploy to steal the taxpayer’s identity or take a cut of the taxpayer’s improperly claimed credit.”

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

AG investigations into churches and nonprofits are on the rise – Part 2

AG investigations can lead to both civil and criminal penalties. What triggers such investigations, and how can your church be prepared? – Posted 9/22/23

What does an attorney general investigation look like?

With an increase in these investigations, church leaders may wonder what to expect if one arises.

At the preliminary stage, there is a unique and limited opportunity to directly refute charges and provide the necessary evidence to do so.

But suppose the investigator sees that the organizational and legal health of the church is in disarray. In that case, it is a sure bet that the attorney general’s office will begin to investigate. At this juncture, this could be a criminal investigation into individual board members. It could also be a civil matter against board members and/or the entity, or a combination of both.

In all matters, hiring competent legal counsel to represent your organization throughout the investigation is critical.

If the matter is potentially criminal, the attorney general will have the option to investigate and present the findings to a grand jury for indictment. In lieu of indictment, some states may allow the church the opportunity to hire its own forensic auditor (holding certified fraud examiner (CFE) and/or certified financial fiduciary (CFF) certifications) to provide an independent report as to whether financial malfeasance occurred.

These audits often require $50,000 to $100,000 to complete. It’s expensive, but it’s better than a criminal indictment. And the state may still choose to indict depending on the findings.

How can my church be prepared for an attorney general investigation?

Our firm has yet to encounter a board involved in an attorney general investigation that had been properly trained on:

Focus on the following areas to reduce the risk of a lengthy investigation:

Board member training covering fiduciary duties, oversight responsibilities, and understanding your church’s governing documents and board policies. Every new board member should also receive this training. Proper board disciplines should include—but not be limited to—keeping accurate minutes and board member recusal of voting as it relates to conflicts of interest.

Written board policies and procedures that promote legal and financial integrity such as:

  • Conflict of interest policy
  • Independent compensation policy
  • Confidentiality policy
  • Restricted funds policy
  • Policy prohibiting cash structuring

Simply ensuring your board members have this information and understand their roles will virtually eliminate this risk.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

AG investigations into churches and nonprofits are on the rise – Part 1

AG investigations can lead to both civil and criminal penalties. What triggers such investigations, and how can your church be prepared? – Posted 9/20/23

While the Internal Revenue Service is seen as the primary watchdog to the nonprofit world, attorneys general also can investigate nonprofits, and AG investigations into nonprofits and churches are on the rise.

This may be surprising, but in most states, attorneys general not only have the power to investigate nonprofits and churches, but they also have the power to render civil and criminal penalties and prosecute and remove board members.

In one non-church nonprofit matter in Minnesota, the attorney general even petitioned to dissolve a nonprofit.

There is certainly an overlap between an attorney general and the IRS’s involvement in investigating churches and nonprofits for financial concerns, but it seems that the attorney general’s offices are picking up in areas where the IRS is not.

Under IRS regulations, the IRS must have a “reasonable belief”—with evidence—that wrongdoing is occurring.

However, “reasonable belief” is not a requirement for attorneys general.

In our law practice—exclusively devoted to representing churches and nonprofits—this has been the fastest-growing trend in years.

From 2010 through 2022, we only saw a handful of these investigations. They predominantly focused on non-church nonprofit organizations.

Since fall 2022, though, we have represented churches and nonprofits in more than a dozen attorney general investigations.

What triggers an attorney general investigation?

Just as Scripture refers to money as the root of all evil, in the nonprofit compliance world, money is indeed the root of all state attorney general investigations.

Due to the potential for fraud, state attorneys general are very interested in how church boards handle money provided by the citizens of their states.

The online complaint process is simple, and can trigger an investigation for reasons that include, but are not limited to, the following:

  • Loans to directors and officers: In many states—such as Florida, Tennessee, New York, and California—it is illegal for a church to loan any money to individual board members. This may even include using church credit cards for personal purchases and reimbursing the church later, which amounts to short-term loans. There are serious legal consequences here for what essentially amounts to the comingling of church and personal funds.
     
  • Misuse of ministry-owned housing: Problems occur in this area when a board member—most often a pastoral staff member—lives in ministry-owned property but does not have a housing allowance set up or in place, and the church does not report the value of the ministry-provided housing on individual tax returns.

  • Questionable expenditures potentially in violation of tax laws: When an attorney general receives a complaint that a board member is personally benefitting, the law treats this as “inurement” (improper personal financial gain from the nonprofit).

Red flags

  • Personal clothing purchases
  • Excessive travel expenses that appear to be personal
  • Personal expenses (food, medical treatment, and other similar items)

Impropriety Related to Unrelated Business Income (UBI): Revenue generated by your church that appears to be substantial and not closely related to its exempt purposes may trigger unrelated business income taxes. Correct legal and accounting counsel on how to properly set up and facilitate your ministry’sUBI is critical. Improperly structuring multi-entity ministries—especially if UBI is involved and board members are involved in the process—can have dire consequences and present the appearance that the church is funneling money to the personal business endeavors of the church’s directors.

Stay tuned for part 2 of this article where we discuss the overall investigation and how you can prepare for an investigation. To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Yes, Ministries Should Embrace AI

AI is a tool that, if used properly, can advance ministry. – Posted 9/19/23

There is no doubt that artificial intelligence (AI) has been a significant technological advancement and will continue to revolutionize our lives, with some suggesting AI is to this generation what dial-up internet was to the prior generation. 

But with artificial intelligence comes many questions.

Is it safe?

Can it be trusted? 

And will AI lead to the destruction of life on our planet?

In many ways, our sci-fi imaginations get the better of us: Is AI the Terminator come to life? Have we finally built Mr. Data from Star Trek: The Next Generation? When can I order my first C-3PO droid from Amazon?

Think critically about AI

But the more constructive question for church leaders is this: How will AI affect churches and ministries? 

One thing to remember: Artificial has been around for a while and has been used in the form of algorithms to process data and determine outcomes. Algorithms determine our social media feeds, protect our bank accounts and personal information, and even help with traffic management.  

As the algorithms get “smarter,” the appearance of intelligence emerges. Add to that the ability to tackle more complex, subjective questions, such as “Which national park is the best?” and the algorithms behind AI begin to give it the appearance of discernment.

But AI can’t discern. Remember, the data from which it draws its conclusions was provided by humans that may not always agree and are often filled with biases. So, while artificial intelligence does its best with what it has, we’ve found it to be extremely flawed.

You remember the adage, Garbage in equals garbage out? It’s still true. But with AI, the scale makes finding the garbage a challenge, and the subjective nature of what one human programmer views as garbage compared to another programmer’s view further complicates the effectiveness.

It harkens to the early days of the internet when we emphasized that not everything you read online is true. 

Now, the emphasis is on reminding people that, not only is the internet not the ultimate source of truth, but neither is social media—and neither is AI.

Embrace AI, do not fear it

How does all of this affect ministries? 

First, there is no need to be scared. Artificial intelligence is not life—only God can create life. No amount of programming or algorithms can change that. AI can only mimic the creative process.

Second, you can’t always trust it.   Phishing scams and get-rich-quick schemes flourish because we believe what we see online. You don’t know if there is another human trying to scam you or another human using AI to make the scam more complex, but you can’t naively trust AI. 

Third, ministries should embrace AI.  (Yes, you read that correctly.)

Churches and ministries should not run and hide just because AI poses risks. Instead, they should use AI, as they hopefully use other technology, for ministry effectiveness.

Convene conversations around AI

AI offers numerous ministry opportunities. Instead of fearing it, use it as a discipleship opportunity.

Sure, your theology will come into play when evaluating artificial intelligence, but is your church teaching about it with any theological depth? 

Have you considered community events to teach the good and the bad? What about teaching basic online safety, including code words to avoid child voice scamming, or that using AI—or any other method—to cheat on one’s homework is a sin?

I assure you: I typed what you are reading here. But how do you know? How would a school know? Even AI tools used to detect AI-created content had to be shut down because the tools failed more than 60 percent of the time.

In many cases, AI should be an opportunity for the church to look deeper at itself, both beneath the steeple and outside the walls.

AI’s undeniable power

Meanwhile, the power of AI is undeniable and creates questions and concerns.

Its ability to generate lifelike videos is amazing. 

The benefits to church production in not having to record your pastor literally saying every word, but rather, setting up an AI version so you can improve efficiency is incredible.

The sin-cursed side of this is, what happens when the pastor leaves and the church holds on to the likeness and makes it say things the pastor would never say? This side of heaven, powerful technology must be applied through the lens of the Bible.

At a more individual level, what happens when artificial intelligence is used to fake the voice of one of your children calling for help when your child is safe? Social media is another powerful technology that can be used for good and evil. The video you posted of your child giving a speech can also be used to get a sample of a child’s voice that, in turn, could be used to scam you through emotional distress. 

The world is constantly changing. We need to teach that the Bible is forever, providing a strong theological foundation so that, whatever comes next, our people are ready to handle it in a Godly manner. None of these technological developments surprised God, but do we really believe and teach that? The Bible teaches the need to discern right from wrong, and yet we are not teaching that same discernment online.

Using AI to strengthen ministry

Other benefits for churches involve data collection and analytics. I’ve written about the data that churches collect and how to keep it safe, but what about using AI to better evaluate that data? Data is fine, but it’s what you do with the data that really matters.

Artificial intelligence can be an ally in this effort by going through data and providing useful information from which to make decisions.

Using AI to help close the proverbial “ministry back door”where people stop attending before leaders realize it. AI can help us better evaluate attendance patterns and changes in involvement, even comparing attendance with giving trends. This information might help us understand who is at risk for leaving the church or struggling in a manner that a call or visit might prove fruitful. What used to be complex and take hours can now be simplified and assessed in real time. 

Copyright and defamation concerns

We have a long way to go to catch up with the advancements artificial intelligence has provided and the law lags these advancements, too. AI has quickly outdated copyright laws. Personal privacy and intellectual property lawsuits are just starting to head to court. Defamation cases are being filed. But in these cases, who’s to blame? The AI? Or those who programmed the AI? The decisions to come will reshape how we know and understand the use of this technology even in church contexts.

Stewarding AI for good

I’m excited about AI’s potential for affecting the Kingdom. 

But, whether with AI, social media, digital projectors, microphones, cameras, or anything else, all new technology requires responsible use. 

Microphones are great, but if you don’t know what you are doing, they will cause piercing feedback. artificial intelligence is also great, but if you don’t know what you are doing, and you aren’t willing to learn, the scale of the feedback could be destructive. 

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Tackling Big-Ticket Repairs on a Housing Allowance

So, you’ve done the hard work of setting a housing allowance and, SURPRISE!, the septic tank fails. What now? – Posted 9/15/23

Q: Unplanned repairs are part of homeownership. What can a church do to help with a big-ticket repair that wasn’t anticipated when designating the pastor’s housing allowance?

Let’s assume we’re talking about an $8,000 septic tank replacement. Let’s say the church agrees to increase the housing allowance for the remainder of the year by $8,000. Either the church can designate an additional $8,000 out of the pastor’s salary as housing or the church can give the pastor the $8,000 and call it housing-related.

From a tax perspective, it’s unlikely either approach will actually help.

Why? To understand, it’s necessary to understand how the housing allowance works.

A calculation game

The amount a pastor is allowed by the Internal Revenue Service (IRS) to exclude from income tax as a housing allowance is the smaller of three separate numbers:

  1. The amount the church designates as a housing allowance;
  2. The actual amounts expended on housing during the year, including mortgage payments, property insurance, property tax, utilities, repairs and maintenance, and furnishings; and
  3. The annual fair rental value of the home, plus utilities, plus furnishings.

Returning to the example above, assume that, regardless of which way the $8,000 is handled, the church designated a total housing allowance for the year, including accounting for the septic tank, of $40,000.

Let’s further assume that, at the end of the year, the pastor adds up all of his or her actual housing expenses and the total is $31,000, plus the $8,000 septic tank repair, for total actual housing expenses of $39,000.

Finally, the pastor consults with a local real estate agent and determines that the annual fair rental value of his or her home, including the effect of the new septic system, is $25,000. Add to this amount an additional $3,600 in utilities and $2,400 in furnishings, and the fair rental value, plus utilities, plus furnishings is $30,000. This amount is well below the actual expenditures (when the septic tank is factored in) and the designated housing allowance amount.

The moral of the story is that the fair rental value, plus utilities, plus furnishings is always going to be a hard cap in terms of how much a pastor can exclude from income tax. That’s because this calculation usually comes in as the lowest of the three figures that need to be calculated. As this example illustrates, designating an additional amount as the housing allowance had no impact on the amount the pastor could actually exclude from tax.

‘Better than a stick in the eye’

Here’s another common example: A pastor wants to add a second story to a home at a cost of $60,000. Let’s say this pastor is making $150,000 a year, of which $40,000 is designated as housing allowance. The pastor comes back to the church and asks the church to bump up that housing allowance from $40,000 to $100,000. That may help to a degree, because a two-story house is going to have a higher fair rental value than a one-story house.

But the pastor is not going to get the full benefit that he or she anticipated getting because the fair rental value calculation still will come in below $100,000.

So, does this mean a big ticket expense is not going to really benefit a pastor?

As my dad would say, it’s better than a stick in the eye.

But the pastor ordinarily is not going to be made whole in the process from a tax benefit perspective. Subject to the general requirement that a church (or any nonprofit organization) not pay its key employees excessive compensation, the church can still provide more money to the pastor in response to the need. It just means the pastor will pay income tax on the added amount.

It is also useful to point out that, in the example cited above, the church must also consider the reasonableness of the pastor’s overall compensation before providing more money.

Timing also matters

Remember a couple of additional things about how the housing allowance works.

  1. The housing allowance is always a prospective thing. The church must always award or pass a resolution to give a pastor a housing allowance on a prospective basis. It can never be applied retroactively.
  2. When changes to the allowance are needed mid-year, those changes also only take place going forward.

Something attorney and senior editor Richard Hammar deals with in the annual “Church and Clergy Tax Guide” is that we don’t have a lot of guidance from the IRS that explains whether a pastor has to have a match between the time he or she incurred expenses and the time he or she gets paid the allowance.

So, consult with a tax advisor.

Hypothetical scenario: Let’s say a large church adds a new pastor midway through last year but forgets to formally set the new pastor’s housing allowance for the first three months of  the new year. In that scenario, the pastor has made several mortgage payments in the new year without the benefit of the allowance. So, the question becomes whether those mortgage payments are countable in the housing costs for the year. The answer? Consult your tax advisor.

In this scenario, the pastor’s responsibility is to accept the risk that he or she may not be able to claim those mortgage payments, regardless of what the church decides to do.

Again, that’s something the pastor and the pastor’s tax advisor must work out.

On the church’s side, I always tell the church, ‘Hey, you were going to give this (pastor) a $20,000 housing allowance and you didn’t do it in the first six semi-monthly pay periods of the year … let’s take that $20,000 and divide it into the remaining payrolls.’

By doing that, we’re giving the pastor the opportunity to decide, in consultation with a tax advisor, whether he or she wants to include those three months of housing expenses.

Q: Can a church declare 100 percent of a pastor’s compensation to be a housing allowance?

There is no legal impediment to do so, although it’s not advisable.

That’s because you’re relying on the pastor and his or her tax advisor to know the rules and exclude the proper amount. You’ve set them up to make a mistake.

In addition, if you offer benefits, such as health insurance for which the pastor must pay a portion, a healthcare flexible spending account, or a 403(b) plan with elective deferrals, the pastor must have cash salary, not housing allowance, from which to deduct these withholdings.

So, as a practical matter, declaring 100 percent of a pastor’s compensation to be a housing allowance would compromise participation in these benefit programs.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

How Churches Can Leverage Higher Interest Rates

Higher interest rates offer churches an opportunity to adopt new cash- and debt-management strategies. – Posted 9/13/23

In an era of higher interest rates, it is essential for churches to adopt new cash- and debt-management strategies. 

Seek an increase in savings, money market interest rates

A good first step for churches is to request an increase in the interest rate on their bank’s savings or money market accounts.

By negotiating better rates, churches can see higher yields in support of their mission. 

Beyond that, reassessing cash management strategies is key when interest rates are high.

Get strategic about cashflow

One effective approach is to redirect cash held in an operating account to savings or money market accounts.

Try to place all cash not needed to pay bills in the next 14-30 days into accounts that gain a higher interest rate. Strategically managing cash flow means a church can strike a balance between accessible funds for day-to-day expenses and maximizing the interest earned on their reserves.

Beef up reserves

Churches looking to build up reserves for future projects should consider investing in bonds or bond mutual funds.

The Federal Deposit Insurance Corporation (FDIC) insures deposits of up to $250,000 per depositor, per insured bank.

If the church leaves its cash reserves in one bank, though, it exposes them to risk without the benefit of a higher potential interest rate (banks do not typically pay high interest on cash savings). Instead, investing in bonds or bond mutual funds enables the church to possess investments with a low risk profile but higher returns than cash.  

Bonds typically offer higher interest rates compared to traditional savings accounts, making them attractive investment vehicles.

By carefully selecting bonds based on risk tolerance and investment objectives, churches can secure steady income streams and potentially grow their money to keep up with the rising cost of construction.

Before investing in bonds, be sure you have your board write an investment policy with the advice of a financial professional.

Higher interest rates and debt paydowns

Some churches enter swap agreements with financial institutions—contractual arrangements that typically exchange cash flow or liabilities from two different financial instruments.

For churches with existing swap agreements on their loans, higher interest rates may present an opportunity to pay down debt. Analyze the terms of the swap agreement and consider reducing the outstanding debt if it is advantageous.

In some cases, churches may find themselves in a favorable position, allowing them to receive payments from investors when paying down their debts.  

Again, though, be sure to seek professional advice before moving forward with such a strategy. 

A word of caution

Though higher interest rates may be advantageous for certain financial strategies, it is crucial for churches to exercise caution when taking on additional debt. Rather than focusing on increasing debt, it is advisable to undertake projects that align with the congregation’s regular patterns of giving. 

Capitalizing on higher interest rates will require some strategic thinking and execution. However, it is essential to remember that every church’s financial situation is unique, and professional advice is crucial for tailoring strategies to specific needs. 

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Key Tax Dates September 2023

Key tax dates for September 2023 include quarterly estimated payments and monthly or semiweekly requirements. – Posted 9/12/23

Monthly requirements

If your church or organization reported withheld taxes of $50,000 or less during the most recent lookback period (for 2023, the lookback period is July 1, 2021, through June 30, 2022), then withheld payroll taxes are deposited monthly. Monthly deposits are due by the 15th day of the following month.

Note, however, that if withheld taxes are less than $2,500 at the end of any calendar quarter (March 31, June 30, September 30, or December 31), the church need not deposit the taxes.

Instead, it can pay the total withheld taxes directly to the IRS with its quarterly Form 941. Withheld taxes include federal income taxes withheld from employee wages, the employee’s share of Social Security and Medicare taxes, and the employer’s share of Social Security and Medicare taxes.

Semiweekly requirements

If your church or organization reported withheld taxes of more than $50,000 during the most recent lookback period (for 2023, the lookback period is July 1, 2021, through June 30, 2022), then the withheld payroll taxes are deposited semiweekly.

This means that for paydays falling on Wednesday, Thursday, or Friday, the payroll taxes must be deposited on or by the following Wednesday. For all other paydays, the payroll taxes must be deposited on the Friday following the payday.

Also note that large employers having withheld taxes of $100,000 or more at the end of any day must deposit the taxes by the next banking day.

The deposit days are based on the timing of the employer’s payroll.

Withheld taxes include federal income taxes withheld from employee wages, the employee’s share of Social Security and Medicare taxes, and the employer’s share of Social Security and Medicare taxes.

September 15, 2023: Quarterly estimated tax payments for certain employees and churches

Filing for certain ministers and self-employed workers

Ministers (who have not elected voluntary withholding) and self-employed workers must file their third quarterly estimated federal tax payment for 2023 by this date. A similar rule applies in many states to payments of estimated state taxes.

Nonminister employees of churches that filed a timely Form 8274 (waiving the church’s obligation to withhold and pay FICA taxes) are treated as self-employed for Social Security, and as a result are subject to the estimated tax deadlines with respect to their self-employment (Social Security) taxes unless they ask their employing church to withhold an additional amount of income taxes from each paycheck that will be sufficient to cover self-employment taxes. Use a new Form W-4 to make this request (the additional withholding is reported on line 4(c)).

Payments for unrelated business income tax liability

A church must make quarterly estimated tax payments if it expects an unrelated business income tax liability for the year to be $500 or more. Use IRS Form 990-W to figure your estimated taxes. Quarterly estimated tax payments of one-fourth of the total tax liability are due by April 18 (April 19 if you live in Maine or Massachusetts), June 15, September 15, and December 15, 2023, for churches on a calendar-year basis. Deposit quarterly tax payments electronically using the Electronic Federal Tax Payment System (EFTPS).

Note: If a date listed for filing a return or making a tax payment falls on a Saturday, Sunday, or legal holiday (either national or statewide in a state where the return is required to be filed), the return or tax payment is due on the following business day.

Note: You must use electronic funds transfer to make all federal employment tax deposits. This is generally done using the Electronic Federal Tax Payment System, a free service provided by the US Department of Treasury. If you don’t wish to use EFTPS, you can arrange for your tax professional, financial institution, or payroll service to make deposits on your behalf. Failure to make a timely deposit may subject you to a 10-percent penalty.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

 

Tax News for August 2023 . . .

Fed Rolls Out New Form I-9, Sunsets Key COVID-19 Deferment – Part 3

The new Form I-9 is for churches, too, and remote examination is an option. – Posted 8/25/23

Key revisions and updates

Several other revisions made by the agency are designed to ease burdens on employers and employees, including:

  • The new form can be completed on tablets and mobile devices.
  • The new form comes with fewer instruction pages.
  • Instructions include how to use a new checkbox for employers who choose to examine Form I–9 documentation under an alternative procedure.
  • Reduced Sections 1 and 2 to a single-sided sheet. No previous fields were removed. Rather, multiple fields were merged into fewer fields when possible.
  • Moved the Section 1 Preparer/Translator Certification area to a separate, standalone supplement (Supplement A) that employers can provide to employees when necessary. Employers may attach additional supplement sheets as needed.
  • Moved the Section 3 Reverification and Rehire area to a separate, standalone supplement (Supplement B) that employers can print if or when rehire occurs or reverification is required. Employers may attach additional supplement sheets as necessary.
  • Removed use of “alien authorized to work” in Section 1 and replaced it with “noncitizen authorized to work” as well as clarified the difference between “noncitizen national” and “noncitizen authorized to work.”
  • Removed certain features to ensure the form can be downloaded easily. This also removes the requirement to enter “n/a” in certain fields.
  • Updated the notice at the top of the Form I–9 that explains how to avoid discrimination in the Form I–9 process.
  • Revised the Lists of Acceptable Documents page to include some acceptable receipts as well as guidance and links to information on automatic extensions of employment authorization documentation.
  • Added a box that eligible employers must check if the employee’s Form I–9 documentation was examined under a DHS-authorized alternative procedure rather than via physical examination.

More about the new form I-9

The new form contains two sections and two supplements:

  • Section 1 of the form collects, at the time of hire, identifying information about the employee (and preparer or translator if used), and requires the employee to attest to whether the employee is a U.S. citizen, noncitizen national, lawful permanent resident, or noncitizen authorized to work in the United States.
  • Section 2 of the form collects, within three days of the employee’s hire, identifying information about the employer and information regarding the employee’s identity and employment authorization. The employee must present original documentation evidencing the employee’s identity and employment authorization, which the employer must review.
  • Supplement A, Preparer and/or Translator Certification for Section 1, is completed when employees have preparers or translators assist them in completing Section 1 of Form I–9.
  • Supplement B, Reverification and Rehire (formerly Section 3), is primarily used to verify the continued employment authorization of the employee.

This Supplement is completed prior to the date that the employee’s employment authorization or employment authorization documentation recorded in either Section 1 or Section 2 of the form expires, if applicable.

It may also be used if the employee is rehired within three years of the date of the initial completion of the form and to record a name change.

Record retention policy

An employer must maintain Forms I–9 for as long as individuals work for the employer and for the required retention period after the termination of an individual’s employment (either three years after the date of hire or one year after the date employment ended, whichever is later).

Also, employers must make their employees’ Forms I–9 available for inspection upon request by Department of Homeland Security (DHS), the Immigrant and Employee Rights Section (IER) in the US Department of Justice’s Civil Rights Division, and the US Department of Labor.

An employer’s failure to ensure proper completion and retention of Forms I–9 may subject the employer to civil money penalties, and, in some cases, criminal penalties.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Fed Rolls Out New Form I-9, Sunsets Key COVID-19 Deferment – Part 2

The new Form I-9 is for churches, too, and remote examination is an option. – Posted 8/23/23

Sunset of COVID-19 verification flexibility

One such change: the sunsetting of a COVID-19-era deferment for employers that allowed remote verification of employee I-9 documentation.

Starting July 31, 2023, employers have 30 days to comply with traditional Form I-9 requirements for employees whose I-9 documents were remotely verified between March 20, 2020, and July 31, 2023.

For employers that are not eligible to participate in the alternative inspection process via E-Verify, this means all I-9 documents remotely inspected under COVID-19 flexibilities must be physically inspected, in-person, by August 30, 2023.

Old form I-9 valid through Oct. 31, 2023

Employers may continue using the old Form I–9 (Rev. 10/21/19) through October 31, 2023, as they adjust to the agency’s various changes.

However, starting November 1, 2023, employers who fail to use the new form may be subject to all applicable penalties under the Immigration and Nationality Act as enforced by U.S. Immigration and Customs Enforcement (ICE).

Important: Employers do not need to complete the new Form I–9 (Rev. 08/01/23) for employees who already have a properly completed Form I–9 on file, unless reverification applies after October 31, 2023.

Stay tuned for part 3 where we will discuss key revisions and updates to form I-9. To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Fed Rolls Out New Form I-9, Sunsets Key COVID-19 Deferment – Part 1

The new Form I-9 is for churches, too, and remote examination is an option. – Posted 8/22/23

All employers, including churches, are to begin using a new Form I-9, the U.S. Citizenship and Immigration Services (USCIS) announced in late July.

Form I-9 is required of employers to verify the identity and the employment authorization of their employees to work in the country.

The new form became available August 1, 2023, and allows certain qualifying employers an alternative way of examining identifying documents for new employees using E-Verify.

According to the Homeland Security Department rule, to use E-Verify, an employer must be an E-Verify participant in good standing, which is defined as:

  • An employer that has enrolled in E-Verify with respect to all hiring sites in the U.S. that use the alternative procedure;
  • is compliant with all requirements of the E-Verify program including but not limited to verifying the employment eligibility of newly hired employees in the U.S.;
  • continues to be a participant in good standing in E-Verify at any time during which the employer uses the alternative procedure.

The agency also announced other key changes likely affecting most, if not all, employers, including many churches.

This is a 3 part series so stay tuned for the next two parts coming later this week. To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Does Your Church Owe Taxes on Alternative Revenue? – Part 5

Answers about the often misunderstood world of unrelated business income. – Posted 8/11/23

Calculation of debt-financed income subject to tax

In most cases, not all of the net income generated from debt-financed property is actually taxable. The amount that is taxable is based on the amount of applicable debt and the church’s basis in the property.

Calculation of unrelated debt-financed income from regular activity (such as rental income)

In determining how much income (such as rental income) is actually unrelated debt-financed income with respect to a specific property, the church needs to know the average amount of acquisition indebtedness that was outstanding during the applicable tax year and the average tax basis (as defined in the Regulations) of the property for the period during the tax year that it held the property. The amount of the rental income that is considered unrelated debt-financed income is determined by multiplying the rental income by the ratio of the average acquisition indebtedness to the average tax basis of the property.

Example: Hickory Church owns a building that is debt-financed and rents it to a commercial tenant for $100,000 per year. For the year 20XX, Hickory Church had average acquisition indebtedness related to the building of $600,000 and its average tax basis for the building was $1 million. The ratio of the average acquisition indebtedness to the average tax basis is 60 percent. Therefore, 60 percent of the rental income, or $60,000, is considered unrelated gross debt-financed income. The church would also apply the 60 percent ratio to allowable expenses associated with the building’s rental activity to determine the expenses that are deductible against the gross revenue of $60,000 in arriving at net unrelated taxable income (or loss) from the activity.

Calculation of unrelated debt-financed income from the sale of property

In determining how much gain from the sale of debt-financed property is actually unrelated debt-financed income with respect to the property, the church needs to know the highest amount of acquisition indebtedness that was outstanding during the twelve-month period preceding the date of the sale and the average tax basis (as defined in the Regulations) of the property for the period during the tax year that it held the property. The amount of gain that is considered unrelated debt-financed income is determined by multiplying the gain from the sale by the ratio of the highest acquisition indebtedness to the average tax basis of the property.

Example: Oak Church buys a vacant parcel of land for $1 million in Year One, incurring debt in the amount of $800,000, with the intent of using the property for exempt purposes at some time in the future. The church never uses the property for exempt purposes. At the end of Year Ten, Oak Church sells the property for $10 million. The church’s acquisition indebtedness related to the property was $600,000 at the beginning of Year Ten and had been paid down to $500,000 by the end of Year Ten when the property was sold. The church’s average tax basis for the property was its original purchase price of $1 million. The church has a gain on the sale of the property of $9 million (the difference between the sales price of $10 million and the church’s basis for the property of $1 million). The highest acquisition indebtedness related to the property during Year Ten was $600,000. The ratio of the highest acquisition indebtedness to the average tax basis is 60 percent. Therefore, 60 percent of the gain (or $5.4 million) is taxable as unrelated debt-financed income. (At current regular federal corporate tax rates, the federal income tax on the gain would be approximately $1.8 million. It is likely that state corporate income tax would also apply.)

Planning pointer: If Oak Church had paid off the acquisition debt thirteen months before it closed on the sale of the property, none of the gain would have been taxable. This is an example of where good tax planning could have resulted in very substantial tax savings!

Section 4: Is Unrelated Business Income Really Such a Bad Thing?

Many churches try to avoid unrelated business income like the plague! But is UBI really such a bad thing? One positive theory is that it is better to have additional income, even if you have to pay some tax on it, than not to have the income at all. While such reasoning is logical, there are several implications associated with generating unrelated business income that a church should carefully consider before deciding.

Federal and state filing requirements and tax rates

When a church generates more than $1,000 of gross revenue from unrelated business activities, the church is required to file a federal income tax return (Form 990-T). Form 990-T is due by the fifteenth day of the fifth month after the church’s year-end (May 15 for a church operating on the calendar year) and may be extended for up to six months.

On Form 990-T, the church reports the revenue from its unrelated business activities and the expenses related to generating the revenue are deducted. If the revenue exceeds the deductible expenses, the church has net income from its unrelated business activities, which is subject to federal tax. If the church is incorporated (that is, it is a corporation, as are most churches in the U.S.) the regular U.S. corporate income tax rates apply.

Most states require a church that files Form 990-T to file a state income tax return as well, and if the church generates net income as calculated under state law, the church will likely also owe state income taxes calculated at applicable state income tax rates.

Implications for state and local taxes other than income taxes

When a church engages in any trade or business activity, whether it generates unrelated business income or not, it should consider the possible tax implications in other jurisdictions. For example, selling goods or services may subject the church to state sales tax laws, requiring the church to collect and remit sales tax on transactions subject to the tax. Renting property to tenants may result in similar obligations.

Laws in some states that provide property tax exemptions for churches require that property to be used exclusively for exempt purposes in order to qualify for exemption. Where that is the case, a church that engages in a trade or business activity or that rents out its property to others should determine whether the conduct of the activity could adversely affect its exemption. The definition of exempt use of property for property tax exemption purposes is state-specific and is often different from the definition of exempt-purpose activity under federal income tax law.

It is possible, therefore, that engaging in any trade or business, including an unrelated business activity, could adversely affect a church’s exemptions under various state or local laws and ordinances.

Calculating and minimizing net unrelated business income

Once a church determines that it has more than $1,000 of gross revenue from one or more unrelated business activities, it must determine its net taxable unrelated business income (or loss). Many organizations that have significant revenue from unrelated business activities actually generate a net loss from the activities after taking into account deductible expenses.

Section 3 addresses the manner in which unrelated debt-financed income is calculated.

To calculate net unrelated business income from other activities, the starting point is gross unrelated business revenue. Allowable expenses attributable to the unrelated business activities are deducted from gross revenue. In addition to expenses incurred by the church, the law allows a standard deduction of up to $1,000 (but the standard deduction cannot create a net loss or make a net loss larger).

In order to be allowable as deductions, expenses must be “directly connected” with carrying on the church’s unrelated business activities. Some expenses are attributable solely to an unrelated business activity, and the relationship is straightforward. A church may incur some expenses that are attributable partly to unrelated business activities and partly to exempt activities, in which case a reasonable allocation must be made, and only that portion of the expense attributable to the unrelated business activity is deductible.

A church that engages in unrelated business activities should carefully evaluate all of its expenses to identify every expense that may be properly and reasonably allocated to, and deducted from, the unrelated business revenue. When all such expenses are identified and deducted, including a reasonably allocable portion of administrative and overhead expenses, the result is often a net loss.

Net losses from unrelated business activities may be carried back or forward to offset net income in other years in the same manner that is allowed under federal tax law for taxable corporations.

Can a church have too much unrelated business activity?

A church may not devote a substantial amount of its time, resources, or activities to any non-exempt purposes. Accordingly, if a substantial portion of a church’s activities are dedicated to the conduct of one or more unrelated business activities, the church can lose its federal tax-exempt status under Section 501(c)(3) of the Internal Revenue Code. Unfortunately, the law is not clear with respect to measuring or determining the limits of unrelated business activity. The conclusions reached in various cases and rulings over the years vary dramatically due to the unique facts and circumstances in each of them. Many tax practitioners suggest that when a tax-exempt organization generates more than about 15 percent of its revenue from unrelated business activities, it should carefully consider (together with knowledgeable tax counsel) whether it may be exposed to the risk of loss of exemption. An insubstantial amount of unrelated business activity is not a threat to a church’s federal tax-exempt status.

Generating Income without Generating Unrelated Business Income Tax

Churches may generate income from a variety of sources other than contributions without generating unrelated business income. Using the information described in the previous sections regarding the definition of unrelated business income and the exceptions and exclusions that apply, a church can wisely plan its revenue-generating activities to avoid UBI treatment. Following are examples of income-generating activities that a church may engage in, along with descriptions of how to avoid unrelated business income in conducting them.

Bookstores and gift shops: the volunteer exception

Income from a church bookstore or gift shop may be excluded entirely from unrelated business income if the activity is conducted substantially entirely (more than 85 percent) by volunteers (uncompensated workers). If the activity qualifies for the volunteer exception, it doesn’t matter whether the items sold in the store or shop are substantially related to the church’s exempt purposes or not; nor does it matter whether the store or shop is located on the church’s property. When the volunteer exception applies, the activity may be conducted in a regular commercial location without affecting the exemption from unrelated business income.

Selling substantially related items

If all the items sold in the store or shop are of a nature that selling them contributes importantly to one or more of the church’s exempt purposes, the activity will not generate unrelated business income. In some cases, the relationship between an item being sold and the church’s exempt purposes may be obvious (e.g., Bibles, prayer books, worship music, and so on). As described in Section 1, in cases where the relationship is not obvious, the church should maintain adequate documentation to support the relationship between each item or category of similar items sold and the specific exempt purposes of the church.

Selling at off-site locations, through catalogs, and so on.

Note that, despite popular perception, a church bookstore does not have to be located on the church’s property, operated with limited hours, or concealed from the public in order to have its activities qualify for exemption. In fact, a church selling items that are substantially related to its exempt purposes may do the following without generating unrelated business income:

  • Operate its store or shop in a commercial location;
  • Operate during regular commercial hours;
  • Promote itself to the public;
  • Sell its items in mail-order catalogs or over the Internet;
  • and use other similar methods of promotion.

In an authoritative ruling issued in the context of a museum selling substantially related greeting cards, the IRS clearly addressed the issue:

The organization sells the cards in the shop it operates in the museum. It also publishes a catalogue in which it solicits mail orders for the greeting cards. The catalogue is available at a small charge and is advertised in magazines and other publications throughout the year. In addition, the shop sells the cards at quantity discounts to retail stores. As a result, a large volume of cards are sold at a significant profit.

The museum is exempt as an educational organization on the basis of its ownership, maintenance, and exhibition for public viewing of works of art. The sale of greeting cards displaying printed reproductions of art works contributes importantly to the achievement of the museum’s exempt educational purposes by stimulating and enhancing public awareness, interest, and appreciation of art. Moreover, a broader segment of the public may be encouraged to visit the museum itself to share in its educational functions and programs as a result of seeing the cards. The fact that the cards are promoted and sold in a clearly commercial manner at a profit and in competition with commercial greeting card publishers does not alter the fact of the activity’s relatedness to the museum’s exempt purpose. (Revenue Ruling 73-104 – Emphasis added.)

The IRS subsequently reaffirmed the conclusion it reached in the Revenue Ruling cited above when it issued a Technical Advice Memorandum (TAM) in a museum context. The question at hand was whether off-site sales by the museum of substantially related items constituted unrelated business activity. In the TAM, in which the museum is referred to as “M,” the IRS stated:

M carries on extensive offsite sales activities. It uses several vehicles to accomplish these sales: retail stores, gift shops, an outlet located in another city, mailorder catalogues, advertisements in various other publications, corporate/ conference program, etc. Clearly, M has developed an off-site outlet network and receives significant revenue from such sales.

It is, therefore, not unreasonable to infer from this that the purpose behind the off-site sales activities is a commercial one. Were this not an exempt organization, such logic would be persuasive. However, regarding the sale of related items by an exempt organization, Rev. Rul. 73-104 holds that neither the proximity of the sale to the museum’s location nor the fact that the individual purchaser never sets foot on the property matters.

In Rev. Rul. 73-104, the organization sold large volumes of cards at quantity discounts to retail stores and through its mail order catalogues. The revenue ruling states the following: “The fact that the greeting cards are promoted and sold in a clearly commercial manner at a profit and in competition with commercial greeting card publishers does not alter the fact of the activity’s relatedness to the museum’s exempt purpose.” Thus, once it is determined that a line of merchandise is related to the purposes of a museum, the broader the market the museum is able to reach, the more it can fulfill its exempt function …. Therefore, exempt product sales occurring outside the Museum Site do not (for that reason alone) constitute unrelated trade or business under section 513 of the Code. (TAM 9550003 – Emphasis added. While a TAM is not authoritative, it is helpful in understanding the IRS’s position on a particular issue.)

A church that wishes to engage in aggressive, commercial-type sales of items that it believes are substantially related to its exempt purposes should obtain advice from tax counsel to ensure that it is in compliance with the law. Depending on the volume and scope of the activity, it may be wise to obtain a private ruling from the IRS.

Parking lots

The IRS has consistently held that the operation of a revenue-producing parking lot by an exempt organization is not a rental of real estate, but rather, is a trade or business activity. As is the case with other trade or business activities, a church may operate a parking lot in a manner where substantially all (more than 85 percent) of the work is performed by volunteers and the operation will be exempt from the tax on unrelated business income.

As an alternative, the church could rent the property on which the parking lot sits to an unrelated parking company and the parking company could operate the parking lot. In that scenario, the revenue to the church is real estate rental income, which is not unrelated business income (unless the property is debt-financed). Even if the property is debt-financed, the church should consider whether it may qualify for:

  • The substantially exempt use exception, or
  • The neighborhood land rule exclusion, if the church plans to convert the property to exempt use within fifteen years of the date it was acquired.

(See Section 3 for a description of these exceptions.)

Concerts or other special events

The conduct of revenue-generating concerts or other events by a church will not generate unrelated business income if the event itself contributes importantly to one or more of the church’s exempt purposes. The relationship between the event and the church’s exempt purposes (e.g., worship, evangelism, and so on) should be well-documented to support the church’s position. Again, as with other trade or business activities, conducting substantially all of the activity by volunteers will also result in the income being exempt from the tax on unrelated business income.

Thrift shops or other sales of donated merchandise

As described in Section 2, a trade or business of selling merchandise is not an unrelated business activity if “substantially all” of the merchandise sold is donated to the church. Court cases and rulings indicate that “substantially all” for this purpose means 85 percent or more of the merchandise sold. Therefore, the operation of a thrift shop selling donated goods is not an unrelated business activity. Similarly, the sale of donated merchandise using other methods (such as online auctions, including eBay) is not an unrelated business activity. (Note: A portion of eBay’s website is dedicated specifically to online sales by nonprofit organizations.)

Corporate sponsorship of events

Also as described extensively in Section 2, revenue received by a church as payment for a qualified sponsorship activity is not unrelated business income. A qualified sponsorship activity is an activity in which an outside party (typically a business) pays a church to sponsor an event or activity conducted by the church and receives, in exchange, certain limited types of recognition or acknowledgment. As long as the acknowledgment or recognition made by the church of the sponsor meets certain criteria, and the church does not provide the sponsor with a “substantial return benefit,” the transaction constitutes a qualified sponsorship activity. (See the detailed description and examples of qualified sponsorship arrangements in Section 2.)

Scrip programs

Scrip programs are activities in which an organization purchases gift cards (or their equivalent) at a discount and then sells them to supporters, often for face value. For example, a church might purchase $100 gift cards from a grocery chain at a price of $90 each and sell them to church members for $100 each. Since the members are able to use the cards to buy $100 of groceries, the scrip program is an appealing way for many organizations to raise money.

