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
Status of the housing allowance
For years, the Freedom from Religion Foundation (FFRF), a not-for-profit atheist organization, has attempted to invalidate Section 107(2) of the tax code, the provision permitting clergy to receive an annual housing allowance designated by their employing house of worship—and not pay federal income taxes on the designated amounts. The FFRF argues the tax law is a constitutionally impermissible preference for religion, since leaders of secular nonprofit organizations are not eligible to receive the same benefit. A valuable benefit. The congressional Joint Committee on Taxation estimates the 65-year-old benefit is worth a combined $700 million annually. At the local level, the housing allowance is the single-most valuable benefit to clergy. It proves especially valuable to those who lead small and mid-sized congregations in small towns and rural areas, although clergy leading large and mega-sized churches also are eligible. In March of 2019, a three-judge panel unanimously affirmed the constitutionality of the housing allowance.
How should churches and pastors respond to this ruling? Consider the following:
- Continue designating housing allowances for ministers. The housing allowance remains valid and active for all churches and qualifying clergy across the country.The fair rental value of church-provided parsonages remains a nontaxable benefit.
- Monitor developments in the event another legal challenge is raised.
- Anticipate what would happen, were a future legal challenge to prevail, invalidating the housing allowance. Churches and clergy should note the following for preventive purposes:
- Many ministers would experience an immediate increase in income taxes. Note that there would be no effect on self-employment taxes for which the housing allowance is not tax-exempt.
- Ministers considering the future purchase of a new home would not want to base the amount and affordability of a home mortgage loan on the availability of a housing allowance exclusion unless and until the outcome of a future legal challenge was final.
- Many churches would want to increase ministers’ compensation to offset the adverse financial impact. Such an increase could be phased out over a period of years to minimize the impact on the church.
Section 107(2) [of the tax code] says that a minister does not have to include in gross income “the rental allowance paid to him as part of his compensation, to the extent used by him to rent or provide a home.” This exclusion is limited to the amount used “to rent or provide a home” and may “not exceed the fair rental value of the home.” This means the exclusion does not apply to money used for food, domestic help, or expenses of a business or investment property.
Congregational gifts to the pastor
The second part of the Tax Court’s memo addresses the church’s use of an envelope system to collect and properly record offerings from its members. A special gift designated for the pastor (or anyone else) is noted on the envelope. If one of these special gifts was by check or credit card, it would first go into the church’s account, and the bookkeeper would later make a check out to the pastor. Not all contributions made to the pastor were made through the envelope system, and therefore not all were recorded by the church. The court started with the “basics”: Section 61(a)(1) [of the tax code] says that gross income includes “compensation for services, including fees, commissions, fringe benefits, and similar items.”
What is a gift? According to the Supreme Court, “a gift in the statutory sense . . . proceeds from a detached and disinterested generosity . . . out of affection, respect, admiration, charity or like impulses.” Commissioner v. Duberstein, 363 U.S. 278 (1960).
- Donations in exchange for services- Donations by church members to their pastor, either directly or by giving them to their church for later distribution to the pastor, are almost always taxable compensation to the pastor since they typically are viewed as attempts to more fully compensate the pastor for services rendered.
- Donation requests- The court noted that “evidence of regular requests for donations to a pastor supports a finding that any donations made in response are income and not gifts.
- Routinized, highly structured program- The court explained the third factor: “Even if congregants claim to have made contributions out of love, admiration, and respect, not out of a sense of obligation or fear that the pastor would leave, they are not gifts as a matter of tax law if made and gathered by congregation leaders in a routinized, highly structured program,” and made on behalf of the whole congregation.
- Ratio of church salary to personal donations: The court noted that the record is full of checks from congregants and the church giving thousands and thousands of dollars in pastoral offerings each year, not to mention the other hefty checks from the church for parsonage, “mortgage,” “vehicle,” “vacation expenses,” and “medical” expenses, among other things.
Revoking an exemption from Social Security
Will Congress give ministers another opportunity to revoke an exemption from Social Security? It does not seem likely, at least for now. No bills were introduced in Congress in 2019 that would have authorized ministers to revoke an exemption from Social Security.
