Pastors Discover They Owe IRS Thousands of Dollars
By Emma Voon
The relationship between church members and their pastor is special. Pastors often serve long hours and make themselves available at a moment’s notice in times of need. It is common for members to show honor and recognition to their pastors by giving a love offering.
Many churches and pastors alike fail to understand how to appropriately account for those love offerings. With good intentions, members give a love offering thinking their gift is precisely that— a gift. However, the laws surrounding love offerings can be confusing.
The confusion surrounding the taxability of love offerings comes from the term itself. The term “love offering” implies a gift that is given out of love and respect for the recipient. This leads many pastors to think love offerings are treated as gifts, which are generally nontaxable. But the IRS doesn’t view love offerings in the same way.
Two pastors in Minnesota recently learned about taxable income the hard way.
Are love offerings considered as a gift or taxable income?
Before we get to the case, let's take a look at how the IRS defines taxable income versus gifts to better understand the tax law behind love offerings.
Internal Revenue Code (IRC) 61(a) defines taxable income as “all income from whatever source derived, including compensation for services.”
However, IRC section 102(a) excludes “gifts” from taxable income. While the members of the church giving the love offering and the pastor who receives the love offering may view it as a gift, the IRS will view the same love offering as taxable income because of what section 102 says shortly after excluding “gifts” from taxable income.
IRC section 102(c)(1) says that "any amount transferred by or for an employer to, or for the benefit of, an employee" shall be treated as gross taxable income.
Wayne R. Felton and Deondra J. Felton v. Commissioner of Internal Revenue
Rev. Wayne R. Felton and his wife, Deondra Felton, lead a diverse, life-giving church called Holy Christian Church in St. Paul, Minnesota. Rev. Felton is also the archbishop of Holy Christian Church International.
The Feltons are intentional about the church functioning as a compliant, tax-exempt organization.
The court case stated that Rev. Felton follows his church bylaws and has “never [overridden] as it pertains to business matters any decision of the executive board.” Rev. Felton and his board members respect each other's positions and work together for the church.
All the church’s business operations are carefully decided upon and executed. This is also evident in the way the church collects and records tithes and offerings from its members.
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Before he started his own church, Rev. Felton learned of “hand-shake” money. He didn't like the way such donations were handled. He was determined that if he ever had his own church, he would create a better system for receiving such donations.
When the time came for Rev. Felton to start his own church, he and his board established a specific procedure for collecting tithes, donations, and love offerings. Here is how it works:
Congregants would use white envelopes for any normal contributions sustaining the church. Any tithes, offerings, pledges, or pastoral donation were placed in a white envelope. Everything in this white envelope would be tax-deductible. Members received a contribution statement for these donations.
There were also blue envelopes. Congregants used these envelopes specifically for love offerings to Rev. Felton. He and his wife did not receive a salary from the church at the time, only what was given through the blue envelopes.
White envelopes were handed out to congregants during Sunday gatherings by the ushers. Congregants who wanted to give a love offering to the pastors had to request a blue envelope.
Rev. Felton informed the congregation about the two envelope system at an annual church business meeting. He explained that if members wanted to donate directly to him, they could use a blue envelope. However, this gift would not be tax-deductible.
Those who gave to Rev. Felton using the blue envelope were aware their donations were not tax-deductible for them. They understood it was a gift.
Rev. Felton also regularly preached about tithes and offerings. He did not preach about congregants giving money to him directly.
All collected white envelopes were opened, and donations were counted and deposited into the church bank account. The blue envelopes, however, were given to Rev. Felton unopened.
In 2008, the church collected $258,001 in the blue envelopes. Rev. Felton received $40,000 in pastoral donations from the white envelope. That year, he reported $40,000 as wages on his tax return. He did not report the $258,001 when filing his taxes.
The following year, the church collected $234,826 in the blue envelopes.
The Feltons made it a point for their church to function as a compliant, tax-exempt organization.
Unfortunately, Rev. Felton failed to report the love offerings he received from his congregants. When going over his tax returns, the Commissioner audited the Feltons and sent a notice of deficiency.
The main issue the Commissioner cited was that none of the donations from the blue envelopes were reported as taxable income. The Feltons disagreed with the Commissioner and petitioned in court.
The Feltons argued their situation was unique because they didn't receive a regular wage from the church, but rather, were supported by love offerings.
The judge noted that the law in the area of gifts for ministers is not abundantly clear. In the end, however, the judge agreed with the IRS’s position. The Court ruled that donations in the blue envelopes were taxable income to Pastor Felton. The Court also coincided with the IRS’s assessment of penalties. They imposed a stiff 20% penalty for “substantial understatement” of income.
If you would like to read the entire court case, click click here.
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The Feltons had good intentions, but they did not fully understand the laws surrounding love offerings. Their misunderstanding resulted in paying a 20% penalty on their income.
From the misfortunes of this case, we learn how important it is for pastors to report love offerings as taxable income.
Keeping up with tax law is time-consuming when you're doing it on your own. That's why at StartCHURCH we make it a point to stay up to date with tax laws so that we can take that burden from our clients. It is our desire to be a reliable source for you to trust when filing your tax return.
We have a team of experts who are specialized in ministerial taxes. Do you need help with recording your finances? Or do you want to find out how to be a compliant, tax-exempt organization? Give us a call at 877-494-4655. We're here to serve you!