Ordinarily, the regular operation of a scrip program by a church would constitute an unrelated business activity. The IRS has ruled, however, that when the volunteer exception applies (i.e., when substantially all of the activity is conducted by volunteers) the activity is not an unrelated business activity.

Coffee shops and cafés

The best way for a church to avoid having a coffee shop or café treated as an unrelated business activity is to limit its activity to providing service in connection with events on the church’s property. Doing so will help the church take advantage of the “convenience of members” exemption described in Section 2. If the church wants to have a full-service coffee shop or café open to the public for regular business hours, it should consider having the activity conducted substantially entirely by volunteers to avoid unrelated business income.

Alternatively, the church could rent a portion of its real property to an unrelated company to operate the coffee shop or café on the site. If the property is not debt-financed, real estate rental income is not unrelated business income. If the church’s real property is debt-financed, the church should determine whether an exception may apply to the debt-financed income rules, such as the rule described in Section 3 that exempts debt-financed income if substantially all (85 percent or more) of the property is used for exempt purposes.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Does Your Church Owe Taxes on Alternative Revenue? – Part 4

Answers about the often misunderstood world of unrelated business income. – Posted 8/9/23

Special exception for educational institutions

A special exception (effectively, an exemption) to the ordinary rules for acquisition indebtedness exists in the law for organizations that are specifically classified by the Internal Revenue Service as educational institutions and for certain organizations related to such educational institutions.

An organization classified by the IRS as an educational institution should have an IRS determination letter indicating that the organization is described in Section 170(b)(1)(A)(ii) of the Internal Revenue Code. This exception would not apply to a church, but it might apply to an entity that is affiliated with a church, such as a school, if that entity is classified by the IRS as an educational institution. The special exception for educational institutions involves several technical criteria that must be met and should be evaluated by tax counsel.

Exception for property used for exempt purposes

Property used by a church exclusively for exempt purposes is not debt-financed property, regardless of the existence of acquisition indebtedness. Additionally, if “substantially all” (85 percent or more) of the use of the property is substantially related to the church’s exempt purposes, the property is excluded from debtfinanced property. The measurement of exempt use and total use may be made by time, space, or a combination of the two. If a church uses property with acquisition indebtedness less than 85 percent for exempt purposes, the portion of the property used for exempt purposes is not debtfinanced property and the remainder is, unless another exception in the law applies.

Example: Second Church owns a building that it acquired with debt financing. The building has 10,000 square feet of space. The church uses all of the space for church activities except a 1,000-square-foot space that it rents to a local restaurant. The building is not debt-financed property because the church uses 90 percent of the building for exempt purposes.

Example: Second Church owns a building that it acquired with debt financing. The building has 10,000 square feet of space. The church uses all of the space for church activities except a 3,000-square-foot space that it rents to a local restaurant. This means 7,000 square feet, or 70 percent of the building, is not debt-financed property. The 3,000 square feet (30 percent) of the building rented to the restaurant is debt-financed property, and the rental income received is debt-financed income unless another exception in the law applies.

Sale of debt-financed property not used for exempt purposes

A church can incur a significant tax liability if it sells debt-financed property that is not used for exempt purposes and generates a gain from the sale. This is an often-overlooked area of the law.

Example: Oak Church buys a vacant parcel of land for $1 million in Year One, incurring debt in the amount of $800,000, with the intent of using the property for exempt purposes at some time in the future. The church never uses the property for exempt purposes. In Year Ten, Oak Church sells the property for $10 million at a time when the remaining acquisition indebtedness is $500,000. Oak Church will incur a substantial tax liability related to its $9 million gain.

Exception for property used in certain activities

Debt-financed property does not include property that is used to conduct any of the following activities for which the income is exempt from unrelated business income (See Section 2 for descriptions of these activities):

  • A trade or business in which substantially all of the work is performed by persons who are not compensated for their work (the “volunteer exception”);
  • A trade or business conducted primarily for the convenience of the church’s members, students, officers, or employees (the “convenience of members exception”); or
  • A trade or business that consists of selling merchandise, substantially all of which was received by the church as gifts or contributions (the “donated goods exception”).

The neighborhood land rule exception

If a church acquires property with debt financing and intends to use the land for exempt purposes within fifteen years of the acquisition date, the property will not be considered debt-financed property. This special rule applies only if the plan to use the property for exempt purposes requires demolition of any buildings or structures on the property. A church relying on the neighborhood land rule to exclude rental income from debt-financed income may not abandon its plan to convert the land to exempt use. In the event the church does abandon its plan, the neighborhood land rule exception fails to apply from that point forward.

Additionally, if the church has not converted the land to exempt use within five years of the acquisition date, the church must notify the IRS that it is relying on the neighborhood land rule at the end of the fifth year and provide to the IRS information and documents supporting its claimed intent. The IRS will rule as to whether the church may continue to rely on the neighborhood land rule for the remainder of the allowable period (up to a total of fifteen years). Even if the IRS does not rule favorably on the request, if the church ultimately does convert the land to exempt use within the allowable period in conformity with the neighborhood land rule, the rule will apply retroactively as if the IRS issued a favorable ruling at the end of the fifth year.

Special note regarding unique treatment for churches

The neighborhood land rule is so-named because in order for it to apply to exempt organizations other than churches, the property acquired must be in the “neighborhood” of the organization’s existing exempt-use property. That rule does not apply to churches. Additionally, the maximum allowable period for which the neighborhood land rule can apply for non-church organizations is ten years, instead of the fifteen-year period that applies to churches.

As is the case with other aspects of the debt-financed income rules, the neighborhood land rule involves a number of technical requirements and conditions that should be assessed by knowledgeable tax counsel.

Example: Pine Church acquires an office building with debt financing at the beginning of Year One and rents the office space to commercial tenants. Pine Church intends to demolish the office building before the end of Year Fifteen and construct a new education building on the property to be used exclusively for exempt purposes. At the end of Year Five, Pine Church notifies the IRS of its intent and provides the IRS with plans and drawings showing its progress toward using the property for exempt purposes within the allowable fifteen-year period.

The IRS issues a ruling stating that Pine Church may continue to rely on the neighborhood land rule through Year Fifteen. At the beginning of Year Twelve, the office building is demolished and Pine Church builds an education building on the property which is used exclusively for exempt purposes. The rental income received by Pine Church for the entire eleven-year period prior to demolition is not debt-financed income because of the neighborhood land rule.

Example: Pine Church acquires an office building with debt financing at the beginning of Year One and rents the office space to commercial tenants. Pine Church intends to demolish the office building before the end of Year Fifteen and construct a new education building on the property to be used exclusively for exempt purposes. At the end of Year Five, Pine Church notifies the IRS of its intent and provides the IRS with plans and drawings showing its progress toward using the property for exempt purposes within the allowable fifteen-year period.

The IRS does not issue a favorable ruling stating that Pine Church may continue to rely on the neighborhood land rule through Year Fifteen. Pine Church begins to treat its rental income from the property as debt-financed income beginning in Year Six. At the beginning of Year Twelve, the office building is demolished and Pine Church builds an education building on the property which is used exclusively for exempt purposes. The rental income received by Pine Church for the entire eleven-year period prior to demolition is not debt-financed income because of the neighborhood land rule. Since the church treated the income as debt-financed income for Years Six through Eleven, the church may file amended returns and obtain a refund of all taxes paid on the income during that period.

Stay tuned for part 5 where we will continue discussing taxes and alternative revenue. To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Does Your Church Owe Taxes on Alternative Revenue? – Part 3

Answers about the often misunderstood world of unrelated business income. – Posted 8/8/23

Specific Exclusions

Federal law provides a number of specific exclusions from the tax on unrelated business income. While there are some exceptions with respect to how certain of the exclusions apply, income from the following sources is generally excluded from UBI:

    1. Dividends, interest, annuities, capital gains, and other investment income;
    2. Gains from the sale of property other than inventory;
    3. Royalties;
    4. Rent from real property;
    5. A trade or business in which substantially all of the work is performed by persons who are not compensated for their work (the “volunteer exception”);
    6. A trade or business conducted primarily for the convenience of the church’s members, students, officers, or employees (the “convenience of members exception”);
    7. A trade or business that consists of selling merchandise, substantially all of which was received by the church as gifts or contributions (the “donated goods exception”);
    8. Qualified sponsorship activities; and
    9. Bingo games that meet certain criteria (the “bingo games exception”).

Note: For income of the types listed in 1 – 4 above, the exclusion does not apply if the income is “debt-financed income” as described in Section 3. Also, special rules apply if interest, annuities, royalties, or rents are received from an entity that is controlled by the organization receiving the income. Churches should consult highly experienced tax counsel to assist in addressing the tax implications of such arrangements.

The volunteer exception

Under the volunteer exception (item 5 above), a trade or business is not an unrelated business activity if “substantially all” of the work in conducting the activity is performed by persons who are not compensated. The law is not specific as to the definition of “substantially all.” However, court cases and rulings on the issue indicate that 85 percent or more of the hours of work constitutes “substantially all” of the work for this purpose.

Example: A church operates a coffee shop in a retail location that is open to the public. The coffee shop is a trade or business that is regularly carried on and its operation is not substantially related to the church’s exempt purposes. The coffee shop is operated entirely by unpaid church volunteers, although a minimal amount of work (less than 10 percent) is performed by the church’s accounting staff related to the store’s recordkeeping. Even though the operation of the coffee shop would ordinarily be an unrelated business activity, the fact that substantially all of the work in conducting the activity is performed by volunteers causes the coffee shop not to be an unrelated business activity.

The convenience of members exception

Under the convenience of members exception (item 6 above), a trade or business is not an unrelated business activity if it is conducted primarily for the convenience of the church’s members, students, officers, or employees. For this purpose, court cases and rulings have interpreted the term “members” to include people who attend or participate in a church’s worship services or other activities, regardless of whether they are actually members of the church.

Example: A church operates a coffee and pastry kiosk during worship services and other events held at the church’s facilities in order to provide refreshments to those attending or participating in the events. Even if operation of the coffee and pastry kiosk meets the ordinary criteria to be an unrelated business activity, it will be excluded in this case, since it is conducted primarily for the convenience of the church’s “members.”

Rental income from communications towers on church property

Many churches allow telecommunications companies to install towers or antennae on their property in exchange for a monthly or annual rental fee. Are such fees subject to the unrelated business income tax?

In 1998 the IRS said no. It reasoned that “rentals from the lease of real property” were exempt from the unrelated business income tax, and this exemption should apply to any items (including communications towers) permanently affixed to real estate. IRS Letter Ruling 9816027.

But in 2001 the IRS revoked its 1998 ruling and concluded that rents received by charities for the use of communications towers or antennae constructed on their property are subject to the unrelated business income tax. It conceded that the tax code exempts rents from real property from the unrelated business income tax. But it concluded that “for purposes of the unrelated business income tax, broadcasting towers are considered personal property,” and so rental income from the use of such towers is not exempt from the unrelated business income tax on the basis of the rental of real estate exception.

The IRS limited its ruling to “receipts attributable solely to the rental of the broadcasting tower.” This suggests that the rental of a specified area of church property on which a communications tower is erected may be partially or wholly exempt from the unrelated business income tax. The IRS did not specifically address this issue in its 2001 ruling. IRS Letter Ruling 200104031.

The donated goods exception

Under the donated goods exception (item 7 above), a trade or business of selling merchandise is not an unrelated business activity if “substantially all” of the merchandise sold is donated to the church. Court cases and rulings indicate that “substantially all” for this purpose means 85 percent or more of the merchandise sold.

Example: A church operates a thrift shop in a retail location on Main Street. The store is open six days per week on a schedule comparable to that of other retailers in the area. The store’s workers are all paid employees of the church. Virtually all of the items sold in the thrift shop are items received by the church as donations. The shop also sells a few items of new clothing because the church is able to purchase and sell those items at a substantial discount. Sales of purchased inventory comprise approximately five percent of the shop’s total sales. The church’s operation of the thrift shop is not an unrelated business activity because substantially all of the shop’s sales consist of merchandise donated to the church.

Qualified sponsorship activities

Revenue received by a church as payment for a qualified sponsorship activity (item 8 above) is not unrelated business income. A qualified sponsorship activity is an activity in which an outside party (typically a business) pays a church to sponsor an event or activity conducted by the church and receives in exchange certain limited types of recognition or acknowledgment. As long as the acknowledgment or recognition made by the church of the sponsor meets certain criteria, and the church does not provide the sponsor with a “substantial return benefit,” the transaction constitutes a qualified sponsorship activity.

Permissible recognition

The following information about a business sponsor may be displayed, used, recognized, and acknowledged by the church as part of a qualified sponsorship arrangement:

      • Name;
      • Logos or slogans that do not contain qualitative or comparative descriptions of the sponsor’s products, services, facilities, or company;
      • Product lines;
      • The fact that the sponsor is an exclusive sponsor of all or part of an event or activity;
      • A list of locations, telephone numbers, or Internet addresses;
      • Value-neutral descriptions, including displays or visual depictions, of the sponsor’s product-line or services; and
      • The sponsor’s brand or trade names and product or service listings.

Federal regulations state that logos or slogans that are an established part of a sponsor’s identity are not considered to contain qualitative or comparative descriptions. Additionally, the display or distribution of a sponsor’s product by the sponsor or the church to the general public at the sponsored activity is permissible.

Advertising is not permissible recognition

Advertising provided by the church in exchange for payment is considered a “substantial return benefit” and is not permissible recognition. For this purpose, the term advertising means any message which is broadcast or otherwise transmitted, published, displayed, or distributed and which promotes or markets any trade or business, or any service, facility, or product.

Advertising includes messages containing qualitative or comparative language, price information or other indications of savings or value, an endorsement, or an inducement to purchase, sell, or use any company, service, facility, or product. A single message that contains both advertising and an acknowledgment is advertising.

Acknowledgments provided to a business in a church’s newsletter, magazine, or other regularly distributed periodical in exchange for payment are not permissible acknowledgments in a qualified sponsorship arrangement. A program or brochure produced and distributed in connection with a specific event is not a periodical for this purpose, and acknowledgments in such a document may be permissible recognition if they meet the criteria set forth above.

Payments for exclusive provider rights are not qualified sponsorship payments

If a church agrees to permit a business to be the exclusive provider of certain types of products or services in connection with the church’s activities or events in exchange for a payment, the payment received by the church for the value of that benefit is not a qualified sponsorship payment.

Payments in excess of the value of substantial return benefits

Payments by a sponsor that exceed the fair value of substantial return benefits constitute qualified sponsorship payments if the applicable criteria are met.

Example: A business pays a church $20,000 to sponsor a weekend retreat for married couples. The church provides the business with advertising valued at $12,000 in exchange for the payment. Except for the advertising, all other benefits provided to the business in connection with the arrangement are permissible benefits in a qualified sponsorship arrangement. $8,000 of the payment by the business is a qualified sponsorship payment.

Special note about arrangements that do not meet criteria for qualified sponsorships

If a church receives a payment in a transaction that does not meet the criteria for a qualified sponsorship payment, the income to the church is not automatically unrelated business income. The transaction would need to be evaluated in light of the definition of unrelated business income in order for that determination to be made. For example, if the church received payment from a business in an arrangement where the church endorsed the business at one event, one time, the payment may not constitute unrelated business income to the church, since the activity is not regularly carried on.

Example: First Church has a Family Fun Weekend in October of each year. The event consists of a variety of entertainment, games, and other activities. Big Car Dealer enters into a sponsorship agreement with the church in which Big Car Dealer pays the church $20,000. In exchange for the payment, First Church agrees to prominently display Big Car Dealer’s name and logo throughout the event and distribute flyers expressing gratitude to Big Car Dealer for its sponsorship and listing its location, website address, and the types of automobiles sold by the dealership. Additionally, First Church agrees to permit Big Car Dealer to park four of its new vehicles at the entrance to the event. The church provides no other benefits to Big Car Dealer. The income of $20,000 received by First Church in this transaction is a qualified sponsorship payment and is not unrelated business income to First Church.

Example: The same facts apply as in the previous example, except that in addition to the benefits provided by the church in that example, the church also agrees to permit Big Car Dealer to be the exclusive sponsor of the event. No other businesses are permitted to sponsor the event. The result is the same. The income received by First Church is not unrelated business income. Exclusive sponsorship is a permissible form of recognition in a qualified sponsorship arrangement.

Example: First Church has a Family Fun Weekend in October of each year. The event consists of a variety of entertainment, games, and other activities. In connection with the event, Great Cola Company pays First Church $10,000 (the fair market value) for the right to be the exclusive provider of beverages to the church for the event. The church agrees not to procure beverages from any other vendor for the event. The payment by Great Cola Company is not a qualified sponsorship payment because the exclusive provider benefit provided by the church is not a permissible benefit in a qualified sponsorship arrangement. The determination of whether the payment is unrelated business income to the church would have to be made based on the regular definition of unrelated business income and other possible exceptions.

The need for good tax counsel for significant sponsorship arrangements

If a church wishes to generate significant revenue from qualified sponsorship arrangements, it should engage legal counsel to draft a standard sponsorship agreement and tax counsel to ensure that the standard agreement complies with the requirements for qualified sponsorships. Failure to comply with the requirements of the law can cause all or part of the income from the activity to be taxable as unrelated business income to the church.

The bingo games exception

Bingo games are not considered unrelated business activities if they:

      • Meet the legal definition of bingo;
      • Are legal where they are played; and
      • Are played in a jurisdiction where bingo games are not regularly offered by for-profit organizations.

A bingo game, as defined by Treasury Regulations, is:

A game of chance played with cards that are generally printed with five rows of five squares each. Participants place markers over randomly called numbers on the cards in an attempt to form a preselected pattern such as a horizontal, vertical, or diagonal line, or all four corners. The first participant to form the preselected pattern wins the game. As used in this section, the term “bingo game” means any game of bingo of the type described above in which wagers are placed, winners are determined, and prizes or other property is distributed in the presence of all persons placing wagers in that game. The term “bingo game” does not refer to any game of chance (including, but not limited to, keno games, dice games, card games, and lotteries) other than the type of game described in this paragraph.

Example: Sycamore Church conducts bingo games each Friday night in Busy City, in which people buy bingo cards and try to be the first contestant to fill a row of spaces on the cards when numbers are called. The winner of each game wins a prize that is distributed at the event. Bingo is legal in Busy City, but only for nonprofit organizations. Income from Sycamore Church’s bingo activity is not unrelated business income because it qualifies for the bingo games exception.

Example: Sycamore Church also sells scratch-off tickets during its Friday bingo nights in Busy City. Players buy individual “$100 Bingo” scratch-off tickets in the hope that each one is a winner. Most tickets are losers. Selling scratch-off tickets is legal in Busy City, but only for nonprofit organizations and the state government. Income from the sale of the scratch-off tickets does not qualify for the bingo games exception, since the scratch-off game does not meet the legal definition of bingo. It does not matter that the game is labeled “$100 Bingo.” The determination of whether the income is unrelated business income to the church would have to be made based on the regular definition of unrelated business income and other possible exceptions.

Example: Hemlock Church conducts bingo games each Friday night in Conservative City, in which people buy bingo cards and try to be the first contestant to fill a row of spaces on the cards when numbers are called. The winner of each game wins a prize that is distributed at the event. Bingo is not legal in Conservative City, but local officials do not enforce the law. Income from the bingo activity does not qualify for the bingo games exception, since the bingo activity is not legal in Conservative City. It does not matter that the law is not enforced. The determination of whether the income is unrelated business income to the church would have to be made based on the regular definition of unrelated business income and other possible exceptions.

Section 3: Debt-Financed Income

The federal tax laws and regulations related to debt-financed income are quite technical and complex. A church that believes it may have debt-financed income, or that wants to proactively prevent or minimize it, should consult knowledgeable tax counsel as early in the process as possible. In many cases, good planning may reduce or eliminate a significant tax liability that could otherwise occur.

As stated in Section 2, investment income, such as interest, dividends, rents, royalties, and capital gains, are ordinarily excluded from unrelated business income. The ordinary exclusion does not apply, however, if such income is generated from “debt-financed property.”

Debt-financed property

According to federal regulations, debtfinanced property is property held to produce income (including a gain on sale) for which there is “acquisition indebtedness” at any time during the tax year or during the twelve-month period prior to the date the property is sold.

Acquisition indebtedness

Acquisition indebtedness is debt incurred when acquiring or improving the property; before acquiring or improving the property if the debt would not have been incurred were it not for the acquisition or improvement; or after acquiring or improving the property if:

• The debt would not have been incurred were it not for the acquisition or improvement; and
• Incurring the debt was reasonably foreseeable when the property was acquired or improved.

In other words, acquisition indebtedness is debt that is incurred because the church acquired or improved certain property, regardless of whether the debt was incurred before or at the time the church acquired or improved the property. Debt incurred after the acquisition or improvement of certain property could also be acquisition indebtedness if it is incurred because of the acquisition or improvement and it was “reasonably foreseeable” that the church would incur the debt when the property was acquired or improved.

Collateralization is not relevant

In determining whether debt is acquisition indebtedness, it does not matter whether it is collateralized by the property in question. The relevant question is why the debt was incurred—not what serves as collateral for it.

Example: A church has a campus in Town A and owns twenty acres of vacant land in neighboring Town B. The church has no outstanding debt. The church borrows $1 million to buy a new parcel of property near its campus in Town A. In doing so, the church uses the twenty acres it owns in Town B as collateral for the new loan. The new property it acquires in Town A is not mortgaged and does not serve as collateral for the new loan. The new loan represents acquisition indebtedness with respect to the newly acquired parcel, even though the newly acquired parcel is not collateral for the loan, because the debt was incurred to acquire the new parcel. The debt is not acquisition indebtedness with respect to the twenty acres in Town B, even though that twenty-acre property is collateral for the loan, because the debt was incurred to acquire the new parcel, not the twenty-acre parcel the church already owned.

Special rules for identification and tracing of indebtedness

Complex issues may arise in determining whether indebtedness was incurred in connection with the acquisition and improvement of property when debt is refinanced, consolidated with other debt, or when a borrower engages in other similar actions. Federal tax law contains rules governing the manner in which the identity of debt related to a specific property is tracked, or traced, when such transactions occur. The tracing rules and process are extremely complex and should definitely be addressed by knowledgeable tax counsel.

Example: First Church buys its first property in Year One for $1 million and incurs debt of $800,000 in doing so. In Year Two, First Church acquires a second parcel of land for $500,000. At the time First Church acquires the second parcel, the debt related to the first parcel has been paid down to $700,000. First Church obtains a new loan in the amount of $1.1 million to pay off the original loan and provide financing for the new property; $400,000 of the new loan (the additional principal borrowed) represents acquisition indebtedness with respect to the second parcel and $700,000 of it relates to the first property acquired. Subsequent principal payments on the combined note must be allocated between the two properties in conformity with federal tax rules for purposes of determining remaining acquisition indebtedness.

Stay tuned for part 4 where we will continue discussing taxes and alternative revenue. To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Does Your Church Owe Taxes on Alternative Revenue? – Part 2

Answers about the often misunderstood world of unrelated business income. – Posted 8/4/23

How does the church determine whether an activity is substantially related to its exempt purposes?

A revenue-generating activity is not considered to be substantially related to a church’s exempt purposes merely because the income generated from the activity is used to fund the church’s exempt purpose activities. In order to support the position that an activity is substantially related to a church’s exempt purposes, the church must show that the conduct of the activity itself (and not the money from it) contributes importantly to the accomplishment of the church’s exempt purposes.

In making this determination, the church must first identify its exempt purposes. This often-overlooked area of the law is extremely important. Most churches (and their tax advisors) assume that their exempt purposes are obvious and that the general concept of having a religious purpose is adequate. However, according to IRS Regulations, in determining whether an activity contributes importantly to a church’s exempt purposes, the IRS looks to “the purposes for which exemption is granted.”

Accordingly, a church should be very deliberate when it comes to defining the exempt purposes for which it exists. Some of a church’s purposes may be religious, some may be educational, and others may be charitable. The church itself establishes the purposes for which it exists, and such purposes are often stated in the church’s governing documents (articles of incorporation or charter and bylaws).

A church’s stated exempt purposes should be drafted broadly so as to include all of its intended purposes and not merely the most common activities of a local church. A church with a more broadly-worded purpose statement will be better able to defend a broader array of revenue-generating activities as contributing importantly to its exempt purposes.

Example: An example of a narrowly worded church purpose statement is:

This corporation shall have as its purpose the gathering of a congregation of believers dedicated to the worship and service of Almighty God.

Example: An example of a more broadly worded church purpose statement is:

This corporation is dedicated exclusively to charitable, religious, educational, scientific, and literary purposes. This corporation’s primary purpose is to reach people with the Christian Gospel message and to disciple Christian believers by and through as many methods and means as possible (including by conduct of public worship; conduct of missions activities; educational activities; creation, sale, and distribution of Christian media; conduct of Christian events; and other related activities) so as to maximize the number of people who may be reached and discipled for the glory of Almighty God. In addition to its primary purpose, the church has the following additional purposes:

  • Fostering an appreciation for and participation in the performing arts, recognizing that the arts are a gift from Almighty God;
  • Serving the needs of the poor, the needy, the outcast, the sick, the widowed, and the elderly;
  • Fostering adequate education among both the young and the old; and
  • Conducting other activities in keeping with the Great Commission.

In addition to establishing a sufficiently broad purpose statement, the church should ensure that the relationship between each of its revenue-producing activities and its purposes is clear. In some cases, such as selling Bibles and other overtly religious literature, the relationship may be obvious. In cases where the relationship is not obvious, the church should maintain documentation to support the relationship.

Example: A church sells decorative candles in its bookstore during the Christmas season. The church should create and maintain a document approved by a leader of the church with respect to its candle sales stating that the sale of candles in the Christmas season facilitates the celebration and reverence of Christ’s birth and the message of hope and deliverance that He brought to earth. The document supports the church’s position that the sale of candles contributes importantly to the church’s exempt purposes. The document should make specific reference to the stated exempt purpose(s) supported by the activity.

Activities that include some related and some unrelated elements

A church may engage in some revenuegenerating activities that include elements that are substantially related to its exempt purposes and others that are not. For example, the church may operate a bookstore that sells Bibles and religious books along with cosmetics. The fact that an activity (such as operating a bookstore) includes both unrelated and related elements does not cause the entire activity to be considered unrelated to the church’s exempt purposes. Federal tax law applies a “fragmentation” rule that requires such activities to be separated into their related and unrelated elements. In this example, the sale of cosmetics would be considered not substantially related to the church’s exempt purposes, while the sale of Bibles and religious books would be substantially related.

Examples of unrelated business activities in a church may include:

  • Operating a public restaurant;
  • Operating a revenue-generating parking lot;
  • Selling non-religious items in a bookstore (such as computers, cosmetics, and popular secular books);
  • Providing administrative services to other unrelated organizations for a fee;
  • Conducting travel tours that are not adequately religious or educational in nature; or
  • Selling advertising in the church’s newsletter.

A church is permitted to conduct an insubstantial amount of unrelated business activity. If a church engages in a substantial amount of unrelated business activity, the church could lose its taxexempt status under Section 501(c)(3) of the Internal Revenue Code. (See Section 4 for a discussion of how much unrelated business activity is too much.)

Stay tuned for part 3 where we will continue discussing taxes and alternative revenue. To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Does Your Church Owe Taxes on Alternative Revenue? – Part 1

Answers about the often misunderstood world of unrelated business income. – Posted 8/2/23

Your church’s annual fall festival is two months away, and you are looking for creative and appropriate ways to generate income from it. You get a call from a local car dealer who is familiar with your festival. The dealership offers to be the exclusive sponsor of the event by paying your church $20,000, so long as you recognize it as the exclusive sponsor by placing a large sign at the entrance with the following message: “Tri-City Motor Company; Exclusive Sponsor; tricitymotorcompany.com.” The dealer also wants to display six new vehicles at the entrance of the festival as a part of the arrangement.

Can you accept the dealer’s offer without jeopardizing the church’s tax-exempt status? If you do, is the $20,000 payment taxable as unrelated business income to the church? You may be surprised by the answers to this and other questions about the often misunderstood world of unrelated business income.

Unrelated Business Income—The General Rules

Federal law imposes an income tax on a church if the church generates net income from one or more unrelated business activities. Congress adopted the tax on unrelated business income (“UBI”) primarily for the purpose of eliminating unfair competition between nonprofit, tax-exempt organizations and for-profit, taxable businesses.

An unrelated business activity is a revenue- generating activity that:

  • Constitutes a trade or business;
  • Is regularly carried on; and
  • Is not substantially related to the church’s exempt purposes.

The law also considers the activity of generating income from “debt-financed property” to constitute an unrelated business activity. (See Section 3 for additional information on this topic.)

What constitutes a trade or business?

For purposes of the tax on UBI, a trade or business generally includes any activity carried on for the production of income from the sale of goods or performance of services. Ordinarily, a church must have a motive (but not necessarily its primary motive) of generating profit from an activity in order for the activity to be considered a trade or business. Most fundraising activities would meet the definition of a trade or business, since fundraising activities are generally conducted for the purpose of generating additional funds for the church.

Example: A church sells T-shirts in connection with its theme of evangelism for the year. Each shirt costs the church $8 and the church sells them to its congregation for $7 each. The T-shirt selling activity is not carried on for the production of income and is not, therefore, a trade or business.

Example: A church sells Christmas trees to the public in a high-traffic area during the period leading up to the Christmas holiday. The church conducts this activity each year for the purpose of raising money for its youth ministry. Christmas trees are generally sold for approximately twice the church’s cost. The activity of selling Christmas trees is a trade or business, because one of the church’s motives is to generate income from the activity.

When is an activity regularly carried on?

In determining whether an activity conducted by a church is regularly carried on, the frequency and continuity of the activity must be addressed. If the activity is of a type normally conducted by taxable, for-profit businesses, the frequency and continuity of the church’s activity is compared to the industry norm. An activity will generally be considered to be regularly carried on if the church conducts the activity with a frequency and continuity that is similar to that of the industry.

Example: A church conducts an annual bake sale in connection with a county fair that is held each year. At the bake sale, which is open to the public, a variety of cakes, cookies, pastries, and other similar products are promoted and sold. The sale and fair last two weeks each year. In addressing the frequency and continuity of the activity, the church compares its annual bake sale to the activities of the retail baking industry and with retail stores that sell baked goods. The church’s activity is conducted for two weeks each year, while the industry norm for taxable businesses is to conduct their activities yearround. Even though the church’s bake sale is conducted every year, it is not conducted with a frequency or continuity that is similar to the business industry norm. Therefore, the church’s annual bake sale is not regularly carried on.

Example: A church sells Christmas trees to the public in a high-traffic area during the period leading up to the Christmas holiday. The church conducts this activity each year for the purpose of raising money for its youth ministry. In addressing the frequency and continuity of the activity, the church compares its annual Christmas tree sale to the activities of for-profit businesses that sell Christmas trees. The for-profit businesses generally sell Christmas trees at the same time of year and for approximately the same duration of time as does the church. The church’s Christmas tree-selling activity is regularly carried on.

Stay tuned for part 2 where we will continue to discuss taxes and alternative revenue. To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Key Tax Dates August 2023

Key tax dates include filing Form 941, and meeting certain monthly or semiweekly filing requirements. – Posted 8/1/23

Monthly requirements

If your church or organization reported withheld taxes of $50,000 or less during the most recent lookback period (for 2023, the lookback period is July 1, 2021, through June 30, 2022), then withheld payroll taxes are deposited monthly. Monthly deposits are due by the 15th day of the following month.

Semiweekly requirements

If your church or organization reported withheld taxes of more than $50,000 during the most recent lookback period (for 2023, the lookback period is July 1, 2020, through June 30, 2021), then the withheld payroll taxes are deposited semiweekly.

This means that for paydays falling on Wednesday, Thursday, or Friday, the payroll taxes must be deposited on or by the following Wednesday. For all other paydays, the payroll taxes must be deposited on the Friday following the payday.

Note further that large employers having withheld taxes of $100,000 or more at the end of any day must deposit the taxes by the next banking day. The deposit days are based on the timing of the employer’s payroll. Withheld taxes include federal income taxes withheld from employee wages, the employee’s share of Social Security and Medicare taxes, and the employer’s share of Social Security and Medicare taxes.

August 10, 2023: Employer’s quarterly federal tax return—Form 941

Churches having nonminister employees (or one or more ministers who report their federal income taxes as employees and who have elected voluntary withholding) may file their employer’s quarterly federal tax return (Form 941) by this date instead of July 31 if all taxes for the second calendar quarter have been deposited in full and on time.

Note: If a date listed for filing a return or making a tax payment falls on a Saturday, Sunday, or legal holiday (either national or statewide in a state where the return is required to be filed), the return or tax payment is due on the following business day.

Note: You must use electronic funds transfer to make all federal employment tax deposits. This is generally done using the Electronic Federal Tax Payment System, a free service provided by the US Department of Treasury. If you don’t wish to use EFTPS, you can arrange for your tax professional, financial institution, or payroll service to make deposits on your behalf. Failure to make a timely deposit may subject you to a 10-percent penalty.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Tax News for July 2023 . . .

Smart Budgeting for Tech Purchases

Why it’s time to rethink the three-year replacement rule for hardware – Posted 7/28/23

Computers are like cars. As soon as you buy one, a newer, faster, nicer—and let’s face it, cooler—one comes out to replace it. An upside to technology advances is improved longevity. Both cars and computers last longer and this reality can have a positive impact on a church budget.

Here are ways your church can further maximize the technology it uses and get more bang for its buck.

Why the three-year rule made sense

Many church have operated under the general rule of thumb of refreshing computer hardware every three years. This approach existed because computers really could only last three years. Desktops and laptops featured many moving parts: internal fans kept them cool (dragging in all the dust they could find, too) and the hard drives relied upon spinning disks inside. Sooner than later, all of these moving parts wore out.

The three-year rule of thumb also worked because operating systems and software upgrades continually created more demand for computer processing resources. These new versions needed more power than the existing machines could provide, so upgrading hardware every three years meant you could keep running the latest versions of your operating system and software.

Lastly, the three-year rule reflected a final variable: users. Replacing computers every three years allowed two things to happen. First, the approach avoided frustrating the skilled users on the church staff, since their frequent and heavy use would make them become quickly aware of slower, poorer performances by their machines. And second, it prevented novice users from falling too far behind everyone else as far as operating systems and applications are concerned.

How computers have changed

As computer hardware evolved, some flexibility emerged with the every-three-year-refresh cadence. Fans and hard drives became more reliable, additional memory became cheaper, and software demanded less of the computer’s hardware. Now, depending on the needs of the user and the demands placed on the computer, churches can rethink the old rule of thumb.

What’s the new rule of thumb?

Now, hardware refresh rates can be in the five- to eight-year range. Here’s why:

  • Computer hardware, in general, has become cheaper;
  • Desktops, laptops, and tablets are all solid state, meaning there are no moving parts and very few, if any, fans. Fewer moving parts, less heat to dissipate, and less dirt and dust to contend with allow computer hardware to last much longer; and
  • New computers also have significant processing resources. This allows operating systems and software to run on them for a long time, regardless of how many times updates are released. As operating systems upgrade, existing hardware is often able to easily meet the minimum requirements to run the latest versions.

The great news about these advances is that your church’s pastors and other staff will be much happier. Skilled users won’t experience decreases in performance, while novice users won’t fall behind. And all users will be satisfied since they no longer have to reinstall their apps and try to remember their settings each time they get a new computer. Fewer computer replacements increases user productivity.

A word of caution

So, what’s the catch? If it sounds too good to be true, it probably is and that applies here. Longer hardware life cycles will save churches money, but stewardship requires effort. Here are three ways your church needs to put forth good effort.

Know your church. There are very few absolutes with technology. While five to eight years for hardware replacements may be a good general guide, it may not work for every user and every organization. Study your church’s needs, systems, and users to make certain the replacement cycle you choose is a good fit.

Know your warranties. Most computers come with a standard three-year warranty, which you can extend to four years, sometimes even five years. If you are going to keep your computer for, say, six years, what happens when the warranty runs out? For some users, you may want to make sure their machine is always under warranty and rotate machines no longer under warranty to other users. You can also stock a spare machine or two, since that may be cheaper than extending warranty coverages that provide next-day service.

The same is true for servers. Servers no longer live in a closet somewhere. With access to state-of-the-art datacenters for servers, they too are lasting longer—but warranty coverage and how long users can tolerate downtime, or being without a computer, must be considered.

Know your software support. While it is great your computer is running longer, what happens when Microsoft stops supporting your version of Windows 10 (similar to what happened in early 2020 when Microsoft ended support for Windows 7)?

This is a legitimate, but manageable, concern. You must make sure you keep your operating system and all other applications current, so that they remain supported, patched, and secure. Otherwise, your hardware will work fine, but your software will become out of date and a security hole will develop on your network.

Rethink your refresh cycle

Proper stewardship of hardware can save churches money and prevent wasteful spending on new computers that may not be needed. But churches must be willing to spend time understanding their computer needs, software needs, and user needs. Such a time investment can create a “refresh cycle plan” for technology that not only saves money, but increases productivity for God’s kingdom.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Designating a Housing Allowance for 2023 – Part 2

Tax reporting & Amendments – Posted 7/26/23

Tax reporting

Most churches reduce the pastor’s W-2 by the amount the church designated as a housing allowance. But remember that the allowance is not necessarily nontaxable for income tax reporting purposes. For ministers who own or rent their home, the allowance is nontaxable only to the extent that it does not exceed actual housing expenses or the annual rental value of the home (furnished, plus utilities). It is the minister’s responsibility to report any excess housing allowance as taxable income on his or her tax return.


IRS Publication 517 states:

You must include in gross income the amount of any [housing, rental, or parsonage] allowance that is more than the smallest of

  • Your reasonable salary,
  • The fair rental value of the home plus utilities, or
  • The amount actually used to provide a home.

Include this amount in the total on Form 1040, line 1. On the dotted line next to line 1, enter “Excess allowance” and the amount.

Example. At the end of 2022, a church board determined that Pastor T’s compensation for 2023 would be $50,000. It designated $20,000 of this amount as a housing allowance. At the end of the year the church treasurer issues Pastor T a W-2 that reports taxable income of $30,000 (salary less housing allowance). However, Pastor T only has $17,000 of housing expenses in 2023. As a result, taxable income is understated on his W-2 by $3,000. It is Pastor T’s responsibility to report this $3,000 as additional income on line 7a of Form 1040.

Church treasurers should be sure that their pastor is aware of this reporting responsibility. Many pastors erroneously assume that they can reduce their taxable income by the full amount of the church-designated housing allowance. This will be true only if the allowance is less than the pastor’s actual housing expenses and the annual rental value of the home (including utilities).

Amending the housing allowance

What if the housing allowance designated for your pastor turns out to be too low? For example, the pastor has to pay for unanticipated home repairs, or begins to prepay part of the home mortgage loan. Can the church amend the pastor’s housing allowance? Yes it can, but note that the amendment only operates prospectively—from the date of the amendment forward.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Designating a Housing Allowance for 2023 – Part 1

Help for setting this important clergy benefit – Posted 7/25/23

The housing allowance is the most important tax benefit available to ministers.

But many ministers do not take full advantage of it because they (or their tax adviser or church board) are not familiar with the rules.

What can church leaders do to help? Consider the following guidance.

If your minister lives in a church-owned parsonage

Ministers who live in a church-provided parsonage or manse can exclude from their income for federal income tax reporting purposes (1) the fair rental value of the parsonage, and (2) the portion of their compensation designated in advance by the church as a “parsonage allowance”—to the extent that it is used to pay for parsonage-related expenses such as utilities, repairs, and furnishings and does not exceed the fair rental value of the home (furnished, plus utilities).

Recommendation. If your pastor lives in a church-provided parsonage or manse, and incurs any out-of-pocket expenses living there (for example, for utilities or furnishings), then have the church designate a portion of the pastor’s 2023 compensation as a “parsonage allowance.” This should be done in December of 2022 so that it will be effective for all of 2023. Parsonage allowances cannot be designated retroactively.

Example. Your youth pastor lives in a church-provided parsonage. He is expected to pay his utilities and provide his furniture. His compensation for 2023 will be $35,000. In its December 2022 meeting, the church board designates $3,000 of this amount as a “parsonage allowance.” The youth pastor has parsonage expenses of at least $3,000 in 2023 (for utilities and furnishings). At the end of the year, the church treasurer issues the youth pastor a W-2 reporting only $32,000 as church compensation. The parsonage allowance is not taxable (assuming that it was used for parsonage expenses) for income tax reporting purposes.

If your minister owns a home

Many ministers own their homes. The portion of their compensation that is designated in advance by the church as a “housing allowance” is not subject to income tax to the extent it is used for housing expenses and does not exceed the home’s annual fair rental value (furnished, plus utilities).

Recommendation. If your pastor owns a home, have the church designate a portion of the pastor’s 2023 compensation as a housing allowance. This action should be taken in December of 2022 so that it will be effective for all of 2023. Housing allowances cannot be designated retroactively.

Tip. Use the form in “Sample Housing Allowance for Pastors.”

Tip. Who should designate the housing allowance? In most churches, it will be the governing board. But this is not always the case. Some church boards delegate this authority (and other compensation decisions) to a personnel or compensation committee. In other churches, the membership approves all compensation decisions at the annual business meeting. Whichever method your church uses, be sure that the allowance is designated in advance, and that the action is in writing.

