Tax News for June 2024 . . .

4 Expense Ratios and Measurements Your Church Should Monitor

How Churches Can Leverage Higher Interest Rates

Key Tax Developments for 2024

Fed Raises Minimum Salary Requirements For Exempt Status

Tax News for October 2023 . . .

Church Cybersecurity Starts With the Human Firewall – Part 3

Welcome back for part 3 concerning the cybersecurity threats and how Churches can protect themselves. – Posted 10/13/23

Setting solid standards

Meanwhile, established standards for good hardware, software, and security protocols are available through the National Institute of Standards and Technology (NIST). These are especially helpful for technical specifications related to firewalls, network security, virtual private networks, password management, and encryption.

Ward and Vaernhoej offer these best practices:

• Take inventory of the devices and software your church uses. Take inventory of the people who possess them (as well as have access to networks).
• Keep up on security patching released by hardware and software vendors.
• Require regular password management and institute multifactor authentication (MFA) preferably through an app-based option from Okta, Microsoft, or Google. This cuts down on the multifactor workarounds that bad actors use with text- and email-based options.
• Use an email filtering solution. Work to balance the sensitivity levels to screen out problem messages while still allowing legitimate ones. Microsoft’s Office365 and Gmail’s cloud email options, work well for small and large operations. Both offer in phishing and malware prevention techniques.
• Use combinations of complementary tools to boost overall security. A good example? Pairing a content filtering firewall with antivirus software. This simple mix of foundational tools will stop many problems before they can cause any damage.

We hope you have enjoyed this 3 part series concerning cybersecurity threats. To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Church Cybersecurity Starts With the Human Firewall – Part 2

Welcome back for part 2 concerning cybersecurity threats and the ways Churches can protect themselves. – Posted 10/10/23

Attacks are on the rise

Several high-profile church cybersecurity breaches have made recent headlines.

• The Florida Baptist Convention had $700,000 stolen in early 2023 after an email purporting to be from the Southern Baptist Church’s North American Mission Board instead proved to be fraudulent. The instructions in the email tricked convention employees into changing account information for routing funds.

• In late 2022, a North Carolina church received an email containing a bill, along with new electronic payment instructions, from a party posing as its building contractor. Nearly $800,000 was lost.

• Another email scam in 2019 cost an Ohio Catholic church $1.7 million after criminals accessed email accounts of parish employees and then sent emails instructing them to change payment information for a construction contractor.

Training and educating

Educating and training church pastors and staff members about these types of tactics—and how they continue to evolve—is critical, says Allison Ward, a partner with CapinTech, a division of church and nonprofit accounting firm CapinCrouse.

Repeating this training and education frequently is needed, too, adds Nick Vaernhoej, chief information security officer for Church Mutual Insurance Company, the largest insurer of US houses of worship. While criminal tactics mostly remain the same, the methods for accomplishing them rapidly shift.

The ways the tactics are adapted to trick recipients “change month by month,” Vaernhoej says.

‘Low-tech’ solutions

Building a strong human firewall is about getting people to:

• Stop before they respond
• Evaluate what’s happening
• Take steps to verify what’s being requested through some other form of communication

“In my experience, the best methods for addressing ‘high-tech’ threats are typically ‘low-tech’ in nature,” Vaernhoej says. “For instance, some type of manual verification system, such as placing a phone call to the requester before releasing the funds requested.”

Smith agrees, adding a live confirmation before changing a payment method or process or releasing any funds is a must. Churches should adopt policies requiring live verifications, he adds, noting a live call, live video call, or in-person conversation should be used.

“AI can now mimic voices, so don’t rely on a voicemail left in tandem with an email,” Smith says.

At Faith Ministries, ongoing training comes multiple ways. The church partners with an outside vendor who sends about four test messages per week to staff members. These message are designed to trick an employee into clicking a link or opening an attachment. Those who fail get follow-up messages and tips.

Periodic staff wide training sessions also occur, Smith says.

KnowBe4—the vendor Faith Ministries uses—charges $3 per user per month. As Smith—who also consults for churches and ministries through his company, MBS Inc.—advises other churches to do the same, he frequently encounters resistance.

“How do we communicate the urgency for this? It’s such a simple thing to solve, it’s inexpensive to solve, and yet few are willing to do it,” Smith says.

Stay tuned for part 3 Friday where we will provide a list of recommended best practices to better protect you from cybersecurity threats. To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Church Cybersecurity Starts With the Human Firewall – Part 1

Tax News for September 2023 . . .

