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Federal Law Disqualifies Church Leaders
By Raul Rivera
Main point: It is important to know who is a disqualified person for the purposes of governing the church. Not knowing could result in severe penalties.
In 1996, Congress authored section 4958. It did so in an effort to combat fraud in many large and well known nonprofit organizations. The law was intended to give the IRS oversight and enforcement power. Before the law was written and passed, the IRS did not have the ability to issue fines to individuals for abusing their office. They could only threaten to revoke an organization’s tax-exempt status. The law now imposes severe penalties (excise taxes) directly to board members, bishops, deacons and others who exercise control or influence in the organization, if they engage in an abusive transaction. So, how does that affect you and your ministry?
Ignorance is dangerous
The provisions of section 4958 can be devastating. The law as written clearly states that the IRS can impose severe penalties on disqualified persons if they engage in a transaction that is later ruled as improper (I will explain later). The law allows the penalties to be imposed even if the transaction was done in ignorance.
What is a disqualified person?
Under the law, a disqualified person is anyone who is in a position to exercise substantial influence over the affairs of the organization. This includes the following:
- Officers, directors, bishops or trustees
- Board members
- Pastor
- Relatives of officers, directors, bishops or trustees, board members or the pastor
The law defines a family member of a disqualified person as a spouse, ancestors, children, grandchildren, great grandchildren, and the spouses of children, grandchildren, and great grandchildren's brothers and sisters (whether whole or half blood) and their spouses.
What is an excess benefit transaction?
An excess benefit transaction is any transaction that results in a disqualified person receiving a benefit from the church that exceeds the value of the consideration received. Let me give you three examples:
Example 1: Pastor John is on salary at the church. He is paid $1,500.00 per week. He writes a book and the church pays for the publishing of the book. Pastor John sells seven thousand copies of the book for his own personal support and keeps all of the proceeds. This is an excess benefit transaction because the church paid for the publishing. On that note it is worth mentioning that some people argue that an excess benefit transaction occurs if the pastor writes a book and pays for his own publishing, but uses the pulpit as a way to directly or indirectly promote his book. There is currently no IRS guidance or anything in the regulation that speaks directly to this type of transaction.
Example 2: Pastor Doe has a son who wants to start a personal services business. The church has extra office space. Pastor Doe allows his son to use the office space and church resources to launch his personal services business. This is an excess benefit transaction because the pastor’s son is a disqualified person. He received a benefit that was in excess of any service he provided the church.
Example 3: John Doe is the youth pastor of a church. He has a full time job outside the church. The church does not pay him a salary, but instead in exchange for his services, allows John Doe to live in the parsonage. The Fair Rental Value of the house is $18,000.00. Because of his job, John dedicates 5 hours a week to the youth ministry. Two years later, the IRS determined that the 5 hours a week that is worth $9,100.00. This type of transaction results in an excess benefit transaction of $8,900.00.
What are the penalties?
The penalties that can be imposed vary:
- The initial penalty tax: The law imposes a 25% penalty on a disqualified person involved in an excess benefit transaction. In example 3 above John Doe has to pay a penalty of $2,225.00. Moreover, each board member who voted and approved John doe’s parsonage agreement have to pay a 10% tax of $890.00.
- The additional Penalty Tax: If the church and Pastor John Doe do not correct the excess benefit transaction after the IRS has imposed the initial penalty tax, the IRS has the power to impose a 200% penalty.
Closing
In an effort to reduce the amount of fraud that was occurring in the nonprofit world, Congress enacted section 4958. The law makes it harder to properly run the church in an orderly manner. As pastors and leaders we must rise to the occasion and become shining examples of how to be in compliance with God’s law by obeying the laws of man.