If your minister rents a home

Many ministers rent their homes. The Apostle Paul did for a brief time during his ministry. Acts 28:30 states that “for two whole years, Paul stayed there in his own rented house.” Perhaps your minister is renting a home or apartment. If so, you should understand that the portion of your minister’s compensation that is designated in advance by the church as a housing or rental allowance is not subject to income tax to the extent that it is used for rental expenses and does not exceed the fair rental value of the home (furnished, plus utilities). See the above recommendations and tips for ministers who own their homes.

Determining the amount of the allowance

How does your church determine the appropriate amount for a parsonage, housing, or rental allowance? A common practice is for churches to provide their pastor with an “estimated expense form” prior to the end of the year. The pastor estimates likely expenses for the following year on this form, and returns it to the board or other body that designates housing allowances. The allowance is based on the pastor’s estimated expenses.

Tip. Sample expense forms are reproduced at the end of chapter 6 in my annual Church & Clergy Tax Guide. There are separate forms for computing parsonage allowances, housing allowances, and rental allowances. This is a simple and convenient way for your church to designate an appropriate allowance.

Tip. Your church should not be too conservative in designating a housing allowance. The pastor cannot exclude from taxable income an amount more than the church-designated allowance. So, your church may want to designate an allowance in excess of a pastor’s estimated housing expenses for the new year.

Stay tuned for part 2 tomorrow where we will discuss tax reporting. To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Is Your Church Buried by Debt?

What should Churches do if they are struggling to make debt payments? – Posted 7/21/23

  1. The very first thing you should do when you see a financial problem is to do something. The natural human tendency is to avoid things and think it’ll get better. You’ve got to face the problem head on.
  2. After you’ve done that, evaluate your financial management. Review cash management policies and procedures to be sure funds are being handled best, examining cash flow, liquidity, and stewardship of other ministry assets.
  3. Review all expenses and consider reductions in all discretionary line items. Evaluate facilities, land, and other assets. Perhaps you need to consider selling under-used portions of your property.
  4. Talk to your lenders. Don’t wait until you can’t make your payments. Share the expense cuts made to date, additional planned cuts, board involvement, and plans to contact key donors. The board should also know, and discuss with the bank, the collateral value of the church property, and the possibility of marketing it to salvage equity prior to a foreclosure. This assures the lender that the church leadership is looking at all scenarios. Lenders will be more willing to work with a borrower when they can see a good management team is fully engaged and communicating.
  5. Implement monthly board meetings for the foreseeable future to primarily focus on year-to-date actual contributions and budget performance.
  6. Finally, talk to your congregation. Why not allow your congregation to make a “fully informed” decision about their participation in resolving the financial situation of the church? There is nothing more heartening than watching God’s Spirit miraculously move within a congregation in situations like these.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Debt campaign or not?

Pros and cons for churches considering a debt-elimination campaign – Posted 7/19/23

Pros:

  1. It can teach the congregation sound biblical principles. Proverbs 22:7 says: “The rich rule over the poor, and the borrower is slave to the lender.”
  2. It can allow money to go into ministry rather than to a creditor.
  3. It can model good stewardship.

Cons:

  1. It can be a difficult sale. “It’s a lot easier to raise funds for ongoing construction or a building project, for something new and exciting,” explains CPA Vonna Laue.”It’s harder to get people excited about paying down for something we already have.”
  2. It can result in prepayment penalties. “Some lenders do include prepayment penalties in their loans that they make to churches, and yes, that’s definitely going to be a consideration,” says Dan Mikes, executive vice president and national division manager of religious institution banking for Bank of the West, based in San Francisco, California.
  3. It can hurt operational funding. “Periodically, folks just shift their (normal) giving toward a campaign … and some of their operating giving goes down,” says Mike Boblit, vice president of ministry relationship banking for the Evangelical Christian Credit Union, based in Brea, California.

Practical steps

What are some practical steps Churches can take to tackle debt?

Some churches hire consulting firms, such as Generis and RSI, to lead debt-elimination campaigns while others seek assistance directly from their congregation.

Regardless of which approach a congregation takes, experts stress that communication is key. Generis’s Sheppard says he always recommends that church leaders meet individually with three important constituencies: major donors, key leaders, and the congregation itself.

RSI’s Mikell adds “total openness and transparency” are essential and that six questions must be answered clearly and concisely:

  1. Why does the church have debt?
  2. How much does the church owe?
  3. How much is being spent to service the debt?
  4. How much interest would be paid over the life of the loan?
  5. How long would it take to retire the current debt if the church maintained the status quo?
  6. How will the money currently being spent on debt service be re-appropriated for ministry?

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Laying Your Church’s Debt Burden Down

The benefits—and drawbacks—of debt-reduction campaigns. – Posted 7/18/23

From the Oak Mountain Presbyterian Church in Birmingham, Alabama, to the Cottonwood Church in Los Alamitos, California, a number of churches across the nation have taken steps to reduce debt.

Those churches typically fall into three categories, says Jim Sheppard, CEO of Generis, a church financial consulting firm based in Atlanta:

  1. Churches that borrowed beyond their means and find themselves in trouble, including facing the possibility of letting staff go.
  2. Churches where mortgage payments are not a burden but do limit financial flexibility, either to expand facilities or focus on other ministry priorities.
  3. Churches that simply want to be debt-free.

In the wake of the 2008 financial crisis, some churches struggled just to meet payroll and pay utilities. Those churches discovered that reducing or eliminating debt payments could help maintain their staff size and avoid ministry cutbacks. 

it makes sense to attack debt, explains John Kim, the general manager who oversees finances for the Cottonwood Church, which built a new campus in recent years.

“On most church loans, it’s usually a three- or four- or five-year fixed rate,” Kim says. “If you keep a large loan at a fixed rate for five years, chances are, when it’s time to roll it over again, it’s going to be higher.”

On the other hand, investing surplus cash reserves might bring a higher return than paying off low-interest loans, adds Mike Batts, managing partner for Batts Morrison Wales & Lee, an Orlando, Florida-based accounting firm that serves churches and ministries, and an Editorial Advisor for CHURCH FINANCE TODAY.

“Paying off or reducing debt is obviously a worthy goal,” Batts explains. “But having adequate liquidity and cash reserves are also a worthy goal. … So I would caution a church that wants to reduce its debt to be careful not to impair its liquidity situation so that it has little or no flexibility in operations.”

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

How Ratios Can Strengthen This Year’s Finances

Key measurements, reported right, can uncover significant trends. – Posted 7/14/23

This article offers guidance for tracking budgets through various key financial ratios—along with insights on why these measurements are important for building financial health.

For many of the ratios, the top number should be divided by the bottom number. This will produce a usable measurement for tracking trends and making comparisons.

Income and giving ratios

There are four ratios that can help you better understand your congregation’s giving patterns.

1. Net income ratio

change in unrestricted net assets
____________________________
unrestricted revenues

This ratio reveals the change in unrestricted net assets to unrestricted revenues. It shows whether your church’s general operations are positive or negative, and by how much. It answers the question of whether the church is making or losing money in its day-to-day ministry.

Obviously a church is not a business that’s trying to generate a profit to stockpile cash. However, if a church continually loses money in its basic operations, it will eventually have to close.

The benchmark for this ratio is a positive result for the year. A more important benchmark, however, is for the ratio to show an improving trend over the years, factoring in both years of surpluses and years of deficits.

2. Unrestricted contributions per average adult attendee and giving unit

unrestricted contributions
________________________________
average adult attendees and giving units

This measurement introduces the concept of a giving unit. A giving unit is a group of family members, or any recurring supporter, who contributes jointly to the church. This excludes individuals who make a smaller one-time gift supporting a specific event. To identify only the regular recurring giving units, set a minimum dollar threshold, such as giving units that contribute more than $250 annually.

This calculation can be compared to other years to see trends and determine the effects on the church and budget. It is also useful to calculate what contributions would be if every giving unit made a certain amount (e.g., $40,000 a year) and tithed on that amount. Your church could use this measurement to make the congregation aware of the current giving per adult attendee and giving unit, and what the projected giving level would be if everyone participated.

3. Total contributions per average adult attendee and giving unit

total contributions – the combination
of accrual pledges and large one-time gifts
______________________________
average adult attendees and giving units

The key difference between this result and the measurement of unrestricted contributions to average adult attendees and giving units is that this one uses total (unrestricted and restricted) contributions and removes the effect of pledges (which are essentially a noncash accrual) and large one-time gifts.

The power of this measurement comes through analyzing trends in congregational giving habits from year to year. During the period of a capital campaign this figure may be inflated due to an increase in smaller gifts, which are not removed from the calculation.

4. Median household income given to the church

total contributions per average
adult attendee and giving unit
(Measurement 3)
____________________________
local median household income

This ratio determines total contributions per average adult attendee and giving unit to local median household income (from the US Census Bureau, American Community Survey). It shows what percentage of the local median county household income adult attendees and giving units are contributing. In essence, it reveals the additional giving capacity of your congregation.

The trends in this data from year to year are important because there are two indicators that affect the outcome of this ratio: congregational giving and local median household income. For example, if local median county income decreased from one year to the next, the measurement could appear to increase while overall giving actually remained the same.

This measurement will enable church leaders to see changes in giving habits from year to year in response to stewardship teaching and focus.

Cash flow ratios

A church without necessary reserves will be scrambling to operate in the short term, no matter what the other balances are. Positive net income and net asset balances won’t make up for inadequate cash reserves or help in months when giving is down. Fortunately, there are five cash-flow measurements you can use to monitor reserves and identify any needed adjustments.

Numbers 1 through 3 offer different cash flow ratios you can use to calculate how many days of cash reserves your church has, using different perspectives from the financial statements. The result of each calculation is multiplied by 365 to determine a total number of days.

1. Days of expendable net asset reserves

unrestricted, undesignated net
assets + board-designated net
assets for operations
__________________________ X 365
cash expenses (total expenses – depreciation)

The first “days of cash” ratio tells how many days of operating expenses are available in net asset reserves. It takes into account the accrual of current assets and current liabilities. Expendable net assets represent the total resources available to spend on operations, excluding future gifts made or revenues generated by the church. It’s similar to a savings account.

Expendable net assets consist of unrestricted, undesignated net assets, which are net assets that result from achieving positive net income from all sources of revenues (excluding restricted revenues). It also includes amounts designated by the board for operating purposes other than capital expenditures. You divide this total by the amount of cash expenses to find your net asset reserves. Since all of these ratios measure cash flow, I use the term “cash expenses.” These are total expenses less deprecation, the most significant noncash expense recorded.

2. Days of operating cash and investments on hand to fund annual cash expenses

operating cash and investments
___________________________ X 365
cash expenses + capitalized interest

This second “days of cash” ratio calculates the days of operating cash and investments on hand to fund annual cash expenses specifically related to liquid assets. That means it only considers operating cash and investments, not other current assets and liabilities. Again, you divide operating cash and investment by the sum of cash expenses plus capitalized interest (interest paid in cash but not expensed by the church) to find on-hand funds.

This measurement will calculate a result that is slightly different (typically higher) than the first ratio (net asset reserves) because it does not include the impact of other current assets and liabilities.

An appropriate benchmark for this ratio is to have 40 to 80 days of cash expenses on hand. Furthermore, a result of less than 20 days could indicate that your church should take action quickly to improve this measurement.

3. Available days of cash flow coverage

operating cash and investments
___________________________ X 365
cash expenses (including debt principal payments)

This final “days of cash” ratio represents the number of days of operations (including making scheduled debt payments) available when calculated from the sum of operating cash flow. This number comes from the statement of cash flows, operating cash and investments on hand at the beginning of the year, and the amount available from the operating line of credit.

Again, divide beginning cash, cash flows from operations, and available line of credit by the amount of total cash expenses and debt principal payments.

Here’s another way to state this: If your church used all of the cash generated from operations, all available cash and investments on hand at the beginning of the year, and your available line of credit, how many days would you be able to operate on these sources of cash? This number represents your maximum level of reserves, and should always be the highest of the three “days of cash” numbers.

4. Liquidity ratio

operating cash and investments
_______________________________
current liabilities – building fund current
liabilities, deferred revenue, and short-term
construction line of credit

The liquidity ratio measures how operating cash and investments are able to cover current operating liabilities, which exclude current building fund liabilities. (These typically have a separate source of cash from restricted revenues or budgets.) This ratio reveals how many times actual operating liabilities can be funded from operating reserves.

Divide operating cash and investments by current liabilities (excluding those items noted in the ratio).

A low result may indicate that the church is keeping fewer liquid reserves and is less likely to be able to handle unexpected operating expenses, events, or new opportunities that may come along.

5. Net cash availability measurement

total cash and investments – adjusted current liabilities (current liabilities excluding amounts borrowed on a construction line of credit) and temporarily restricted net assets

The fifth and final cash flow item is not a ratio but a measurement of the sum of total cash and investments less certain amounts the church may owe or be required to spend for specific purposes due to donor restrictions. This measurement calculates the amount of cash available for other uses after the church has satisfied its adjusted current liabilities and set aside appropriate funds for temporarily restricted projects. Amounts borrowed on a construction line of credit are also excluded, as they will ultimately be refinanced with the debt and paid over time.

Your statement of financial position answers the question, “How much cash do we have?” but it doesn’t answer the question, “Whose cash is it and how much of it can we spend?” The answers to those questions are typically very different. Therefore, this is one of the most important measurements you can provide church leadership.

The minimum for this number is at least one month’s worth of cash expenses. Any positive amount less than this is in the warning range. Any negative amount indicates the church is borrowing from temporarily restricted funds—a warning that corrective action is needed.

Expense ratios

Expense ratios can help identify trends in the outflow of resources over the years. They also allow you to compare your church with other churches and check the reasonableness of your expenses.

1. Personnel and mandatory debt service payments to total expenses (excluding depreciation expenses)

personnel (salaries including benefits)
+ mandatory debt service payments
(principal + interest expense)
________________________________
total expenses – depreciation expense

The largest expense of most churches is salaries and benefits. Debt service payments—which are a reduction of a liability and not an expense—represent the second largest outlay. Together, these items represent a majority of resource outflows from the local church.

Continually monitor these levels as a percentage of cash expenses. Cash expenses are total expenses minus depreciation, the most significant noncash expense recorded. It is also important to promptly follow up on changes in trends or unusual variances from peers to ensure that your resources are continually maximized.

This ratio, which can be split into two separate pieces, allows you to look at two of your largest outflows and determine the portion of the operating budget that will be used. Often, a growth cycle results in an amount of debt the church anticipates being able to pay off as more people start attending. However, the church needs to be able to pay the bills and provide the services that will attract new people with the current budget. Reviewing this ratio in advance of any major debt decisions will help you analyze the feasibility of facility expansion goals.

Reasonable benchmarks for these ratios are:

  • Personnel costs (salaries and benefits) should fall between 40 percent and 55 percent of expenses.
  • Mandatory debt service payments, including interest, should be no more than 15 percent of total expenses.
  • Total personnel and debt service costs should be no more than 40 percent to 70 percent of total church expenditures.

2. Expenses (excluding depreciation) per average adult attendee and giving unit

total expenses (excluding depreciation expense)
________________________________
average adult attendees and giving units

This measurement tells you the cost to the church for each adult attendee or giving unit. It takes total cash expenses and divides that total by the average adult attendees or giving units.

The power of this measurement is in the peer group comparison. This allows your church to see if your cash expenses are high or low compared to your peers. Analyzing trends over the years is also important. Another benefit of this measurement is that it can be subtracted from total contributions per attendee and giving unit to show if contributions are high enough to cover the monetary cost per individual. In other words, are you taking in enough contributions to cover the costs of having people attend your church?

3. Total missions categories to total expenses

total outreach expenses (local and global)
_________________________________
total expenses

This ratio looks at the combined total of local and global outreach (missions and benevolence) expenses as a percentage of total expenditures. It can be separated into two pieces and calculated by local and global activities. Global activities include actual expenditures for cross-cultural missions activities in the United States and other countries. This includes direct support to missionaries; outside agencies, including national partners; and cross-cultural missions trips. It excludes internally allocated costs and salaries of employees included within missions for some church budgets. This is because internal allocations vary significantly among churches.

Local outreach includes expenditures for local missions activities not classified as “global.” This includes direct support of community-based church ministries, local missionaries and agencies, and benevolence given to local individuals. It excludes internally allocated costs and salaries of church employees included within missions for the same reason as stated above.

This ratio can be useful in benchmarking your total outreach expenditures with other churches. More importantly, when a church experiences economic difficulties, the ministry and mission expenses are usually the first to be decreased as debt service payments are not discretionary and personnel costs are difficult to reduce. Declines in this ratio can allude to other issues. Monitoring these ratios over time will allow the church to identify any significant changes.

4. Facility cost per square foot (excluding interest expense)

total facility costs (excluding interest
expense on the debt and depreciation)
_______________________________
total facility square footage

This measurement answers the question, “How much does it cost to operate the church building?” Total facility costs include building and grounds maintenance, personnel salaries and benefits, outside contract labor, utilities (excluding telephone), security, liability insurance, and rent or mortgage payments. It should also include the cost of general repairs to the facility and other facility-use expenses, but not equipment purchases or the cost of major renovations. This overall expense excludes both vehicle-related expenses and interest expense on debt and depreciation.

Facility expenses measurements can vary, depending on whether the church has new or older facilities and is in one or multiple locations. Facility expenses measurements can also vary by geographic area. The most accurate comparison would be against churches with buildings of a similar age as yours (e.g., built within a decade of your own).

The ratios detailed above can provide valuable insights for leaders. They are tools that can be used proactively to minimize the need to respond to financial crises later.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Some Churches Keep Their Budgets Rolling

Navigating unexpected ups and downs with an alternative budget. – Posted 7/12/23

American churches tend to operate with the mindset that budgeting is a formal, annual process that must be performed in a manner and time frame that aligns with the church’s fiscal year. In reality, there is no legal requirement for such a formal or annual process.

Caution. Consideration must be made, however, of an individual church’s governing documents (articles of incorporation, constitution, bylaws, etc.) and polity, including denominational books of order or other similar authoritative sources that may impose specific, formal, annual budgeting requirements.

Fluid, dynamic alternatives

With improved technologies and availability of more timely financial information on a regular basis, churches are able to monitor and forecast activities and costs on a more dynamic basis than has been the case in the past. As a result, some churches have adopted alternatives to (either as a supplement or in lieu of) the formal, annual budgeting process that are more fluid and dynamic. Such an approach allows church leaders to adapt on an ongoing basis to changing expectations regarding revenues and other dynamic developments.

A more dynamic budgeting or forecasting process is likely essential for a church undergoing rapid change—particularly a church experiencing rapid growth or a church that has experienced a sudden and unexpected challenge or crisis. Whether a church chooses to abandon formal, annual budgeting, or not, is a decision to be made by its governing body and possibly (depending on the church’s governance model) its membership.

The importance of a policy

A commonly used alternative to the formal, annual budgeting process is some form of rolling forecast or rolling budget. For example, a church may adopt a rolling forecast looking forward to the next 12 months and update the forecast each quarter. For obvious reasons, utilizing a rolling forecast or rolling budget in which forecasted or budgeted amounts change frequently presents challenges for a church that wishes to use its budget as an expense control mechanism. Accordingly, it may be wise for a church that utilizes a rolling forecast or rolling budget model to officially adopt policies or constraints on spending. For example, a church may adopt a resolution providing that the financial management of the church shall result in a minimum cash flow surplus for each calendar quarter or for a calendar year. Such a resolution may also adopt targeted benchmarks for the church to reach each quarter, or year, as progress toward its longer-term targets for improved liquidity and financial position.

A tool for internal control

If a rolling forecast or rolling budget model is used, it is still important for the church to utilize its forecast or budget as a tool for effective stewardship and internal control. Comparing actual results with budgeted or forecasted amounts for the applicable periods of time is a particularly effective financial oversight exercise and an important element of sound internal control. The fact that the church may not utilize a formal, annual budgeting process is not a basis for abandoning the process of comparing actual results with forecasted or budgeted amounts.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Budgeting Major Repairs and Replacements

Five considerations to help determine future costs and build a capital reserve. – Posted 7/11/23

A capital reserve account is one that is established to save up money, in a designated account, to pay for a major capital expenditure (replacement, repurposing, and so on) when an expensive item’s effective life is over. For example, the average life of your church’s HVAC systems may be 15 years. If you spend $100,000 on a new HVAC system today, how much should you set aside in a reserve account to have the adequate funds to replace it in 15 years? Is it $100,000? More? Less?

Here are five considerations that will help determine future costs and develop a capital reserve account for any inevitable expenditures:

1.) Deferred maintenance. If you have any deferred maintenance, you must develop a plan to bring things current based on their age and expected life. If that is not done prior to developing the ongoing capital reserves, you will always be playing catch up.

2.) Current replacement value. What would it cost today to replace the item?

3.) Expected life. How many years of life are still expected from this item?

4.) Annual inflation. As you look at the economic environment, what percentage of annual inflation would be prudent to plan on?

5.) Annual budget. Based on the above four considerations, how much money should be set aside every year?

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Three Questions to Ask About Your Church’s Financial Management

Do your compensation, reimbursements, and restricted giving practices need a check-up? – Posted 7/6/23

When it comes to staying above reproach in finances, churches generally struggle with the same few issues, over and over again. They play out in different ways but the biggest questions they need to answer in order to assess the health of their financial administration are these three.

1. Does your church have fair compensation?

Is that compensation approved independently of the individuals who receive that compensation? You need to make sure that your staff members aren’t directly or indirectly helping determine how much they will be paid. Another question in this area is, Is all of the compensation that is taxable reported as taxable? Or are you giving the pastors a pass and not reporting taxable compensation? How are fringe benefits being reported? Are they taxable, tax-deferred, or tax-free? Dealing with issues of financial reporting is a large task, but it’s necessary to have guidelines in place in order to protect your pastors, your staff, and yourself.

2. Is anyone at your church challenging your senior pastor’s expense report?

If the treasurer is a volunteer on the board, he or she might have a basis for challenging, but if the treasurer is a paid staff member, who is he or she to tell the senior pastor that the documentation is not adequate? It’s critically important to have your pastor’s expense report independently reviewed. In a 2021 nationwide survey conducted by Church Law & Tax, inappropriate expenses or reimbursements was the top form of financial misconduct reported by churches.

 

Let’s use a business trip taken by me as an example for expense reporting. I traveled for business purposes, so I’m going to turn in an expense report when I get back. Let’s say I use my personal credit cards to charge everything for this trip. I’ll get reimbursed for those expenses only if I can document the business purposes of all of the expenses on my trip. My organization is not on the line for this trip; I’m on the line. And after my expenses are reimbursed for this trip, my expense report goes to the chair of our board for approval. He gets to look at everything I spent, and everything I was reimbursed for. And so the independent review—which doesn’t happen very often in any churches in America—the independent review of the pastor’s expense reports is extremely important.

 

3. Is your church handling “restricted gifts” properly?

Churches often encounter “restricted” gifts (also commonly referred to as “designated” gifts). A donor gives a gift for a specific project, but the church doesn’t spend the money for the project, and then what happens with that money? It has to go to that specific project. And then you have the issue of gifts being given for the benefit of an individual, which is a situation that is going to raise a concern in most cases.

Adoption funding is one of the biggest restricted giving issues. There’s a natural desire to help families who are adopting. That’s wonderful. But there’s a difference between giving a gift to a church or a charity to provide the adoption funds, and giving the money specifically for one family. When it’s given specifically for one family, this translates the gift into a personal gift, not a charitable gift. This is happening in the crowdfunding arena as well. People are very well intended, and their hearts are obviously in the right place. But they’re raising money, adoption-by-adoption, family-by-family, instead of raising money for adoption in general and letting the organization decide who should receive the adoption funding. It’s kind of a combination of the high interest in helping people adopt children and some of the new funding techniques, as in crowdfunding, that are beginning to come together that we’re going to have to work through so that it’s done legally and ethically and in good order.

Fundraising needs to be given for projects. When you start naming individuals, that is going to raise a concern about benevolence, adoption, or other issues. If I make a gift that is specified for one person for adoption or is specified for a person for a mission trip, those are generally going to be viewed as personal expenses. But if I only suggest the missionary or preference—so it’s a gift to the church but my preference would be that it would go for Bill for his church mission trip or career mission trip, then that’s generally acceptable. But when we’re restricted, it’s like me giving you a personal gift; it’s not taxable to you, but it’s not deductible to me.

Those are the three hot-button issues that we’re seeing right now. Compensation, expense reimbursements, and restricted giving. Of course, there are other issues that churches struggle with, and we see those on an individual basis, but overall, if you’ve got these three covered, you are doing a lot right.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Tax News for June 2023 . . .

Correcting Improper FICA Withholdings

What to expect when correcting improper FICA withholdings for a pastor. – Posted 6/30/23

Wages paid to ministers are not included in the definition of wages for the purposes of withholding FICA/Medicare tax. This includes the related employer matching of these taxes by the church.   

Instead, ministers must pay into the Social Security/Medicare systems through self-employment tax calculated on Schedule SE with their personal tax returns (unless they obtain an exemption). 

FICA withholding rules are confusing

Improper FICA withholdings is not uncommon. Churches often incorrectly withhold and match the FICA/Medicare taxes on ministers. If the IRS determines this treatment has occurred, it takes the position that the church has determined the employee is not a minister for payroll tax purposes. This may affect the taxation of other benefits. That’s because it’s impossible to claim to be a minister for one portion of the rules but not for another.

For an example of how the incorrect withholding of a minister’s payroll taxes can prove so consequential, look no further than the housing allowance that qualifying ministers are eligible to receive.

The housing allowance is one of the most valuable tax benefits available to ministers. If a church treats a minister incorrectly and withholds and matches the minister’s FICA/Medicare taxes, then the IRS views him or her as an employee, not a minister. The IRS then would tax the housing allowance paid by the church for the minister, representing a sizable financial loss for the minister. 

Correcting Improper FICA Withholdings

Churches that have improperly withheld/matched a minister’s FICA/Medicare taxes should amend the payroll reports for the three tax years open under the statute of limitations.

This requires amending quarterly Forms 941 and annual Forms W-2. Taxes paid will be refunded to the church. And, because it mistakenly overpaid its taxes, the church will not face any penalties.

The minister will need to report the compensation as self-employment income for the past three years. This is done by amending the related Forms 1040.

The minister also needs to pay the related self-employment tax owed. Interest will be calculated on the tax owed when he or she amends the Forms 1040. 

These amendments can be complicated, so a church may require professional assistance in filing the related amended reports and returns.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

What is a group exemption and why is it helpful?

-Posted 6/28/23

The IRS sometimes recognizes a group of organizations as tax-exempt if they are affiliated with a central organization—such as a denomination covered by the group ruling. This avoids the need for each of the organizations to apply for exemption individually. A group exemption letter has the same effect as an individual exemption letter except that it applies to more than one organization.

Group exemptions are an administrative convenience for both the IRS and organizations with many affiliated organizations. Subordinates in a group exemption do not have to file, and the IRS does not have to process separate applications for exemption. Consequently, subordinates do not receive individual exemption letters.

Exempt organizations that have, or plan to have, related organizations that are very similar to each other may apply for a group exemption. Groups of organizations with group exemption letters have a “head” or main organization, referred to as a central organization. The central organization generally supervises or controls many affiliates, called subordinate organizations. The subordinate organizations typically have similar structures, purposes, and activities.

To qualify for a group exemption, the central organization and its subordinates must have a defined relationship. Subordinates must be:

  • Affiliated with the central organization;
  • Subject to the central organization’s general supervision or control; and
  • Exempt under the same paragraph of IRC 501(c), though not necessarily the paragraph under which the central organization is exempt.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

The Two Most Confusing Aspects of Classifying Your Minister for Tax Purposes

When it comes to payroll, does your church get turned around on this critical matter? – Posted 6/27/23

Unlike any other employee, a minister creates special issues for the payroll functions of a church. These issues aren’t intuitive in nature, so it’s not uncommon for errors to occur in the payroll reporting of a minister’s compensation package. One of the most confusing aspects of a minister’s compensation package is how he or she will be classified when paying into the Social Security and Medicare system.

There are two methods of paying into the Social Security and Medicare system.

1. Federal Insurance Contributions Act (FICA)

Employees traditionally pay in through the Federal Insurance Contributions Act. The employee pays into FICA via taxes withheld from their paychecks by their employers. The employer then matches the employee’s amount and pays it directly into the system on the employee’s behalf.

2. Self Employed Contributions Act (SECA)

The other system is the Self Employed Contributions Act, which assesses the tax to the self-employed individual on a Schedule SE filed with an individual’s Federal Form 1040.

Participation in each of these systems is defined in the Internal Revenue Code (IRC).

The Internal Revenue Code

IRC Section 3121 determines who is covered by FICA. IRC Section 3121(b)(8) states that employment for this tax doesn’t include services performed by an ordained, commissioned, or licensed minister in the exercise of his ministry.

IRC Section 1402 governs who is covered by SECA. IRC Section 1402(c) states that a “trade or business” for purposes of SECA will include the performance of services by a duly ordained, commissioned, or licensed minister in the exercise of his ministry (if no exemption as provided by IRC Sec. 1402(e) is in effect). This explanation demonstrates that, by law, the compensation paid to a minister (for the performance of ministerial duties) is a trade or business subject to self-employment tax. It can’t be considered as wages for FICA withholding and matching. This self-employment status is mandatory, and for people who employ ministers, it’s a key concept to understand. If a minster is paid for ministerial duties, the church may never withhold FICA/Medicare taxes from the minister and pay the matching portion.

As referenced above, under IRC Sec. 1402(e), a minister may obtain an exemption from paying the self-employment tax. The minister accomplishes this by filing Form 4361. The Form 4361 is the personal responsibility of a minister and does not involve any action on the part of either the employing church or the church that issues his or her credentials. If a minister has an approved Form 4361, he or she is not required to pay self-employment tax on ministerial earnings through his or her personal tax return.

This unique treatment of ministers for purposes of paying into the Social Security system often creates two areas of confusion for churches. Let’s break down those myths:

Myth #1. If the minister is self employed, the wages should be reported on Form 1099-MISC.

As unusual as it may seem, most ministers are not truly self employed in all aspects of employment. If a minister is employed by one employer, he or she is actually considered a common law employee. This means most ministers have “dual tax status”—they are self employed for payment into the Social Security and Medicare system, but they are employees in most other instances. Therefore, unless the minister qualifies as an independent contractor, his or her wages are reported on Form W-2. This also means he or she is eligible for participation in benefit plans.

If a church treats a minister as self employed for all purposes, and reports compensation on a Form 1099-MISC, it cannot allow the minister to participate in the majority of its fringe benefit plans on a tax-free basis. For example, health insurance premiums paid by an employer for an independent contractor are taxable compensation to the contractor, but the benefit is tax-free to an employee.

Myth #2. If the minister does not have an approved Form 4361, the employer should allow the minister to have FICA/Medicare taxes withheld from his or her pay and matched by the employer.

People who do not fully understand how the systems work tend to confuse the issues by assuming that if the minister doesn’t have an approved Form 4361, he or she must have FICA withheld from his or her paycheck, like other employees. This is false. The truth is, the church shouldn’t be concerned with whether or not a minister has an approved Form 4361, because the minister’s exemption from self-employment tax doesn’t play a role in the how the church treats the minister for tax purposes. Once a church determines an employee is a minister, and that he or she performs ministerial duties, it can never withhold FICA/Medicare tax from the compensation paid for such services. If a church withholds FICA/Medicare taxes from a minister’s compensation, it is telling the IRS that the employee is not a minister and is not performing ministerial duties. This means a minister would lose his or her ministerial benefits, including the housing allowance under IRC Sec. 107.

Additionally, since, by law, the minister owes self -employment tax, the IRS has a basis to charge the minister self-employment tax in addition to the FICA/Medicare taxes that may have been incorrectly withheld through his or her employer.

When a minister is properly reported for purposes of paying into the Social Security system, his or her Form W-2 should never have any amounts reported in Boxes 3, 4, 5, and 6.

It’s important for churches to clearly understand these concepts. If they don’t, they will be unable to properly report compensation paid to ministers, or help ministers understand their tax obligations.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

A Peek Inside How Churches Spend Their Money

The trends from the past 20 years. – Posted 6/23/23

Each month we receive questions from church leaders like you. Many of these questions share a common theme. They go something like this:

We’re a small church in Florida. We’re trying to figure out how our spending on personnel compares to other churches like us. Can you help?

The specifics to this question always vary. The state differs, as does the church’s size. And while the inquiry often involves personnel expenses, it also looks for insights into other budget topics, such as expenses for buildings, missions, or ministry programs, and processes for approval.

Differences aside, the sentiment is the same. Church leaders like you appreciate the ability to compare their churches’ budget situations to others.

While the practice of making such comparisons isn’t perfect—each church’s situation is unique—it can prove useful when done right. For this reason, Church Law & Tax has conducted its church budget priorities survey periodically since 1999. “Such comparisons can help leaders discern whether what they spend on things like salaries, facilities, ministry programs, and missions, are too much, too little, or just right,” as I noted back in 2014, the last time the survey was offered.

Why is this project important? Aside from equipping you with the insights this information provides to individual churches, it also sheds light on broader trends. Over the past 20 years, we’ve determined some recurring benchmarks. We’ve also observed a few shifts.

Below are five notable highlights of these trends, broken down by year. But before we share them, please note these disclaimers:

  • The methodology and line of questions have shifted over time. In 1999, the survey was entirely paper-based and targeted subscribers of various Christianity Today publications. In 2009 and 2014, the survey was entirely online-based, allowing a much wider net to be cast for survey responses. The more recent surveys have also delved further into general economic factors, something that wasn’t done in 1999.
  • The respondent pools changed each time, so comparisons are not scientific. Only general observations can be made, and even then, caution must be exercised, given any number of variables that affected outcomes specific to the survey. For instance, the smaller net that was cast in 1999 likely contributed to smaller budget sizes when compared to 2014.
  • The 2009 survey reported only median figures—not averages. Again, general indicators can be gleaned from this information, not hard-and-fast lessons.
  • All actual dollar figures shown below were adjusted to 2019 dollars using the US Bureau of Labor Statistics inflation calculator.

1999

  • Both the average and median budget sizes among the roughly 1,200 qualified responses was about $445,500.
  • Personnel (salary and wages) represented the largest budget expenditure (40% of the average budget, 26% of the median).
  • Facilities ranked second (18% of the average budget, 10% of the median).
  • For sources of income, 93% came from tithes and offerings.
  • For budget planning and approval processes, 73% said they used a traditional calendar year (January 1-December 31), rather than some type of alternative fiscal year (e.g., July 1-June 30). About 10% said their church spent one month or less on preparation and approval, 17% spent one to two months, 35% spent two to three months, and 35% spent three to six months.

2009

  • The survey, conducted through a Christianity Today polling website, drew 1,800 qualified responses. The median budget size was about $350,000 (again, no averages were reported with this survey).
  • Personnel was again the largest budget expenditure (38%).
  • Facilities ranked second (12% of the median).
  • For sources of income, 87% came from tithes and offerings.
  • For budget planning and approval processes, 73% said they used a traditional calendar year (January 1-December 31), rather than some type of alternative fiscal year (e.g., July 1-June 30). About 6% said their church spent one month or less on preparation and approval, 12% spent one to two months, 20% spent two to three months, and 26% spent three to six months.

2014

  • The average and median budget sizes among the nearly 2,200 qualified responses was significantly higher (again, note the disclaimer above). The average church budget was $937,400, while the median budget was $654,600.
  • Personnel again was the largest budget expenditure (47% of the average budget).
  • Facilities again ranked second (with 7% devoted to a mortgage or rent payment, 7% spent on utilities, and 5% spent on maintenance, cleaning, and landscaping in the average budget).
  • For sources of income, 91% came from tithes and offerings.
  • For budget planning and approval processes, 71% said they used a traditional calendar year (January 1-December 31), rather than some type of alternative fiscal year (e.g., July 1-June 30). About 7% spent one month or less on budget preparation and approval processes, 14% spent one to two months, 30% spent two to three months, and 41% spent three to six months.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Housing Allowances

Understand how to properly set this significant pastoral benefit. – Posted 6/21/23

The housing allowance is the most important tax benefit available to ministers. But many ministers do not take full advantage of it because they (or their tax adviser or church board) are not familiar with the rules.

The three most commonly used housing arrangements for ministers are (1) owning a home, (2) renting a home or apartment, and (3) living in a church-provided parsonage. The tax code provides a significant benefit to each housing arrangement. The rules are summarized below.

Housing allowance: minister owns the home

Ministers who own their home do not pay federal income taxes on the amount of their compensation that their employing church designates in advance as a housing allowance, to the extent that the allowance represents compensation for ministerial services, is used to pay housing expenses, and does not exceed the fair rental value of the home (furnished, plus utilities). Housing-related expenses include mortgage payments, utilities, repairs, furnishings, insurance, property taxes, additions, and maintenance.

Housing allowance: minister rents the home

Ministers who rent a home or apartment do not pay federal income taxes on the amount of their compensation that their employing church designates in advance as a housing allowance, to the extent that the allowance represents compensation for ministerial services and is used to pay rental expenses and does not exceed the fair rental value of the home (furnished, plus utilities).

Parsonages

Ministers who live in a church-owned parsonage that is provided rent-free as compensation for ministerial services do not include the annual fair rental value of the parsonage as income in computing their federal income taxes. The annual fair rental value is not deducted from the minister’s income. Rather, it is not reported as additional income anywhere on Form 1040 (as it generally would be by most non-clergy workers).

In addition, ministers who live in a church-provided parsonage do not pay federal income taxes on the amount of their compensation that their employing church designates in advance as a parsonage allowance, to the extent that the allowance represents compensation for ministerial services and is used to pay parsonage-related expenses such as utilities, repairs, and furnishings.

How to set parsonage and housing allowances

Parsonage and housing allowances should be (1) adopted by the church board or congregation, (2) in writing, and (3) in advance of the calendar year. However, churches that fail to designate an allowance in advance of a calendar year should do so as soon as possible in the new year (though the allowance will only operate prospectively). In designating housing allowances, churches should keep in mind that the nontaxable portion of a housing allowance cannot exceed the fair rental value of a minister’s home (furnished, plus utilities). Therefore, nothing will be accomplished by designating allowances significantly above this limit.

Using “safety nets”

Many churches do not limit housing allowances to a particular cal­endar year. For example, if a church intends to designate $12,000 of its senior pastor’s salary in 2021 as a housing allowance, its designa­tion could state that the allowance is effective for calendar year 2021 and all future years unless otherwise provided. This clause may provide a “safety net,” protecting the pastor in the event that the board neglects to designate an allow­ance prior to the beginning of a future year.

A church also would be wise to have a “safety net” designation to cover midyear changes in personnel, delayed designations, and other unexpected contingencies. To illustrate, such a designation could simply state that a specified percentage (e.g., 40 percent) of the compensation of all ministers on staff, regardless of when hired, is designated as a housing allowance for the current year and all future years unless otherwise specifically provided.

Such safety net designations should not be used as a substitute for annual housing allowance designations for each minister. They are simply a means of protecting ministers against inadvertent failures by the church board to designate a timely housing allowance.

Key details

Here is a recap of some important details, along with some helpful additional information ministers should know about the housing allowance:

  • A housing allowance must be designated in advance. Retroactive designations of housing allowances are not effective.
  • The housing allowance designated by the church is not necessarily nontaxable. It is nontaxable (for income taxes) only to the extent that it is used to pay for housing expenses, and, for ministers who own or rent their home, does not exceed the fair rental value of their home (furnished, plus utilities).
  • A housing allowance can be amended during the year if a minister’s housing expenses are more than expected. However, an amendment is only effective prospectively. Ministers should notify their church if their actual housing expenses are significantly more than the housing allowance designated by their church. But note that it serves no purpose to designate a housing allowance greater than the fair rental value of a minister’s home (furnished, plus utilities).
  • If the housing allowance designated by the church exceeds housing expenses or the fair rental value of a minister’s home, the excess housing allowance should be reported on line 1 of Form 1040.
  • The housing allowance exclusion is an exclusion for federal income taxes only. Ministers must add the housing allowance as income in reporting self-employment taxes on Schedule SE (unless they are exempt from self-employment taxes).
  • The fair rental value of a church-owned home provided to a minister as compensation for ministerial services is not subject to federal income tax.
  • Ministers should be sure that the designation of a housing or parsonage allowance for the next year is on the agenda of the church board for one of its final meetings during the current year. The designation should be an official action, and it should be duly recorded in the minutes of the meeting. The IRS also recognizes designations included in employment contracts and budget line items—assuming in each case that the designation was duly adopted in advance by the church.
  • Many churches base the housing allowance on their minister’s estimate of actual housing expenses for the new year. The church provides the minister with a form on which anticipated housing expenses for the new year are reported. For ministers who own their homes, the form asks for projected expenses in the following categories: down payment; mortgage payments; property taxes; property insurance; utilities, furnishings, and appliances; repairs and improvements; maintenance; and miscellaneous. Many churches designate an allowance in excess of the anticipated expenses itemized by the minister. Basing the allowance solely on a minister’s anticipated expenses penalizes the minister if actual housing expenses turn out to be higher than expected. In other words, the allowance should take into account unexpected housing costs or underestimated projections of expenses.
  • Ministers who own their homes lose the largest component of their housing allowance exclusion when they pay off their home mortgage. Many ministers in this position have obtained home equity loans—or a conventional loan secured by a mortgage on their otherwise debt-free home—and have claimed their payments under these kinds of loans as a housing expense in computing their housing allowance exclusion. The Tax Court has ruled that this is permissible only if the loan was obtained for housing-related expenses.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Six Insights About Summer Slump

Some churches keep their ministries robust during the so-called “downtime.” – Posted 6/20/23

“I hate summer attendance!”