Q&A: Churches and Form 990

Q&A: Can a For-Profit Food Truck Make Money on Church Property?

IRS Again Alerts Employers to Improper ERC Claims

AG investigations into churches and nonprofits are on the rise – Part 2

What does an attorney general investigation look like?

With an increase in these investigations, church leaders may wonder what to expect if one arises.

At the preliminary stage, there is a unique and limited opportunity to directly refute charges and provide the necessary evidence to do so.

But suppose the investigator sees that the organizational and legal health of the church is in disarray. In that case, it is a sure bet that the attorney general’s office will begin to investigate. At this juncture, this could be a criminal investigation into individual board members. It could also be a civil matter against board members and/or the entity, or a combination of both.

In all matters, hiring competent legal counsel to represent your organization throughout the investigation is critical.

If the matter is potentially criminal, the attorney general will have the option to investigate and present the findings to a grand jury for indictment. In lieu of indictment, some states may allow the church the opportunity to hire its own forensic auditor (holding certified fraud examiner (CFE) and/or certified financial fiduciary (CFF) certifications) to provide an independent report as to whether financial malfeasance occurred.

These audits often require $50,000 to $100,000 to complete. It’s expensive, but it’s better than a criminal indictment. And the state may still choose to indict depending on the findings.

How can my church be prepared for an attorney general investigation?

Our firm has yet to encounter a board involved in an attorney general investigation that had been properly trained on:

Focus on the following areas to reduce the risk of a lengthy investigation:

Board member training covering fiduciary duties, oversight responsibilities, and understanding your church’s governing documents and board policies. Every new board member should also receive this training. Proper board disciplines should include—but not be limited to—keeping accurate minutes and board member recusal of voting as it relates to conflicts of interest.

Written board policies and procedures that promote legal and financial integrity such as:

• Conflict of interest policy
• Independent compensation policy
• Confidentiality policy
• Restricted funds policy
• Policy prohibiting cash structuring

Simply ensuring your board members have this information and understand their roles will virtually eliminate this risk.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

AG investigations into churches and nonprofits are on the rise – Part 1

Yes, Ministries Should Embrace AI

Tackling Big-Ticket Repairs on a Housing Allowance

How Churches Can Leverage Higher Interest Rates

Key Tax Dates September 2023

Tax News for August 2023 . . .

Fed Rolls Out New Form I-9, Sunsets Key COVID-19 Deferment – Part 3

The new Form I-9 is for churches, too, and remote examination is an option. – Posted 8/25/23

Key revisions and updates

Several other revisions made by the agency are designed to ease burdens on employers and employees, including:

• The new form can be completed on tablets and mobile devices.
• The new form comes with fewer instruction pages.
• Instructions include how to use a new checkbox for employers who choose to examine Form I–9 documentation under an alternative procedure.
• Reduced Sections 1 and 2 to a single-sided sheet. No previous fields were removed. Rather, multiple fields were merged into fewer fields when possible.
• Moved the Section 1 Preparer/Translator Certification area to a separate, standalone supplement (Supplement A) that employers can provide to employees when necessary. Employers may attach additional supplement sheets as needed.
• Moved the Section 3 Reverification and Rehire area to a separate, standalone supplement (Supplement B) that employers can print if or when rehire occurs or reverification is required. Employers may attach additional supplement sheets as necessary.
• Removed use of “alien authorized to work” in Section 1 and replaced it with “noncitizen authorized to work” as well as clarified the difference between “noncitizen national” and “noncitizen authorized to work.”
• Removed certain features to ensure the form can be downloaded easily. This also removes the requirement to enter “n/a” in certain fields.
• Updated the notice at the top of the Form I–9 that explains how to avoid discrimination in the Form I–9 process.
• Revised the Lists of Acceptable Documents page to include some acceptable receipts as well as guidance and links to information on automatic extensions of employment authorization documentation.
• Added a box that eligible employers must check if the employee’s Form I–9 documentation was examined under a DHS-authorized alternative procedure rather than via physical examination.

More about the new form I-9

The new form contains two sections and two supplements:

• Section 1 of the form collects, at the time of hire, identifying information about the employee (and preparer or translator if used), and requires the employee to attest to whether the employee is a U.S. citizen, noncitizen national, lawful permanent resident, or noncitizen authorized to work in the United States.

