The landscape for churches and ministries is one that is filled with many pitfalls. Over the last twenty years, Congress and the IRS have become very interested in the activities of churches, ministries and nonprofits. It led to the enactment of section 4958, and the creation of the Exempt Organizations Executive Compensation Compliance Project, which resulted in increased enforcement presence and multi millions of dollars in fines. Those who do not perceive how the legal landscape has been changing may find themselves inundated with tax trouble. Moreover, they also miss out on the hundreds of truly great benefits and exemptions that the law provides.
With that said, let me show you the path that churches and ministries will have to walk through. I am going to discuss just a few areas that can bring challenges to your ministry unless you take the proper precautions after becoming aware of them. While I am always convinced that the Lord will lead His church in victory, one of the ways He does it is by sounding the alarm so that His church is not caught off guard.
1. Supreme Court case potentially changes the definition of a minister
This is actually a good thing. On January 11, 2012, for the first time ever, the Supreme Court issued a ruling that affects the definition of a minister and gives guidance on what steps a church can take to ordain their own ministers. A church assigning the title of minister is not enough. In this case, the court looked at facts and circumstances and that the individual in question was ordained by a church even though most of her duties were clerical and education, and not sacerdotal. The details are too many to list here. We will teach this at all of our future conferences. if you have never attended one, I guarantee you will receive very empowering information that is timely for the church today.
2. The IRS is allowed to give you bad advice and not be responsible
In a recent court case (David Michael Maser v. Commissioner), the court ruled that if the IRS gives you bad advice it is not binding on the IRS. Can you imagine what that may mean to your church? Many agents are not sufficiently trained to answer questions dealing with even simple matters, let alone the complexities of church and ministry tax codes. I have called the IRS on many occasions with my own tax questions, and many times (most of the time) they answer them incorrectly. So, if you have a question, don't call the IRS. Get good help.
3. Watch your activities
The activities of churches and ministries on a day-to-day basis need to be balanced with the income tax regulation in 1.501. In essence, the regulation states that if an organization in a substantial way participates in an activity that is not tax exempt, the organization loses its tax-exempt status. Furthermore, the US Supreme Court ruled that "a single nonexempt purpose, if substantial in nature, would preclude an organization from qualifying under section 501(c)(3) of the Code." This brings to question some of the activities that churches engage in, that if audited could preclude them from tax exempt status: Let's review some of them:
- Renting out facilities to the local public
- Having too many bake sales
- Running a café or bookstore during non-church or non-ministry events
It is not that a church cannot engage in any of these activities, but rather that these activities, if not done correctly, can cause them to be classified as unrelated activities and possibly get ruled by the IRS to be substantial. If this happens, your ministry will lose its tax-exempt status.
4. Federal government changes the rules concerning baby cribs in the nursery
Though this one is not enforced by the IRS, getting informed on this one is very crcial. If you ever need a baby crib for the church nursery, getting a parent to donate his/her child's out-grown crib is no longer legal. You will have to throw all such donated cribs out and replace them with cribs that are compliant with Code 1219.2. When purchasing a new crib, make sure it complies with the requirements of ASTM F 406-10a. If your insurance company has not required it by now, they will soon, or else they may terminate your policy.
One thing you should not do is take a non-compliant crib that looks perfectly good and give it to a needy family. It may sound completely contrary to your mission of helping the poor, but keep in mind that by donating such a crib, you take on a huge risk of liability if the child gets hurt in the crib or worse yet, suffers a fatal accident. Guess who will knock at your door?
5. Changes to tax withholdings and deposits
If your church has employees, all taxes that you withhold must now be paid to the IRS electronically, using the Electronic Federal Tax Payment System (EFTPS). When you pay your taxes electronically you will be given a number that can be used as a receipt or to trace the payment. Make sure you do not lose it.
At the present time, or at least through February, the FICA withholdings on an employee's pay is 4.2%. That will change to 6.2% unless Congress acts to keep the rate at 4.2%. Do not forget to report this correctly.
The vast majority of churches must pay their payroll taxes on a monthly basis by the 15th day of each month. The dates to pay the payroll taxes are very strict and can easily lead to penalties, as shown below.
2% - Deposits made 1 to 5 days late.
5% - Deposits made 6 to 15 days late.
10% - Deposits made 16 or more days late.
Sound the alarm
So, what do you do with information like this? What I have discovered is that though I am announcing it at a level 10 volume, many leaders hear it at only a level 1 volume. Even though many churches have significant compliance issues; with increased church scrutiny and IRS enforcement presence, the years ahead may become more challenging to StartRIGHT and StayRIGHT.
The IRS tax gap
On January 6th, 2012 the IRS released its tax gap report. This is a report that it releases every five years. In essence, it shows the amount of tax that is owed to the IRS and how much of that tax is actually collected. There is close to one-half trillion dollars out there that is owed to the IRS, 90% of it primarily due to underreporting and underpayment.
That looks like the legal landscape of too many churches. The most common form of tax non-compliance that churches experience is underreporting, as shown below.
- 1099 forms to guests, nursery workers, and contractors: Churches often give their guest speakers a love offering either in cash or with a check, and they never consider if it has to be reported on form 1099-Misc. This is a very common mistake churches make, and this year it can be very costly. Another one is the support they send to missionaries doing work overseas. Many churches send money to a U.S. citizen who is a missionary, but they do not correctly fill out the proper forms to document that.
- Pastoral love offerings: There are many names for blessing the pastor. Some call it a "pastoral love offering", a "love token", or a "first fruit", while others may refer to it as a "love gift" or a "freewill offering". No matter what you call it, it has to be reported on a W-2 form. Every year, millions of dollars in pastoral love offerings go unreported because many churches do not properly report to the IRS these gifts given, as the law requires. Likewise, many pastors, believing it is a gift, do not report it either.
- Undocumented housing allowance: I talk to many pastors that tell me, "I'm not on a salary at the church; I just get a housing allowance." Unbeknownst to them, section 107 of the Internal Revenue Code requires it to be properly documented; it is subject to federal income tax. Additionally, unless the pastor has successfully applied for and received self-employment tax exemption, the housing allowance paid to a minister is subject to a self-employment tax of 15.3%. This is a little fact that can bring devastating consequences to churches and ministers today.
- Improperly documented pastoral salary: Did you know that section 4958 strictly prohibits a salary agreement between the church and the pastor to have any open-ended items? Section 4958 mandates that his/her salary be approved before he/she starts receiving it and that it must be a fixed salary amount. The mistake is made when the church and pastor agree to and document a salary, but never discuss love offerings and other sources of income he/she may receive through the church. When the pastor's salary is documented in such a way that the church never really knows how much his/her salary will be, section 4958 calls it an excess benefit transaction. His/her salary can be penalized up to 200%.
The IRS is fully aware that these common underreporting compliance issues exist in churches. It is just a matter of finding them. More than ever, the tax gap is a reminder that the IRS has an ever-increasing incentive to improve its ability to find these issues at the street level. For the church, our incentive for getting right goes far deeper than what the IRS can do; what matters more is what our Heavenly Father requires of us.
Your church can close the tax gap one of two ways--through voluntary compliance, which is a scriptural mandate, or through involuntary compliance enforced by the IRS. I think you know which one is best.
*Shortly after posting this article, I received a letter from the president of the ECFA. He wanted to make clear that the ECFA, created the commission at "the request of U.S. Senate Finance Committee member, Charles Grassley (R-IA). He also stated that the commission will take small churches into consideration when making its proposals.