That sentence came from a pastor whose church is consistently down in attendance in the summer. Indeed, his sentiments were echoed in many conversations I had with pastors. The conversation began at the consulting and coaching hub at ChurchAnswers.com. I expanded it with some inquiries via emails, calls, and texts.

The insights these pastors shared were invaluable. Perhaps you can identify with many of them.

1. A typical average decline is 20 percent.

We used average worship attendance as our metric. The 20 percent number was the response from two out of three pastors in this survey. So, for a church with an average worship attendance of 200 during the non-summer months, attendance drops to 160 in the summer.

2. Snowbird churches tend to have greater fluctuations.

For example, churches in southwest Florida and south Florida tend to have an exodus of attendees in the summer, usually greater than 20 percent. On the other hand, a pastor in Minnesota told us his church’s summer attendance was unchanged. Vacationers were offset by returning snowbirds.

3. Churches in towns dominated by colleges have declined greater than 20 percent.

Of course, this issue is often a reflection of the robustness of the church’s college ministry. A pastor in a town where the college makes up a major part of the population told us his church’s summer decline was around 50 percent!

4. Year-round school is impacting the summer slump.

A year-round school system could have a six-week summer break instead of the usual full summer break. Those six weeks of attendance could be down dramatically, well above the 20 percent norm noted by the majority of pastors.

5. Churches that give a summer break to their small groups typically have a decline greater than 20 percent.

It is absolutely amazing how involvement in groups like community groups, small groups, life groups, and Sunday school classes positively affect ministry involvement, giving, and attendance frequency. When churches keep their groups active in the summer, attendance slumps are not as pronounced.

6. Many churches have become intentional about battling the summer slump.

Instead of ramping down they, at the very least, keep their regularly-scheduled ministries on the same schedule. But a number of the churches actually introduce new ministries and opportunities in the summer. For example, the tried- and-true Vacation Bible School tends to impact attendance positively for at least two weeks of the summer.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Reporting Financial Crime as a Matter of Stewardship

When misconduct arises, contacting the authorities is an act of safeguarding God’s resources. – Posted 6/16/23

Nearly 70 percent of churches that have experienced fraud chose not to report it to the police, according to a new nationwide survey of church leaders.

The study on financial misconduct was conducted in the spring of 2021. It surveyed 706 church leaders.

About one-third of leaders said financial misconduct had taken place in their churches. Among those churches that experienced fraud, only a third filed a report with law enforcement.

In my own experience, the vast majority of churches that know or believe financial misconduct occurred are reluctant to contact law enforcement. In fact, nearly every single time I have been contacted by a church, I was told the church’s leaders did not want to file a police report. These leaders told me they would rather handle the matter internally. This sentiment was overwhelmingly confirmed through Church Law & Tax’s nationwide survey.

Additionally, nearly half of the respondents said their church boards have not discussed how they would respond to suspected fraud.

In the survey, leaders most frequently gave these explanations as to why they did not contact authorities:

  • We were able to recover the money without having to take legal action (27.7 percent).
  • We wanted to work on restoration with the individual(s) (26.5 percent).
  • We did not want to make it public to protect the church’s reputation (20.5 percent).
  • The church chose to forgive rather than report to the authorities (19.3 percent).
  • We did not want to make it public to protect the individual(s) (16.9 percent).
  • Legal action would go against the church’s ministry philosophy (7.2 percent).

(Note: Respondents were asked to check all that apply.)

When I speak with church leaders, their hesitations for contacting law enforcement often arise because the suspected embezzler is almost always a trusted member or employee, and church leaders are reluctant to accuse such a person without irrefutable evidence of guilt.

Seldom does such evidence exist. The pastor may confront the person about the suspicion, but the individual will often deny any wrongdoing—even if guilty. This only increases the frustration of church officials who do not know how to proceed.

Three cautions

For church leaders who believe authorities should not be contacted when financial misconduct arises, I offer three cautions.

One, the fraud perpetrated by the person is often far greater than the church realizes. A failure to involve authorities may hide the true depth and extent of the crime committed. CPA Vonna Laue’s experience certainly affirms this. “Each time I have been brought into a ministry’s financial fraud situation, the amount of loss grew as more information was uncovered,” said Laue, a Church Law & Tax senior editorial advisor who advised this nationwide survey project. “It was always more than the perpetrator indicated and sometimes even they were surprised by the total.”

Two, it does not matter whether the embezzler intended to pay back the embezzled funds someday. This intent in no way justifies or excuses the crime. The crime is complete when the funds are converted to one’s own use—whether or not there was an intent to pay them back.

Of course, an offender’s repayment may make it less likely that a prosecutor will prosecute the case. And even if the embezzler is prosecuted, this evidence may lessen the punishment. But the courts have consistently ruled that an actual return of embezzled property does not purge the offense of its criminal nature or absolve the embezzler from punishment for his or her wrongdoing. Also, note that church officials seldom know if all embezzled funds are being returned. They are relying almost entirely on the word of the thief.

And three, whether a church opts to notify law enforcement or not, there are tax law obligations with the Internal Revenue Service (IRS) that must be fulfilled.

Responding to suspected cases of fraud

Church leaders often learn of suspected financial misconduct because discrepancies or irregularities arise or someone submits a tip.

Along with the red flags noted in the “Top Six Red Flags” sidebar, consider the following scenarios that point to the possibility that fraud might be taking place:

  • Giving is always higher when the person who usually does the counting is on vacation or ill during a weekend service.
  • A church bookkeeper lives a higher standard of living than is realistic given her or her income.
  • Church offerings have remained constant, or increased slightly, despite that attendance has steadily increased.
  • A church official with sole signature authority on the church checking account has purchased a number of expensive items from unknown companies without any documentation to prove what was purchased and why.

When unusual activity gets detected, or a tip is received, church leaders should take the following three steps in this order to effectively respond.

1. Carefully gather information

When evidence of actual or suspected financial misconduct surfaces, the pastor and/or church leaders should gather as much information as possible. Compile all documents and records that point to the possible irregularities and inconsistencies. The church should contact its attorney. It also should strongly consider hiring a qualified CPA firm or Certified Fraud Examiner (CFE) to conduct a more thorough investigation.

Note. Some churches have used CFEs to detect embezzlement and estimate the amount of loss. But note that CFEs are not required to be CPAs, and many have far less familiarity with accounting records than a CPA. The ideal professional would be a CPA who is also a CFE. For more information on CFEs, and to find one nearby, go to the website of the Association of Certified Fraud Examiners.

A deeper investigation offers the best way to quickly determine if the irregularities and inconsistencies are a product of human error or misconduct, and the amounts of money lost. If the cause is error, then the church can address the problem while avoiding making any erroneous and harmful accusations. If the cause is misconduct, then the church knows it must take appropriate next steps to address it.

2. Sit down with the suspected perpetrator

If sufficient information points to a suspected perpetrator, at least two church leaders, and possibly the church’s attorney and the CPA or CFE (if one is hired) should meet with the person. Provide some general descriptions about the irregularities or inconsistencies that have arisen and ask the person what they can tell you about them. Take careful notes, including any questions or comments the person makes.

If the person confesses and asks how things will be handled, explain the criminal nature of the offense. Also explain the legal requirements to contact the IRS (see more below).

Caution. Always keep in mind that embezzlement is a criminal offense. Depending on the amount of funds or property taken, it may be a felony that can result in a sentence in the state penitentiary.

If the person confesses, evaluate with the church’s attorney the possible ways the person can possibly repay the stolen funds—but know that such a step does not absolve the person of his or her crime, nor does it eliminate potential consequences with the IRS. Also know upfront that such agreements by embezzlers to repay funds often are not honored.

3. Contact authorities

If there is a confession, or if the evidence clearly indicates the person stole church funds, church leaders must consider turning the matter over to the police or local prosecutor and the IRS. These are very difficult decisions, since doing them may result in the prosecution, penalization, and possible incarceration of a member of the congregation.

Note. Embezzlers never report their illegally obtained “income” on their tax returns. Nor do they suspect that failure to do so may subject them to criminal tax evasion charges. In fact, in some cases. it is actually more likely that the IRS will prosecute the embezzler for tax evasion than the local prosecutor will prosecute for the crime of embezzlement. Along with contacting local authorities, your church also should contact the IRS regarding the matter.

Before you “forgive and forget”

In some cases, a person confesses to the misconduct. Often, this is to prevent the church from turning the case over to the police or the IRS. Perpetrators believe they will receive “better treatment” from their own church than from the government. In many cases, they are correct.

It often is astonishing how quickly church members will rally in support of the embezzler once he or she confesses—no matter how much money was stolen from the church. This is especially true when the perpetrator used the stolen funds for a “noble” purpose, such as medical bills for a sick child.

Many church members demand that the perpetrator be forgiven. They are shocked and repulsed by the suggestion that the embezzler—their friend and fellow church member—be turned over to the IRS or the police. But is it this simple? Should church leaders join in the outpouring of sympathy? Should the matter be dropped once the embezzler confesses?

These are questions that each church will have to answer for itself, depending on the circumstances of each case.

Before forgiving the embezzler and dropping the matter, though, church leaders should consider the following.

A serious crime has been committed, and the embezzler has breached a sacred trust

The church should insist, at a minimum, that the embezzler must:

  • disclose how much money was embezzled,
  • make full restitution by paying back all embezzled funds within a specified period of time, and
  • immediately and permanently be removed from any position within the church involving access to church funds.

Closely scrutinize and question the amount of funds the embezzler claims to have taken. Remember, you are relying on the word of an admitted thief. That is why it is important to involve the church’s attorney, as well as a CPA or CFE, when suspicions first arise.

The embezzler should be informed that the embezzled funds must either be returned within a specified time, or a promissory note must be signed promising to pay back the embezzled funds within a specified period of time.

Caution. An attorney should be consulted before the church has any discussions about an agreement with the embezzler about paying back stolen funds.

The church faces tax consequences if it doesn’t notify the IRS

The embezzler should also be informed that embezzled funds constitute taxable income and failure to agree to either of the above alternatives will force the church to issue him or her a 1099 (or a corrected W-2 if the embezzler is an employee) reporting the embezzled funds as taxable income.

If funds were embezzled in prior years, then the employee will need to file amended tax returns for each of those years to report the illegal income since embezzlement occurs in the year the funds are misappropriated.

Failure to report taxable income will subject the church to a potential penalty (up to $10,000) for aiding and abetting in the substantial understatement of taxable income under section 6701 of the tax code.

Note. If an employer is able to determine the actual amount of embezzled funds as well as the perpetrator’s identity, the full amount may be added to the employee’s W-2, or it can be reported on a Form 1099 as miscellaneous income. But remember, do not use this option unless you are certain that you know the amount that was stolen as well as the thief’s identity.

If the full amount of the embezzlement is not known with certainty, then church leaders have the option of filing a Form 3949-A (“Information Referral”) with the IRS. Form 3949-A is a form that allows employers to report suspected illegal activity, including embezzlement, to the IRS. The IRS will launch an investigation based on the information provided on the Form 3949-A. If the employee in fact has embezzled funds and not reported them as taxable income, the IRS may assess criminal sanctions for failure to report taxable income.

Caution. If the embezzler agrees to pay back the stolen money and does so, does this convert the embezzled funds into a loan, thereby relieving the employee and the church of any obligation to report the funds as taxable income in the year the embezzlement occurred? The answer is no.

Most people who embezzle funds insist that they intended to pay the money back and were simply “borrowing” the funds temporarily. An intent to pay back embezzled funds is not a defense to the crime of embezzlement.

The courts are not persuaded by the claims of embezzlers that they intended to fully pay back the funds they misappropriated. The crime is complete when the embezzler misappropriates the church’s funds to his or her own personal use.

There is yet another problem with attempting to recharacterize embezzled funds as a loan. If the church enters into a loan agreement with the embezzler, this may require congregational approval. Many church bylaws require congregational authorization of any indebtedness, and this would include any attempt to reclassify embezzled funds as a loan. Of course, this would have the collateral consequence of apprising the congregation of what has happened.

A church has a fiduciary obligation to properly steward its financial resources

Viewing the offender with mercy does not necessarily mean that the debt must be forgiven and a criminal act ignored. Churches are public charities that exist to serve religious purposes, and they are funded entirely out of charitable contributions from persons who justifiably assume that their contributions will be used to further the church’s mission. These purposes may not be served when a church forgives and ignores cases of embezzlement.

The church should care about other churches

As Church Law & Tax’s findings also reveal, the average tenure of embezzlers tended to be less than 10 years, and oftentimes measured less than 5 years.

If an offender is “let off the hook,” so to speak, and quietly leaves the church, then he or she is in a position to victimize another church in the future. No record of the offender’s activities will be available—and that means even a church that follows healthy screening and selection steps (including criminal background checks) will be unable to detect this person’s past offenses.

As Laue, the CPA who advised the survey project, also notes: “We have a responsibility to protect Kingdom resources, whether they are ours or someone else’s, and we can’t do that if we don’t take the necessary steps to make others aware of the fraudulent activity.”

The bottom line: Churches should report financial misconduct as an act of stewardship for the global church.

Case Study: A Repeat Embezzler. A church administrator embezzled over $350,000 from his church. He wrote unauthorized checks to himself and others from the church’s accounts, and used the church’s credit card on over 300 occasions to purchase personal items. Police officers were called and he made a full confession.

The church secured a $1 million civil judgment against him. He was prosecuted and convicted on four felony counts including forgery and theft, and he was sentenced to 32 years in prison based on “aggravated circumstances” (the large amount of money that had been stolen, the care and planning that went into the crimes and their concealment, the fact that a great number of checks were stolen and unauthorized credit card charges made, and breach of trust).

Several years earlier, the administrator embezzled a large amount from a prior church employer. However, that church chose not to initiate criminal charges, believing that he had learned his lesson.

This case study is taken from the “Embezzlement” section of the Legal Library.

Follow the law, practice good stewardship

As Church Law & Tax’s new study on fraud demonstrates, financial misconduct is an all-too-common experience for churches. This finding is certainly supported by my own decades of offering legal guidance to churches that have had to deal with fraudulent activity.

And as both the study and my own experience show, a most-troubling aspect of financial misconduct in churches is the unfortunate reality that many pastors and other leaders choose to handle fraud or suspected fraud internally—meaning they avoid involving a CPA or CFE, the IRS, and law enforcement. But the failure to report can be problematic for the reasons I have detailed in this article.

For the sake of practicing good financial stewardship, it is my hope and prayer that churches will carefully consider the advice I offer in this article. Most importantly, my hope is that churches will seek do all they can to prevent financial misconduct from happening in the first place through implementing a system of sound internal control.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Every Church Is at Risk for Fraud. Here’s Why.

Church Law & Tax’s nationwide survey shows churches of all sizes, ages, and locations are susceptible to financial misconduct. – Posted 6/14/23

A new nationwide survey of more than 700 church leaders conducted by Church Law & Tax shows nearly one-third serve in congregations that have suffered from some form of financial misconduct.

Among those experiencing it, half said an incident occurred within the past 10 years.

Prior research conducted by other organizations throughout the past 20 years has usually pegged the figure closer to 10 percent or 15 percent for houses of worship. Still, church financial experts have long estimated that the figure was at least one-third or even higher for all congregations across the nation—a figure that appears to track closely with the new study.

“It was disheartening to see 30 percent of churches responding had experienced fraud,” said CPA Vonna Laue, a senior editorial advisor for Church Law & Tax who co-led the survey project. “It did confirm to me how prevalent this situation is in churches.”

Churches of all sizes, ages, and locations are susceptible, according to the survey’s findings—and fraud prevention experts say the vulnerabilities that perpetrators commonly exploit are ones easily remedied.

“The primary types of financial misconduct that occurred are the most preventable with a good internal control structure,” Laue said.

Yet many churches do not install simple safeguards out of a perceived high level of trust among their ranks, a noted frustration among the financial experts who reviewed Church Law & Tax’s results and provided comment.

“It will never happen here”

Two-thirds of survey respondents who said they weren’t aware of fraud in their churches also said they believe the problem is unlikely or “will never” happen in their churches. Ironically, among those who endured misconduct, half said they shared a similar “it-will-never-happen” sentiment before uncovering a case—and 80 percent then implemented several basic measures after the fact.

“This is one of the most important takeaways from this study,” noted Rollie Dimos, a Certified Fraud Examiner (CFE) and author of Integrity at Stake: Safeguarding Your Church from Financial Fraud. “Most people think that their church is immune from the risk of fraud because [their] staff and volunteers are trustworthy. . . . We trust people to do the right thing, but we can fail them if we don’t hold them accountable or provide controls to protect them.”

Nathan Salsbery, a CFE and a partner and executive vice president for nonprofit CPA firm CapinCrouse, said many congregations “do not implement effective internal controls until they feel the pain of fraud firsthand.”

Salsbery is currently assisting fraud investigations at three different churches. “Had these churches implemented a few basic internal controls, they would have either prevented the fraud or would have detected it much sooner,” he added.

A costly toll

The failure to prevent or quickly detect financial misconduct exacts heavy tolls on congregations. In a 2022 study, Gordon-Conwell Theological Seminary’s Center for the Study of Global Christianity estimates church fraud globally will total $70 billion a year by 2025.

The fallout extends beyond pure dollars, though, and often with devastating effects. In an analysis of the language used by respondents to Church Law & Tax’s survey, words associated with anger and sadness appeared repeatedly among respondents who experienced fraud.

“The financial losses can be staggering,” Salsbery said. “While the financial losses are bad enough, there are usually many other losses that result from the inevitable broken trust and relationships damaged by such long-term acts.”

Such damage is understandable, given the typical identity of the perpetrator and the amounts that he or she steals.

As the Church Law & Tax research shows, the profiles of offenders frequently included treasurers, board members, and middle-aged pastors. Financial losses were the largest among perpetrators with long tenures at their churches (see “Loved and Trusted: What Shocks Us Most about Fraud Perpetrators”).

 

As for the amounts stolen, Church Law & Tax’s research showed 69 percent of those victimized said their losses measured less than $100,000. About 14 percent said the amounts topped $100,000, while another 15 percent said they did not know how much was taken.

Precise financial losses are difficult to pinpoint since the perpetrator may not know or may lie. And churches that choose not to contact law enforcement likely will miss out on learning the full extent because a thorough investigation never happens. Nearly 70 percent of victimized churches chose not to report their cases to police. Overall, only 22 percent of all respondents said their boards would contact law enforcement in the event a future suspected or actual case arose (see “Reporting Financial Crime as a Matter of Stewardship”).

Easy opportunities

Nearly 42 percent of cases involved “inappropriate expenses or inappropriate expense reimbursements,” the survey showed. Slightly more than 30 percent involved stealing contributions. Payroll fraud and inaccurate timesheets combined constituted 12 percent of the cases. And another 11 percent took tangible church property, while about 9 percent forged check signatures. (Note: Respondents to the “Types of Financial Misconduct” infographic were asked to check all that apply.)

While the type of theft men and women committed against their churches varied, according to the survey, it generally boiled down to one thing: easy opportunities.

“While TV shows often depict fraud as grand and complicated schemes, most fraud committed in the church is simply an individual taking advantage of a situation where no one is looking,” Salsbery observed.

Just assigning another set of eyes to monitor a variety of financial activities could greatly reduce easy opportunities. For instance, the leading “red flag” for persons who committed fraud was excessive control over his or her duties or an “unwillingness to have others cover his/her job duties.”

“Nearly half of fraud schemes found were detected as a result of another employee performing a person’s duties” in their absence, noted CPA Michael Batts, another Church Law & Tax senior editorial advisor who reviewed the results. “The rotating duties of workers performing certain financial duties is, itself, an effective internal control mechanism, especially where adequate segregation of duties for a particular position is not in place.”

Encouraging signs—but much room for improvement

While the ease with which perpetrators stole from their churches is troubling, many of the practices best positioned to thwart such efforts do not require extensive time or expense.

On an encouraging note, many respondents indicated at least some best practices are already in place.

About 86 percent of all respondents regularly generate and review financial statements, and 83 percent make certain two unrelated people work together to handle financial tasks.

Around three-quarters of those who had experienced fraud said they use separate individuals—the “segregation of duties” in accounting parlance—for authorizing cash disbursements, maintaining custody or control over cash, and handling accounting responsibilities. (Note: Most of those who responded to the question about “segregation of duties” were in churches that had experienced fraud. Respondents highlighted in the “Top measures churches take to prevent financial misconduct” infographic were asked to check all that apply.)

Still, the responses for these categories show between 17 percent and 25 percent of churches are not performing these basic measures.

The percentages worsen when considering other areas of financial accountability or internal controls recommended by experts. For instance:

  • Slightly more than half of respondents said one person in their church has the ability to perform all aspects of cash disbursements without requiring another individual’s involvement. “That is a staggering statistic,” Laue noted.

Dimos said this problem, along with improper expenses or expense reimbursements—the leading type of fraud found in the survey—can be easily prevented by “[r]equiring a second person to review and approve all credit card purchases or reviewing invoices or reimbursement requests before signing checks.”

Additionally, “disciplined monthly reviews of cancelled checks (or images) and reviews of monthly credit card statements and related documentation and support [can] significantly reduce risk,” Salsbery said.

  • Only one-third of churches store their collections in a safe and secure manner and require dual controls for access when they cannot be immediately deposited at the bank (again, stolen contributions constituted the second-highest type of fraud in the survey).
  • Only one-third of churches have their payroll approved by someone other than the preparer and then reconciled to the church’s accounting system.
  • Only 22 percent apply accounting procedures to tangible property susceptible to theft, such as electronic equipment or bookstore inventories.

“The addition of internal controls to protect your church will not cost the church anything,” Dimos observed. “Having a second person—like a staff member, trusted volunteer, or board member—be responsible to review the bank reconciliation and bank statements, or review a general ledger detail report, can provide a great deal of accountability, but not add any extra expense for the church.”

Audits and assessments

Financial audits and fraud risk assessments offer additional protections for churches, although unlike the previously mentioned preventive steps, these typically come with a cost.

An ongoing audit process “can help a church greatly reduce the risk of misappropriation and embezzlement,” Batts said. Dimos agreed, adding the use of fraud risk assessments can go one step further and “help a church test their controls and identify potential weaknesses and risk areas.”

In the survey, about 24 percent of respondents conducted outside audits with a CPA, which involves documentation and third-party support of the financial information, Laue said. Thirty percent hired a CPA or financial expert to perform a less intensive outside review, which relies on inquiries and analytical procedures, Laue noted. Almost 38 percent said they perform internal audits using church staff and volunteers.

In terms of fraud risk assessments, nearly 51 percent said they do not use them at all.

Learning from “hard lessons”

Church Law & Tax’s survey “presents a strong case for churches to be proactive in preventing fraud,” Dimos said.

The fact that 30 percent of churches reported experiencing financial misconduct at some point, and that the possibility exists even more experience it without realizing it, reveals “the risk of fraud is very real in all churches,” Salsbery said.

While many will think the steps are unnecessary, or shouldn’t be necessary because people should know better, Salsbery pointed to examples of fraud contained in the Bible—including Judas’s thefts from Jesus and the disciples’ ministry account or Ananias and Sapphira’s attempt to deceive Peter—as reminders that anyone can succumb to temptation.

“Just as policies are put in place to help prevent other sins from damaging the church, controls are needed to protect churches from the sin of fraud,” Salsbery said.

And taking time now to review practices and strengthen them—especially when no apparent problem exists—only ensures church leaders are stewarding resources well, Laue added.

“Let’s learn from the hard lessons of others,” Laue said. “I strongly encourage churches to take the step and carefully review internal controls or even hire someone to help assess and implement better internal controls now. Even if fraud was never to occur, it won’t hurt for us to operate with good processes in place.”

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Monetary Gifts for Pastors Who Leave

Churches must follow special rules when it comes to monetary gifts. – Posted 6/13/23

With the best of intentions, churches often want to present a monetary thank-you gift (sometimes called a “love gift”) to a pastor who is either retiring or leaving to serve another congregation. Churches must keep in mind that such gifts are subject to special rules.

Costly missteps

When it comes to presenting monetary gifts, two issues must be addressed: (1) whether the gift will create excessive compensation for the minister, and (2) whether the gift(s) given by the individual(s) will be deductible.

To properly structure a thank-you gift, you will likely need to engage a compensation expert with lots of experience with nonprofit organizations. You will also likely need the assistance of a nonprofit attorney. I do not say these things lightly. A single misstep can cost three to four times the amount of the gift in tax penalties and legal fees.

It is expensive to structure a thank-you gift correctly. If the gift is relatively small (less than 2 percent of the minister’s total annual compensation), you still must meet all the requirements discussed below, though you can reduce the cost by not hiring a compensation expert. As a minimum, budget at least $1,500 for attorneys’ fees and other costs.

Compensation rules

The church cannot pay the pastor more than reasonable compensation, including the thank-you gift. The church must determine whether it has adequately compensated the pastor during his or her tenure. This rule requires the church to gather data and compare the pastor’s compensation with what would be the expected reasonable amount of compensation for the pastor during his or her tenure. For larger gifts (gifts that exceed 5 percent of the pastor’s total compensation), this data gathering is better accomplished by a qualified compensation expert. I anticipate that the compensation expert will cost between $5,000 and $50,000, in addition to the $1,500 in attorneys’ fees mentioned earlier.

Second, your church board or finance committee must evaluate the compensation data and determine whether the minister has been undercompensated during his or her tenure. If so, the board or committee needs to determine the maximum amount of a thank-you gift it will authorize. If the minister has not been undercompensated, then no thank-you gift can be given by the church. Stated another way, if the minister has been adequately compensated or overcompensated over the years, then the church may not give him any additional compensation, including a thank-you gift.

Third, the board will then notify the members it is raising funds to help with its approved thank-you gift, but donations received will be subject to the control of the church and it cannot guaranty that the donated funds will go toward the minister’s gift. If excess funds are received, they will be used for other church purposes. If funds are received prior to the board approving the thank-you gift and amount, those donations should be returned to the donors.

Donation rules

To be tax deductible, the donor must unconditionally transfer control over the funds to the church. Also, the donor may not direct the use of the funds to benefit any individual. The rules outlined in the prior paragraph demonstrate that the church assumed complete control over the donations received for the thank-you gift. By returning the donations received before approving the gift, the board is assuring the IRS that no donor can tell the church it must send their gift to the pastor.

Gifts must be reported

Finally, you will need a qualified nonprofit attorney to assure that the church documents the above requirements so the thank-you gift will not cause the pastor to pay up to 225 percent of the amount that is considered compensation over a reasonable amount in penalties under Section 4858 (Intermediate Sanctions).

In all cases, gifts from employers to employees are always taxable and reportable on Form W-2 in Box 1. The thank-you gift should be included in Box 1 of the pastor’s Form W-2.

If a pastor is already compensated fairly, thank-you gifts may be more trouble than they’re worth due to the risk of invoking the severe penalties outlined above. I recommend that the church seriously consider the potential adverse consequences to the minister if it gives a thank-you gift. If the church still wants to provide a thank-you gift, it will need the guidance of a qualified nonprofit attorney, meaning minimum costs of around $1,500.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

When Ministry Becomes Business

How to know when a new bookstore or childcare center will attract IRS attention. – Posted 6/9/23

Churches and religious organizations start revenue-generating operations for two reasons. For some, the activity starts as a ministry and is intended to remain that, but the ministry generates some nonvital cash flow. For others, cash flow is critical to the success of the ministry.

The difference between the two types of cash flow is critical to the Internal Revenue Service. The IRS has been paying closer attention to the business operations of tax-exempt organizations to determine whether each activity is an extension of the mission of the organization or a freestanding business with income that should be taxed.

The IRS allows nonrelated business income. But income—as distinct from donations—is taxable if it stems from an activity not “substantially related” to the organization’s activities and income. What does that mean? According to IRS regulations, “substantially related” means the trade or business must “contribute importantly to the accomplishment of the exempt purpose of an organization.”

The IRS applies three standards when considering whether the activities of tax-exempt organizations are taxable. Income is presumed to be exempt from taxes unless the activity

  • is not substantially related to the organization’s exempt purpose or function,
  • is a trade or business, and/or
  • is regularly carried on.

In addition, the income must amount to at least $1,000 in a fiscal year. An exempt organization that has $1,000 or more or gross income from an unrelated business must file Form 990-T. See Unrelated Business Income Tax Returns and the Form 990-T instructions for more information about return filing at www.irs.gov.

So how should churches proceed? Here are some examples worth considering:

  • Bookstore ministry. To provide members with helpful books and study guides, church members open a small bookstore inside the facility. The bookstore is open on Sundays and a few hours during the week while church activities take place. Even though materials are sold at a profit, the income is not taxable because the activity supports the church’s educational mission and operates primarily for the convenience of its members.
  • Bookstore business. A church bookstore becomes so popular that it begins to stock a variety of books, cards, and gifts and establishes regular hours for the public. It also moves to a location within the building that has an outside entrance. It’s a stretch to say that the church’s mission includes providing a retail outlet for Christian books and gifts. Reasonable observers will deem this a business.
  • Newsletter with ads. A church publishes a regular newspaper that is sent to people’s homes as an evangelistic tool. To pay for printing and mailing costs, the church sells advertising. Eventually it realizes a profit from ad sales. The newspaper may be part of the church’s evangelistic mission, but sponsorship income, or ad sales, could be taxed. The local newspaper, which competes for the same advertising dollars and pays taxes on that income, may complain.
  • No-go parking lot. A downtown church has an empty parking lot during the week, while nearby parking garages are full. A business-minded trustee sees an idle asset—parking spaces that could be leased on a monthly basis. What’s more, this income is passive—no one has to work to obtain it. The income is taxable because the church’s mission does not include leasing space.

Steps to Help Avoid an Audit

To help avoid an IRS audit, church leaders need to take four steps:

Clarify your mission. A mission statement answers the question “What kind of business are you in?” It provides a reference for board and staff members to decide whether a particular activity or ministry is consistent with the church’s mission.

Separate ministry from business. While there is no definitive rule about when a church should consider separately incorporating a ministry that becomes a business unit, many churches find that an activity becomes a business when its liability risk becomes significant, and/or when the church board discovers that this operation is gobbling up the time of staff members. If a nonministry operation contributes 50 percent to 80 percent of the church’s income, it could raise red flags for the IRS. Note: It’s possible to form a subsidiary corporation that puts its profits back into the business and into the church.

Take care in property use. Churches are most vulnerable on this point. Be very careful when considering rental income to help finance a construction project. Make sure building plans move ahead without undue delay. If your church receives land as a gift, liquidate it unless a ministry, like a church camp, will be developed on the property within ten years.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Clerical Errors Cost Church Its Tax Exemption

As this Oregon case shows, even the smallest clerical errors can derail a church’s tax status. – Posted 6/6/23

Key point. Clerical errors can derail a church’s tax exemption and application and since most states do not automatically exempt from churches from property taxation, an error-free and timely application is crucial for getting and keeping that tax-free status.

Summary: The Oregon Tax Court ruled that a church’s property did not qualify for exemption from tax because of defects in the church’s application for exemption.

Church had two chances to retain tax exemption

A church failed to timely respond to a county tax assessor’s multiple, written requests for information related to the church’s March 2020 application for a property tax exemption on its leased space.

After sending two letters regarding the incomplete application, the tax assessor sent another letter on November 24, 2020, asking the church:

  • To clarify the years for which the application was being sought.
  • To provide square footage of the church’s lease.
  • To provide a contact email address for the church.

The assessor gave the church a final deadline of December 9, 2020, to respond. The church failed to do so, and the county denied the church’s application on December 22, 2020.

The church appealed the denial to the Oregon Tax Court, claiming that church services, postal mail activities, and email communications all were affected by the COVID-19 pandemic during 2020.

Clerical errors derailed the process

The Oregon Tax Court began its opinion by recognizing the exemption from property taxation available to religious organizations in the state. The court also noted the application process a religious organization must follow to receive an exemption.

The court then noted that properties that are leased can be eligible for an exemption if certain requirements are met:

The application for exemption must provide … a complete description of the property claimed exempt; facts regarding the use of the property proving exempt purposes; a copy of the lease; and “any other information required by the claim form.” The claim form asks the question ‘is any portion of the property you lease used by others?” Next, the form asks, “if yes, what is the square footage of the area used by others?” Only the portion of the property which is “exclusively occupied and used” for an exempt purpose is eligible for exemption. … A county may request additional documentation or information if a taxpayer’s application is incomplete (emphasis added).

Clerical errors could have been ‘easily fixed’

The court concluded:

The court understands the hardships surrounding COVID-19 during 2020.

Employees in many businesses, as well as this court and many county offices, were limited in working from the office during 2020.

This likely was the cause of the county’s delay in asking the church for more information.

However [the pastor] received actual notice of the county’s request for information to correct the application’s defects in November 2020 … . The application could have been easily fixed, but for unknown reasons, the church did not do so.

Even still, the church could have filed a late application for exemption until December 31, 2020, and did not do so. The result here is unfortunate, but it is correct under the law… (emphasis added).

[The pastor] filed a timely application for a property tax exemption. The application was defective, and the county gave proper notice of the defects and requested [the church] to provide missing information. The church did not provide the missing information, and thus the county was correct in denying the exemption for the 2020-21 tax year.

What this means for churches

There are many reasons why church property may not qualify for exemption under state law, including:

  • Failure to file an application. State law requires churches to file an application for exemption. Churches should not assume they are automatically exempt.
  • Defects in a church’s application for exemption.
  • A church’s property does not satisfy all the conditions for exemption.
  • A church lost its property tax exemption because of commercial or rental activities.
  • Failure to renew the exemption if required by state law.

Church leaders should not assume that church property is exempt from tax, but instead should periodically confirm the exemption. This is a simple task that can be performed in a few minutes online.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Key Tax Dates June 2023

Key tax dates in June include housing allowance designations, quarterly payments, and monthly or semiweekly requirements. – Posted 6/1/23

Monthly requirements

If your church or organization reported withheld taxes of $50,000 or less during the most recent lookback period (for 2023 the lookback period is July 1, 2021, through June 30, 2022), then withheld payroll taxes are deposited monthly.

Monthly deposits are due by the 15th day of the following month. Note, however, that if withheld taxes are less than $2,500 at the end of any calendar quarter (March 31, June 30, September 30, or December 31), the church or organization need not deposit the taxes.

Tip: The 2023 Church & Clergy Tax Guide is available—order a print copy today (while supplies last) or download the .pdf version now.

Instead, it can pay the total withheld taxes directly to the IRS with its quarterly Form 941. Withheld taxes include federal income taxes withheld from employee wages, the employee’s share of Social Security and Medicare taxes (7.65 percent of wages), and the employer’s share of Social Security and Medicare taxes (an additional 7.65 percent of employee wages).

Semiweekly requirements

If your church or organization reported withheld taxes of more than $50,000 during the most recent lookback period (for 2023 the lookback period is July 1, 2021, through June 30, 2022), then the withheld payroll taxes are deposited semiweekly.

For paydays falling on Wednesday, Thursday, or Friday, the payroll taxes must be deposited on or by the following Wednesday.

For all other paydays, the payroll taxes must be deposited on the Friday following the payday.

Large employers having withheld taxes of $100,000 or more at the end of any day must deposit the taxes by the next banking day. The deposit days are based on the timing of the employer’s payroll. Withheld taxes include federal income taxes withheld from employee wages, the employee’s share of Social Security and Medicare taxes (7.65 percent of wages), and the employer’s share of Social Security and Medicare taxes (an additional 7.65 percent of employee wages).

June 15, 2023: Quarterly estimated tax payments for certain employees and churches

Filing for certain ministers and self-employed workers

Ministers who have not elected voluntary withholding and self-employed workers must file their second quarterly estimated federal tax payment for 2023 by June 15. A similar rule applies in many states to payments of estimated state taxes.

Nonminister employees of churches that filed a timely Form 8274 (waiving the church’s obligation to withhold and pay FICA taxes) are treated as self-employed for Social Security. They are subject to the estimated tax deadlines with respect to their self-employment (Social Security) taxes unless they ask their employing church to withhold an additional amount of income taxes from each paycheck that will be sufficient to cover self-employment taxes (use a new Form W-4, Step 4(c), to make this request).

Payments for unrelated business income tax liability

A church must make quarterly estimated tax payments if it expects an unrelated business income tax liability for the year to be $500 or more. Use IRS Form 990-W to figure your estimated taxes. Quarterly estimated tax payments of one-fourth of the total tax liability are due by April 15, June 15, September 15, and December 15, 2023, for churches on a calendar-year basis. Deposit quarterly tax payments electronically using the Electronic Federal Tax Payment System (EFTPS).

June 30, 2023: Review housing or parsonage allowance designations

Now is a good time to review the 2023 housing or parsonage allowances designated for all ministers on staff. If an allowance designated for 2023 is clearly below actual housing expenses, then the church board should consider declaring a larger portion of the minister’s remaining compensation as a housing or parsonage allowance.

A church is free to designate any portion of a minister’s compensation as a housing allowance but remember that clergy who own their home cannot claim a housing allowance exclusion greater than the fair rental value of the home (furnished, including utilities).

Therefore, the allowance ordinarily should not be significantly more than this amount.

Note: If a date listed for filing a return or making a tax payment falls on a Saturday, Sunday, or legal holiday (either national or statewide in a state where the return is required to be filed), the return or tax payment is due on the following business day.

Note: You must use electronic funds transfer to make all federal employment tax deposits. This is generally done using the Electronic Federal Tax Payment System, a free service provided by the US Department of Treasury. If you don’t wish to use EFTPS, you can arrange for your tax professional, financial institution, or payroll service to make deposits on your behalf. Failure to make a timely deposit may subject you to a 10-percent penalty.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Tax News for May 2023 . . .

Where to Find Reliable Financial Data

Replace assumptions with research and insights you can trust. – Posted 5/19/23

Church leaders know that money is an essential resource that helps make the work of the church possible: the engine that powers yearly mission trips to South America, the technology broadcasting worship services online, the repair of a leaky roof on an aging building, and of course, the staff that ministers to the entire community.

To lead well on issues of congregational finances, leaders need reliable information to understand the modern landscape of congregations’ economic practices and the unique challenges of congregational finances.

Yet, information about congregational finances can be hard to find. Oftentimes, executive pastors and other church finance staff are left to make assumptions as to best practices or trade insights from coffee conversations or zoom calls with their peers around the country.

There are a number of reliable resources available for church leaders—along with some significant ongoing research. Consider the following:

What the research tells us

NSCEP is the largest, most comprehensive study of congregation finances in the past 25 years surveying a nationally representative sample of 1,231 religious congregations and achieving a 40-percent response rate. It included congregations from all major religious traditions, every state of the country, and represents congregations from storefront gatherings to megachurches. Lake Institute focused its study on the trends in how congregations receive, manage, and spend resources along with mapping the changes in revenue and size.

During 2020, the NSCEP will also expand to include in-depth interviews with leaders and observations at select congregations.

The NSCEP and CBP reveal strikingly similar results and introduce complexity into the narrative about congregational finances.

The NSCEP asked congregations to compare changes to their sizes and revenues from 2014 to 2017, while CBP asked about changes over the past year. Both studies revealed some decline among congregations, but the percentage of congregations growing in revenue and size were higher than those in decline.

A strength of NSCEP was its nationally representative design. It revealed that a greater proportion of congregations were small (under 100 adults), and that 20 percent of congregations have a bi-vocational pastor.

CBP’s sample skewed a bit more to larger congregations, but still demonstrated the relatively small size of most faith communities. Though a smaller part of NSCEP’s samples, congregations that were established since 2000 and large churches with multiple revenue streams each reported growth in higher percentages.

NSCEP also captured the perspectives from multiple religious traditions and found that Catholic and Jewish congregations are experiencing the most decline while black Protestant, evangelical Protestant, and congregations from other world religions are the most likely to be growing.

Answering core questions

Underneath these larger trends, however, were three core questions raised by both projects:

Where does the money come from?

Both studies report that over 80 percent of congregational revenue comes from individual donations. The NSCEP provides a bit deeper analysis on the forms of individual income, finding that an additional 6 percent on average comes from special fundraisers outside of regular tithes and offerings.

Of particular note: NSCEP found half of congregations were conducting a capital campaign or had held one in the previous five years. Congregations often focus their attention on promoting regular giving whether digitally or through an offering plate, and that clearly remains the bulk of congregations’ revenue, but it is worth noting that individuals are supporting the work of the church in a variety of ways.

Other forms of revenue came from rent, endowments/reserves, the selling of products and services, and grants.

As simple as it sounds, NSCEP found that the primary driver for increasing revenue was the frequency of teaching about giving—90 percent of congregations who discussed or taught explicitly about giving weekly experienced growth. Yet, it was clear that the vast majority of congregations (79%) only talked explicitly about giving in worship services quarterly or less.

How do congregations spend their money?

Both the NSCEP and CBP found that overhead is high in congregations. Almost half of congregational resources are invested in personnel and another quarter in maintaining facilities.

CBP provides a more fine-tuned breakdown of facility costs by separating expenses on utilities, repairs, and mortgage costs. Yet, staff and facilities are an essential part of the mission and ministries of any congregation. Religious leaders would do well to emphasize the ways in which these assets are not seen as “overhead” or “administrative costs,” but rather, as vital aspects of congregational life.

Congregations also budget resources to provide for their congregants through ministries and programs as well as to outreach beyond their members through mission and service.