• Section 2 of the form collects, within three days of the employee’s hire, identifying information about the employer and information regarding the employee’s identity and employment authorization. The employee must present original documentation evidencing the employee’s identity and employment authorization, which the employer must review.

• Supplement A, Preparer and/or Translator Certification for Section 1, is completed when employees have preparers or translators assist them in completing Section 1 of Form I–9.

• Supplement B, Reverification and Rehire (formerly Section 3), is primarily used to verify the continued employment authorization of the employee.

This Supplement is completed prior to the date that the employee’s employment authorization or employment authorization documentation recorded in either Section 1 or Section 2 of the form expires, if applicable.

It may also be used if the employee is rehired within three years of the date of the initial completion of the form and to record a name change.

Record retention policy

An employer must maintain Forms I–9 for as long as individuals work for the employer and for the required retention period after the termination of an individual’s employment (either three years after the date of hire or one year after the date employment ended, whichever is later).

Also, employers must make their employees’ Forms I–9 available for inspection upon request by Department of Homeland Security (DHS), the Immigrant and Employee Rights Section (IER) in the US Department of Justice’s Civil Rights Division, and the US Department of Labor.

An employer’s failure to ensure proper completion and retention of Forms I–9 may subject the employer to civil money penalties, and, in some cases, criminal penalties.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Fed Rolls Out New Form I-9, Sunsets Key COVID-19 Deferment – Part 2

The new Form I-9 is for churches, too, and remote examination is an option. – Posted 8/23/23

Sunset of COVID-19 verification flexibility

One such change: the sunsetting of a COVID-19-era deferment for employers that allowed remote verification of employee I-9 documentation.

Starting July 31, 2023, employers have 30 days to comply with traditional Form I-9 requirements for employees whose I-9 documents were remotely verified between March 20, 2020, and July 31, 2023.

For employers that are not eligible to participate in the alternative inspection process via E-Verify, this means all I-9 documents remotely inspected under COVID-19 flexibilities must be physically inspected, in-person, by August 30, 2023.

Old form I-9 valid through Oct. 31, 2023

Employers may continue using the old Form I–9 (Rev. 10/21/19) through October 31, 2023, as they adjust to the agency’s various changes.

However, starting November 1, 2023, employers who fail to use the new form may be subject to all applicable penalties under the Immigration and Nationality Act as enforced by U.S. Immigration and Customs Enforcement (ICE).

Important: Employers do not need to complete the new Form I–9 (Rev. 08/01/23) for employees who already have a properly completed Form I–9 on file, unless reverification applies after October 31, 2023.

Stay tuned for part 3 where we will discuss key revisions and updates to form I-9. To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Fed Rolls Out New Form I-9, Sunsets Key COVID-19 Deferment – Part 1

The new Form I-9 is for churches, too, and remote examination is an option. – Posted 8/22/23

All employers, including churches, are to begin using a new Form I-9, the U.S. Citizenship and Immigration Services (USCIS) announced in late July.

Form I-9 is required of employers to verify the identity and the employment authorization of their employees to work in the country.

The new form became available August 1, 2023, and allows certain qualifying employers an alternative way of examining identifying documents for new employees using E-Verify.

According to the Homeland Security Department rule, to use E-Verify, an employer must be an E-Verify participant in good standing, which is defined as:

• An employer that has enrolled in E-Verify with respect to all hiring sites in the U.S. that use the alternative procedure;
• is compliant with all requirements of the E-Verify program including but not limited to verifying the employment eligibility of newly hired employees in the U.S.;
• continues to be a participant in good standing in E-Verify at any time during which the employer uses the alternative procedure.

The agency also announced other key changes likely affecting most, if not all, employers, including many churches.

This is a 3 part series so stay tuned for the next two parts coming later this week. To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Does Your Church Owe Taxes on Alternative Revenue? – Part 5

Answers about the often misunderstood world of unrelated business income. – Posted 8/11/23

Calculation of debt-financed income subject to tax

In most cases, not all of the net income generated from debt-financed property is actually taxable. The amount that is taxable is based on the amount of applicable debt and the church’s basis in the property.

Calculation of unrelated debt-financed income from regular activity (such as rental income)

In determining how much income (such as rental income) is actually unrelated debt-financed income with respect to a specific property, the church needs to know the average amount of acquisition indebtedness that was outstanding during the applicable tax year and the average tax basis (as defined in the Regulations) of the property for the period during the tax year that it held the property. The amount of the rental income that is considered unrelated debt-financed income is determined by multiplying the rental income by the ratio of the average acquisition indebtedness to the average tax basis of the property.