Inflation adjustments for 2019
Key changes affecting 2019 returns include the following: The alternative minimum tax exemption amount for tax year 2019 for single taxpayers is $71,700 and begins to phase out at $510,300. The exemption amount for married couples filing jointly is $111,700 and begins to phase out at $1,020,600. For estates of any decedent passing away in calendar year 2019, the basic exclusion amount is $11,400,000. For 2019, the foreign earned income exclusion will be $105,900. The maximum earned income credit amount will be $6,557 for taxpayers with three or more qualifying children for 2019.
Working after retirement
Many churches employ retired persons who are receiving Social Security benefits. 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 2020, that limit is $18,240. 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 2020, that limit is $48,600, but only earnings before the month you reach full retirement age are counted.
Individual coverage health reimbursement arrangements (ICHRAs)
Health reimbursement arrangements (HRAs) are a type of account-based health plan that employers can use to reimburse employees for their medical care expenses. New rules released in 2019 by the US Departments of Labor, US Department of Health and Human Services, and the US Department of the Treasury permit employers to offer a new individual coverage HRA (ICHRA) as an alternative to traditional group health plan coverage, subject to certain conditions.
Among other medical care expenses, ICHRAs can be used to reimburse premiums for individual health insurance chosen by the employee, promoting employee and employer flexibility, while also maintaining the same tax-favored status for employer contributions toward a traditional group health plan.
The new rules also increase flexibility in employer-sponsored insurance by creating another, limited kind of HRA that can be offered in addition to a traditional group health plan. These “excepted benefit” HRAs permit employers to finance additional medical care.
This significant development will again allow employers to (1) reimburse employees for some or all of the premium expenses incurred for an individual health insurance policy, and (2) use their funds to directly pay the premiums for an individual health insurance policy covering employees. This benefit was commonly used by employers to provide health insurance for employees for over half a century, but was made unlawful by the Affordable Care Act (Obamacare).
The new “parking lot tax” on churches
Editor’s note: On December 20, 2019, the “parking lot tax” was officially repealed. Here is a brief update. An obscure provision in the comprehensive tax reform legislation enacted by Congress in 2017 (the Tax Cuts and Jobs Act) purports to impose a tax (the unrelated business income tax) of 21 percent on the value of free parking provided by tax-exempt organizations, including churches, to their employees.
Note two developments:
- The IRS issued guidance on implementing the new rules. I.R. 2018-247.
- Legislation was introduced in Congress in 2019, with broad bipartisan support, to exempt churches from this tax. But as of the date of publication no action had been taken.
Charitable contribution denied due to failure to comply with substantiation requirements
The IRS audited a taxpayer’s tax return and disallowed a charitable contribution deduction of $250,000 for the taxpayer’s contribution of his home to a religious charity (the “donee”) on the ground that he failed to comply with the substantiation requirements that apply to donations of noncash property valued at more than $5,000. Generally, if the claimed deduction for an item or group of similar items of donated property is more than $5,000, you must get a qualified appraisal made by a qualified appraiser, and you must attach a “qualified appraisal summary” (Section B of IRS Form 8283) to your tax return. There are some exceptions.
Pledges made by donors to a church are legally enforceable
The Supreme Court of Nebraska ruled that pledges made by donors promising to donate to a church or other charity in the future are legally enforceable.
Enforcement of restricted contributions
A Connecticut court ruled that only the state attorney general could enforce a restricted contribution to charity. Connecticut is among the majority of jurisdictions that have codified this common-law rule and has entrusted the attorney general with the responsibility and duty to represent the public interest in the protection of any gifts, legacies or devises intended for public or charitable purposes. As stated by our Supreme Court, “[the] theory underlying the power of the attorney general to enforce gifts for a stated purpose is that a donor who attaches conditions to his gift has a right to have his intention enforced. The donor’s right, however, is enforceable only at the instance of the attorney general. As observed by our Appellate Court, at common law, a donor who has made a completed charitable contribution, whether as an absolute gift or in trust, had no standing to bring an action to enforce the terms of his or her gift or trust unless he or she had expressly reserved the right to do so. For full article and more information visit https://www.churchlawandtax.com/