According to NSCEP, congregations prioritize spending on missions (11%). The majority of this funding is local (61%), but another 20 percent is invested nationally, and 19 percent on international causes. Congregations are not doing their mission and service work alone. Among those congregations engaged in social service ministries, such as providing food, clothing, or disaster relief, 98 percent are collaborating with another agency, enabling them to scale their overall impact.

How do churches manage congregational resources?

In addition to how congregations receive and spend money, the NSCEP also helps us understand how congregations manage congregational resources. A quarter of congregations leverage digital technologies to collect money and half use software to track their weekly expenses. While these technologies allow for more direct contact with members, congregations still acknowledge their members contributions quarterly or less.

The often-taboo topic of money is evident when examining clergy’s access to financial and donor records. Only 55 percent of congregations claimed that their clergy had access to giving records, and among that group, only 58 percent of clergy actually looked at that information. However, these congregations were much more likely to be growing in their revenue. (Editor’s note: Attorney and senior editor Richard Hammar offers several cautions about clergy access to giving records.)

“Knowledge is power”

Given what we have found from both the NSCEP and CBP, the story about congregational economic practices is complicated. But as the saying goes, “Knowledge is power.” Having better information about what is happening in faith communities across the country, as well as an interest in attending to the economic practices of your own congregation, are essential for healthy leadership. As we continue to learn more about how money flows in and out of congregations, we can better prepare for the present and vibrant future of our institutions.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Where’s the Money to Fix This?

Six tips that will keep a church from breaking the bank on big-ticket fixes. – Posted 5/18/23

Several years ago, members of the Bridge Church in Fresno, California, committed millions of dollars to a special capital campaign to upgrade facilities and expand parking lots.

But the church didn’t make a plan to set aside the future funds needed to keep its facilities running well.

“There had been pretty serious deferred maintenance for a while prior to that date,” recalled Dave Cowin, who serves as chairman of the church’s elder board.

When Cowin joined the elder board of Bridge Church in 2012, he proposed creating a capital reserve fund as part of the church’s annual budgeting process. The board chose to go with Cowin’s proposal. It was a wise decision that safeguarded the church’s resources and saved thousands of dollars for other ministry priorities just a few years later.

Like Bridge Church, many churches spend valuable time, energy, and money getting buildings, but then neglect to plan—and budget—for the expenses needed to keep those buildings operating.

“They are more than happy to raise the money to move into a building,” said Tim Cool, chief solutions officer and project facilitator for North Carolina-based Cool Solutions Group. But after they move in, churches “fail to plan for the fact that everything in [their] buildings has a natural life of deterioration.”

Items such as air-conditioning systems and roofs are major expenses that all churches must think about repairing or replacing at some point. Without adequate capital reserves, churches find themselves scrambling when a major repair or replacement arises—and often paying more than necessary because of the need to finance the expenses through a loan.

How can churches plan? These six tips are a good way for any church to get started.

1. Avoid the “if it ain’t broke, don’t fix it” mentality.

Every air-conditioning unit, every piece of carpet, every window, every light, and the entire roof will need to be replaced at some point. It’s vital for leaders to recognize all of it needs to be replaced sooner or later. And setting funds aside now may avoid more painful scenarios later—like a church that needs to rent temporary worship space while its air conditioning gets fixed.

“A church generally should figure somewhere between $2 and $2.50 per square foot* annually for maintenance” of all types, Cool said.

2. Don’t ignore “out of sight, out of mind” items.

The two most expensive items that surprise churches most often: broken air-conditioning systems and roofs that need to be replaced.

Church officials “tend to look at the thermostat, but the HVAC unit itself may be in a mechanical room or may be in a basement or up on a roof,” said Matthew Swain of Association Reserves, a company that conducts reserve studies for worship facilities and other types of properties. “And they just hit the thermostat Sunday morning to make sure it turns on.” Then suddenly there’s no heat or AC on a Sunday morning, Swain said. “So that’s usually the most common thing. Roofing would be next because it’s out of sight, out of mind.”

An unexpected repair or replacement can be much more expensive than preventing the problem from occurring in the first place, said Vonna Laue, a CPA and senior editorial advisor for Church Law & Tax.

“So if we can have a good system of preventive maintenance, it just allows things to last longer and keep their costs down,” Laue said. “If you don’t have reserves in place, and all of a sudden you have to scramble to finance something, you could find yourself being subject to significant interest rates or financial difficulties because of the lack of planning.”

3. Good stewardship includes physical assets.

As Swain sees it, churches must maximize their time, talent, and treasure to fulfill the Great Commission of Matthew 28:19-20, where Jesus said, “Go and make disciples of all nations.”

“If we replace things on time and on budget, we can be dedicated to preaching the Good News and toward making disciples,” he said. That way, “we’re not dealing with facility crises or leaking roofs, with mold intrusion or with having parishioners—on a Sunday in August—sweating it out because we didn’t replace that AC unit back in April. So it is absolutely a biblical issue, and we need to make sure we’re protecting the spiritual welfare of the church.”

At the same time, a financial crisis or a poorly maintained building reflects poorly on the church in the community, Laue said.

“That’s part of our testimony,” she stressed. “We need to represent Christ the best we can in everything that we do, and this is just one aspect of that.”

4. Tap experts to assess your needs.

In some cases, a volunteer within the congregation—perhaps a contractor or a facility administrator for a school or hospital—may be helpful in assessing a church’s facility needs.

These volunteers can help identify the most significant needs and where critical items are in their life cycle, Laue said. And they can start to put together a budgeted replacement plan. Online tools, such as Cool Solutions’ eSPACE.cool, are available.

In other cases, a church may benefit from hiring a professional consultant.

Kevin Folsom, director of special projects at Building Solutions, said he would recommend a consultant with experience working with both smaller and larger churches.

“Look at their ability to be cost-effective for smaller churches,” Folsom said. “If they also have the sophistication of doing larger institutions, that’s probably a good mix for a consultant.”

Laue recommended reviewing a consultant’s sample reports from previous jobs, and Swain said professional credentials from accredited organizations are important. Experience working with churches is crucial, Cool said, as is an ability both to identify current needs as well as develop financial plans for the future.

5. Create a capital reserve account, even if you start small.

Swain recommends a church keep 100 percent funding in the bank to cover all potential maintenance and replacement needs.

“It’s a pretty simple mathematical concept if we boil it down to its fundamental value,” he said. “What we do is we take the percentage of life that’s used up (for example, on a roof expected to last 30 years) and we multiply that by the total current replacement cost. And that gives each church a marker in time that says, as of today, here’s how much money you should have set aside for this component.”

At Bridge Church, however, Cowin said leaders—who benefited from Swain’s consulting work—have taken a more conservative approach to developing a capital reserve program. Setting aside monthly contributions for a “fully funded” capital improvement program would “hold too much of God’s money under a rock where it’s just sitting there,” Cowin said.

Instead, the church has budgeted about $60,000 a year for the capital reserve fund—out of a total annual church budget of about $2.4 million—for what’s referred to in the industry as a “baseline” capital improvement program.*

That reserve fund is now at roughly $200,000* and is sufficient to meet most anticipated needs, such as replacing the church’s aging HVAC units, as well as expected needs, Cowin said. The goal, he said, is to responsibly address maintenance and replacement needs without “financially crippling the church’s primary missional purpose.”

6. Work toward your plan every year.

The proactive approach, in contrast to its previous reactive philosophy, has already paid dividends for Bridge Church.

“We’re able to do things that we wouldn’t be able to do otherwise, such as replacing the roof on our sanctuary without a capital campaign,” Cowin said. “We’re able to make upgrades to our audio-visual system. We’re putting in a state-of-the-art video surveillance system throughout the entire campus. And we’re paying for these things debt-free and not asking the congregation for additional money because contributions toward our capital reserve program are now part of the general fund budget.”

When Bridge Church started assessing its facility needs, 46 of its 52 HVAC units were over 30 years old. Maintenance costs for those aging units were getting expensive. Moreover, the older HVAC units cost more to operate because of the lost energy savings otherwise available with higher energy efficiency technology used in newer HVAC units.

There’s now a scheduled multiyear timeline for replacing the units—and no financial scramble if one happens to break down before its scheduled replacement.

“We just replaced six HVAC units per our schedule before they broke down,” Cowin said. “What happens if three units were to unexpectedly go out next week? Not a problem. We can replace them the next day because we already have the money available to pay for them.”

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Q&A: Should We Start Digging into Our Reserves?

Churches that deplete their reserves should replenish them over time. – Posted 5/17/23

My church is fortunate enough to have a number of investments in reserve. We really don’t want to deplete those investments, but our current cash flow is down because of the pandemic and we’re wondering if now would be the time to convert some of those investments into cash. Should we start digging into our reserves? Is this a good or bad idea?

A: Like you, churches and other organizations with liquid assets will sometimes put additional assets into marketable security holdings with the hope of generating investment income while they’re being held as reserves. The assumption is that you would convert those investments to cash when they are needed. Normally, we don’t assume that everyone would want to liquidate their investments and convert them to cash at the same time, but that is, to a large extent, what happened early in this pandemic. That is one of the reasons the stock market dropped as much as it did early on.

 

I generally believe and espouse the view that having three months’ worth of operating expenses in cash reserves is sound. And having six months’ worth of operating expenses in cash reserves would be strong.

Churches that begin to utilize their reserves—and deplete them going forward—must remember that the fundamentals regarding reserves don’t change. And while we don’t know what the future is going to look like in terms of our financial operations, we still need to keep in mind that cash reserves have a place for unexpected developments that can still be coming.

Once you prudently use cash reserves to help the church through a challenging time, then begin consistently and intentionally restoring the reserves to sound or strong levels over a reasonable period of time.

For many churches, it can reasonably take a year to add one month’s worth of operating expenses to cash reserves. In my opinion, that is a reasonable time frame. So, if reduced your reserves during the pandemic from six months of operating expenses to three, it is reasonable to expect that it might take three years to restore the reserves to their former level.

Of course, the specific time frame will be unique to each church, taking into consideration the priority that the church assigns to restoring reserves.

So, yes, it is appropriate to prudently use cash reserves when unexpected developments cause cash flow shortages from regular operations. That is the essential purpose of cash reserves.

To view this article online, please visit the Church Tax & Law Website . For more information concerning Church finances or any other tax related questions, please contact our office.

How Do We Budget During This Time of Rapid Change and Uncertainty?

**Posted 5/15/23

Here’s some fairly radical advice as it relates to budgeting—radical in the sense that this is not conventional church financial management wisdom: Stop focusing on your regular annual budget. For churches experiencing rapid changes in their giving levels, the annual budget developed months ago is largely irrelevant.

I realize that as a matter of church governance and policy, you might have to have a budget. But what you planned when you developed that budget is no longer reality. Your spending levels and spending categories most likely have changed. Your revenue levels may be very different. So, what do you do?

Stop focusing on what you’re calling the budget and start doing what I call dynamic cash-flow forecasting and planning. That may sound like a fancy term. Dynamic just means it’s changing. It’s moving. And cash-flow forecasting and planning means estimating what’s going to happen, as best you can, and continuously updating your estimate based on new developments as they unfold.

Forecast this way each week over the next few months. Estimate as best you can, and adjust the forecast frequently based on new developments.

What weekly cash-flow forecasts look like

Weekly cash-flow forecasts could start with a spreadsheet in which you start with your beginning cash and then project your expected cash inflow and your expected cash outflow. Put simply: cash inflow, which might include borrowing, is cash that’s coming into your church. And then cash outflow, including debt service—is whatever cash is going out for whatever purpose. And then, of course, the difference between your expected inflow and your expected outflow is your expected net cash flow. Add your beginning cash to your expected net cash flow; this would be your expected ending cash.

Forecasting also includes modeling different scenarios with different assumptions. If giving for your church so far is relatively flat, you should model one scenario that shows your giving level staying flat. You might also want to model a scenario of your giving level going down by 10 percent or 15 percent, or whatever makes sense to you depending on your current circumstances and trending. You might want to run various scenarios and update them each time as you have better information about what seems to be happening.

Weekly cash-flow forecasts should be developed for a reasonable and appropriate period of time in the future. I would suggest at least eight to ten weeks out. A forecast much shorter than that has little value for cash-flow planning and strategic decision-making. And in a highly dynamic environment, a forecast much longer than that is likely to have less reliability.

Rolling budgets

Rolling budgets are an alternative to annual budgets suitable for some churches to use as their regular approach to budgeting. Maintaining weekly cash-flow forecasts is an accelerated version of maintaining rolling budgets. Maintaining rolling budgets is not a “do it once a year” approach to budgeting. (I discuss this process on pages 18 and 19 of Church Finance: The Church Leader’s Guide to Financial Operations and also in another article.)

Churches that are experiencing rapid growth are good candidates for rolling budgets, since their revenue and expense levels change more rapidly than a full-year budget is typically designed to address. Normally, for churches that utilize rolling budgets, I would recommend updating the rolling budget approximately quarterly. But these are not normal times. For this reason, I recommend updating it weekly—or every time you learn or observe something new and different. Doing this allows you to better manage cash and financial activities during a dynamic or very challenging, rapidly changing season.

To view this article online, please visit the Church Tax & Law Website . For more information budgeting strategies or any other tax related questions, please contact our office.

Key Tax Dates May 2023

Along with monthly and semiweekly requirements, May includes several quarterly filings and forms for churches, ministries, and church-run schools. – Posted 5/12/23

Monthly requirements

If your church or organization reported withheld taxes of $50,000 or less during the most recent lookback period (for 2023 the lookback period is July 1, 2021, through June 30, 2022), then withheld payroll taxes are deposited monthly.

Monthly deposits are due by the 15th day of the following month. Note, however, that if withheld taxes are less than $2,500 at the end of any calendar quarter (March 31, June 30, September 30, or December 31), the church or organization need not deposit the taxes.

Instead, it can pay the total withheld taxes directly to the Internal Revenue Service (IRS) with its quarterly Form 941. Withheld taxes include federal income taxes withheld from employee wages, the employee’s share of Social Security and Medicare taxes (7.65 percent of wages), and the employer’s share of Social Security and Medicare taxes (an additional 7.65 percent of employee wages).

Semiweekly requirements

If your church or organization reported withheld taxes of more than $50,000 during the most recent lookback period (for 2023 the lookback period is July 1, 2021, through June 30, 2022), then the withheld payroll taxes are deposited semiweekly.

This means that for paydays falling on Wednesday, Thursday, or Friday, the payroll taxes must be deposited on or by the following Wednesday. For all other paydays, the payroll taxes must be deposited on the Friday following the payday.

Note further that large employers having withheld taxes of $100,000 or more at the end of any day must deposit the taxes by the next banking day. The deposit days are based on the timing of the employer’s payroll. Withheld taxes include federal income taxes withheld from employee wages, the employee’s share of Social Security and Medicare taxes (7.65 percent of wages), and the employer’s share of Social Security and Medicare taxes (an additional 7.65 percent of employee wages).

May 10, 2023: Employer’s quarterly federal tax return—Form 941

Churches having non-minister employees (or one or more ministers who report their federal income taxes as employees and who have elected voluntary withholding) may file their employer’s quarterly federal tax return (Form 941) by this date instead of April 30 if all taxes for the first calendar quarter have been deposited in full and on time.

May 15, 2023: File forms 990, 990-T, and 5578

Information return—Form 990

An annual information return (Form 990) for tax-exempt organizations is due by this date for tax year 2022. Form 990 summarizes revenue, expenses, and services rendered. Organizations exempt from federal income tax under section 501(c)(3) of the Internal Revenue Code must report additional information on Schedule A.

Note. Churches, conventions, and associations of churches, “integrated auxiliaries” of churches, and church-affiliated elementary and secondary schools are among the organizations that are exempt from this reporting requirement. Organizations not exempt from this reporting requirement must file Form 990 if they normally have annual gross receipts of $50,000 or more.

Unrelated business income tax return—Form 990-T

An unrelated business income tax return (Form 990-T) must be filed by this date by churches and any other organization exempt from federal income tax that had gross income from an unrelated trade or business of $1,000 or more in 2022. Learn more about unrelated business income on this Recommended Reading page.

Certificate of racial nondiscrimination—Form 5578

Annual certification (for calendar year 2022) of racial nondiscrimination by a private school exempt from federal income tax (Form 5578) must be filed by this date by schools that operate on a calendar-year basis.

This form must be filed by preschools, primary and secondary schools, and colleges, whether operated as a separate legal entity or by a church.

To view this article online, please visit the Church Tax & Law Website . For more information on these key tax dates or any other tax related questions, please contact our office.

Workers’ Compensation: Who Is—and Isn’t—Covered?

A look at how churches should weigh costs and coverages. – Posted 5/5/23

Ministry can be a surprisingly hazardous profession.

Just ask Luke Trouten.

Back in 2010, Trouten, a youth pastor at Northwood Church in Maple Grove, Minnesota, was on a missions trip with junior high students when they decided to cool off at a local park.

Things went well till Trouten fell off a ledge and busted his leg.

“I ended up with some rods and screws and all kinds of things,” he said. “Didn’t walk for almost a year.”

Fortunately for Trouten, workers’ compensation covered all of his medical bills—including a couple of surgeries and a long hospital stay.

The process, at least as far as paperwork went, was fairly simple. The church’s office manager took care of contacting the insurance company. Once the company determined Trouten was working when he was injured, his bills were covered.

Accidents like Trouten’s aren’t that uncommon.

Staff and volunteers get hurt at church all the time, said Bill Mech, assistant vice president for health services and workers’ compensation at GuideOne Insurance, a company that specializes in insuring churches.

That’s in part because churches do a lot—from youth-group trips and kids programs to church work days and community concerts. And church staff can throw out their backs while picking up a box or volunteers can trip and fall, just like they do at any other workplace.

Then there’s the tendency for church staff and volunteers to do things themselves because finances are tight. So they may take a few more risks.

“There are a lot of times when a pastor gets up on a ladder and bad things happen,” Mech said.

Know your state’s rules

Workers’ compensation rules are set by each state. In many states—such as Illinois, Colorado, and Michigan—any organization with more than one staff person has to have workers’ compensation insurance. For the most part, churches are required to purchase it for their employees. A few states, like Texas, allow churches and other organizations to opt out of workers’ compensation. Also, most states draw a clear line between employees and volunteers, but a few, such as California, allow volunteers to be covered by workers’ compensation—more on this later. (To find workers’ compensation rules in each state, go to dol.gov.)

Still, there are advantages to having workers’ compensation insurance, even if it is not required, said Ryan Inzenga, an underwriting specialist for GuideOne.

“The injured worker can have their medical bills paid,” he said, “and the employer doesn’t have to worry about being sued.”

In general, the state laws that govern workers’ compensation prohibit employees from suing their employer if they are injured on the job, said Frank Sommerville, an attorney who specializes in legal issues facing churches and serves as an editorial advisor for Church Finance Today.

And churches are still responsible when an employee is injured, even if they don’t have workers’ compensation insurance.

“Even if a state allows churches to opt out, it’s probably not a good idea to do so,” said John A. Anthony, an attorney whose clients include churches, ministries, healthcare businesses, and physician practices. “Churches think if they do that, they are off the hook. But they are still responsible for what happens on their property and to their employees.”

Classify employees correctly

There are more than 600 classifications for employees. Not all position classifications are treated the same, either—roofers, for example, are more expensive to cover under workers’ compensation than office workers.

Sommerville said churches can run into trouble by misclassifying workers in order to save money on premiums. He knows of churches that classified maintenance staff as office workers, since it’s less expensive to insure them—only to be hit with thousands of dollars in penalties.

“That should not have happened in the first place,” he said.

Handling volunteers

Some states allow insurance companies to add an endorsement in their policies that includes volunteers.

GuideOne’s Inzenga and Mech are skeptical about that approach.

For one, volunteers aren’t really employees, they pointed out, and so trying to cover them through workers’ compensation is complicated.

Unlike employees, volunteers are not restricted to making workers’ compensation claims if they are injured, Sommerville said. So they may still sue a church, even if an endorsement is in place.

Further, if churches use an endorsement, said Inzenga and Mech, they would likely have to keep track of every volunteer, including logging each volunteer’s hours and duties performed. That’s because the price of workers’ compensation insurance is tied to the size of an organization’s payroll. And since volunteers aren’t paid, insurance carriers need to estimate the value of the labor done by volunteers.

“In some cases, the church could be facing a 50 percent increase in the cost of their coverage,” Mech said.

One alternative is to add an accident policy for volunteers, which would cover volunteers injured while working at the church, suggested the representatives of GuideOne.

Jeffrey Szalacinski, vice president of claims for Church Mutual Insurance Company, said a church’s general liability policy can cover volunteers, and churches can also purchase policies that specifically cover injuries to volunteers.

What about volunteer waivers?

Ron Smedley of California-based Employers Resource Associates believes that many churches have volunteers sign a waiver, agreeing to hold a church harmless if they get injured.

That approach may appear to be cost effective, he said, and some churches may feel they need to take that approach. But waivers can be challenged if someone is actually injured. And a waiver can create the perception that the church does not see their employees or volunteers as valuable.

In addition, as attorney Richard R. Hammar warns, waivers and releases often are viewed with disfavor by courts, and will not hold up when a situation involves gross negligence.

Pursuing prevention

Rather than leaning on some sort of waiver, Smedley believes churches should strive to provide some form of insurance for injured volunteers. Churches should also be proactive about preventing injuries in the first place.

Churches should designate someone to serve as volunteer coordinator and put together a volunteer handbook that includes safety rules and procedures. The handbook should also outline a plan for responding when an accident or injury happens. It’s a way to practice good stewardship, Smedley said, and to show care and concern for the well-being of volunteers.

The goal should be to prevent injuries—and to help people recover if they are injured, he said.

Having the right safety policies and insurance coverage helps create an environment that demonstrates the church’s messages that God loves and cares for his people, Smedley said.

Szalacinski also stressed that churches should be proactive with preventing injuries. An approaching big event or missions trip is a good time to go over a safety plan, he said. And insurance companies that work with churches publish guides for how churches can avoid or reduce risk.

Work closely with your agent

While churches need to be proactive about creating a safe environment for workers and volunteers, it’s very important that they also have the right insurance—just in case, Sommerville said.

“You are trying to keep your volunteers and your workers safe—but you also need the insurance in case bad things happen,” he stressed. “Because bad things can happen.”

In order to purchase the kind of insurance that’s best for your church, Sommerville said it’s crucial for a church to work closely with its insurance agent to audit its coverage. The more homework churches do, he said, the better price they’ll get.

Szalacinski recommended the same approach when exploring liability coverage for volunteers. And be sure to explain to your insurance agent all the different kinds of work that volunteers do at your church. The more your insurance agent understands about your church, the easier it will be to tailor a plan to meet your church’s needs and budget, he said.

Mech said most insurance companies have a minimum annual premium they charge, which can be as low as $500 to $1,000 for a smaller church. For a megachurch with many programs—such as a daycare, school, or camp—the premiums can reach six figures, he said.

If a church does have a workers’ compensation claim, their insurance may cost more. Mech said a claim in the vicinity of $5,000 can qualify for what’s known as an “eligibility rating,” and could cause rates to go up. It depends, in part, on the size of the church and how many claims are expected in a year.

Respond immediately to accidents

If an employee or a volunteer gets hurt, it’s important to respond immediately and also take the injury seriously, Anthony said.

“You’d be shocked at how often someone says they’re fine when an accident happens at church,” Anthony said. “And then it turns out they were injured and need to file a workers’ compensation or liability claim.”

If someone gets hurt at church, make sure they get immediate assistance, Szalacinksi stressed, then report any injuries to your insurance company as soon as possible.

“The earlier those claims are reported, the quicker a claims representative can provide guidance to the church and to the injured worker or volunteer,” he said.

Court cases offer insights into who qualifies for workers’ comp

Three kinds of people generally work at churches, said Inzenga. There are employees, volunteers, and then independent contractors or “casual labor.”

Employees are paid staff, like pastors or office workers—those who generally qualify for workers’ compensation. Volunteers aren’t paid for their work—though they can be reimbursed for expenses or receive gifts, like meals, from the church. Then there are independent contractors—those who are hired to mow the lawns, fix the air conditioning, or do other tasks.

And what about a missionary? If a missionary speaks at a church and gets a “love offering” or other honorarium, they’re unlikely to be treated as an employee if they get hurt.

Things are more complicated if a church supports a missionary in the field. If a missionary is funded by the church—and isn’t employed by a mission board or other agency—then the missionary is likely an employee and needs to be covered by workers’ compensation.

Sometimes categories overlap. And that can cause headaches, confusion, and lawsuits—if someone gets injured.

Take the case of Brookhaven Baptist Church in Pennsylvania.

A small congregation, the church relied on volunteer members to take care of maintenance. Among them was Edwin Halvorson, who joined the church in the late 1980s. As a volunteer trustee, he did a number of tasks—painting a bathroom, changing light bulbs, and vacuuming rugs. Eventually the church paid him to cut the lawn.

After mowing the lawn one day, Halverson also trimmed some bushes and decided to burn the leftover brush. He set them on fire, after dousing the brush with gasoline. The flames got too high and burned Halvorson. He died as a result of his injuries.

His family claimed he was an employee of the church—because he was paid to cut the lawn and used the church’s equipment—and filed a workers’ compensation claim. A workers’ claim tribunal agreed with the claim. The church appealed and in 2006, the Pennsylvania Supreme Court ruled that because Halvorson was serving in his role as a volunteer trustee, he was not eligible for workers’ compensation benefits.

A similar case occurred in Kansas, after a group of church volunteers decided to cut down trees on church property. They brought their own chainsaws. One of the volunteers, the son of a board member, volunteered to haul away the wood from the trees with his pickup.

A week later, the church’s pastor asked the same volunteer to get rid of the stumps from the trees that had been cut down. Unfortunately, he cut his hand with the chainsaw while working on the stumps and ended up with $50,000 in medical bills.

So he filed a workers’ compensation claim, arguing that the church’s pastor had set the time and date the work on the stumps would be done and that his father and the pastor had supervised the job. In addition, he was allowed to keep the wood from the trees—which he claimed was a form of payment or compensation.

The courts ruled that the volunteer was an independent contractor—rather than an employee—and wasn’t eligible for workers’ compensation.

A tool for ministry

Insurance is a tool for ministry—helping a church or an injured worker or volunteer get back to where they were before an accident occurred.

Northwood Church’s Trouten is grateful his church had the right workers’ compensation insurance.

Four years after he broke his leg, he got hurt again, this time during a church clean-up day. He and other church staff and volunteers had piled up some brush to burn. Trouten went inside to get a lighter to set it on fire.

While he was gone, one of the other workers dumped gasoline on the brush but didn’t tell him.

When he leaned over to light the fire, there was a huge fireball—landing Trouten back in the hospital with burns over 20 percent of his body.

Fortunately the burns weren’t too severe and workers’ compensation insurance paid his medical bills.

He still helps out during the annual work day at church—though he steers clear of fire.

To view this article online, please visit the Church Tax & Law Website . For more information regarding worker’s compensation coverage or any other tax related questions, please contact our office.

Top 3 Most Confusing Tax Issues for Clergy

What new—and veteran—ministers and treasurers need to know to file taxes correctly and receive maximum tax benefits. – Posted 5/4/23

Ministers and treasurers must be familiar with the tax rules that apply to clergy. Unfortunately, seminary training rarely equips new ministers with this information, and church treasurers often don’t know about the unique tax laws that apply to clergy. This information gap means ministers and treasurers frequently handle clergy income and the payment of related taxes incorrectly, and they fail to take advantage of the tax benefits that are available to ministers.

For instance, ministers are eligible for five special tax rules with respect to services they perform in the exercise of their ministry. These include (1) not paying federal income taxes on the portion of their church compensation designated in advance by their church as a housing allowance (limitations apply), (2) not paying federal income taxes on the annual rental value of a parsonage provided by their church, (3) being exempt from “self-employment taxes” (Social Security taxes paid by the self-employed) if several conditions are met, (4) being considered self-employed for Social Security (if not exempt), and (5) having ministers’ wages exempt from income tax withholding.

In order to qualify for these tax savings, however, you must meet the IRS’s definition of a “minister.” The IRS applies a five-factor test to determine whether an individual qualifies as a minister for federal income tax purposes. In general, for individuals to enjoy the five special tax rules summarized above, they must satisfy two main requirements: they must be a minister, and they must be engaged in the exercise of ministry.

Assuming you clear these IRS hurdles for establishing whether or not you’re a minister for federal tax purposes, you then need to know how to file taxes properly to ensure you receive the benefits available to you.

In this article, we focus on three of the most perennially perplexing tax issues for clergy. While there are many more we could cover, these are the three that pose confusion and uncertainty for many ministers and church treasurers, new and seasoned.

1. Should a Minister Report Income Taxes as an Employee or as Self-Employed?

The question of whether ministers should report their federal income taxes as an employee or as self-employed is a significant one. Most new ministers should report their federal income taxes as employees, because they will be considered employees under the tests currently used by the IRS and the courts. Most clergy will be “better off” reporting as employees, since (1) the value of various fringe benefits will be excludable, including the cost of employer-paid health insurance premiums on the life of the minister, (2) the risk of an IRS audit is substantially lower, and (3) reporting as an employee avoids the additional taxes and penalties that often apply to self-employed clergy who are audited by the IRS and reclassified as employees.

2. Should a Minister Report Social Security Taxes as an Employee or as Self-Employed?

There is one provision in the tax code that has caused more confusion for ministers and church treasurers than any other, and it is this: ministers are always treated as self-employed for Social Security with regard to services they perform in the exercise of their ministry (except for some chaplains). This is true even if they are employees for federal income tax reporting. This is sometimes referred to as the “dual tax status” of ministers.

Many new (and even veteran) ministers are surprised to learn that their employment status for income tax purposes has no bearing on their employment status for Social Security taxes. This often creates confusion. Ministers are always self-employed for Social Security with respect to their ministerial services. This is true even if you are treated as an employee for federal income tax purposes. This means you pay the self-employment tax, not “Social Security” and “Medicare” taxes. Your employing church must not treat you as an employee for Social Security, even though it issues you a W-2 for income taxes.

The most important consequence of this dual tax status is that ministers pay the so-called “self-employment tax.” This is the Social Security tax that is paid by self-employed workers. It amounts to 15.3 percent of a minister’s taxable earnings. Employees and employers pay “Social Security” and “Medicare” taxes (sometimes collectively referred to as “FICA” taxes). Like self-employment taxes, these taxes amount to 15.3 percent of a minister’s taxable earnings. But there is a big difference. Employers and employees split the 15.3 percent tax rate, with each paying 7.65 percent. Self-employed persons pay the entire self-employment tax. Many churches pay half, or even all, of a minister’s self-employment tax. This is perfectly appropriate, but any amount paid by the church must be reported as taxable income to the minister.

3. How Does a Minister Pay Taxes?

Many churches erroneously withhold the employee’s share of Social Security and Medicare taxes from ministers’ compensation, and then pay the employer’s share. In other words, they treat their minister as an employee for Social Security. This is understandable, especially when the church treats the minister as an employee for purposes of federal income taxation. But, it is always incorrect for a church to treat a minister as an employee for Social Security. Self-employment taxes for ministers are computed on Schedule SE of Form 1040.

The federal income tax is a “pay as you go” tax. This means that you must pay your tax as you earn income during the year. There are two ways to do this—quarterly estimated tax payments and tax withholding.

Ministers must prepay their income taxes and self-employment taxes using the estimated tax procedure, which can be confusing. Nonetheless, it’s important to understand how to calculate and pay estimated taxes to avoid significant tax liabilities.

Generally, you should make estimated tax payments if your estimated tax for this year will be $1,000 or more and the total amount of income tax that will be withheld from your income will be less than the lesser of (1) 90 percent of your tax liability for the current year, or (2) 100 percent of your tax liability for the previous year (if it covered all 12 months of the year). If you are required to pay estimated taxes, but fail to do so, you will be subject to an “underpayment penalty.” Since the penalty is figured separately for each quarterly period, you may owe a penalty for an earlier payment period even if you later paid enough to make up the underpayment. If you did not pay enough tax by the due date of each of the payment periods, you may owe a penalty even if you are due a refund when you file your income tax return!

The 4-step procedure for paying estimated taxes

Complying with the estimated tax procedure is easier than it seems. Here are the four steps you need to follow:

Step 1–Obtain a copy of IRS Form 1040-ES prior to April 15 of the current year.
Step 2–Compute estimated taxes.

Calculate your estimated tax for the current year by estimating adjusted gross income and then subtracting estimated adjustments, deductions, exemptions, and credits. Multiply estimated taxable income times the applicable tax rate contained in the Tax Rate Schedule reproduced on Form 1040-ES. Include your estimated Social Security tax on the worksheet if you are not exempt, and include your housing allowance exclusion in computing your estimated earnings subject to the self-employment tax.

Step 3–Pay estimated taxes in quarterly installments.

If estimated taxes (federal income taxes and self-employment taxes) are more than $1,000 for the current year, and the total amount of taxes to be withheld from your compensation is less than the lesser of (1) 90 percent of your tax liability for the current year, or (2) 100 percent of your tax liability for the previous year, then you must pay one-fourth of your total estimated taxes in four quarterly installments (by April 15 for January 1 to March 31; by June 15 for April 1 to May 31; by September 15 for June 1 to August 31; and by January 15 for September 1 to December 31). If the due date for making an estimated tax payment falls on a Saturday, Sunday, or legal holiday, the payment will be on time if you make it on the next business day.

Payment vouchers. You must send each payment to the IRS, accompanied by one of the four payment vouchers contained in Form 1040-ES.

Starting a job in mid-year. A minister who becomes liable for estimated tax payments midway through a year should submit a payment voucher by the next filing deadline accompanied by a check for a prorated portion of the entire estimated tax liability for the year.

Changing your quarterly payments. Changes in your income, deductions, credits, or exemptions may make it necessary for you to refigure your estimated tax and adjust your remaining quarterly payments accordingly.

Step 4–Compute actual taxes.

After the close of the year, compute your actual tax liability on Form 1040. Only then will you know your actual income, deductions, exclusions, and credits. Estimated tax payments rarely reflect actual tax liability. Most taxpayers’ estimated tax payments are either more or less than actual taxes as computed on Form 1040 (usually less).

Overpayment. If you overpaid, you can elect to have the overpayment credited against your first quarterly estimated tax payment of the following year or spread out in any way you choose among any or all of your next four quarterly installments. Alternatively, you can request a refund of the overpayment.

Underpayment. If you underpaid your estimated taxes you may have to pay a penalty. The penalty is computed separately for each quarterly payment period. Contrary to popular belief, payment of your entire estimated tax liability with your Form 1040 will not relieve you of the penalty if you did not pay the estimated income tax due earlier in the year.

Form 2210. You can use Form 2210 to see if you owe a penalty and to figure the amount of the penalty. If you owe a penalty and do not attach Form 2210 to your Form 1040, the IRS will compute your penalty and send you a bill. You do not have to fill out a Form 2210 or pay any penalty if either of two conditions apply: (1) your total tax less income tax withheld is less than $1,000, or (2) you had no tax liability last year and you were a United States citizen or resident for the entire year. The IRS can waive the underpayment penalty if the underpayment was due to casualty, disaster, or other unusual circumstance and it would be inequitable to impose the penalty.

Special rule for high-income taxpayers. A high-income taxpayer with adjusted gross income for the previous year of at least $150,000 cannot avoid the underpayment penalty by paying estimated taxes for the current year of at least 100 percent of last year’s tax. For such persons, the “100 percent rule” is replaced with a 110 percent rule, meaning that they will be subject to an underpayment penalty unless they have paid estimated taxes for the current year of at least the lesser of (1) 90 percent of the current year’s actual tax liability, or (2) 110 percent of last year’s actual tax liability.

Voluntary withholding

Ministers who report their income taxes as an employee may request “voluntary withholding” of their income taxes and self-employment taxes by filing a Form W-4 with the church. A self-employed minister is free to enter into an “unofficial” withholding arrangement whereby the church withholds a portion of his or her compensation each week and deposits it in a church account, and then distributes the balance to the minister in advance of each quarterly estimated tax payment due date.

To view this article online, please visit the Church Tax & Law Website . For more information regarding clergy tax issues or any other tax related questions, please contact our office.

Can Pastors and Staff Deduct Expenses Incurred While Working from Home?

**Posted 5/3/23

The Tax Cuts and Jobs Act of 2017 changed what’s allowed for tax purposes—but employer reimbursements of certain employee business expenses is still a tax-advantaged practice.

That’s because of provisions contained in the Tax Cuts and Jobs Act of 2017.

But that doesn’t mean churches can’t help pastors and staff with their home office expenses.

Two key points come to mind:

First, for ministers, remember that they are treated uniquely under the tax code. They have “dual tax status,” meaning they are treated as employees for income tax purposes, but they are treated as self-employed for purposes of Social Security and Medicare (the Self Employed Contributions Act, or SECA).

Because of this unique status, ministers still may be able to deduct their unreimbursed business expenses in arriving at their net income subject to self-employment tax. They should consult with qualified tax counsel to further explore this possibility.

And second, churches that allow, or perhaps even require, ministers and staff members to work from home in some capacity should recognize that the costs for equipment and supplies used by these individuals may constitute valid business expenses.

Expenses incurred by an employee for supplies and equipment used exclusively in connection with his or her employment are typically valid business expenses that can be reimbursed tax-free by the employer under an accountable reimbursement arrangement.

Advantages to reimbursements

There may be additional advantages to reimbursing some of these expenses. Requiring a certain type of computer or laptop may make sense for cybersecurity and productivity purposes.

Covering all or part of the monthly internet service may make sense for ensuring minimum speeds required by the employer for video calls and other activities requiring large bandwidth.

Other costs that may qualify include office supplies, a printer, a scanner, and, depending on the circumstances, office furniture.

For more information or to view this article online, please visit the Church Tax & Law Website . For more recommendations regarding the deadline for form 5578 or any other tax related questions, please contact our office.

But two cautions should be noted:

Pastors and employees: Remember that if the employer pays or reimburses the cost for furniture or equipment, the employer owns the items purchased. So, individuals have a responsibility to steward these items well—and recognize that they will need to return them if their employment ends.

Churches: Remember that reimbursements have a budgetary impact. But also remember that reimbursing employees for costs they incur for required elements of their job is very helpful to them financially … and generally not taxable.

To view this article online, please visit the Church Tax & Law Website . For more information regarding at home work expenses or any other tax related questions, please contact our office.

Tax News for April 2023 . . .

Church-Run Schools Face Annual Deadline for Federal Form

Leaders should not overlook the Form 5578, an oft-forgotten IRS requirement. – Posted 4/28/23

Churches and other religious organizations that operate, supervise, or control a private school must file a certificate of racial nondiscrimination (Form 5578) each year with the Internal Revenue Service (IRS).

The certificate is due by the 15th day of the fifth month following the end of the organization’s fiscal year. This is May 15 of the following year for organizations that operate on a calendar-year basis. For example, the Form 5578 for 2022 is due May 15, 2023.

What is a “private school?”

A private school is defined as an educational organization that normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly conducted. The term includes primary, secondary, preparatory, or high schools, as well as colleges and universities, whether operated as a separate legal entity or an activity of a church.

Key point. The term school also includes preschools, and this is what makes the reporting requirement relevant for many churches. As many as 25 percent of all churches operate a preschool program.

Key point. Independent religious schools that are not affiliated with a church or denomination and that file Form 990 (see above) do not file Form 5578. Instead, they make their annual certification of racial nondiscrimination directly on Form 990 (Schedule E).

Filing the certificate of racial nondiscrimination is one of the most ignored federal reporting requirements.

Churches that operate a private school (including a preschool), as well as independent schools, may obtain Form 5578 through the IRS website.

Completing Form 5578 is easy

Form 5578 is not complicated. A church official simply identifies the church and the school and certifies that the school has “satisfied the applicable requirements of sections 4.01 through 4.05 of Revenue Procedure 75-50.”

The applicable requirements are:

(1) The school has a statement in its charter, bylaws, or other governing instrument, or in a resolution of its governing body, that it has a racially nondiscriminatory policy toward students.

(2) The school has a statement of its racially nondiscriminatory policy toward students in all its brochures and catalogs dealing with student admissions, programs, and scholarships.

(3) The school makes its racially nondiscriminatory policy known to all segments of the general community served by the school in one of the following ways:

publishing a notice of its racially nondiscriminatory policy at least annually in a newspaper of general circulation,

utilizing broadcast media, or

displaying a notice of its racially nondiscriminatory policy on its primary, publicly accessible Internet homepage at all times during its taxable year (excluding temporary outages due to website maintenance or technical problems) in a manner reasonably expected to be noticed by visitors to the homepage. IRS Revenue Procedure 2019-22.

The IRS has clarified that “a publicly accessible homepage is one that does not require a visitor to input information, such as an email address or a username and password, to access the homepage.

Factors in determining whether a notice is reasonably expected to be noticed by visitors to the homepage include the size, color, and graphic treatment of the notice in relation to other parts of the homepage, whether the notice is unavoidable, whether other parts of the homepage distract attention from the notice, and whether the notice is visible without a visitor having to do anything other than simple scrolling on the homepage.

A link on the homepage to another page where the notice appears, or a notice that appears in a carousel or only by selecting a dropdown or by hover (mouseover) is not acceptable. If a school does not have its own website, but has webpages contained in a website, the school must display a notice of its racially nondiscriminatory policy on its primary landing page within the website.”