Example: Hickory Church owns a building that is debt-financed and rents it to a commercial tenant for $100,000 per year. For the year 20XX, Hickory Church had average acquisition indebtedness related to the building of $600,000 and its average tax basis for the building was $1 million. The ratio of the average acquisition indebtedness to the average tax basis is 60 percent. Therefore, 60 percent of the rental income, or $60,000, is considered unrelated gross debt-financed income. The church would also apply the 60 percent ratio to allowable expenses associated with the building’s rental activity to determine the expenses that are deductible against the gross revenue of $60,000 in arriving at net unrelated taxable income (or loss) from the activity.

Calculation of unrelated debt-financed income from the sale of property

In determining how much gain from the sale of debt-financed property is actually unrelated debt-financed income with respect to the property, the church needs to know the highest amount of acquisition indebtedness that was outstanding during the twelve-month period preceding the date of the sale and the average tax basis (as defined in the Regulations) of the property for the period during the tax year that it held the property. The amount of gain that is considered unrelated debt-financed income is determined by multiplying the gain from the sale by the ratio of the highest acquisition indebtedness to the average tax basis of the property.

Example: Oak Church buys a vacant parcel of land for $1 million in Year One, incurring debt in the amount of $800,000, with the intent of using the property for exempt purposes at some time in the future. The church never uses the property for exempt purposes. At the end of Year Ten, Oak Church sells the property for $10 million. The church’s acquisition indebtedness related to the property was $600,000 at the beginning of Year Ten and had been paid down to $500,000 by the end of Year Ten when the property was sold. The church’s average tax basis for the property was its original purchase price of $1 million. The church has a gain on the sale of the property of $9 million (the difference between the sales price of $10 million and the church’s basis for the property of $1 million). The highest acquisition indebtedness related to the property during Year Ten was $600,000. The ratio of the highest acquisition indebtedness to the average tax basis is 60 percent. Therefore, 60 percent of the gain (or $5.4 million) is taxable as unrelated debt-financed income. (At current regular federal corporate tax rates, the federal income tax on the gain would be approximately $1.8 million. It is likely that state corporate income tax would also apply.)

Planning pointer: If Oak Church had paid off the acquisition debt thirteen months before it closed on the sale of the property, none of the gain would have been taxable. This is an example of where good tax planning could have resulted in very substantial tax savings!

Section 4: Is Unrelated Business Income Really Such a Bad Thing?

Many churches try to avoid unrelated business income like the plague! But is UBI really such a bad thing? One positive theory is that it is better to have additional income, even if you have to pay some tax on it, than not to have the income at all. While such reasoning is logical, there are several implications associated with generating unrelated business income that a church should carefully consider before deciding.

Federal and state filing requirements and tax rates

When a church generates more than $1,000 of gross revenue from unrelated business activities, the church is required to file a federal income tax return (Form 990-T). Form 990-T is due by the fifteenth day of the fifth month after the church’s year-end (May 15 for a church operating on the calendar year) and may be extended for up to six months.

On Form 990-T, the church reports the revenue from its unrelated business activities and the expenses related to generating the revenue are deducted. If the revenue exceeds the deductible expenses, the church has net income from its unrelated business activities, which is subject to federal tax. If the church is incorporated (that is, it is a corporation, as are most churches in the U.S.) the regular U.S. corporate income tax rates apply.

Most states require a church that files Form 990-T to file a state income tax return as well, and if the church generates net income as calculated under state law, the church will likely also owe state income taxes calculated at applicable state income tax rates.

Implications for state and local taxes other than income taxes

When a church engages in any trade or business activity, whether it generates unrelated business income or not, it should consider the possible tax implications in other jurisdictions. For example, selling goods or services may subject the church to state sales tax laws, requiring the church to collect and remit sales tax on transactions subject to the tax. Renting property to tenants may result in similar obligations.

Laws in some states that provide property tax exemptions for churches require that property to be used exclusively for exempt purposes in order to qualify for exemption. Where that is the case, a church that engages in a trade or business activity or that rents out its property to others should determine whether the conduct of the activity could adversely affect its exemption. The definition of exempt use of property for property tax exemption purposes is state-specific and is often different from the definition of exempt-purpose activity under federal income tax law.

