How Protect Your Church from an IRS Audit
For the past 6 years, Michelle has faithfully served as her church’s secretary. She has been a member of her church for the past 8 years, and between being a member and the secretary, Michelle has seen a lot of the good her church does.
However, because of her position as secretary, Michelle has also seen some of her church’s “backside.” To Michelle, the “backside” consisted of little things, such as the pastor taking $100 from the offering and giving it to the worship leader as a token of appreciation (“love offering”), or the handful of times the church treasurer instructed Michelle to pay a bill for the pastor in order to help him out.
She knew that these actions were being done in good nature, but there was something about them which gave her an unsettled feeling that she did not know how to verbalize.
The source of many church audits
The scenario with Michelle is more common than you might realize. Although this story is fictional, it is one that reflects the many stories we hear form pastors and church leaders at our conferences.
Perhaps, it is a scenario that hits close to home for you. Regardless, well-meaning pastors and church leaders often unknowingly make decisions that could either jeopardize their church’s tax-exempt status or result in hefty fees and penalties if discovered by the IRS.
Now, there is no reason to fret at this very moment. The IRS cannot simply knock upon the doors of your church with the intention of performing an audit. There are specific requirements and steps that the IRS must follow before conducting a church audit.
The IRS cannot simply knock upon the doors of your church with the intention of performing an audit.
Unfortunately, many church audits ensue from a church member or church employee (like Michelle) who get hurt by the church in some way or another. As a form of retaliation, the member or employee may use his/her firsthand witness of the church’s “backside” as a means to get even.
That is a scenario that happens far too often in the church today. However, that is not the point of this blog. The intent of this blog post is to shed light on such situations so you can get your “house” together to prevent any potential IRS audit.
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What is a church audit and how does one start?
The Internal Revenue Manual (IRM) defines a church tax inquiry as “any inquiry to a church … that serves as a basis for determining whether the organization qualifies for tax exemption as a church, or whether it is carrying on an unrelated trade or business or otherwise engaged in activities subjected to any [Internal Revenue Code] IRC tax.” (See IRM 188.8.131.52)
Furthermore, section 7611 of the IRC gives guidelines for how the IRS may begin a church tax inquiry. According to section 7611, the IRS may begin a church tax inquiry only if the following are met:
An appropriate high-level treasury official reasonably believes, based on written data, that a church is not operating in a manner consistent with its purpose and section 501(c)(3), or the church is conducting any unrelated business activities.
The IRS sends the church a written inquiry notice containing an explanation of the concerns it has that have caused the inquiry, the subject of the inquiry, and the legal authority it is given to perform said inquiry based on its concerns.
How does the IRS establish reasonable belief?
Before we look at how you can prevent an IRS church audit, we need to first understand what may help the IRS establish “reasonable belief” in order to begin the process of a church audit. There are several things that an IRS high-level treasury official can rely upon to establish reasonable belief, such as:
- Newspaper, magazine, television, or radio articles or ads involving a church;
- Church websites;
- Voter guides created or distributed by the church;
- Documents on file with the IRS, such as Form 990-T (used to report unrelated business income tax);
- Records concerning the church in possession of third parties or informants; and
- Letters from current or past church members or board members.
From the scenario presented earlier in this post, we can see that it would not take much for Michelle to have sufficient evidence of the church’s compliance “indiscretions.”
Now that we are aware of the parameters and guidelines, which the IRS must follow in the event of a church audit to help establish reasonable belief, let us look at what you can do to help prevent an IRS audit from happening to your church.
5 ways to protect your church from an IRS audit
The rules and regulations that govern the way churches conduct business have dramatically changed throughout the years. The way that churches once did business and maintained records will no longer fly in the world of church compliance today.
In order to keep up with the current compliance regulations and to ensure that your corporate records are airtight, below are five basic steps that will help you to prevent an IRS audit happening in your church.
1. Maintain board meeting minutes
Most of us assume that the most important records to maintain are financial records. Though maintaining the financial records is important for the daily management of your church, it can be argued that board meeting minutes are the most important records for churches to properly maintain. Here is why: board meeting minutes serve as the official documentation of the corporate acts of your church.
Without board meeting minutes, your church cannot show proof that the church properly approved corporate actions such as the appointment of board members, the adoption of your bylaws and policies, and the approval of salaries.
As a nonprofit organization, it is imperative that all corporate actions of the church be properly documented in well-maintained board meeting minutes.
(Recommended reading: “Do You Know How to Take Board Meeting Minutes?”)
2. Document all salaries and compensation
Salaries and compensation should be maintained with diligence. Salaries paid by your church should be approved annually by the board of directors during a properly called board meeting.
In general, salary compensation agreements should include, but are not limited to, the monetary amount to be paid, what the job entails, the number of hours required, any benefits being offered, and comparability data for other similar positions.
Additionally, honorariums to guest speakers should be treated properly. This means that your church should obtain Form W-9 from every guest speaker and a 1099-MISC should be given to each speaker that receives $600 or more from your church in one year.
3. Review your church’s activities
As we saw earlier in this post, one of the purposes of the IRS during a church audit is to determine whether the church is operating in a manner that is consistent with its purpose and section 501(c)(3). Therefore, it is important to review the activities of your church in order to make that determination.
When reviewing the activities of your church, you will want to make sure that each ministry and department directly relates to the purpose of your church. If, through your review of church activities, you determine that an activity may be considered an unrelated trade or business activity (e.g., a bookstore or coffee shop) then you will want to consider starting a church-owned business.
(Recommended reading: “Can Our Church Own a Business?”)
4. Review your church’s printed and publicized materials
Since the IRS can use any printed or publicized material as a source of “reasonable belief” to begin a church inquiry, you will want to be sure to keep a close guard on such materials. This also includes your church’s website. It is best not to include any type of advertisements on your church’s website because, depending on the facts and circumstances, they may be considered unrelated business activity and could potentially jeopardize your church’s tax-exempt status.
5. Review all of your church’s internal governing documents
There are several documents that your church must review and maintain on a regular basis, such as:
- Your church’s articles of incorporation, amendments, annual reports, charity registration, IRS approval letter, and any letters regarding the church updating its public record;
- Your church’s bylaws;
- Your church’s written doctrines;
- Your church’s policies and procedures. (You will want to make sure that your church has a conflict of interest policy, accountable reimbursement policy, and a benevolence policy.);
- Corporate contracts such as leases and titles to property;
- Accounting and bookkeeping records; and
- Current and accurate membership records.
What will you do?
Although Michelle had an unsettled feeling about some of her church’s actions, she chose not to do anything about it. It is not because she did not care, but rather, she did not know where to begin or how to address her concerns, and so she decided to keep silent.
Perhaps you are also unsure of where to begin or what to do. To help you with this process, I recommend a resource we offer called “Audit,” which is a part of our Management Suite™. This resource includes 53 simple steps that will help you and your church along in the right direction.
Additionally, I encourage you to register for one of our Ultimate Church Structure Conferences. This conference will be a day of learning, revelation, and rejuvenation for you and any staff or board members that you bring.
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May you be encouraged in the fact that you are not alone, and that God has gone before you to provide everything needed to help you in what you are called to do! We would be honored to serve you as part of that provision.
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