The IRS has drafted the following statement that satisfies the publicity requirement:

Notice Of Nondiscriminatory Policy As To Students

The (name) school admits students of any race, color, national and ethnic origin to all the rights, privileges, programs, and activities generally accorded or made available to students at the school. It does not discriminate on the basis of race, color, national and ethnic origin in administration of its educational policies, admissions policies, scholarship and loan programs, and athletic and other school-administered programs.

The publicity requirement is waived if one or more of the following exceptions apply:

• During the preceding three years, the enrollment consists of students at least 75 percent of whom are members of the sponsoring church or religious denomination, and the school publicizes its nondiscriminatory policy in religious periodicals distributed in the community.

• The school draws its students from local communities and follows a racially nondiscriminatory policy toward students and demonstrates that it follows a racially nondiscriminatory policy by showing that it currently enrolls students of racial minority groups in meaningful numbers.

(4) The school can demonstrate that all scholarships or other comparable benefits are offered on a racially nondiscriminatory basis.

For more information or to view this article online, please visit the Church Tax & Law Website . For more recommendations regarding the deadline for form 5578 or any other tax related questions, please contact our office.

10 Key Tax Developments Affecting Churches and Pastors in 2023

What you need to understand for 2022 filing and 2023 compliance. – Posted 4/27/23

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

  1. The Tax Court rejected a minister’s tax arguments, subjecting him to back taxes, interest, and a penalty for filing a frivolous return.
  2. A Florida case underscored the power of the IRS to impose tax liens on ministries.
  3. 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.

For more information or to view this article online, please visit the Church Tax & Law Website . For more recommendations regarding the 10 key tax developments for 2023 or any other tax related questions, please contact our office.

Keeping Your Church’s Deposits Safe in a Jittery Bank Environment

Silicon Valley Bank’s failure shows we never really know whether a bank is truly safe and sound. – Posted 4/26/23

Many church and nonprofit leaders are wondering if their organizations’ bank deposits are safe in the current banking environment. And for good reason.

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Immediately before Silicon Valley Bank (SVB) was taken over by the FDIC on March 10, 2023, one major ratings agency had an “A” rating outstanding for the bank, and another had a “B” rating outstanding.

SVB’s failure was the second largest in US history, according to The Wall Street Journal, which offered a truly remarkable observation about it: “The bank was in sound financial condition on Wednesday, the regulator said. A day later, it was insolvent.”

When a bank with “A” and “B” ratings is considered by regulators to be sound one day, and taken over by the FDIC two days later, it’s only logical to wonder how any reasonable, prudent person can know whether any bank is in healthy financial condition.

Fortunately for SVB’s depositors, federal banking officials have indicated that all SVB depositors will be made whole, even beyond the $250,000-per-depositor FDIC coverage cap because of SVB’s systemic importance.

But a logical corollary is that one cannot assume that the same will be true for the next bank that fails. Another bank, Signature Bank, also recently failed.

Assessing where your organization banks

Given the practical limitations on the ability to know whether any bank is truly safe and sound, what can–and should—church and nonprofit leaders do to ensure that their organizations’ bank cash deposits are safe?

Some people are suggesting that perhaps the only safe banks are the very largest banks in the country … those that many believe regulators deem are “too big to fail.” It is important to note that the assumption that regulators would make all depositors of a very large bank whole in any failure scenario is just that…an assumption. There is no federal guarantee of regular deposits in any bank beyond the FDIC’s $250,000 per depositor insurance coverage.

Additionally, If all depositors decided to bank only with the largest banks, smaller local and regional banks would be wiped out, and local banking relationships could be more difficult to maintain. And depending on the size of your organization’s deposit balances, it may not be practical to try to spread deposits among multiple banks keeping balances below the FDIC coverage cap of $250,000 per depositor.

So, let’s turn to the topic of making deposits in the banking system.

Clearly, there are ways to protect cash outside of the banking system in an investment portfolio, such as investing (with the help of a properly credentialed investment advisor) in short-term US Treasury securities or in appropriate investment funds that hold such securities. But what about cash that your organization simply wants to keep in the bank?

It is probably true that the larger the bank, the more likely it is that federal regulators would deem it too big to fail.

So, if your organization wants to bank with a big bank, that could be an appropriate strategy. Bankrate offers a list of the 15 largest banks in the US. It is interesting to note, however, that #14 on the list, First Republic Bank, recently had a severe challenge. Bankrate’s website includes an update on First Republic Bank dated March 17, 2023, which states:

It’s also important to note that First Republic recently faced turmoil that threatened its solvency following the collapse of Silicon Valley Bank and Signature Bank. However, 11 of the largest US banks came together to save the bank, depositing $30 billion into First Republic to keep it afloat.

Just know the fact that a bank is large–even very large–is not, in and of itself, assurance of the bank’s financial health.

A word of caution: Any organizations or persons considering any strategy to manage the risk of their bank deposits or other assets should perform their own due diligence before taking action.

Tapping into IntraFi

Is there a way to ensure that an organization’s bank cash deposits are safe, even with a local or regional bank?

Many such banks would answer that question with a resounding “Yes!,” and a number of them would point to their participation in programs offered by IntraFi Network, LLC (IntraFi). IntraFi’s website describes its two main programs, ICSand CDARS, as follows:

Using IntraFi Cash Service, or ICS, and CDARS you can access millions in FDIC insurance for cash deposits from IntraFi® network banks and enjoy the simplicity of banking with just one trusted, local institution. Conveniently and easily secure funds placed into demand deposit accounts, money market deposit accounts, or CDs.

Banks that participate in the IntraFi network allow customers to maintain a relationship with one bank and have FDIC insurance coverage for deposits well beyond the standard FDIC coverage cap of $250,000 per depositor per bank. The network allows for the larger deposits to be spread among multiple banks in the network in amounts below the $250,000 FDIC cap while maintaining one point of contact with one participating bank.

IntraFi offers programs for demand deposit (checking) accounts, money market accounts, and CDs. Participation in the IntraFi program with a participating bank can carry a cost or fee . The cost can apply as a reduction in the interest rate you earn on your deposit balances. For example, in another alert about earning interest on your organization’s excess checking account funds, I quoted Texas Security Bank president, Craig Scheef, who stated that his bank reduces the interest rate it pays on money market accounts (currently, approximately 4% annualized) by 0.15% for deposits that participate in the IntraFi program.

The IntraFi website, which says that thousands of financial institutions across the country participate in its programs, has a web page that allows you to find banks that participate in the program as well as an FAQ page. In the current environment, interest in the IntraFi program has increased significantly, according to Scheef.

For more information or to view this article online, please visit the Church Tax & Law Website or if you have any further questions regarding the safekeeping of your Church’s deposits, especially during uncertain economic conditions, please contact our office.

Tax News for February 2023 . . .

Accountable Reimbursement Arrangements

Review the four specific requirements for business expense reimbursements. – Posted 2/2/23

Most ministers and lay church employees incur expenses when performing their duties. The tax treatment of these expenses depends on whether a person is an employee or self-employed, whether the expenses are reimbursed by the church, and whether any reimbursed expenses are paid under an accountable or a nonaccountable reimbursement plan.

Here are a few important details to understand about business expense reimbursements.

Unreimbursed business expenses

These expenses were no longer deductible by employees as itemized expenses on Schedule A (Form 1040) after 2017.

Employee business expenses reimbursed under a nonaccountable arrangement

These expenses were no longer deductible by employees as itemized expenses on Schedule A (Form 1040) after 2017.

Avoid limitations with an accountable arrangement

The limitations on the deductibility of employee business expenses (summarized above) can be avoided if the church adopts an accountable reimbursement plan. An accountable plan is one that meets all of the following requirements:

  1. Only business expenses are reimbursed.
  2. No reimbursement is allowed without an adequate accounting of expenses within a reasonable period of time—not more than 60 days after an expense is incurred.
  3. Any excess reimbursement must be returned to the employer within a reasonable period of time—not more than 120 days after an excess reimbursement is paid.
  4. An employer’s reimbursements must come out of the employer’s funds and not by reducing the employee’s salary.

Under an accountable plan, an employee reports to the church rather than to the IRS. The reimbursements are not reported as income to the employee, and the employee does not claim any deductions. This is the best way for churches to handle reimbursements of business expenses.

If the requirements of an accountable reimbursement arrangement are not met, then the church’s reimbursement of an employee’s business expenses must be reported by the church as taxable income to the recipient.

For more information or to view this article online, please visit the Church Tax & Law Website . For more recommendations regarding the 2023 business use mileage rate or any other tax related questions, please contact our office.

Tax News for January 2023 . . .

Tracking Expenses During Mission Trips

What church leaders should know about documenting expenses in foreign countries – Posted 1/27/23

Many foreign countries have no sophisticated system of receipting expenditures and many mission trip leaders fail to understand the documentation standards placed on a US exempt organization. The trip leader should understand the following:

  • The dollars he or she cannot specifically account for will be his or her responsibility to return to the church at the end of the trip. There is no presumption of exempt purpose;
  • Where possible, receipts must be obtained for expenditures;
  • A detailed log of all the trip’s expenditures must be maintained, indicating dates, identities of those who received the money, amounts, and purposes of the expenses;
  • If funds are given to individuals for benevolent purposes, the trip leader will have the recipient sign that they received the funds and will document the benevolent need that necessitated the support.

At this time, the IRS is very focused on exempt organizations’ activities in foreign countries. It is always best to remember that the IRS never presumes any expense is spent on exempt purposes until it is proven, and with expenses in foreign countries, the IRS tends to presume that the money was personally spent by the trip leader.

For more information or to view this article online, please visit the Church Tax & Law Website . For more information on Accountable Reimbursement Arrangements or any other tax related questions, please contact our office.

IRS Bumps 2023 Business Use Mileage Rate to 65.5 Cents per Mile

No change to charitable mileage and qualified medical, moving mileage rates left alone. – Posted 1/13/23

The Internal Revenue Service (IRS) has released the 2023 optional standard mileage rates used to calculate the deductible costs of operating an automobile for business, charitable, medical or moving purposes.

Effective January 01, 2023, the rates are:

  • 65.5 cents per mile driven for business use, an increase of 3 cents from the rate set in mid-2022.
  • 22 cents per mile driven for medical or moving purposes, consistent with the rate set in mid-2022.
  • 14 cents per mile driven in service of charitable organizations—the rate remains unchanged and can only be changed by an act of Congress.

Note: The rates apply to electric and hybrid-electric automobiles, as well as gasoline and diesel-powered vehicles.

Under the Tax Cuts and Jobs Act of 2017, taxpayers cannot:

  • claim a miscellaneous itemized deduction for unreimbursed employee travel expenses and,
  • cannot claim a deduction for moving expenses, unless they are members of the Armed Forces on active duty moving under orders to a permanent change of station. See Moving Expenses for Members of the Armed Forces for more details

According to the IRS, taxpayers always have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates. Taxpayers can use the standard mileage rate but generally must opt to use it in the first year the car is available for business use and then, in later years, choose either the standard mileage rate or actual expenses. Leased vehicles must use the standard mileage rate method for the entire lease period (including renewals) if the standard mileage rate is chosen.

Are you a Church Law & Tax Advantage Member? If so, read on to learn more about other key tax developments affecting pastors and church leaders heading into 2023.

What does the business mileage rate increase mean for churches?

It’s a pinch, for sure.

Increased amounts of reimbursement represent increased budget expenses, and that means adjusting budgets in ways that affect other ministry spending.

Conversely, attempts to minimize budget impacts by reimbursing only a portion of the rate—or not reimbursing at all—creates increased burdens for pastors and employees who use their vehicles for church-related business.

And because unreimbursed employee business expenses are not deductible under the Tax Cuts and Jobs Act of 2017, pastors and employees with unreimbursed mileage cannot seek any tax relief when they file next year’s federal income tax returns.

As you and your leaders navigate how to handle this increased expense, you may want to review some wise guidance provided by CPA and Church Law & Tax Senior Editorial Advisor Michael Batts.

In this Q&A, he answers this question: How does our church adjust its budget
during times of rapid change and uncertainty?

One final note:

Church employees who drive their personal vehicles for church-related business (visitations, special events, and so on) can be reimbursed by the church, if the church has an accountable reimbursement arrangement and employees and pastors properly track and document their business miles. Since unreimbursed employee business expenses are currently not deductible, employees can no longer calculate a mileage deduction on their annual tax returns. Current law allows for a reinstatement of the deduction for unreimbursed employee business expenses in 2026.

For more information or to view this article online, please visit the Church Tax & Law Website . For more recommendations regarding the 2023 business use mileage rate or any other tax related questions, please contact our office.

Key Tax Dates January 2023

Noting the key tax forms due this month, along with other recurring deadlines. – Posted 1/12/23

Monthly requirements

If your church or organization reported withheld taxes of $50,000 or less during the most recent lookback period (for 2023, the lookback period is July 1, 2021, through June 30, 2022), then withheld payroll taxes are deposited monthly. Monthly deposits are due by the 15th day of the following month.

Tip: The 2023 Church & Clergy Tax Guide is out—preorder your copy today (it will ship in January) or download the .pdf version now.

Note, however, if withheld taxes are less than $2,500 at the end of any calendar quarter (March 31, June 30, September 30, or December 31), the church need not deposit the taxes.

Instead, it can pay the total withheld taxes directly to the IRS with its quarterly Form 941. Withheld taxes include federal income taxes withheld from employee wages, the employee’s share of Social Security and Medicare taxes, and the employer’s share of Social Security and Medicare taxes.

Semiweekly requirements

If your church or organization reported withheld taxes of more than $50,000 during the most recent lookback period (for 2023, the lookback period is July 1, 2021, through June 30, 2022), then the withheld payroll taxes are deposited semiweekly.

This means that for paydays falling on Wednesday, Thursday, or Friday, the payroll taxes must be deposited on or by the following Wednesday. For all other paydays, the payroll taxes must be deposited on the Friday following the payday.

Note further that large employers having withheld taxes of $100,000 or more at the end of any day must deposit the taxes by the next banking day. The deposit days are based on the timing of the employer’s payroll. Withheld taxes include federal income taxes withheld from employee wages, the employee’s share of Social Security and Medicare taxes (7.65 percent of wages), and the employer’s share of Social Security and Medicare taxes (an additional 7.65 percent of employee wages).

January 1, 2023: Payroll taxes

Social Security and Medicare taxes

Employees and employers each pay Social Security and Medicare taxes equal to 7.65 percent of an employee’s wages. The tax rate does not change in 2023.

While federal law exempts ministers from mandatory federal income tax withholding, many states may not have the same exemption available for ministerial employees. Check your specific state for details. Meanwhile, for a more comprehensive guide to church compensation and taxation, check out CPA Elaine Sommerville’s Church Compensation, Second Edition.

The 7.65 percent tax rate is comprised of two components: 1) a Medicare hospital insurance tax of 1.45 percent, and 2) an “old age, survivor and disability” (Social Security) tax of 6.2 percent. There is no maximum amount of wages subject to the Medicare tax. The tax is imposed on all wages regardless of amount.

For 2023, the maximum wages subject to Social Security taxes (the 6.2 percent amount) is $160,200. Stated differently, employees who receive wages in excess of $160,200 in 2023 pay the full 7.65 percent tax rate for wages up to $160,200, and the Medicare tax rate of 1.45 percent on all earnings above $160,200. Employers pay an identical amount. The Medicare tax rate for certain high-income taxpayers increases by an additional 0.9 percent.

Self-employment taxes

The self-employment tax rate (15.3 percent) does not change in 2023. The 15.3 percent tax rate consists of two components: (1) a Medicare hospital insurance tax of 2.9 percent, and (2) an “old age, survivor and disability” (Social Security) tax of 12.4 percent. There is no maximum amount of self-employment earnings subject to the Medicare tax. The tax is imposed on all net earnings regardless of the amount.

For 2023, the maximum earnings subject to the Social Security portion of self-employment taxes (the 12.4 percent amount) is $160,200. Stated differently, persons who receive compensation in excess of $160,200 in 2023 pay the combined 15.3 percent tax rate for net self-employment earnings up to $160,200, and only the Medicare tax rate of 2.9 percent on earnings above $160,200. The Medicare tax rate for certain high-income taxpayers increases by an additional 0.9 percent.

These rules directly impact ministers, who are considered self-employed for Social Security with respect to their ministerial services. Ministers should take these rules into account in computing their quarterly estimated tax payments.

Federal income taxes

Beginning on this date, churches having non-minister employees (or a minister who has elected voluntary withholding) should begin withholding federal income taxes from employee wages. To know how much federal income tax to withhold from employees’ wages, employers should have a Form W-4 on file for each employee. Employees should file an updated Form W-4 for 2023, especially if they owed taxes or received a large refund when filing their previous tax return. Employees should use the IRS Tax Withholding Estimator to determine accurate withholding.

January 17, 2023: Fourth quarter estimated taxes due

Ministers (who have not elected voluntary withholding) and self-employed workers must file their fourth quarterly estimated federal tax payment for 2022 by this date (a similar rule applies in many states to payments of estimated state taxes).

Employees of churches that filed a timely Form 8274 (waiving the church’s obligation to withhold and pay FICA taxes) are treated as self-employed for Social Security purposes, and accordingly are subject to the estimated tax deadlines with respect to their self-employment (Social Security) taxes unless they have entered into a voluntary withholding arrangement with their employing church or organization.

January 31, 2023: Tax forms due

Churches must furnish Copies B, C, and 2 of Form W-2 (“wage and tax statement”) by this date to each person who was an employee during 2022. This requirement applies to clergy who report their federal income taxes as employees rather than as self-employed, even though they are not subject to mandatory income tax (or FICA) withholding. Non-minister church employees must also receive a W-2.

Churches must send Copy A of Forms W-2, along with Form W-3, by this date to the Social Security Administration. If you file electronically, the due date is also January 31, 2023.

Churches must issue Copy B of Form 1099-NEC (“nonemployee compensation”) by this date to any self-employed person to whom the church paid nonemployee compensation of $600 or more in 2022. This form (rather than a W-2) should be provided to clergy who report their federal income taxes as self-employed, since the Tax Court and the IRS have both ruled that a worker who receives a W-2 rather than a 1099-NEC is presumed to be an employee rather than self-employed. Other persons to whom churches may be required to issue a Form 1099-NEC include evangelists, guest speakers, contractors, and part-time custodians.

Churches must send Copy A of Forms 1099-NEC, along with Form 1096, to the IRS by this date.

Churches must distribute a 2022 1099-INT form to any person paid $600 or more in interest during 2022 by this date (a $10 rule applies in some cases).

For more information or to view this article online, please visit the Church Tax & Law Website or if you have any questions regarding these key January dates, please contact our office.

When Expenses Are Higher than Your Budget

Does your policy have the answer on what to do? – Posted 1/11/23

For churches that view the operating budget as an expense control mechanism, the matter of how to deal with expenditures in excess of budgeted amounts is an important element of policy that is poorly developed in many churches.

For example, a church operating budget will typically include line items for each of the church’s main areas of ministry operations. Line items will exist for worship activities, educational activities, children and youth ministries, missions, and so on.

Suppose a church develops and approves an operating budget for the year reflecting total expenses of $1.5 million, of which $200,000 relates to educational activities. Also suppose that, due to unexpected developments, it appears the church’s expenses for its educational activities will exceed the amount budgeted by $50,000 for the year. Consider these questions:

  • Is it acceptable for the church’s staff leadership to make the additional expenditures for the educational ministries, so long as total expenses do not exceed the total amount of expenses budgeted for the church of $1.5 million?
  • Even if church staff leaders are permitted to reallocate budget line items so long as the total amount spent remains within the amount of total expenses authorized by the budget, who on the church staff leadership has the authority to make such a reallocation decision?
  • Or should church staff leaders be required to obtain specific authorization to incur expenses that exceed the amount budgeted for the educational ministries?
  • If authorization is required in order to exceed expenses for an individual line item or for the budget as a whole, who must provide that authorization? If the congregation approved the annual budget, must the congregation be involved in an authorization for such a variance?
  • Or, may such approval be granted by the governing body of the church or by some other group?
  • Would the answer to these questions change, depending on the amount by which actual expenditures are expected to exceed budgeted amounts?

Many churches do not have good answers to these questions. For churches that view the operating budget as an expense control mechanism, it is essential to have an appropriate budget policy that clearly addresses such matters and leaves little room for misunderstanding.

For more information or to view this article online, please visit the Church Tax & Law Website . For more recommendations dealing with expenditures in excess of budgeted amounts or any other tax related questions, please contact our office.

Mastering Seventeen End-of-Year Tasks

Use this to-do list to finish the year well and start 2023 right. – Posted 1/6/23

Various critical financial tasks should be completed before January 1, 2023. To help church treasurers navigate this, Church Law & Tax asked tax and accounting experts to review and update our list of tasks that might affect a treasurer’s year-end to-do list.

Here, then, is an updated list that should help you finish 2022 strong and get started right in 2023.

1. Designate a housing allowance

The board or congregation should designate a housing allowance for 2023 for ministers who own or rent their home (and for ministers who live in a parsonage and who pay some of their housing expenses from their own funds). Find sample housing allowance and parsonage allowance resolutions in chapter 6 of Richard Hammar’s annual Church & Clergy Tax Guide.

“Because housing allowances can only be provided prospectively (that is, after they have been approved by the board or the board’s designee), obtain approval from the board prior to January 1,” advised Rob Faulk, a CPA and partner with CapinCrouse.

2. Review W-4 forms

All employees should review their W-4 form and submit a new form if circumstances have changed. This will ensure accurate tax withholding.

“Many employees are surprised when they complete their tax return and find they owe money,” said Elaine Sommerville, a CPA and senior editorial advisor for Church Law & Tax. “Employees may be caught short on taxes paid if both spouses are working.”

She explained that the tax withholding tables “don’t appropriately take a dual-earner household into consideration. It is advisable for employees who owed money with their 2021 Form 1040 to complete a new Form W-4 at this time.”

And don’t leave out ministers, stressed Frank Sommerville, a CPA, tax attorney, and senior editorial advisor for Church Law & Tax. Unfortunately, “many ministers just go to the treasurer and say, ‘Withhold such-and-such from a paycheck,’” he said. “But the pastor should also fill out a W-4 or provide other written documentation for withholding income tax.” (For more information on this aspect of the topic, see #9 below.)

Tip. Visit irs.gov/publications to download the 2023 edition of IRS Publication 15 for the new withholding tables. (This publication is regularly updated each December for the upcoming year.)

3. Provide a notice to donors

Donors should be advised in the church bulletin or newsletter, on the church website, or in a letter or email from the church, not to file their federal income tax return before they receive their contribution summary from the church. Donors may not be able to deduct individual contributions of $250 or more if they file a tax return before receiving a qualified contribution receipt from their church.

Churches should also double check software used for preparing charitable contributions receipts to confirm that the vital “no goods or services other than intangible religious benefits were provided” statement will be included when the receipts are prepared.

“Making sure donors have those contribution acknowledgements prior to filing is definitely important,” added Kaylyn Varnum, a partner and assistant national director for tax services for the accounting firm Batts Morrison Wales & Lee, and an advisor-at-large for Church Law & Tax.

While deductions may be available to fewer donors, it’s still important to notify all donors, Frank Sommerville stressed, because churches simply don’t know who might qualify for a deduction.

Tip. Answer many of your members’ questions about charitable giving and tax law with the Charitable Contributions Tax Reminder (for their 2022 returns).

4. Determine if contributions are effective for 2022 or 2023

The general rule is that a contribution is effective when delivered. A check deposited in the church offering in January of 2023 cannot be deducted in 2022, even if it is backdated to 2022. One exception—checks that are mailed and postmarked in 2022 are deductible in 2022, even if they are not received until 2023.

IRS Publication 526 offers these guidelines for three other types of giving (adapted):

  • Text message. Contributions made by text message are deductible in the year the donor sends the text message if the contribution is charged to the telephone or wireless account.
  • Credit card. Contributions charged on the donor’s bank credit card are deductible in the year the donor makes the charge.
  • Pay-by-phone account. Contributions made through a pay-by-phone account are considered delivered on the date the financial institution pays the amount. This date should be shown on the statement the financial institution sends the donor.

5. Correctly handle gifts and noncash/cash benefits to staff and volunteers

Consider these two categories of gifts:

  • Cash Christmas gifts to employees. Be sure to correctly handle any Christmas gifts made by the church or congregation to a minister or lay staff member. In most cases, these transfers represent taxable income and not a tax-free gift and must be reported as income on the recipient’s W-2. “If the gifts are paid through accounts payable, the value of the gifts will need to be submitted to the payroll system prior to the end of the year to allow for correct reporting on the recipient’s W-2 and on the church’s fourth-quarter Form 941,” Elaine Sommerville explained.
  • Noncash gifts to employees and volunteers. Noncash gifts may also create income requiring payroll reporting. A gift of property having a value so small “as to make accounting for it unreasonable or administratively impracticable” is a nontaxable “de minimis fringe benefit” (see Section 132(e)(1) of the tax code). This exception does not apply to cash or “cash equivalents” (such as gift certificates). “Information on noncash gifts that may not be considered as ‘de minimis’ will need to be provided to the payroll system prior to the end of the year to allow for correct reporting on the recipient’s Form W-2 and the church’s Form 941,” Elaine Sommerville said.

Monetary gifts (including gifts cards) to volunteers of any amount should be avoided, said Frank Sommerville. “Once you give people money, they are no longer volunteers,” he said. “They are employees. Once you compensate them, then you’re getting into all kinds of issues. Does employment law apply? Does workers’ comp apply? Once you give them anything of value, they no longer qualify as a volunteer under many, many statutes.”

6. Be careful about accepting certain types of end-of-the-year noncash donations

Near the end of the year, churches should be wary of a noncash donation of significant value, such as an antique car or a gift of real estate. Some gifts might be hard to sell. With land, there could be unresolvable zoning issues or issues with toxic soil. With a building, there could be structural issues or a problem with lead or asbestos.

“You don’t want to be rushed into making a decision,” said Frank Sommerville. “If a gift comes in near the end of the year, you don’t have the time to do your due diligence.” He stressed that the gift could end up costing you a lot more than it is worth. An exception: publicly traded stock. “Stock is pretty easy to address appropriately as a year-end gift,” he said.

Additional resources:Gifts of Property: Help Donors Get It Right” offers tips on handling noncash gifts of real property (buildings and land) while “Tax Rules for Gifts of Personal Property” offers tips on handling noncash gifts of personal property (such as cars, household items, and stock).

7. Review classification of employees for US Department of Labor (DOL) purposes

“Now is the time to decide if employees are properly classified for wage and hour purposes,” Elaine Sommerville said. “Job descriptions should be reviewed to determine if employees qualify for the ministerial exception. And for all employees not qualifying under the ministerial exception, job descriptions and salary amounts should be reviewed to determine if the employee is exempt or nonexempt.

Past year determinations may be affected by the current minimum weekly salary requirement of $684 for exempt employees. While this change was effective January 1, 2020, many churches still are not aware of its implications. Churches may find that employees previously classified as exempt employees must be moved to the nonexempt classification due to the higher minimum weekly salary requirement. For further guidance, see Elaine Sommerville’s article “The Right Way to Handle Wage Classifications.”

8. Make sure ministers are properly classified for paying into the Social Security system

Separate from applying the DOL’s ministerial exception discussed above, a church must also determine who is a minister for IRS and Social Security purposes.

Many churches incorrectly report ministers as employees for paying into the Social Security system by withholding Social Security and Medicare taxes from their wages. This is incorrect, since the tax code classifies ministers as self-employed for purposes of paying into the Social Security/Medicare system with respect to services they perform in the exercise of ministry. As a result, they pay the self-employment tax with their individual income tax returns and not through withholding and employer matching of Social Security and Medicare taxes.

Now is also a good time to provide information to ministers regarding their unique tax classifications to make them aware of the unusual filing requirements.

Caution. Ministers who are incorrectly classified for Social Security and Medicare jeopardize their ability to receive the tax-free housing allowance. The ideal time to reclassify these ministers as self-employed for Social Security is January 1 and the prior year’s reporting should be corrected to preserve the other benefits afforded to ministers.

9. Voluntary withholding

Since ministers’ wages are exempt from Social Security, Medicare, and federal income tax withholding (with respect to services performed in the exercise of their ministry), they use the quarterly estimated tax procedure to prepay their federal taxes.

However, ministers who report their income taxes as employees can enter into a voluntary withholding arrangement with their employing church by submitting written authorization—such as a letter, email, or a W-4 form—to the appropriate church representative. Under such an arrangement, the employing church withholds income taxes as it would for any other employee, and also can withhold an additional amount of income taxes to cover the minister’s self-employment tax liability.

Tip. The ideal time to start voluntary withholding is January 1. However, Ted Batson, a CPA and tax attorney with CapinCrouse, and an advisor-at-large for Church Law & Tax, said adjustments in voluntary withholding can be made at any time during the year.

In addition, some churches have filed a Form 8274 with the IRS exempting themselves from the employer’s share of Social Security and Medicare taxes. Lay employees of such churches are treated as self-employed for Social Security, meaning that they must pay self-employment taxes. These taxes must be paid by making quarterly estimated tax payments to the IRS unless additional voluntary withholding is requested. Under such an arrangement, the church withholds an additional amount of federal income taxes to cover their estimated self-employment tax liability.

“For ministers who prefer to make estimated tax payments rather than allowing the church to withhold federal income tax, it is beneficial to enroll in the IRS Electronic Funds Transfer Payment System (EFTPS),” Elaine Sommerville suggested. “Making tax payments through the EFTPS system provides the minister with the ability to preschedule estimated tax payments and to receive immediate confirmations of the payments. The 2020 pandemic raised awareness of the benefits of the system as the IRS continues to struggle in the timely processing incoming mail.”

10. Review plans for compensation in 2023

Review compensation and benefits for employees for the upcoming year. Doing so will “provide for the proper documentation of compensation packages and proper taxation of benefits provided to employees,” said Elaine Sommerville.

Additional resource: Find help for your various compensation issues in Elaine Sommerville’s book , Church Compensation – 2nd Edition: From Strategic Plan to Compliance.

11. Have applicable employees fill out various required elections

Certain benefit plans require elections to be completed by the beginning of the plan year. These include benefit elections for a church’s cafeteria plan or Section 125 plan, enrollment in insurance plans that begin on January 1, and the required health insurance opt-out election certificates required by large employers.

For any church that’s an applicable large employer—and currently in its annual benefit enrollment period—Rob Faulk from CapinCrouse offers this guidance: Ensure that any employee who chooses to opt out of the health benefit plan completes an opt-out election certificate [or waiver] and furnishes proof of enrollment in another qualified group health benefit plan from a source other than your church’s plan before coverage is terminated.

12. Review payments to any independent contractors

Preparations for filing the annual Forms 1099-NEC should include a review of payments to unincorporated independent contractors, including LLCs, and their related W-9 forms. (Any payment made via a credit card or PayPal is not reported on the Form 1099-NEC.)

“If a Form W-9 hasn’t been obtained for a contractor, determine if the church has the correct address and Social Security/employer identification number for the contractor,” Elaine Sommerville stressed. “And don’t forget to include payments to attorneys even if paid to a law firm that is incorporated.”

Tip. The Form 1099-MISC is still used for other reportable payments, so make sure the church orders the right forms to report all necessary payments. For example, payments made to unincorporated lessors are still reported in Box 1 of Form 1099-MISC. Forms 1099-NEC are due to the IRS and the recipients by January 31, 2023, and Forms 1099-MISC are due to recipients by January 31, 2023, and to the IRS by February 28, 2023.

13. Report all taxable fringe benefits on W-2 forms

Did your church give a low-interest or interest-free loan to your pastor this year? Did you forgive interest or principal on a loan to your pastor during the year? Did you allow children of employees to attend your summer camp without charge? Did you provide employees with free memberships to the local gym?

The value of such benefits needs to be reported on your employees’ W-2s “and included on your Form 941 with tax withholdings and payroll taxes paid as applicable,” Batson said.

“Whenever possible, taxes for fringe benefits should be withheld throughout the year and at the time the fringe benefit was received,” Batson said. “But in cases where that has not happened, the value of the fringe benefit should still be included on the W-2s at the end of the year.” Elaine Sommerville added that “taxes associated with the fringe benefits may still be calculated and paid through additional withholding from employees’ final paychecks this year, if not calculated at the time the benefit was provided.”

“Fringe benefit plans should be reviewed to determine the plan documents are still in compliance with applicable law and the church is operating within the boundaries of the applicable benefit plan,” Elaine Sommerville said.

A church that provides its minister a car should download IRS Publication 15-B and review the Fringe Benefit Valuation Rules to ensure the proper amount for personal use is included in the pastor’s W-2”, Batson said.

14. Prepare for proper filing of Forms W-2 and 1099

The Taxpayer First Act of 2019 requires electronic filing for employers filing 10 or more Forms W-2 starting with the filings in January 2023. However, this new law is pending enforcement until the IRS issues the related regulations. Until the IRS updates these regulations, the current threshold for mandatory electronic filing is 250 Forms W-2. Electronic filing requirements may be confirmed in January at irs.gov.

For filing Forms 1099, electronic filing is required for filers of 250 or more forms. This may be lowered to 100 forms, so churches should also verify this requirement in January of 2023 at irs.gov.

There are many easy systems allowing for electronic filing of payroll reports. The Social Security Administration maintains a portal for filing Forms W-2 electronically for smaller employers. Congress has charged the IRS to create a similar portal for filing Forms 1099, and it may be available for the 2023 filing season. Hard copy forms may be obtained from local office supply stores. While many forms may be downloaded at irs.gov/forms, Form 1096, Form 1099-MISC, and Form 1099-NEC still require original, red-colored forms to be used if filing paper forms.

The IRS is still struggling to timely process any paper returns, so it is a good time to see how all payroll tax filings can be moved to a method of electronic filing for 2022 returns due in 2023.

15. Finalize 2023 budgets and take care of any budgeting issues

If your current budget year ends on December 31, finalize your 2023 budget before then, Faulk advised. Further, he said to perform a variance review of income statement (actual vs. budget). “This process may affect decisions about next year’s budget and may be particularly challenging due to the changes caused by the pandemic,” Faulk explained. “To help, CapinCrouse offers a free e-book, How to Budget Effectively in Changing Times.”

Additional resource:Managing Tough Financial Times,” offers several helpful articles and a video on budgeting and financial management for churches.

16. List and take care of any additional year-end items

Sit down and list any additional items that could easily slip through the cracks, which are particular to your church, then take care of them before the end of the year. Faulk mentioned the following items:

  • Reconcile your church’s donor system to your general ledger, and then investigate any significant differences. This is an important internal control to help detect any errors and to prevent fraud.
  • If your church has a loan, talk to your lender about instances of noncompliance before the end of the year.
  • Learn more about how many of these year-end steps are effective tools for preventing financial fraud in your church.
  • Get annual conflict-of-interest forms signed and reviewed.
  • Reconcile detailed property and equipment depreciation listings to the general ledger.
  • Record destroyed items in accordance with document retention and destruction policies.
  • Review insurance policies and update as appropriate.
  • Document a list of authorized check signers and update bank records.
  • Document a list of those authorized to approve expenditures.
  • Document a list of approved bank accounts and close any that are not needed.
  • If your church will have an audit or review, your finance or audit committee should be in the process of selecting the independent auditors.
  • Make sure the church has adopted an accountable expense reimbursement plan and makes it available to all employees, especially those with church-issued credit cards.
  • Confirm the church is still in good standing with the state where it formed and make sure the name and address for the registered agent is current.

17. Update your church’s resource guides

If you have not already done so, now is a good time to order Church Compensation – 2nd Edition: From Strategic Plan to Compliance by Elaine Sommerville and preorder the 2023 edition of Richard Hammar’s Church & Clergy Tax Guide. These resources will help you properly answer the various tax, payroll, and compensation questions that will invariably arise throughout the coming year.

For more information or to view this article online, please visit the Church Tax & Law Website . For more recommendations regarding your end of year tax to-do-list or any other tax related questions, please contact our office.

Tax News for December 2022 . . .

Don’t Be Blindsided by Three “Unexpected Expenses”

Planning ahead can keep you from being caught off guard. – Posted 12/27/22

Small-church pastor Karl Vaters offers these tips that could keep you from being caught off guard by three types of expenses.

Set aside money every month for annual bills

Most bills come monthly. But every church has annual bills (like insurance) that we have to stop being surprised by. Any healthy church anticipates these bills and plans for them by laying some money aside every month so it’s there when the bill inevitably arrives.

Start an emergency fund

Heaters break. Roofs leak. Regular givers lose their jobs and move away. Wise church leaders plan for such eventualities. No matter how little we have coming in, we need to create a line item [for] a fund to cover such emergencies. . . . According to most financial experts, an ideal amount in that fund would be six months’ worth of income. (Yes, I can hear you laughing from here. Our church doesn’t have that either.) In lieu of that, we should aim for three months’ worth. We can get there by setting up a budget that saves one month’s worth of income every year until the three months of income is reached. That can be done by setting aside eight percent of your income every month for three years.

Have an ongoing building maintenance plan

Don’t let deferred maintenance build up. Having an annual cleanout of the plumbing lines will be cheaper in the long run than letting things build up until the toilets overflow in the middle of a Sunday morning service. The same goes for cleaning, painting, cracked windows, and so on.

For more information concerning unexpected expenses, see visit the ChurchLaw & Tax website or call our office for further details.

Year End Planning For Businesses

**Posted 12/23/22

With year-end approaching, it is time to start thinking about moves that may help lower your business’s taxes for this year and next. This year’s planning is more challenging than usual due to recent changes made by the Inflation Reduction Act of 2022 and the potential change in congressional balance of power resulting from the midterm elections.

Whether or not tax increases become effective next year, the standard year-end approach of deferring income and accelerating deductions to minimize taxes will continue to produce the best results for most small businesses, as will the bunching of deductible expenses into this year or next to maximize their tax value.

If proposed tax increases do pass, however, the highest income businesses and owners may find that the opposite strategies produce better results: Pulling income into 2022 to be taxed at currently lower rates, and deferring deductible expenses until 2023, when they can be taken to offset what would be higher-taxed income. This will require careful evaluation of all relevant factors.

We have compiled a list of actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all of them will apply to you or your business, but you may benefit from many of them. We can narrow down specific actions when we meet to tailor a particular plan for your business, In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves might be beneficial:

  • Taxpayers other than corporations may be entitled to a deduction of up to 20% of their qualified business income. For 2022, if taxable income exceeds $340,100 for a married couple filing jointly, (about half that for others), the deduction may be limited based on whether the taxpayer is engaged in a service-type trade or business (such as law, accounting, health, or consulting), the amount of W-2 wages paid by the business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the business. The limitations are phased in; for example, the phase-in applies to joint filers with taxable income up to $100,000 above the threshold, and to other filers with taxable income up to $50,000 above their threshold.
  • Taxpayers may be able to salvage some or all of this deduction, by deferring income or accelerating deductions to keep income under the dollar thresholds (or be subject to a smaller deduction phaseout) for 2022. Depending on their business model, taxpayers also may be able increase the deduction by increasing W-2 wages before year-end. The rules are quite complex, so don’t make a move in this area without consulting us.
  • More small businesses are able to use the cash (as opposed to accrual) method of accounting than were allowed to do so in earlier years. To qualify as a small business a taxpayer must, among other things, satisfy a gross receipts test, which is satisfied for 2022 if, during a three-year testing period, average annual gross receipts don’t exceed $27 million (next year this dollar amount is estimated to increase to $29 million). Not that many years ago it was $1 million. Cash method taxpayers may find it a lot easier to shift income, for example by holding off billings till next year or by accelerating expenses, for example, paying bills early or by making certain prepayments.
  • Businesses should consider making expenditures that qualify for the liberalized business property expensing option. For tax years beginning in 2022, the expensing limit is $1,080,000, and the investment ceiling limit is $2,700,000. Expensing is generally available for most depreciable property (other than buildings) and off-the-shelf computer software. It is also available for interior improvements to a building (but not for its enlargement), elevators or escalators, or the internal structural framework), for roofs, and for HVAC, fire protection, alarm, and security systems.
  • The generous dollar ceilings mean that many small and medium sized businesses that make timely purchases will be able to currently deduct most if not all their outlays for machinery and equipment. What’s more, the expensing deduction is not prorated for the time that the asset is in service during the year. So expensing eligible items acquired and placed in service in the last days of 2022, rather than at the beginning of 2023, can result in a full expensing deduction for 2022.
  • Businesses also can claim a 100% bonus first year depreciation deduction for machinery and equipment bought used (with some exceptions) or new if purchased and placed in service this year, and for qualified improvement property, described above as related to the expensing deduction. The 100% write-off is permitted without any proration based on the length of time that an asset is in service during the tax year. As a result, the 100% bonus first-year write-off is available even if qualifying assets are in service for only a few days in 2022.
  • Businesses may be able to take advantage of the de minimis safe harbor election (also known as the book-tax conformity election) to expense the costs of lower-cost assets and materials and supplies, assuming the costs aren’t required to be capitalized under the UNICAP rules. To qualify for the election, the cost of a unit of property can’t exceed $5,000 if the taxpayer has an applicable financial statement (AFS, e.g., a certified audited financial statement along with an independent CPA’s report). If there’s no AFS, the cost of a unit of property can’t exceed $2,500. Where the UNICAP rules aren’t an issue, and where potentially increasing tax rates for 2023 aren’t a concern, consider purchasing qualifying items before the end of 2022.
  • A corporation (other than a large corporation) that anticipates a small net operating loss (NOL) for 2022 (and substantial net income in 2023) may find it worthwhile to accelerate just enough of its 2023 income (or to defer just enough of its 2022 deductions) to create a small amount of net income for 2022. This allows the corporation to base its 2023 estimated tax installments on the relatively small amount of income shown on its 2022 return, rather than having to pay estimated taxes based on 100% of its much larger 2023 taxable income.
  • Year-end bonuses can be timed for maximum tax effect by both cash-and accrual-basis employers. Cash-basis employers deduct bonuses in the year paid, so they can time the payment for maximum tax effect. Accrual-basis employers deduct bonuses in the accrual year, when all events related to them are established with reasonable certainty. However, the bonus must be paid within 2½ months after the end of the employer’s tax year for the deduction to be allowed in the earlier accrual year. Accrual employers looking to defer deductions to a higher-taxed future year should consider changing their bonus plans before year-end to set the payment date later than the 2.5-month window or change the bonus plan’s terms to make the bonus amount not determinable at year end.
  • To reduce 2022 taxable income, consider deferring a debt-cancellation event until 2023.
  • Sometimes the disposition of a passive activity can be timed to make best use of its freed-up suspended losses. Where reduction of 2022 income is desired, consider disposing of a passive activity before year-end to take the suspended losses against 2022 income. If possible 2023 top rate increases are a concern, holding off on disposing of the activity until 2023 might save more in future taxes.