It is possible, therefore, that engaging in any trade or business, including an unrelated business activity, could adversely affect a church’s exemptions under various state or local laws and ordinances.

Calculating and minimizing net unrelated business income

Once a church determines that it has more than $1,000 of gross revenue from one or more unrelated business activities, it must determine its net taxable unrelated business income (or loss). Many organizations that have significant revenue from unrelated business activities actually generate a net loss from the activities after taking into account deductible expenses.

Section 3 addresses the manner in which unrelated debt-financed income is calculated.

To calculate net unrelated business income from other activities, the starting point is gross unrelated business revenue. Allowable expenses attributable to the unrelated business activities are deducted from gross revenue. In addition to expenses incurred by the church, the law allows a standard deduction of up to $1,000 (but the standard deduction cannot create a net loss or make a net loss larger).

In order to be allowable as deductions, expenses must be “directly connected” with carrying on the church’s unrelated business activities. Some expenses are attributable solely to an unrelated business activity, and the relationship is straightforward. A church may incur some expenses that are attributable partly to unrelated business activities and partly to exempt activities, in which case a reasonable allocation must be made, and only that portion of the expense attributable to the unrelated business activity is deductible.

A church that engages in unrelated business activities should carefully evaluate all of its expenses to identify every expense that may be properly and reasonably allocated to, and deducted from, the unrelated business revenue. When all such expenses are identified and deducted, including a reasonably allocable portion of administrative and overhead expenses, the result is often a net loss.

Net losses from unrelated business activities may be carried back or forward to offset net income in other years in the same manner that is allowed under federal tax law for taxable corporations.

Can a church have too much unrelated business activity?

A church may not devote a substantial amount of its time, resources, or activities to any non-exempt purposes. Accordingly, if a substantial portion of a church’s activities are dedicated to the conduct of one or more unrelated business activities, the church can lose its federal tax-exempt status under Section 501(c)(3) of the Internal Revenue Code. Unfortunately, the law is not clear with respect to measuring or determining the limits of unrelated business activity. The conclusions reached in various cases and rulings over the years vary dramatically due to the unique facts and circumstances in each of them. Many tax practitioners suggest that when a tax-exempt organization generates more than about 15 percent of its revenue from unrelated business activities, it should carefully consider (together with knowledgeable tax counsel) whether it may be exposed to the risk of loss of exemption. An insubstantial amount of unrelated business activity is not a threat to a church’s federal tax-exempt status.

Generating Income without Generating Unrelated Business Income Tax

Churches may generate income from a variety of sources other than contributions without generating unrelated business income. Using the information described in the previous sections regarding the definition of unrelated business income and the exceptions and exclusions that apply, a church can wisely plan its revenue-generating activities to avoid UBI treatment. Following are examples of income-generating activities that a church may engage in, along with descriptions of how to avoid unrelated business income in conducting them.

Bookstores and gift shops: the volunteer exception

Income from a church bookstore or gift shop may be excluded entirely from unrelated business income if the activity is conducted substantially entirely (more than 85 percent) by volunteers (uncompensated workers). If the activity qualifies for the volunteer exception, it doesn’t matter whether the items sold in the store or shop are substantially related to the church’s exempt purposes or not; nor does it matter whether the store or shop is located on the church’s property. When the volunteer exception applies, the activity may be conducted in a regular commercial location without affecting the exemption from unrelated business income.

Selling substantially related items

If all the items sold in the store or shop are of a nature that selling them contributes importantly to one or more of the church’s exempt purposes, the activity will not generate unrelated business income. In some cases, the relationship between an item being sold and the church’s exempt purposes may be obvious (e.g., Bibles, prayer books, worship music, and so on). As described in Section 1, in cases where the relationship is not obvious, the church should maintain adequate documentation to support the relationship between each item or category of similar items sold and the specific exempt purposes of the church.

Selling at off-site locations, through catalogs, and so on.

Note that, despite popular perception, a church bookstore does not have to be located on the church’s property, operated with limited hours, or concealed from the public in order to have its activities qualify for exemption. In fact, a church selling items that are substantially related to its exempt purposes may do the following without generating unrelated business income:

• Operate its store or shop in a commercial location;
• Operate during regular commercial hours;
• Promote itself to the public;
• Sell its items in mail-order catalogs or over the Internet;
• and use other similar methods of promotion.

In an authoritative ruling issued in the context of a museum selling substantially related greeting cards, the IRS clearly addressed the issue:

The organization sells the cards in the shop it operates in the museum. It also publishes a catalogue in which it solicits mail orders for the greeting cards. The catalogue is available at a small charge and is advertised in magazines and other publications throughout the year. In addition, the shop sells the cards at quantity discounts to retail stores. As a result, a large volume of cards are sold at a significant profit.

The museum is exempt as an educational organization on the basis of its ownership, maintenance, and exhibition for public viewing of works of art. The sale of greeting cards displaying printed reproductions of art works contributes importantly to the achievement of the museum’s exempt educational purposes by stimulating and enhancing public awareness, interest, and appreciation of art. Moreover, a broader segment of the public may be encouraged to visit the museum itself to share in its educational functions and programs as a result of seeing the cards. The fact that the cards are promoted and sold in a clearly commercial manner at a profit and in competition with commercial greeting card publishers does not alter the fact of the activity’s relatedness to the museum’s exempt purpose. (Revenue Ruling 73-104 – Emphasis added.)

The IRS subsequently reaffirmed the conclusion it reached in the Revenue Ruling cited above when it issued a Technical Advice Memorandum (TAM) in a museum context. The question at hand was whether off-site sales by the museum of substantially related items constituted unrelated business activity. In the TAM, in which the museum is referred to as “M,” the IRS stated:

M carries on extensive offsite sales activities. It uses several vehicles to accomplish these sales: retail stores, gift shops, an outlet located in another city, mailorder catalogues, advertisements in various other publications, corporate/ conference program, etc. Clearly, M has developed an off-site outlet network and receives significant revenue from such sales.

It is, therefore, not unreasonable to infer from this that the purpose behind the off-site sales activities is a commercial one. Were this not an exempt organization, such logic would be persuasive. However, regarding the sale of related items by an exempt organization, Rev. Rul. 73-104 holds that neither the proximity of the sale to the museum’s location nor the fact that the individual purchaser never sets foot on the property matters.

In Rev. Rul. 73-104, the organization sold large volumes of cards at quantity discounts to retail stores and through its mail order catalogues. The revenue ruling states the following: “The fact that the greeting cards are promoted and sold in a clearly commercial manner at a profit and in competition with commercial greeting card publishers does not alter the fact of the activity’s relatedness to the museum’s exempt purpose.” Thus, once it is determined that a line of merchandise is related to the purposes of a museum, the broader the market the museum is able to reach, the more it can fulfill its exempt function …. Therefore, exempt product sales occurring outside the Museum Site do not (for that reason alone) constitute unrelated trade or business under section 513 of the Code. (TAM 9550003 – Emphasis added. While a TAM is not authoritative, it is helpful in understanding the IRS’s position on a particular issue.)

A church that wishes to engage in aggressive, commercial-type sales of items that it believes are substantially related to its exempt purposes should obtain advice from tax counsel to ensure that it is in compliance with the law. Depending on the volume and scope of the activity, it may be wise to obtain a private ruling from the IRS.

Parking lots

The IRS has consistently held that the operation of a revenue-producing parking lot by an exempt organization is not a rental of real estate, but rather, is a trade or business activity. As is the case with other trade or business activities, a church may operate a parking lot in a manner where substantially all (more than 85 percent) of the work is performed by volunteers and the operation will be exempt from the tax on unrelated business income.

As an alternative, the church could rent the property on which the parking lot sits to an unrelated parking company and the parking company could operate the parking lot. In that scenario, the revenue to the church is real estate rental income, which is not unrelated business income (unless the property is debt-financed). Even if the property is debt-financed, the church should consider whether it may qualify for:

• The substantially exempt use exception, or
• The neighborhood land rule exclusion, if the church plans to convert the property to exempt use within fifteen years of the date it was acquired.

(See Section 3 for a description of these exceptions.)

Concerts or other special events

The conduct of revenue-generating concerts or other events by a church will not generate unrelated business income if the event itself contributes importantly to one or more of the church’s exempt purposes. The relationship between the event and the church’s exempt purposes (e.g., worship, evangelism, and so on) should be well-documented to support the church’s position. Again, as with other trade or business activities, conducting substantially all of the activity by volunteers will also result in the income being exempt from the tax on unrelated business income.