These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you.

Very truly yours,

Barbara

Year End Planning For Individuals

With year-end approaching, it is time to start thinking about moves that may help lower your tax bill for this year and next. This year’s planning is more challenging than usual due to recent changes made by the Inflation Reduction Act of 2022 and the potential change in congressional balance of power resulting from the midterm elections.

Whether or not tax increases become effective next year, the standard year-end approach of deferring income and accelerating deductions to minimize taxes will continue to produce the best results for all but the highest income taxpayers, as will the bunching of deductible expenses into this year or next to avoid restrictions and maximize deductions.

If proposed tax increases do pass, however, the highest income taxpayers may find that the opposite strategies produce better results: Pulling income into 2022 to be taxed at currently lower rates, and deferring deductible expenses until 2023, when they can be taken to offset what would be higher-taxed income. This will require careful evaluation of all relevant factors.

We have compiled a list of actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all of them will apply to you, but you (or a family member) may benefit from many of them. We can narrow down specific actions when we meet to tailor a particular plan for you. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves might be beneficial:

  • Higher-income individuals must be wary of the 3.8% surtax on certain unearned income. The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of MAGI over a threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case).
  • As year-end nears, the approach taken to minimize or eliminate the 3.8% surtax will depend on the taxpayer’s estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to reduce MAGI other than NII, and some individuals will need to consider ways to minimize both NII and other types of MAGI. An important exception is that NII does not include distributions from IRAs or most other retirement plans.
  • The 0.9% additional Medicare tax also may require higher-income earners to take year-end action. It applies to individuals whose employment wages and self-employment income total more than an amount equal to the NIIT thresholds, above. Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Selfemployed persons must take it into account in figuring estimated tax. There could be situations where an employee may need to have more withheld toward the end of the year to cover the tax. This would be the case, for example, if an employee earns less than $200,000 from multiple employers but more than that amount in total. Such an employee would owe the additional Medicare tax, but nothing would have been withheld by any employer.
  • Long-term capital gain from sales of assets held for over one year is taxed at 0%, 15% or 20%, depending on the taxpayer’s taxable income. If you hold long-term appreciated-in-value assets, consider selling enough of them to generate long-term capital gains that can be sheltered by the 0% rate. The 0% rate generally applies to net long-term capital gain to the extent that, when added to regular taxable income, it is not more than the maximum zero rate amount (e.g., $83,350 for a married couple; estimated to be $89,250 in 2022). If, say, $5,000 of long-term capital gains you took earlier this year qualifies for the zero rate then try not to sell assets yielding a capital loss before year-end, because the first $5,000 of those losses will offset $5,000 of capital gain that is already tax-free.
  • Postpone income until 2023and accelerate deductions into 2022 if doing so will enable you to claim larger deductions, credits, and other tax breaks for 2021 that are phased out over varying levels of AGI. These include deductible IRA contributions, child tax credits, higher education tax credits, and deductions for student loan interest. Postponing income also is desirable for taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may actually pay to accelerate income into 2022. For example, that may be the case for a person who will have a more favorable filing status this year than next (e.g., head of household versus individual filing status), or who expects to be in a higher tax bracket next year. That’s especially a consideration for high-income taxpayers who may be subject to higher rates next year under proposed legislation.
  • If you believe a Roth IRA is better for you than a traditional IRA, consider converting traditionalIRA money invested in any beaten-down stocks (or mutual funds) into a Roth IRA in 2022 if eligible to do so. Keep in mind that the conversion will increase your income for 2022, possibly reducing tax breaks subject to phaseout at higher AGI levels. This may be desirable, however, for those potentially subject to higher tax rates under pending legislation.
  • It may be advantageous to try to arrange with your employer to defer, until early 2023, a bonus that may be coming your way. This might cut as well as defer your tax. Again, considerations may be different for the highest income individuals.
  • Many taxpayers won’t want to itemize because of the high basic standard deduction amounts that apply for 2022 ($27,700 for joint filers, $13,850 for singles and for marrieds filing separately, $20,800 for heads of household), and because many itemized deductions have been reduced or abolished, including the $10,000 limit on state and local taxes; miscellaneous itemized deductions; and non-disaster related personal casualty losses. You can still itemize medical expenses that exceed 7.5% of your AGI, state and local taxes up to $10,000, your charitable contributions, plus mortgage interest deductions on a restricted amount of debt, but these deductions won’t save taxes unless they total more than your standard deduction.
  • Some taxpayers may be able to work around these deduction restrictions by applying a bunching strategy to pull or push discretionary medical expenses and charitable contributions into the year where they will do some tax good. For example, a taxpayer who will be able to itemize deductions this year but not next will benefit by making two years’ worth of charitable contributions this year. The COVID-related increase for 2022 in the income-based charitable deduction limit for cash contributions from 60% to 100% of MAGI assists in this bunching strategy.
  • Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2022 deductions even if you don’t pay your credit card bill until after the end of the year.
  • If you expect to owe state and local income taxes when you file your return next year and you will be itemizing in 2022, consider asking your employer to increase withholding of state and local taxes (or make estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2022. But this strategy is not good to the extent it causes your 2022 state and local tax payments to exceed $10,000.
  • Required minimum distributions RMDs from an IRA or 401(k) plan (or other employer-sponsored retirement plan) have not been waived for 2022. If you were 72 or older in 2022 you must take an RMD. Those who turn 72 this year have until April 1 of 2023 to take their first RMD but may want to take it by the end of 2022 to avoid having to double up on RMDs next year.
  • If you are age 70½ or older by the end of 2022, and especially if you are unable to itemize your deductions, consider making 2022 charitable donations via qualified charitable distributions from your traditional IRAs. These distributions are made directly to charities from your IRAs, and the amount of the contribution is neither included in your gross income nor deductible on Schedule A, Form 1040. However, you are still entitled to claim the entire standard deduction. (The qualified charitable distribution amount is reduced by any deductible contributions to an IRA made for any year in which you were age 70½ or older, unless it reduced a previous qualified charitable distribution exclusion.)
  • Take an eligible rollover distribution from a qualified retirement plan before the end of 2022 if you are facing a penalty for underpayment of estimated tax and increasing your wage withholding won’t sufficiently address the problem. Income tax will be withheld from the distribution and will be CHECKPOINT PLANNING 34 applied toward the taxes owed for 2022. You can then timely roll over the gross amount of the distribution, i.e., the net amount you received plus the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2022, but the withheld tax will be applied pro rata over the full 2022 tax year to reduce previous underpayments of estimated tax.
  • Consider increasing the amount you set aside for next year in your employer’s FSA if you set aside too little for this year and anticipate similar medical costs next year.
  • If you become eligible in December of 2022 to make HSA contributions, you can make a full year’s worth of deductible HSA contributions for 2022.
  • Make gifts sheltered by the annual gift tax exclusion before the end of the year if doing so may save gift and estate taxes. The exclusion applies to gifts of up to $16,000 made in 2022 to each of an unlimited number of individuals. You can’t carry over unused exclusions to another year. These transfers may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.
  • If you were in federally declared disaster area, and you suffered uninsured or unreimbursed disaster-related losses, keep in mind you can choose to claim them either on the return for the year the loss occurred (in this instance, the 2022 return normally filed next year), or on the return for the prior year (2021), generating a quicker refund.
  • If you were in a federally declared disaster area, you may want to settle an insurance or damage claim in 2022 to maximize your casualty loss deduction this year.

These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you.

Very truly yours,

Barbara

Top Tips to Prepare for the 2023 Tax Filing Season

With a little preparation, taxpayers can approach the upcoming tax filing season with confidence. Here are some things taxpayers can do to prepare for the 2023 tax filing season. ( IR 2022-203 )

1. Gather tax records.  First, taxpayers should gather all their tax records. Taxpayers who have all their tax documentation gathered and organized, are in the best position to file an accurate return and avoid processing or refund delays or receiving IRS letters.

Note. Tax records include copies of filed tax returns for at least the last three tax years and all supporting documents for those returns. These old returns will help the taxpayer to prepare their 2022 return. 

2. Taxpayers should consider financial transactions that occurred in 2022 to determine if they are taxable and how they should be reported. Taxpayers should have an electronic or paper record-keeping system to store tax-related information in one place for easy access.

Note.  Taxpayers should remember most income is taxable. This includes unemployment income, refund interest, and income from the gig economy and/or digital assets. Taxpayers should report all the income they’ve earned, including from tips, part-time work, side jobs, or the sale of goods and services or digital assets, unless its specifically tax-exempt.

3. Before year’s end.  Taxpayers should confirm their employer, bank, and other payors have the taxpayer’s current mailing address and email address. This will ensure that they receive their year-end tax statements.

4. Typically, year-end tax forms start arriving by mail or are available online in mid-to-late January. Taxpayers should carefully review each income statement for accuracy and contact the issuer to correct information that needs to be updated.

Reminder. Taxpayers who are paid for goods or services through a third-party payment network (i.e., Paypal, Venmo) will now receive a reporting form (Form 1099  – K , Payment Card and Third-party Network Transactions) once the amount of their business transactions exceeds $600.

5. Remember, money received through third-party payment networks from friends and relatives as personal gifts or reimbursements for personal expenses is generally not taxable. Those who receive a 1099  -K  reflecting income they didn’t earn should call the issuer.

Note. The IRS can’t change the amounts listed on a reporting form such as Form W-2 or Form 1099-NEC. If the taxpayer finds incorrect information on a reporting form, they must contact the issuer to get the form corrected. Taxpayers who receive a Form 1099  -K  for money received from friends or family as a gift or reimbursement for personal expenses should contact the issuer to get a corrected Form 1099  -K.

6. Withholding and estimated payments.  Taxpayers who had life changes in 2022, like getting married, divorced, welcoming a child, or taking on a second job, should take advantage of the IRS’ Tax Withholding Estimator on IRS.gov before the end of the year. This tool is designed to help taxpayers determine the right amount of tax to have withheld from their paycheck. A taxpayer with insufficient withholding should consider making an estimated payment to avoid penalties.

Taxpayers who need to make estimated tax payments on non-wage income from unemployment, self-employment, or who have annuity income or digital asset income should calculate their estimated payment soon. The last quarterly payment for 2022 is due on January 17, 2023.

7. Renew ITINs.  Taxpayers who have individual tax identification numbers (ITINs) should be sure that their number hasn’t expired before filing their 2022 return. Taxpayers who need to renew their ITIN to file a tax return should submit a Form W-7, Application for IRS Individual Taxpayer Identification Number, now. Applying now will allow the taxpayer to avoid the Spring rush to get an ITIN as well as refund and return processing delays.

For more information about how taxable income is computed, see Checkpoint’s Federal Tax Coordinator ¶ A-1000 . or call our office for further details.

Mastercard Rolls Out New Standards for Recurring Billing

Understanding these standards is important for churches and church-run schools with sustainer donor programs. – Posted 12/15/22

You may have heard that Mastercard was implementing new required standards for merchants that use subscription or recurring billing, which includes recurring gifts made to nonprofit entities, churches, and church-run schools.

However, after receiving feedback from merchants, Mastercard has now made the new standards best practices؅—not a requirement—for nonprofit and charity merchants, as long as those entities do not have excessive chargebacks.

Understanding these new standards is crucial for any church or church-run school with a recurring giving program (also known as a sustainer donor program), including which merchants must comply with the standards, what is required, and the potential penalties for noncompliance.

For those who may wonder, these new standards do not stem from a government regulation. They are a contractual matter with Mastercard and only apply to donations that automatically recur. For example, a one-time gift made by using the “donate” button on a church or school’s website would not be considered a subscription payment.

Furthermore, there has been no indication that other payment processors plan to follow Mastercard’s lead and implement similar required standards.

The back story

On June 14, 2022, Mastercard introduced Transaction Processing Rules that include new standards, outlined in Section 5.4.1, for subscription billing.

While the Transaction Processing Rules state that these standards apply to “subscription billing in which the Cardholder has agreed for the Merchant to provide ongoing and/or periodic delivery of physical products or Digital Goods,” Mastercard later clarified that this includes recurring donations made to nonprofit and charitable organizations.

While the new standards went into effect on September 22, 2022, Mastercard extended the effective date to March 21, 2023, for nonprofit organizations.

In October, Mastercard then announced that, effective October 11, 2022, only nonprofits and charity merchants with excessive chargebacks will be required to comply with the new standards.

Noncompliance is costly

Under the modified requirements, all the standards described below that took effect on September 22, 2022, are recommended as a best practice for nonprofit and charity merchants with a recurring payment program.

However, the standards become a requirement if a nonprofit or charity merchant that uses a recurring payment plan is placed into Mastercard’s Acquirer Chargeback Monitoring Program (ACMP) as an Excessive Chargeback Merchant, High Excessive Chargeback Merchant, or Excessive Fraud Merchant for at least four months. (Mastercard offers a “Data Integrity Monitoring Program” module as well as an updated, downloadable rules document.)

Organizations in the ACMP for at least four months or more that do not implement the required standards may be subject to a costly Category A noncompliance assessment each month, in addition to the assessments applicable under the ACMP.

A Category A noncompliance assessment can be up to $25,000 for the first violation and increase with each subsequent violation, up to $100,000 per violation for the fourth and subsequent violations within 12 months. More information about Category A noncompliance assessments is available in Section 2.1.4 of the Mastercard Rules.

The new, recommended standards entail:

  • Disclosing the donor’s selected donation amount and frequency when requesting credit card information as well as on any payment and order summary webpages and asking donors to accept the subscription terms before completing the donation.
  • Sending a subscription confirmation at the time of enrollment in recurring giving. The confirmation should include the terms of the subscription (the recurring donation) and instructions on how to cancel it.
  • Providing an electronic receipt after every successful billing. This should include instructions on how to cancel the subscription (the recurring donation).
  • Providing an online cancellation method or clear instructions on how to cancel that are “easily accessible online,” such as through a “Cancel Subscription” or “Manage Subscription” link on the organization’s home page.
  • For recurring payment plans that bill less frequently than every six months (180 days), sending an electronic reminder outlining the terms of the subscription (the recurring donation) and instructions on how to cancel the subscription or recurring donation 7 to 30 days before the next scheduled billing date. The communication should reference in the subject line that it relates to upcoming charges, and the message should be distinct from marketing communications.

In its statement about the revised standards, Mastercard said that it changed the requirements after engaging with merchants and recognizing that “some of these requirements present unique challenges to merchants that have found other effective ways to manage their subscription and recurring payment model.”

For more information or to view this article online, please visit the Church Tax & Law Website . For more recommendations regarding reoccurring billing or any other tax related questions, please contact our office.

Common Church Finance Department Mistakes and How to Remedy Them

Seven ways church finances can go awry and the guidance needed to keep them on track. – Posted 12/14/22

Romans 12:4 notes that the body is made up of many parts, and they all have different functions. We use this analogy in many contexts, and it is appropriate when considering the workings of a church. Your church needs ministries such as preaching, discipleship, and worship, but you also need support ministries. These can include IT, facilities, administrative . . . and financial operations.

A church’s finance department is one of the most significant of its support ministries, as well as being one of the most misunderstood and overlooked. Yet church leaders rely on the information their finance departments provide, and if that information is inaccurate, significant—or even catastrophic—results can occur.

In the work I have done for churches and ministries as a certified public accountant, I’ve seen personnel layoffs, ministry reductions or discontinuations, and lack of debt compliance as results of improper financial management.

Even if a church finds itself in a difficult economic position, options are available through access to accurate and timely information. But the longer the problem continues without proper attention, the worse the consequences will be.

If you’ve lapsed in one or more of the following seven areas, it’s important to recognize why any lapses need to be remedied for the good of your ministry.

1. Proper internal controls

As a career auditor and consultant, I would be remiss if I didn’t note the most common mistake I see affecting ministries of all sizes. Weak internal controls not only leave the church vulnerable to financial losses, weak controls also leave individual staff and volunteers vulnerable to allegations that they may not be able to defend. To provide basic protection for the church’s financial assets, it’s critical to have segregation of duties over cash receipts. It’s also vital for disbursements to involve at least two people in the custody of the asset, record keeping, and authority of transactions.

2. Competent Staffing

It is not uncommon to “settle” for someone when filling a paid or volunteer position, but the resulting lack of competence can be frustrating for both the individual and the ministry and can certainly diminish the capacity of the role. Management of the church’s finances provides the foundation on which the rest of ministry happens. Allowing someone to serve in a role for which he or she is not qualified is not helpful, even if you are doing it to help an individual in need of a job or a relative of another employee. Having the right people in the right positions is crucial.

3. Adequate training

Try to name something a person can be successful at without training. Whether it is a hobby or a career, everyone needs to have the proper training in order to do his or her best. Training, however, is often overlooked or cut from budgets as a “perk.” That mindset needs to change, because a well-trained, proactive finance team will make better decisions, provide better information, and become a crucial element in the ministry’s success.

4. Financial reporting

There are two aspects of financial reporting: preparation of the reports and understanding the information reported. Financial managers need to help with both. You should consider the information and format of the report to be certain it is accurate, timely, relevant, and succinct. You should also help the individuals who use the information to understand what the report means and how to apply the information. Just as the finance department needs training, church leadership and the board will need training, as well. The finance department can provide this training or help find others who can.

5. Documented processes and procedures

Documenting processes and procedures is not something that should be done once and checked off a list forever. Every church needs to have a processes and procedures manual in place and review and update it at least annually. People, processes, and software change, and information can quickly become outdated when that happens. Churches should also have a record retention and document destruction policy in place. This will notify individuals of the requirements necessary to maintain and destroy financial information.

6. Succession planning

More ministries are becoming aware of the need for succession planning for the senior pastor. If your church has not done this, or you feel you have several years before your leader retires, please consider the importance of taking this step now. Things can change unexpectedly, and a well-considered and thorough plan takes time. Considering succession planning for other roles within the church—both paid and volunteer positions—is also important. You should always be considering the next person in line for any key position.

7. Staying updated

It’s a true saying that “The one thing you can count on in life is change.” If you are reading this, you likely have some responsibility for or interest in the finances of your church. It’s an environment that is constantly changing. It is critical that someone in your ministry be tasked with understanding the implications of changes in state legislation, accounting standards, and the regulatory environment (such as tax laws and employment regulations).

Providing support, serving the kingdom

This list of areas covered in this article is not comprehensive, but it certainly provides key areas to consider as you conduct your various financial operations. Your church is most likely better at some of these items than others. I encourage you to go back to the links offered in this article for additional information on areas that may not be as strong. And keep turning to Church Law & Tax for other practical articles and books and downloadable resources on finance-related topics that will help you do your job well as you seek to support your church and serve God’s kingdom purposes.

For more information or to view this article online, please visit the Church Tax & Law Website . To learn more about how you can avoid making financial mistakes or any other tax related questions, please contact our office.

Reduce Your Church’s Expenses

How to strengthen your bottom line and eliminate activities that miss your mission. – Posted 12/13/22

An interesting phenomenon developed during the Great Recession of 2008. Faced with sudden revenue decreases of 30 percent or more, some churches were forced to quickly make dramatic expense reductions. These churches reduced or eliminated multiple programs, ministries, and staff positions to avoid catastrophic cash flow deficits.

In some cases, when the churches informed their congregations of the massive expense reductions, members remarked that the expense cuts had “no noticeable impact.” Such perceptions on the part of congregations raised some interesting questions such as:

  • How was a church able to reduce its operating expenses by 30 percent with no noticeable effects on the key elements of the church’s activities?
  • Was the church previously wasting that money?
  • Why can’t the church ordinarily operate with a lower level of expenses?

Church leaders should contemplate the answers to such questions as part of their overall evaluation of the effectiveness of the church’s spending. They should also evaluate whether a particular program, activity, or initiative contributes to the church’s mission and purpose before committing funds to it.

Mission and purpose

Clearly identify your church’s specific mission and purpose. Next, critically evaluate each program, activity, and initiative through the filter of your mission and purpose. Doing so can ferret out waste or marginally beneficial expenses. Coupled with a zero-based budgeting approach (see chapter 1 in Church Finance), such an exercise can help identify areas that are prime candidates for expense reductions. It can also assist church leaders in reallocating expense priorities toward activities that more effectively accomplish the church’s mission and purpose.

Obvious places to look

Churches looking to reduce expenses will typically look first at these rather obvious areas for cost savings:

  • Reducing or eliminating specific programs, activities, and initiatives
  • Reducing staff work hours and compensation
  • Reducing employer-paid staff benefits
  • Renegotiating costs with vendors
  • Renegotiating debt terms
  • Deferring maintenance on property and equipment
  • Eliminating staff positions

Think carefully before eliminating staff

Church leaders who consider terminating employees for expense reduction purposes should remember churches are exempt from both the federal and state unemployment compensation tax and benefit systems. Accordingly, terminated employees will not be eligible for unemployment benefits. Church leaders may wish to consider offering a severance package to terminated employees. Of course, the cost of any severance benefits must be considered when evaluating savings associated with terminations.

Four not-so-obvious places to look

Here are four less-obvious ways churches may be able to reduce expenses:

1. Streamline processes and systems
A Wall Street Journal article stated that a business check costs between $4 and $20 to fully prepare and process, and that the cost of writing a check can be as much as 5 times the cost of an e-payment. Or, consider a staff member who must leave her desk and go to a centralized scanner (as opposed to using a scanner at her desk) every time a document requires scanning may spend 3 to 5 extra minutes on that process. Multiply that 3 to 5 extra minutes by 10 times a day and the result is an extra 30 to 50 minutes per staff member per day. Churches typically have many processes and systems that have not been seriously evaluated for efficiency. A church that wishes to reduce expenses should consider streamlining its processes and systems.

Addressing the following questions (and others like them) can help a church streamline its processes and systems and, as a result, operate more efficiently and at a lower cost.

  • How much does it cost for your church to pay a bill with a check? (Not the bill itself, but the process of paying the bill.)
  • Does your staff use computerized bank account reconciliation applications? How much time does the account reconciliation process take?
  • Are expense reports submitted on paper with receipts attached? How much collective staff time (all staff) is spent preparing and addressing paper expense reports for reimbursement?
  • How much collective staff time does your church spend completing, approving, and otherwise addressing purchase orders and similar authorizations?
  • Have you actively encouraged your congregation to give electronically? Is giving to your church as easy as buying a book on Amazon.com? How much time does your staff spend processing check-based offerings?
  • How much time does your staff spend filing documents and retrieving (or searching for) documents in paper files?
  • Do you still have a person answering your telephones?

2. Energy studies and adaptations
Many churches have hired experts to perform energy usage analyses. Experts will typically recommend adaptations to equipment, fixtures, insulation, lighting, software, and usage management systems—all with the goal of operating with greater energy efficiency. The changes necessary to generate significant energy savings may require a substantial initial investment. Of course, a church must evaluate its expected return on that investment. A church interested in pursuing an energy study should reach out to other churches for referrals to a reputable service provider. The church may also wish to consult its own electrical utility company to identify energy analysis options.

3. Outsourcing
Many churches outsource certain aspects of their operations. Why do they choose to do so? In many cases, outsourcing places work in the hands of experts who can perform a given function or activity more effectively, more efficiently, and less costly.

For example, churches commonly outsource the administration of their employee retirement plans, cafeteria (Section 125) plans, and other employee benefit plans. Many churches with investment portfolios outsource the asset management function for those portfolios. Churches commonly outsource the processing and disbursement of their payrolls. Other services commonly outsourced include grounds maintenance, information technology (IT) services, vehicle maintenance, and security. Churches also may outsource:

  • Regular accounting and financial reporting activities
  • Bill-paying activities
  • Human resources (or some aspects of it, such as employee screening; the service provider must be fully aware of the unique legal attributes that apply to churches in the HR arena)
  • Document printing, preparation, and graphic design
  • Document editing and proofing
  • Website and social media management
  • Public relations

4. Collaboration
To more effectively and efficiently carry out their mission and purpose, churches sometimes collaborate with each other or with other Christian ministries. While collaboration with international missions and humanitarian relief activities is common, collaboration with domestic ministry activities is also an area of growing interest. Collaboration can take forms similar to outsourcing and can offer many of the same advantages. The primary differences between collaboration and outsourcing are that:

  • In collaboration arrangements, the church often participates directly alongside another church or ministry.
  • Outsourcing is most commonly a contractual arrangement with a vendor or service provider, whereas some aspects of collaboration may not involve formal contractual agreements.

Here is an example of collaboration:

Elm Church desires to meet the needs of homeless people in its area. Rather than start its own ministry to the homeless, Elm Church collaborates with a Christian homeless ministry in the same community. One of Elm Church’s staff members works with the staff of the local Christian homeless ministry as part of his duties for Elm Church. Elm Church also provides volunteers to serve at the homeless ministry center, and Elm Church makes grants to the homeless ministry to help fund its operations.*

A church that considers collaborating with other churches or ministries should make sure that the expectations of all parties involved are clearly spelled out. Depending on the nature and extent of the collaboration, a legal agreement may be appropriate and necessary. Collaboration agreements can take various forms. However, it is wise for a church considering such an arrangement to consult with its legal counsel in order to ensure that a proposed collaboration arrangement and its related agreements are appropriate for the church and do not subject the church to unintended risks or other unanticipated consequences.

Consider the possibilities

As a normal part of the budgeting process, churches find themselves wishing to conduct more programs, activities, and initiatives than available funds will allow. By reducing certain expenses, they may be able to fund viable ministries that fulfill their mission. Additionally, churches that wish to improve their liquidity and financial position may need to reduce expenses in an effort to generate reasonable and appropriate cash flow surpluses to reach their targets.

For more information or to view this article online, please visit the Church Tax & Law Website . For more advice on cutting Church expenses or any other tax related questions, please contact our office.

Lunch Expenses for Church Staff—Business or Personal?

How to determine what your church should be paying for. – Posted 12/12/22

What is required for a lunch to be considered a business expense?

For lunches to qualify as a business expense, they need to have a legitimate business purpose, and that purpose has to be documented. Similar to needing receipts whenever there’s a meal involved, you also need to document who participated and the ministry purpose for the lunch.

You have to be honest and legitimate about your claim, and if it were ever challenged, the standard would be: “What would a reasonable person say?” If a youth pastor is claiming they’ve got a business lunch every day, a reasonable person may look at that and say, “That’s abusive.” A youth pastor may have a number of meetings outside of the church with students who are near the church: at a high school, a college campus, or somewhere similar. But would a reasonable person look at it and say, “That seems prudent to me”?

There isn’t a hard-and-fast rule or a checklist you can complete. But you need to make sure you can legitimately document a lunch’s purpose and that if other people look at it, they’d determine the expense was reasonable.

What about offsite meals with internal staff only—do churches need to exercise more caution then?

They need to be careful—again, they must make sure meals are not on a consistent basis and there are reasons for them.

For instance, why did a lunch have to take place outside of the church? Was it a meeting that could have taken place inside? It may be that it’s simply a periodic benefit to the employee: e.g., a performance evaluation was done outside the church as a matter of employee morale. But if that is being done on a consistent basis, then you go back to that “reasonable person” standard to see if it’s inappropriate.

How should church staff document these expenses?

Staff should create an expense report that is part of an accountable reimbursement plan the board has approved: one that lays out the criteria for expense reports. The report needs to be completed and submitted in a timely fashion, with receipts attached.

If the lunch expense is on a corporate credit card, you still need to turn the receipts in and have the documentation. The documentation should include who participated, the business purpose of the meeting, and usually the receipt will have the “when” and “how much” and “where.” If there is an individual expense reimbursement for it, it should be submitted and reimbursed within 60 days as a general guideline.

For expense reimbursements and charges on corporate credit cards, one of the most important things is that a supervisor needs to review and approve them. For a staff pastor, that supervisor may be the executive pastor or the senior pastor. For a senior pastor, a member of the board should be reviewing and approving those at least on a periodic basis—quarterly, for instance. That allows the “reasonable person” standard: if the supervisor looks at it and asks, “Why did you take the same person to lunch three times a week and submit it for expense reimbursement or put it on the corporate card?” that’s going to help cut down on that.

For more information or to view this article online, please visit the Church Tax & Law Website . If you have any questions regarding lunch expenses or any other tax related questions, please contact our office.

Key Tax Dates December 2022

Housing allowance designations, year-end transactions, 2022 donations, and more – Posted 12/9/22

Monthly requirements

If your church or organization reported withheld taxes of $50,000 or less during the most recent lookback period (for 2022, the lookback period is July 1, 2020, through June 30, 2021), then withheld payroll taxes are deposited monthly. Monthly deposits are due by the 15th day of the following month.

Note, however, that if withheld taxes are less than $2,500 at the end of any calendar quarter (March 31, June 30, September 30, or December 31), the church need not deposit the taxes. Instead, it can pay the total withheld taxes directly to the IRS with its quarterly Form 941. Withheld taxes include federal income taxes withheld from employee wages, the employee’s share of Social Security and Medicare taxes, and the employer’s share of Social Security and Medicare taxes.

Semiweekly requirements

If your church or organization reported withheld taxes of more than $50,000 during the most recent lookback period (for 2022, the lookback period is July 1, 2020, through June 30, 2021), then the withheld payroll taxes are deposited semiweekly.

This means that for paydays falling on Wednesday, Thursday, or Friday, the payroll taxes must be deposited on or by the following Wednesday. For all other paydays, the payroll taxes must be deposited on the Friday following the payday.

Note further that large employers having withheld taxes of $100,000 or more at the end of any day must deposit the taxes by the next banking day. The deposit days are based on the timing of the employer’s payroll. Withheld taxes include federal income taxes withheld from employee wages, the employee’s share of Social Security and Medicare taxes, and the employer’s share of Social Security and Medicare taxes.

December 15, 2022

  • Complete all year-end transactions to be sure that they are reportable on your income tax return.
  • A church must make quarterly estimated tax payments if it expects an unrelated business income tax (UBIT) liability for the year to be $500 or more. Use IRS Form 990-W to figure your estimated taxes.
  • For 2022, quarterly estimated tax payments of one-fourth of the total tax liability are due by April 18 (April 19 if you live in Maine or Massachusetts), June 15, September 15, and December 15, 2022, for churches on a calendar-year basis. Deposit quarterly tax payments using Electronic Federal Tax Payment System (EFTPS).

December 31, 2022

  • Churches must designate a portion of each minister’s compensation as a housing allowance by this date in order for ministers who own or rent their homes to receive the full benefit of a housing allowance exclusion for calendar year 2023. The designation should be adopted during a regular or special meeting of the church board and should be contained in the written minutes of the meeting.
  • Churches should designate a parsonage allowance for any minister who lives in a parsonage and who is expected to pay some of the expenses of maintaining the parsonage (e.g., utilities, furnishings, repairs, improvements, yard care, insurance).
  • Donors must deliver checks on or by this date to claim a charitable contribution deduction for 2022. Checks that are placed in the church offering during the first worship service in 2023 will not qualify for a charitable contribution deduction in 2022, even if the check is predated to 2022 or was written in 2022. However, checks that are written, mailed, and postmarked in 2022 will be deductible in 2022 even though they are not received by a church until 2023.
  • An employee’s marital status on this date determines his or her filing status for the year.
  • If you have a minister or lay worker who is treated as self-employed for federal income tax reporting purposes, but who you would like to reclassify as an employee, the ideal time to make the change is on January 1, 2023.

For more information or to view this article online, please visit the Church Tax & Law Website . If you have any questions regarding these deadlines or any other tax related questions, please contact our office.

Responding to the Elimination of the Business Expense Deduction

This tax reform change might mean it’s time to start an accountable reimbursement plan. – Posted 12/8/22

Prior to the Tax Cuts and Jobs Act of 2017, certain business expenses were deductible if, in aggregate, they exceeded 2 percent of the taxpayer’s adjusted gross income (AGI), said Richard Hammar, tax attorney, CPA, and senior editor of Church Finance Today.

Some expenses subject to the 2 percent AGI floor included:

  • overnight out-of-town travel;
  • local transportation;
  • meals (subject to a 50 percent AGI floor);
  • entertainment (subject to a 50 percent AGI floor);
  • home office expenses;
  • business gifts;
  • dues to professional societies;
  • work-related education;
  • work clothes and uniforms if required and not suitable for everyday use;
  • malpractice insurance;
  • subscriptions to professional journals and trade magazines related to the taxpayer’s work; and
  • equipment and supplies used in the tax- payer’s work.

The Tax Cuts and Jobs Act, however, “suspends all miscellaneous itemized deductions that are subject to the 2 percent floor,” Hammar said.The inability to itemize and deduct business expenses “will hit some clergy hard,” Hammar said. He suggested this possible workaround: “Churches could reimburse employees’ business expenses under an accountable expense reimbursement arrangement.”

To be accountable, a church’s reimbursement arrangement must comply with these four rules:

  1. Expenses must have a business connection—that is, the reimbursed expenses must represent expenses incurred by an employee while performing services for the employer.
  2. Employees are only reimbursed for expenses for which they provide an adequate accounting within a reasonable period of time (not more than 60 days after an expense is incurred).
  3. Employees must return any excess reimbursement or allowance within a reasonable period of time (not more than 120 days after an excess reimbursement is paid).
  4. In order for an employer’s reimbursement arrangement to be accountable, the income tax regulations caution, it must meet a “reimbursement requirement” in addition to the three requirements summarized above. The reimbursement requirement means that an employer’s reimbursements of an employee’s business expenses come out of the employer’s funds and not by reducing the employee’s salary.

“I have advocated for years that churches need to get on board with an accountable expense reimbursement plan,” said Frank Sommerville, tax attorney, CPA, and an editorial advisor for Church Finance Today. He then added, “Frankly, I applaud the elimination of the deduction for the unreimbursed employee business expenses,” explaining that far too many churches simply do not properly review and report taxable employee business expense reimbursements. “I’m handling an IRS exam right now on a pastor who didn’t do it right,” he said. “Pastors just don’t do it right. It’s a complicated process.”

Tax attorney and CPA Ted Batson, however, is not convinced that an accountable expense reimbursement plan is practical or affordable for many smaller churches. Churches would need to carefully consider whether or not they can afford reimbursing a pastor’s business expenses, Batson explained, because it would mean more out-of-pocket expenses for the church.

Prior to the new law, he said, pastors could claim a “tax benefit,” but now that is no longer the case.

Paying for a pastor’s business expenses could be very difficult for a small church on a tight budget. To emphasize his point, Batson gave this scenario:

A pastor of a rural church makes weekly and multiple visits to homebound parishioners and to hospitalized members. Because the congregation is spread across many miles of countryside, the pastor puts in an average of 10,000 miles per year. At a mileage rate of 54.5 cents a mile, the pastor would incur an expense of $5,450.

Reimbursing a travel expense like that, Batson said, would greatly stretch or even break the budget of a small church and also create a system that is difficult for a smaller church to manage. Unlike larger churches, smaller churches often lack the staff size and well-defined financial systems that allow them to make use of such a plan. “This will create a quandary for small churches: they will either need to find a way to accommodate an accountable expense plan, perhaps with a cap, or the pastor will suffer the brunt of the tax law change,” Batson explained.

Sommerville feels that setting a cap could make such an accountable plan work for smaller churches. They would just need to establish and adhere to certain stipulations on spending, which includes setting a reasonable and affordable cap. “You let the pastor know that you are going to reimburse his or her expenses up to $4,000, $5,000, or whatever the church can afford.”

Along with that, Sommerville said that the church treasurer or financial manager must commit to reviewing and approving the expense for which the pastor is seeking reimbursement. And that can sometimes create a problem. Nobody wants to get on the pastor’s bad side, he said. Even so, it is a financial manager’s job to hold a pastor and all church staff accountable for the use of the church’s funds—and an accountable reimbursement plan would help a church financial manager do just that.

For more information or to view this article online, please visit the Church Tax & Law Website . If you have any questions regarding the elimination of the business expense deduction or any other tax related questions, please contact our office.

Top 3 Most Confusing Tax Issues for Clergy

What new—and veteran—ministers and treasurers need to know to file taxes correctly and receive maximum tax benefits. – Posted 12/7/22

Ministers and treasurers must be familiar with the tax rules that apply to clergy. Unfortunately, seminary training rarely equips new ministers with this information, and church treasurers often don’t know about the unique tax laws that apply to clergy. This information gap means ministers and treasurers frequently handle clergy income and the payment of related taxes incorrectly, and they fail to take advantage of the tax benefits that are available to ministers.

For instance, ministers are eligible for five special tax rules with respect to services they perform in the exercise of their ministry. These include (1) not paying federal income taxes on the portion of their church compensation designated in advance by their church as a housing allowance (limitations apply), (2) not paying federal income taxes on the annual rental value of a parsonage provided by their church, (3) being exempt from “self-employment taxes” (Social Security taxes paid by the self-employed) if several conditions are met, (4) being considered self-employed for Social Security (if not exempt), and (5) having ministers’ wages exempt from income tax withholding.

In order to qualify for these tax savings, however, you must meet the IRS’s definition of a “minister.” The IRS applies a five-factor test to determine whether an individual qualifies as a minister for federal income tax purposes. In general, for individuals to enjoy the five special tax rules summarized above, they must satisfy two main requirements: they must be a minister, and they must be engaged in the exercise of ministry.

Assuming you clear these IRS hurdles for establishing whether or not you’re a minister for federal tax purposes, you then need to know how to file taxes properly to ensure you receive the benefits available to you.

In this article, we focus on three of the most perennially perplexing tax issues for clergy. While there are many more we could cover, these are the three that pose confusion and uncertainty for many ministers and church treasurers, new and seasoned.

1. Should a Minister Report Income Taxes as an Employee or as Self-Employed?

The question of whether ministers should report their federal income taxes as an employee or as self-employed is a significant one. Most new ministers should report their federal income taxes as employees, because they will be considered employees under the tests currently used by the IRS and the courts. Most clergy will be “better off” reporting as employees, since (1) the value of various fringe benefits will be excludable, including the cost of employer-paid health insurance premiums on the life of the minister, (2) the risk of an IRS audit is substantially lower, and (3) reporting as an employee avoids the additional taxes and penalties that often apply to self-employed clergy who are audited by the IRS and reclassified as employees.

2. Should a Minister Report Social Security Taxes as an Employee or as Self-Employed?

There is one provision in the tax code that has caused more confusion for ministers and church treasurers than any other, and it is this: ministers are always treated as self-employed for Social Security with regard to services they perform in the exercise of their ministry (except for some chaplains). This is true even if they are employees for federal income tax reporting. This is sometimes referred to as the “dual tax status” of ministers.

Many new (and even veteran) ministers are surprised to learn that their employment status for income tax purposes has no bearing on their employment status for Social Security taxes. This often creates confusion. Ministers are always self-employed for Social Security with respect to their ministerial services. This is true even if you are treated as an employee for federal income tax purposes. This means you pay the self-employment tax, not “Social Security” and “Medicare” taxes. Your employing church must not treat you as an employee for Social Security, even though it issues you a W-2 for income taxes.

The most important consequence of this dual tax status is that ministers pay the so-called “self-employment tax.” This is the Social Security tax that is paid by self-employed workers. It amounts to 15.3 percent of a minister’s taxable earnings. Employees and employers pay “Social Security” and “Medicare” taxes (sometimes collectively referred to as “FICA” taxes). Like self-employment taxes, these taxes amount to 15.3 percent of a minister’s taxable earnings. But there is a big difference. Employers and employees split the 15.3 percent tax rate, with each paying 7.65 percent. Self-employed persons pay the entire self-employment tax. Many churches pay half, or even all, of a minister’s self-employment tax. This is perfectly appropriate, but any amount paid by the church must be reported as taxable income to the minister.

3. How Does a Minister Pay Taxes?

Many churches erroneously withhold the employee’s share of Social Security and Medicare taxes from ministers’ compensation, and then pay the employer’s share. In other words, they treat their minister as an employee for Social Security. This is understandable, especially when the church treats the minister as an employee for purposes of federal income taxation. But, it is always incorrect for a church to treat a minister as an employee for Social Security. Self-employment taxes for ministers are computed on Schedule SE of Form 1040.

The federal income tax is a “pay as you go” tax. This means that you must pay your tax as you earn income during the year. There are two ways to do this—quarterly estimated tax payments and tax withholding.

Ministers must prepay their income taxes and self-employment taxes using the estimated tax procedure, which can be confusing. Nonetheless, it’s important to understand how to calculate and pay estimated taxes to avoid significant tax liabilities.

Generally, you should make estimated tax payments if your estimated tax for this year will be $1,000 or more and the total amount of income tax that will be withheld from your income will be less than the lesser of (1) 90 percent of your tax liability for the current year, or (2) 100 percent of your tax liability for the previous year (if it covered all 12 months of the year). If you are required to pay estimated taxes, but fail to do so, you will be subject to an “underpayment penalty.” Since the penalty is figured separately for each quarterly period, you may owe a penalty for an earlier payment period even if you later paid enough to make up the underpayment. If you did not pay enough tax by the due date of each of the payment periods, you may owe a penalty even if you are due a refund when you file your income tax return!

The 4-step procedure for paying estimated taxes

Complying with the estimated tax procedure is easier than it seems. Here are the four steps you need to follow:

Step 1–Obtain a copy of IRS Form 1040-ES prior to April 15 of the current year.
Step 2–Compute estimated taxes.

Calculate your estimated tax for the current year by estimating adjusted gross income and then subtracting estimated adjustments, deductions, exemptions, and credits. Multiply estimated taxable income times the applicable tax rate contained in the Tax Rate Schedule reproduced on Form 1040-ES. Include your estimated Social Security tax on the worksheet if you are not exempt, and include your housing allowance exclusion in computing your estimated earnings subject to the self-employment tax.

Step 3–Pay estimated taxes in quarterly installments.

If estimated taxes (federal income taxes and self-employment taxes) are more than $1,000 for the current year, and the total amount of taxes to be withheld from your compensation is less than the lesser of (1) 90 percent of your tax liability for the current year, or (2) 100 percent of your tax liability for the previous year, then you must pay one-fourth of your total estimated taxes in four quarterly installments (by April 15 for January 1 to March 31; by June 15 for April 1 to May 31; by September 15 for June 1 to August 31; and by January 15 for September 1 to December 31). If the due date for making an estimated tax payment falls on a Saturday, Sunday, or legal holiday, the payment will be on time if you make it on the next business day.

Payment vouchers. You must send each payment to the IRS, accompanied by one of the four payment vouchers contained in Form 1040-ES.

Starting a job in mid-year. A minister who becomes liable for estimated tax payments midway through a year should submit a payment voucher by the next filing deadline accompanied by a check for a prorated portion of the entire estimated tax liability for the year.

Changing your quarterly payments. Changes in your income, deductions, credits, or exemptions may make it necessary for you to refigure your estimated tax and adjust your remaining quarterly payments accordingly.

Step 4–Compute actual taxes.

After the close of the year, compute your actual tax liability on Form 1040. Only then will you know your actual income, deductions, exclusions, and credits. Estimated tax payments rarely reflect actual tax liability. Most taxpayers’ estimated tax payments are either more or less than actual taxes as computed on Form 1040 (usually less).

Overpayment. If you overpaid, you can elect to have the overpayment credited against your first quarterly estimated tax payment of the following year or spread out in any way you choose among any or all of your next four quarterly installments. Alternatively, you can request a refund of the overpayment.

Underpayment. If you underpaid your estimated taxes you may have to pay a penalty. The penalty is computed separately for each quarterly payment period. Contrary to popular belief, payment of your entire estimated tax liability with your Form 1040 will not relieve you of the penalty if you did not pay the estimated income tax due earlier in the year.

Form 2210. You can use Form 2210 to see if you owe a penalty and to figure the amount of the penalty. If you owe a penalty and do not attach Form 2210 to your Form 1040, the IRS will compute your penalty and send you a bill. You do not have to fill out a Form 2210 or pay any penalty if either of two conditions apply: (1) your total tax less income tax withheld is less than $1,000, or (2) you had no tax liability last year and you were a United States citizen or resident for the entire year. The IRS can waive the underpayment penalty if the underpayment was due to casualty, disaster, or other unusual circumstance and it would be inequitable to impose the penalty.

Special rule for high-income taxpayers. A high-income taxpayer with adjusted gross income for the previous year of at least $150,000 cannot avoid the underpayment penalty by paying estimated taxes for the current year of at least 100 percent of last year’s tax. For such persons, the “100 percent rule” is replaced with a 110 percent rule, meaning that they will be subject to an underpayment penalty unless they have paid estimated taxes for the current year of at least the lesser of (1) 90 percent of the current year’s actual tax liability, or (2) 110 percent of last year’s actual tax liability.

Voluntary withholding

Ministers who report their income taxes as an employee may request “voluntary withholding” of their income taxes and self-employment taxes by filing a Form W-4 with the church. A self-employed minister is free to enter into an “unofficial” withholding arrangement whereby the church withholds a portion of his or her compensation each week and deposits it in a church account, and then distributes the balance to the minister in advance of each quarterly estimated tax payment due date.

For more information or to view this article online, please visit the Church Tax & Law Website . If you have any questions regarding these tax issues or any other non-profit tax questions, please contact our office.

What to Know About Tax Preparation Software for Pastors

Understanding the benefits and pitfalls of using tax programs for clergy. – Posted 12/6/22

Tax preparation software packages, such as TurboTax, TaxAct, H&R Block, and TaxSlayer, are becoming popular ways for individuals to prepare their own income tax returns. However, these software packages are not specifically designed to address some of the tax rules unique to ministers.

Ministers using a tax software package to prepare their income tax returns should be familiar with these unique rules, and should consider seeking the advice of a tax professional with experience in preparing ministers’ tax returns, in order to ensure that their tax returns are prepared accurately.

Software benefits

Most of the leading income tax software products are offered in boxed, downloadable, or online versions, making them easily accessible. They are also relatively inexpensive, generally in the $50 to $100 range for the federal self-employed version, with an additional cost to prepare a state income tax return (some versions are even offered free of charge to lower income individuals).

The ability to import tax data from other sources (e.g., from investment accounts or from Quicken/QuickBooks);These packages also offer the ability to electronically file the federal (and sometimes the state) income tax return, which greatly speeds up the refund process. A top-notch package will also include additional features (sometimes for an additional price), such as:

  • An interview interface to guide you through the preparation process;
  • Error-checking of the return after it has been prepared;
  • A deduction finder to alert you to income tax deductions that may be applicable;
  • Easy access to IRS publications;
  • Tax planning assistance;
  • Audit defense (for example, in the case of an IRS audit, the manufacturer will defend the income tax filer if there is an error resulting from the use of the manufacturer’s product); and
  • Financial or retirement planning assistance.

Three rules unique to ministers

While the benefits noted above can make using tax preparation software packages an attractive alternative for ministers preparing their own returns, these packages are often limited in their ability to address some of the unique tax rules applicable to ministers.


1. Social Security and Medicare taxes

Three rules, outlined below, are applicable to duly ordained, licensed, or commissioned ministers who are being paid for services performed in the exercise of their ministry. These rules are not applicable to income or wages earned by a minister outside of the ministerial context (such as for secular employment).

Under federal tax law, ministers employed by a church have a “dual tax status.”

They are considered employees for federal income tax purposes, but are considered self-employed for federal employment tax purposes. Therefore, a minister will generally receive a Form W-2 from his employing church for wages earned, but those wages are not subject to employee- and employer-paid FICA taxes (related to Social Security and Medicare). Instead, ministers are responsible for paying the full amount due into the Social Security and Medicare systems through the payment of self-employment (also known as SECA) taxes, computed on Schedule SE of their personal income tax returns.

Ministers who are conscientiously opposed to, or because of their religious principles are opposed to, the acceptance of any public insurance (such as Social Security or Medicare) with respect to their ministerial earnings may elect out of the Social Security/Medicare system by filing Form 4361 with the IRS.

The Form 4361 must generally be filed within two years of the first year that a minister has earnings from ministerial work. Ministers who have made this election would not complete Schedule SE, but would enter “Exempt-Form 4361” on the dotted line next to Form 1040, Schedule 2, line 4, and/or Form 1040, line 23 (other taxes, including self-employment tax).

Ministers using tax preparation software should check to make sure that the software accepts their Form W-2, since a properly prepared Form W-2 will not show their wages as subject to Social Security or Medicare taxes.

The minister also should make sure that their wages are properly being treated by the software package as self-employment income, for purposes of computing the self-employment tax, if applicable to the minister. For ministers electing out of the Social Security system, check to make sure that the tax software package makes the notational entry on Schedule 2, line 4, and/or line 23 of the Form 1040.

2. Parsonage or housing allowance exclusion

Ministers may exclude from their taxable income the annual fair rental value of a parsonage provided rent-free by their church as part of their compensation package.

Ministers may also exclude from their taxable income cash payments that have been properly designated by their employing church as a ministerial housing allowance, up to the lesser of: (1) the amount used to pay for housing-related expenses (such as mortgage payments or rent, utilities, repairs, furnishings, insurance, property taxes, improvements, maintenance, and homeowners’ association dues), or (2) the fair rental value of the home, including furnishings and utilities.

The parsonage/housing allowance is excludible for income tax purposes only. For ministers who have not opted out of the Social Security system, their parsonage/housing allowance must generally be included in determining their self-employment tax.

Ministers using tax preparation software should therefore check to make sure the package is properly limiting the housing allowance exclusion based on the limitations noted above, and that the package is properly including the parsonage/housing allowance amount in the calculation of self-employment income.

3. Limitation on/disallowance of business expense deductions

Many ministers may incur expenses in connection with their church employment, which are not reimbursed by the church. For tax years 2018 through 2025, such unreimbursed employee business expenses are not deductible for federal income tax purposes.

Ministers may also incur expenses, such as travel expenses, in connection with ministerial income earned outside of their employment (such as honorarium payments received for speaking engagements, weddings, or funerals). Business expenses related to ministerial income earned outside of a minister’s employment (reportable on Form 1040, Schedule C) incurred in connection with ministerial earnings are not deductible for federal income tax purposes to the extent that they are allocable to tax-exempt parsonage or housing allowances.

In order to compute the nondeductible portion, the minister should first determine his total ministerial income, including the parsonage/housing allowance. The minister should then divide the parsonage/housing allowance by the total ministerial income to determine the nontaxable percentage. This percentage should then be applied to any business expenses incurred to determine the nondeductible portion. Only the deductible portion should then be reported on Schedule C.

Many of the tax software packages do not automatically calculate the nondeductible portion of business expenses allocable to the tax-free portion of a minister’s income. Ministers will therefore need to manually adjust these expenses and input the reduced figure into the software for purposes of computing the income tax deduction. However, since the parsonage/housing allowance is included in the computation of the amount subject to the self-employment tax, the full amount of the business expenses should be used to compute the net earnings from self-employment reportable on Schedule SE.

Exercise Caution

Tax preparation software packages offer many benefits and conveniences, making them an attractive alternative for individuals wishing to prepare their own income tax returns. However, ministers who are considering using an income tax software package should carefully check their returns to ensure that the situations outlined above are addressed correctly.

For more information or to view this article online, please visit the Church Tax & Law Website . If you would like to learn more about tax preparation software and how if will benefit your ministry, please contact our office.

Housing Allowances

Understand how to properly set this significant pastoral benefit. – Posted 12/5/22

The housing allowance is the most important tax benefit available to ministers. But many ministers do not take full advantage of it because they (or their tax adviser or church board) are not familiar with the rules.

The three most commonly used housing arrangements for ministers are (1) owning a home, (2) renting a home or apartment, and (3) living in a church-provided parsonage. The tax code provides a significant benefit to each housing arrangement. The rules are summarized below.

Housing allowance: minister owns the home

Ministers who own their home do not pay federal income taxes on the amount of their compensation that their employing church designates in advance as a housing allowance, to the extent that the allowance represents compensation for ministerial services, is used to pay housing expenses, and does not exceed the fair rental value of the home (furnished, plus utilities). Housing-related expenses include mortgage payments, utilities, repairs, furnishings, insurance, property taxes, additions, and maintenance.

Housing allowance: minister rents the home

Ministers who rent a home or apartment do not pay federal income taxes on the amount of their compensation that their employing church designates in advance as a housing allowance, to the extent that the allowance represents compensation for ministerial services and is used to pay rental expenses and does not exceed the fair rental value of the home (furnished, plus utilities).

Parsonages

Ministers who live in a church-owned parsonage that is provided rent-free as compensation for ministerial services do not include the annual fair rental value of the parsonage as income in computing their federal income taxes. The annual fair rental value is not deducted from the minister’s income. Rather, it is not reported as additional income anywhere on Form 1040 (as it generally would be by most non-clergy workers).

In addition, ministers who live in a church-provided parsonage do not pay federal income taxes on the amount of their compensation that their employing church designates in advance as a parsonage allowance, to the extent that the allowance represents compensation for ministerial services and is used to pay parsonage-related expenses such as utilities, repairs, and furnishings.

How to set parsonage and housing allowances

Parsonage and housing allowances should be (1) adopted by the church board or congregation, (2) in writing, and (3) in advance of the calendar year. However, churches that fail to designate an allowance in advance of a calendar year should do so as soon as possible in the new year (though the allowance will only operate prospectively). In designating housing allowances, churches should keep in mind that the nontaxable portion of a housing allowance cannot exceed the fair rental value of a minister’s home (furnished, plus utilities). Therefore, nothing will be accomplished by designating allowances significantly above this limit.

Using “safety nets”

Many churches do not limit housing allowances to a particular cal­endar year. For example, if a church intends to designate $12,000 of its senior pastor’s salary in 2021 as a housing allowance, its designa­tion could state that the allowance is effective for calendar year 2021 and all future years unless otherwise provided. This clause may provide a “safety net,” protecting the pastor in the event that the board neglects to designate an allow­ance prior to the beginning of a future year.

A church also would be wise to have a “safety net” designation to cover midyear changes in personnel, delayed designations, and other unexpected contingencies. To illustrate, such a designation could simply state that a specified percentage (e.g., 40 percent) of the compensation of all ministers on staff, regardless of when hired, is designated as a housing allowance for the current year and all future years unless otherwise specifically provided.

Such safety net designations should not be used as a substitute for annual housing allowance designations for each minister. They are simply a means of protecting ministers against inadvertent failures by the church board to designate a timely housing allowance.

Key details

Here is a recap of some important details, along with some helpful additional information ministers should know about the housing allowance:

  • A housing allowance must be designated in advance. Retroactive designations of housing allowances are not effective.
  • The housing allowance designated by the church is not necessarily nontaxable. It is nontaxable (for income taxes) only to the extent that it is used to pay for housing expenses, and, for ministers who own or rent their home, does not exceed the fair rental value of their home (furnished, plus utilities).
  • A housing allowance can be amended during the year if a minister’s housing expenses are more than expected. However, an amendment is only effective prospectively. Ministers should notify their church if their actual housing expenses are significantly more than the housing allowance designated by their church. But note that it serves no purpose to designate a housing allowance greater than the fair rental value of a minister’s home (furnished, plus utilities).
  • If the housing allowance designated by the church exceeds housing expenses or the fair rental value of a minister’s home, the excess housing allowance should be reported on line 1 of Form 1040.
  • The housing allowance exclusion is an exclusion for federal income taxes only. Ministers must add the housing allowance as income in reporting self-employment taxes on Schedule SE (unless they are exempt from self-employment taxes).
  • The fair rental value of a church-owned home provided to a minister as compensation for ministerial services is not subject to federal income tax.
  • Ministers should be sure that the designation of a housing or parsonage allowance for the next year is on the agenda of the church board for one of its final meetings during the current year. The designation should be an official action, and it should be duly recorded in the minutes of the meeting. The IRS also recognizes designations included in employment contracts and budget line items—assuming in each case that the designation was duly adopted in advance by the church.
  • Many churches base the housing allowance on their minister’s estimate of actual housing expenses for the new year. The church provides the minister with a form on which anticipated housing expenses for the new year are reported. For ministers who own their homes, the form asks for projected expenses in the following categories: down payment; mortgage payments; property taxes; property insurance; utilities, furnishings, and appliances; repairs and improvements; maintenance; and miscellaneous. Many churches designate an allowance in excess of the anticipated expenses itemized by the minister. Basing the allowance solely on a minister’s anticipated expenses penalizes the minister if actual housing expenses turn out to be higher than expected. In other words, the allowance should take into account unexpected housing costs or underestimated projections of expenses.
  • Ministers who own their homes lose the largest component of their housing allowance exclusion when they pay off their home mortgage. Many ministers in this position have obtained home equity loans—or a conventional loan secured by a mortgage on their otherwise debt-free home—and have claimed their payments under these kinds of loans as a housing expense in computing their housing allowance exclusion. The Tax Court has ruled that this is permissible only if the loan was obtained for housing-related expenses.

For more information or to view this article online, please visit the Church Law & Tax Website. To learn more about housing allowance benefits or if you have any questions, please contact our office.

Making Sense of the Tax Cuts and Jobs Act – What tax law changes mean for church employees and donors.

**Posted 12/2/22

The Tax Cuts and Jobs Act of 2017 amends the Internal Revenue Code to reduce tax rates and modify credits and deductions for individuals and businesses. With respect to individuals, the bill:

  • Replaces the seven existing tax brackets (10 percent, 15 percent, 25 percent, 28 percent, 33 percent, 35 percent, and 39.6 percent) with seven new and lower brackets (10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent, and 37 percent).
  • Temporarily increases (through 2025) the basic standard deduction to $24,000 for married individuals filing a joint return, $18,000 for head-of-household filers, and $12,000 for all other individuals.

    1. Estimates of the impact of the new law on charitable giving differ widely.

    2. IRS statistics demonstrate that the taxpayers who give the largest percentage of their income to charity are lower income individuals who claim the standard deduction and therefore receive no “benefit” in the form of an itemized deduction for making gifts to charity.

    3. Some donors may be incentivized to give more to charity because of their concern over the potentially negative impact of the Act’s substantial increase in the standard deduction on charitable giving.

    4. Perhaps more so than any other charitable donors, those who give to their church or other religious organization do so out of a desire to benefit the recipient rather than provide a tax break for themselves.

    5. Should the substantial increase in the standard deduction result in a material decline in charitable giving, Congress will face increasing pressure from a wide array of prominent religious and secular charities to provide relief.

  • The significantly increased standard deduction will reduce the number of persons who are able to itemize deductions on Schedule A (Form 1040) from 30 percent to as few as 5 percent of all taxpayers. The result will be a significant decrease in the number of taxpayers who can claim a tax deduction for contributions they make to churches and other charities. Will the loss of a charitable contribution deduction by 95 percent of all taxpayers discourage them from contributing to their church or favorite charities? Possibly, but note the following:
  • A section 529 plan (also known as a “qualified tuition plan”) is a plan operated by a state or educational institution with tax advantages and potentially other incentives to make it easier to save for college and other post-secondary training for a designated beneficiary, such as a child or grandchild. The main tax advantage of a 529 plan is that earnings are not subject to federal tax and generally are not subject to state tax when used for the qualified education expenses of the designated beneficiary, such as tuition, fees, books, as well as room and board. The Tax Cuts and Jobs Act modifies section 529 plans to allow such plans to distribute not more than $10,000 in expenses for tuition incurred during the taxable year in connection with the enrollment or attendance of the designated beneficiary at a public, private, or religious elementary or secondary school. The new rules apply to distributions made after December 31, 2017.
  • The Tax Cuts and Jobs Act repeals both the moving expense deduction, and the exclusion of employer reimbursements of moving expenses under an accountable arrangement—except in the case of a member of the Armed Forces of the United States on active duty who moves pursuant to a military order. This provision is effective for taxable years 2018 through 2025.
  • Under the Affordable Care Act (Obamacare) individuals must be covered by a health plan that provides at least minimum essential coverage or be subject to a tax (also referred to as a penalty) for failure to maintain the coverage (commonly referred to as the “individual mandate”). The Tax Cuts and Jobs Act reduced the amount of the ACA’s individual responsibility payment to zero with respect to health coverage status for months beginning after December 31, 2018.
  • Under prior law, in determining taxable income, an individual reduced adjusted gross income (AGI) by any personal exemption deductions and either the applicable standard deduction or itemized deductions. Personal exemptions generally were allowed for the taxpayer, the taxpayer’s spouse, and any dependents. For 2017, the amount deductible for each personal exemption was $4,050. This amount was indexed annually for inflation, and would have been $4,150 for 2018. The Tax Cuts and Jobs Act of 2017 repeals the deduction for personal exemptions for taxable years 2018 through 2025.
  • Under prior law, individuals could claim itemized deductions for certain miscellaneous expenses. Certain of these expenses were not deductible unless, in aggregate, they exceeded 2 percent of the taxpayer’s AGI. The Tax Cuts and Jobs Act suspends all miscellaneous itemized deductions that are subject to the 2-percent floor under present law. As a result, taxpayers may not claim these personal and business expense items as itemized deductions for the taxable years to which the suspension applies.
  • This provision is effective for taxable years 2018 through 2025 and will not apply thereafter unless extended by Congress.
  • The Act temporarily increases the child tax credit to $2,000 per qualifying child (the maximum amount refundable may not exceed $1,400 per qualifying child). The credit is further modified to temporarily provide for a $500 nonrefundable credit for qualifying dependents other than qualifying children (such as aging parents). The provision generally retains the present-law definition of dependent.
  • The Act allows taxpayers to claim an itemized deduction of up to $10,000 ($5,000 for a married taxpayer filing a separate return) for the aggregate of state and local property taxes and state and local income taxes (or sales taxes in lieu of income taxes) paid or accrued in the taxable year. The new rules apply to taxable years 2018 through 2025.
  • Under prior law, individuals could claim an itemized deduction for unreimbursed medical expenses, but only to the extent that such expenses exceeded 10 percent of AGI. The Tax Cuts and Jobs Act provided that, for taxable years 2017 and 2018, the threshold for deducting medical expenses would be 7.5 percent for all taxpayers. It went back to 10 percent in 2019.
  • The alternative minimum tax (AMT) was enacted by Congress in 1969 in response to public outrage over the disclosure that 155 wealthy Americans paid no federal income taxes. From its beginnings a half century ago, affecting a handful of taxpayers, the AMT steadily captured more and more Americans. According to the Tax Foundation, 9.7 million Americans had to do the AMT calculations last year, and of these, 3.9 million owed additional taxes. The modifications contained in the Tax Cuts and Jobs Act of 2017 do not repeal the AMT, but ensure that very few taxpayers will be affected. Specifically, the Act temporarily increases both the exemption amount and the exemption amount phaseout thresholds for the individual AMT. The AMT exemption amount is increased to $109,400 for married taxpayers filing a joint return (half this amount for married taxpayers filing a separate return), and $70,300 for all other taxpayers. The phaseout thresholds are increased to $1 million for married taxpayers filing a joint return, and $500,000 for all other taxpayers (other than estates and trusts). These amounts are indexed for inflation.
  • The Tax Cuts and Jobs Act doubles the estate and gift tax exemption for estates of decedents dying after 2017 and before 2026. This is accomplished by increasing the basic exclusion amount provided in section 2010(c)(3) of the tax code from $5 million to $10 million. The $10 million amount is indexed for inflation occurring after 2011, and for 2018 was $11.2 million. This amount can be doubled to $22.4 million for married couples who establish a marital deduction trust or qualified terminable interest property trust (QTIP trust).

For more information or to view this article online, please visit the Church Law & Tax website

Tax News for November 2022 . . .

IRS posts info on required amendments for 403(b) plans

The Internal Revenue Service issued a notice containing a list of required amendments needed for Section 403(b) plans. 

A 403(b) plan, also called a tax-sheltered annuity plan, is a retirement plan for certain employees of public schools, employees of certain Section 501(c)(3) tax-exempt organizations and certain ministers. A 403(b) plan allows employees to contribute some of their salary toward the plan.

Notice 2022-62, released Monday by the IRS, contains the 2022 required amendments list, establishing the end of the remedial amendment period and the plan amendment deadline for changes in qualification requirements and Section 403(b) requirements for both qualified individually designed plans and individually designed plans, respectively.

The list is divided into two parts. Part A covers changes in requirements that generally would require an amendment to most plans or to most plans of the type affected by the change. Part B includes changes in requirements that the Treasury Department and the IRS don’t expect to require amendments to most plans but might require an amendment because of an unusual plan provision in a specific plan.

For instance, the IRS noted, if a change affects a particular requirement that most plans incorporate by reference, Part B would include that change because a particular plan might not incorporate the requirement by reference, so it might include language that’s inconsistent with the change. 

Source: Accounting Today

 

With year-end approaching, it is time to start thinking about moves that may help lower your tax bill for this year and next. This year’s planning is more challenging than usual due to recent changes made by the Inflation Reduction Act of 2022 and the potential change in congressional balance of power resulting from the midterm elections.

Thomson Reuters Checkpoint has compiled a list of actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all of them will apply to you, but you (or a family member) may benefit from many of them . . .

  • Higher-income individuals must be wary of the 3.8% surtax on certain unearned income.
  • As year-end nears, the approach taken to minimize or eliminate the 3.8% surtax will depend on the taxpayer’s estimated MAGI and NII for the year.
  • The 0.9% additional Medicare tax also may require higher-income earners to take year-end action. Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed persons must take it into account in figuring estimated tax. 
  • Long-term capital gain from sales of assets held for over one year is taxed at 0%, 15% or 20%, depending on the taxpayer’s taxable income. If you hold long-term appreciated-in-value assets, consider selling enough of them to generate long-term capital gains that can be sheltered by the 0% rate
  • Postpone income until 2023 and accelerate deductions into 2022 if doing so will enable you to claim larger deductions, credits, and other tax breaks for 2021 that are phased out over varying levels of AGI.
  • Consider converting traditional IRA money invested in any beaten-down stocks (or mutual funds) into a Roth IRA in 2022 if eligible to do so.
  • Try to arrange with your employer to defer, until early 2023, a bonus that may be coming your way.
  • You can still itemize medical expenses that exceed 7.5% of your AGI, state and local taxes up to $10,000, your charitable contributions, plus mortgage interest deductions on a restricted amount of debt, but these deductions won’t save taxes unless they total more than your standard deduction.
  • Some taxpayers may be able to work around these deduction restrictions by applying a bunching strategy to pull or push discretionary medical expenses and charitable contributions into the year where they will do some tax good.
  • Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2022 deductions even if you don’t pay your credit card bill until after the end of the year.
  • If you expect to owe state and local income taxes when you file your return next year and you will be itemizing in 2022, consider asking your employer to increase withholding of state and local taxes (or make estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2022.
  • Required minimum distributions RMDs from an IRA or 401(k) plan (or other employer-sponsored retirement plan) have not been waived for 2022. If you were 72 or older in 2022 you must take an RMD. Those who turn 72 this year have until April 1 of 2023 to take their first RMD but may want to take it by the end of 2022 to avoid having to double up on RMDs next year.
  • If you are age 70½ or older by the end of 2022, and especially if you are unable to itemize your deductions, consider making 2022 charitable donations via qualified charitable distributions from your traditional IRAs.
  • Take an eligible rollover distribution from a qualified retirement plan before the end of 2022 if you are facing a penalty for underpayment of estimated tax and increasing your wage withholding won’t sufficiently address the problem.
  • Consider increasing the amount you set aside for next year in your employer’s FSA if you set aside too little for this year and anticipate similar medical costs next year.
  • If you become eligible in December of 2022 to make HSA contributions, you can make a full year’s worth of deductible HSA contributions for 2022.
  • Make gifts sheltered by the annual gift tax exclusion before the end of the year if doing so may save gift and estate taxes.
  • If you were in federally declared disaster area, and you suffered uninsured or unreimbursed disaster-related losses, keep in mind you can choose to claim them either on the return for the year the loss occurred (in this instance, the 2022 return normally filed next year), or on the return for the prior year (2021), generating a quicker refund.
  • If you were in a federally declared disaster area, you may want to settle an insurance or damage claim in 2022 to maximize your casualty loss deduction this year.

These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you. Please contact the office if you have any questions.

IRS: Penalty Relief for Taxpayers Filing 2019, 2020 Returns

IR 2022-155, 8/24/2022; Notice 2022-36, 2022-36 IRB

The IRS is providing penalty relief to certain taxpayers who filed their 2019 and/or 2020 tax returns late. The penalty relief also extends to certain domestic and international information return filers. 

Who qualifies for relief? For income tax filers to qualify for this penalty relief, any “eligible income tax return” must be filed on or before September 30, 2022.

Penalty relief is automatic. Eligible return filers don’t need to apply for this relief. If the IRS has already assessed a late-filing penalty, it will be abated. If a filer has already paid a late-filing penalty, the filer will receive a credit or refund.

Note. According to the IRS, nearly 1.6 million taxpayers will automatically receive penalty refunds or credits. Many of these payments will be completed by the end of September 2022, the IRS said.

 
 

Inflation Reduction Act’s Individual, Small-Business Credits

The recently enacted Inflation Reduction Act of 2022 contains several new environment-related tax credits that are of interest to individuals and small businesses. The Act also extends and modifies some pre-existing credits.

Extension, Increase, and Modifications of Non-business Energy Property Credit

Before the enactment of the Act, you were allowed a personal credit for specified non-business energy property expenditures. The credit applied only to property placed in service before January 1, 2022. Now you may take the credit for energy-efficient property placed in service before January 1, 2033.

Increased credit. The Act increases the credit for a tax year to an amount equal to 30% of the sum of (a) the amount paid or incurred by you for qualified energy efficiency improvements installed during that year, and (b) the amount of the residential energy property expenditures paid or incurred by you during that year. The credit is further increased for amounts spent for a home energy audit. The amount of the increase due to a home energy audit can’t exceed $150.

Annual limitation in lieu of lifetime limitation. The Act also repeals the lifetime credit limitation, and instead limits the allowable credit to $1,200 per taxpayer per year. In addition, there are annual limits of $600 for credits with respect to residential energy property expenditures, windows, and skylights, and $250 for any exterior door ($500 total for all exterior doors). Notwithstanding these limitations, a $2,000 annual limit applies with respect to amounts paid or incurred for specified heat pumps, heat pump water heaters, and biomass stoves and boilers.

Extension and Modification of Residential Clean-Energy Credit

Before the enactment of the Act, you were allowed a personal tax credit, known as the residential energy efficient property (REEP) credit, for solar electric, solar hot water, fuel cell, small wind energy, geothermal heat pump, and biomass fuel property installed in homes in years before 2024.

The Act makes the credit available for property installed in years before 2035. The Act also makes the credit available for qualified battery storage technology expenditures.

Extension, Increase, and Modifications of New Energy Efficient Home Credit

Before the enactment of the Act a New Energy Efficient Home Credit (NEEHC) was available to eligible contractors for qualified new energy efficient homes acquired by a homeowner before Jan. 1, 2022. A home had to satisfy specified energy saving requirements to qualify for the credit. The credit was either $1,000 or $2,000, depending on which energy efficiency requirements the home satisfied.

The Act makes the credit available for qualified new energy efficient homes acquired before January 1, 2033. The amount of the credit is increased, and can be $500, $1,000, $2,500, or $5,000, depending on which energy efficiency requirements the home satisfies and whether the construction of the home meets prevailing wage requirements.

New Clean-Vehicle Credit

Before the enactment of the Act, you could claim a credit for each new qualified plug-in electric drive motor vehicle (NQPEDMV) placed in service during the tax year.

The Act, among other things, retitles the NQPEDMV credit as the Clean Vehicle Credit and eliminates the limitation on the number of vehicles eligible for the credit. Also, final assembly of the vehicle must take place in North America.

No credit is allowed if the lesser of your modified adjusted gross income for the year of purchase or the preceding year exceeds $300,000 for a joint return or surviving spouse, $225,000 for a head of household, or $150,000 for others. In addition, no credit is allowed if the manufacturer’s suggested retail price for the vehicle is more than $55,000 ($80,000 for pickups, vans, or SUVs).

Finally, the way the credit is calculated is changing. The rules are complicated, but they place more emphasis on where the battery components (and critical minerals used in the battery) are sourced.

Credit for Previously Owned Clean Vehicles

A qualified buyer who acquires and places in service a previously owned clean vehicle after 2022 is allowed an income tax credit equal to the lesser of $4,000 or 30% of the vehicle’s sale price. No credit is allowed if the lesser of your modified adjusted gross income for the year of purchase or the preceding year exceeds $150,000 for a joint return or surviving spouse, $112,500 for a head of household, or $75,000 for others. In addition, the maximum price per vehicle is $25,000.

New Credit for Qualified Commercial Clean Vehicles

There is a new qualified commercial clean-vehicle credit for qualified vehicles acquired and placed in service after December 31, 2022.

The credit per vehicle is the lesser of: 1) 15% of the vehicle’s basis (30% for vehicles not powered by a gasoline or diesel engine) or 2) the “incremental cost” of the vehicle over the cost of a comparable vehicle powered solely by a gasoline or diesel engine. The maximum credit per vehicle is $7,500 for vehicles with gross vehicle weight ratings of less than 14,000 pounds, or $40,000 for heavier vehicles.

Increase in Qualified Small Business Payroll Tax Credit for Increasing Research Activities

Under pre-Inflation Reduction Act law, a “qualified small business” (QSB) with qualifying research expenses could elect to claim up to $250,000 of its credit for increasing research activities as a payroll tax credit against the employer’s share of Social Security tax.

Due to concerns that some small businesses may not have a large enough income tax liability to take advantage of the research credit, for tax years beginning after December 31, 2022, QSBs may apply an additional $250,000 in qualifying research expenses as a payroll tax credit against the employer share of Medicare. The credit can’t exceed the tax imposed for any calendar quarter, with unused amounts of the credit carried forward.

Extension of Incentives for Biodiesel, Renewable Diesel and Alternative Fuels

Under pre-Act law, you could claim a credit for sales and use of biodiesel and renewable diesel that you use in your trade or business or sold at retail and placed in the fuel tank of the buyer for such use and sales on or before December 31, 2022. Now you are permitted to claim a credit for sales and use of biodiesel and renewable diesel fuel, biodiesel fuel mixtures, alternative fuel, and alternative fuel mixtures on or before December 31, 2024.

You’re also now allowed to claim a refund of excise tax for use of 1) biodiesel fuel mixtures for a purpose other than for which they were sold or for resale of such mixtures on or before December 31, 2024, and 2) alternative fuel as that used in a motor vehicle or motorboat or as aviation fuel, for a purpose other than for which they were sold or for resale of such alternative fuel mixtures on or before December 31, 2024.

 
 
 
 
Ten Tax-Related Changes Churches and Clergy Should Understand in 2020
Important information and guidance for tax filing and recording-keeping requirements.
Richard R. Hammar (2020). Christianity Today. Church, Law and Tax
 

There were several important tax developments in 2019 that affect tax reporting by ministers, church staff, and churches for the upcoming tax-filing season as well as reporting and records-keeping requirements in 2020 and beyond. For more information click here

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TIPS FOR END OF YEAR PLANNING [click here for details]

 
 
 
 
 
 
My first book in a series on the Great Reset titled “Economic Alchemy is the Key to Unlimited Wealth: Biblical Principles of Wealth Transference” was released on Monday, August 19, 2019. Printed copies are available through Amazon.com.
 

See the Governance page. [click here for details]

REGARDING THE COMING INCREASE OF CHURCH AUDITS
The Internal Revenue Service (IRS) is issuing several hundred church examinations to seek out organizations that are not complying with the Affordable Care Act (ACT). While this is affecting only a fraction of churches nationwide, there are a few precautions you can take to ensure that your church is not one of them. The main practices being targeted by the IRS are 1) the incorrect processes by which full-time church employees are opting out of their church’s group health insurance plan and 2) the church’s provision of reimbursements to employees for purchasing their own health insurance.

Regarding opting-out processes: If a church offers/is required to provide group health insurance, the church must comply with the group health benefit rules outlined in the ACA. Employees of said churches are only allowed to legally opt out of this insurance by transferring to a different group plan, i.e. a spouse’s plan. They cannot purchase any form of individual health insurance; acting otherwise is a violation of IRC. Sec. 4980H(a) and will result in an ACA penalty. 

  • Churches are responsible for informing their employees that they are ineligible to sign up for an insurance exchange for any individual health plan. In turn, the employee is required to represent that the church participates in an alternative group health insurance plan. This is extremely important, as the employer can be charged up to $2500 per employee over 30 employees that purchases an individual health plan.
  • It is also important to note that churches with between two (2) and fifty (50) FTEs are not required to provide group health insurance. However, those that choose to must comply with the ACA’s group health benefit rules.

Regarding the use of individual health insurance: While it was once legal for churches to provide employees with reimbursements for switching health plans, the ACA no longer permits it. Many churches continue the practice today; if yours is one of them, please cease immediately to avoid penalties.

IRC Sec. 7611 requires the IRS to have concrete written evidence that a church is not complying with the ACA’s rules before they conduct an examination, and this evidence typically comes in the form of W-2s and other filings.

What to Do:
If you are unsure whether or not your church is abiding by the aforementioned rules, it is extremely important that you verify your compliance. The best ways to do so are to:

  1. Perform a self-audit, or
  2. Hire a professional to conduct a compliance audit.

Once you complete either of those options, immediately rectify any discovery of noncompliance.

If you are contacted by the IRS, hire a licensed tax professional as soon as possible, preferably one that specializes in helping churches. They can work with the IRS on your behalf at pre-exam conferences, help the IRS agent hone in on specific problems even before the exam begins, assist the church in identifying and rectifying problems, and keep the process as clean and professional as possible.

Please remain vigilant and do your best to abide by the ACA’s provisions– even minor violations can garner staggering financial penalties at worst, and a huge headache at best.

REGARDING INTERNAL REVENUE SERVICE RELIEVING 2019 & 2020 FAILURE TO FILE PENALTIES

The following is an article posted by the Journal of Accountancy . . .

IRS relieves penalties for 2019 and 2020

By Paul Bonner (August 24, 2022)

A broad range of tax and information returns for 2019 and 2020 tax years will receive automatic relief from failure-to-file penalties, under Notice 2022-36 released by the IRS Wednesday.

The estimated 1.6 million taxpayers who have already paid these penalties will automatically receive an estimated $1.2 billion in refunds or credits, the IRS said in the notice and announced in a news release. Abatement of the penalties is also automatic.

Taxpayers do not need to request this relief, and the IRS said it will pay most of the refunds or apply credits by the end of next month. However, any return still unfiled for the two tax years must be filed by Sept. 30, 2022, to be eligible for the relief.

Also, the notice abates penalties for failure to timely file any information return (as defined in Sec. 6724(d)(1)), such as those in the Form 1099 series, for the two tax years. To be eligible, information returns for 2019 must have been filed on or before Aug. 3, 2020, and 2020 information returns by Aug. 2, 2021.

In addition, various international information returns such as those reporting transactions with foreign trusts, receipt of foreign gifts, and ownership interests in foreign corporations will receive similar relief. However, to qualify for the relief, any eligible tax return must be filed on or before Sept. 30, 2022.

The relief measure is intended “to help struggling taxpayers affected by the COVID-19 pandemic” and to allow the Service to “focus its resources on processing backlogged tax returns and taxpayer correspondence to help return to normal operations for the 2023 filing season,” the IRS said in the release.

Another reason for the relief is that additions to tax or penalties for failure to timely file returns continued to accrue during periods of postponed filing dates for returns for both years, under the presidential emergency declaration in March 2020 in response to the pandemic, the IRS acknowledged in the notice.

The AICPA Form 3520 Penalties Task Force had requested penalty relief for Forms 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, and 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner, especially in light of the backlog, and is pleased the IRS listened and provided some blanket relief, the task force chair, Hank Alden, said Wednesday.

Tax returns eligible for the relief include specified returns in the Form 1040, 1041, and 1120 series. Also eligible are Form 1066, U.S. Real Estate Mortgage Investment Conduit (REMIC) Income Tax Return; Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Trust Treated as Private Foundation; and Form 990-T, Exempt Organization Business Income Tax Return (and Proxy Tax Under Section 6033(e).

In addition, Form 1065, U.S. Return of Partnership Income, and Form 1120-S, U.S. Income Tax Return for an S Corporation, may have penalties forgiven for failure to timely file and for failure to show required information.

The notice also covers certain international information returns, such as Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, and Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business, attached only to Forms 1065 and 1120. It does not provide relief for taxpayers filing returns with certain international information returns, e.g., Form 5471, attached to returns other than Forms 1065 and 1120, such as Form 1040 or 1041.

Penalties for fraudulent failure to file under Sec. 6651(f) or the penalty for fraud under Sec. 6663 are not eligible for relief. Any penalties included in an accepted offer in compromise, settled in a closing agreement under Sec. 7121, or finally determined in a judicial proceeding are also ineligible.

The AICPA and other groups and firms have repeatedly advocated that the IRS provide failure-to-file and other penalty relief under procedures similar to those for a first-time abatement administrative waiver but based upon the COVID-19 pandemic as reasonable cause for the failure.

“As the coronavirus is an extraordinary event unlike anything faced in recent history, penalty relief based on a coronavirus effect should not be considered first-time abate,” the AICPA said in a May 17, 2021, letter to IRS Commissioner Charles Rettig and Acting Assistant Secretary for Tax Policy Mark Mazur.

In the IRS news release, Rettig acknowledged such input.

“We’ve been working on this initiative for months following concerns we’ve heard from taxpayers, the tax community, and others, including Congress,” Rettig said.


Welcome to Barbara Holmes’ page. For several decades, companies, organizations and individuals alike have relied on and trusted Barbara to help them navigate through today’s complex tax laws and regulations.

In addition to general accounting knowledge and tax preparation, Barbara also is very knowledgeable about the special requirements and needs of non-profits, both secular and religious.

For more information about Barbara, the services her company offers and accounting and tax resources, select one of the options on the above menu.