Thrift shops or other sales of donated merchandise

As described in Section 2, a trade or business of selling merchandise is not an unrelated business activity if “substantially all” of the merchandise sold is donated to the church. Court cases and rulings indicate that “substantially all” for this purpose means 85 percent or more of the merchandise sold. Therefore, the operation of a thrift shop selling donated goods is not an unrelated business activity. Similarly, the sale of donated merchandise using other methods (such as online auctions, including eBay) is not an unrelated business activity. (Note: A portion of eBay’s website is dedicated specifically to online sales by nonprofit organizations.)

Corporate sponsorship of events

Also as described extensively in Section 2, revenue received by a church as payment for a qualified sponsorship activity is not unrelated business income. A qualified sponsorship activity is an activity in which an outside party (typically a business) pays a church to sponsor an event or activity conducted by the church and receives, in exchange, certain limited types of recognition or acknowledgment. As long as the acknowledgment or recognition made by the church of the sponsor meets certain criteria, and the church does not provide the sponsor with a “substantial return benefit,” the transaction constitutes a qualified sponsorship activity. (See the detailed description and examples of qualified sponsorship arrangements in Section 2.)

Scrip programs

Scrip programs are activities in which an organization purchases gift cards (or their equivalent) at a discount and then sells them to supporters, often for face value. For example, a church might purchase $100 gift cards from a grocery chain at a price of $90 each and sell them to church members for $100 each. Since the members are able to use the cards to buy $100 of groceries, the scrip program is an appealing way for many organizations to raise money.

Ordinarily, the regular operation of a scrip program by a church would constitute an unrelated business activity. The IRS has ruled, however, that when the volunteer exception applies (i.e., when substantially all of the activity is conducted by volunteers) the activity is not an unrelated business activity.

Coffee shops and cafés

The best way for a church to avoid having a coffee shop or café treated as an unrelated business activity is to limit its activity to providing service in connection with events on the church’s property. Doing so will help the church take advantage of the “convenience of members” exemption described in Section 2. If the church wants to have a full-service coffee shop or café open to the public for regular business hours, it should consider having the activity conducted substantially entirely by volunteers to avoid unrelated business income.

Alternatively, the church could rent a portion of its real property to an unrelated company to operate the coffee shop or café on the site. If the property is not debt-financed, real estate rental income is not unrelated business income. If the church’s real property is debt-financed, the church should determine whether an exception may apply to the debt-financed income rules, such as the rule described in Section 3 that exempts debt-financed income if substantially all (85 percent or more) of the property is used for exempt purposes.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Does Your Church Owe Taxes on Alternative Revenue? – Part 4

Answers about the often misunderstood world of unrelated business income. – Posted 8/9/23

Special exception for educational institutions

A special exception (effectively, an exemption) to the ordinary rules for acquisition indebtedness exists in the law for organizations that are specifically classified by the Internal Revenue Service as educational institutions and for certain organizations related to such educational institutions.

An organization classified by the IRS as an educational institution should have an IRS determination letter indicating that the organization is described in Section 170(b)(1)(A)(ii) of the Internal Revenue Code. This exception would not apply to a church, but it might apply to an entity that is affiliated with a church, such as a school, if that entity is classified by the IRS as an educational institution. The special exception for educational institutions involves several technical criteria that must be met and should be evaluated by tax counsel.

Exception for property used for exempt purposes

Property used by a church exclusively for exempt purposes is not debt-financed property, regardless of the existence of acquisition indebtedness. Additionally, if “substantially all” (85 percent or more) of the use of the property is substantially related to the church’s exempt purposes, the property is excluded from debtfinanced property. The measurement of exempt use and total use may be made by time, space, or a combination of the two. If a church uses property with acquisition indebtedness less than 85 percent for exempt purposes, the portion of the property used for exempt purposes is not debtfinanced property and the remainder is, unless another exception in the law applies.

Example: Second Church owns a building that it acquired with debt financing. The building has 10,000 square feet of space. The church uses all of the space for church activities except a 1,000-square-foot space that it rents to a local restaurant. The building is not debt-financed property because the church uses 90 percent of the building for exempt purposes.

Example: Second Church owns a building that it acquired with debt financing. The building has 10,000 square feet of space. The church uses all of the space for church activities except a 3,000-square-foot space that it rents to a local restaurant. This means 7,000 square feet, or 70 percent of the building, is not debt-financed property. The 3,000 square feet (30 percent) of the building rented to the restaurant is debt-financed property, and the rental income received is debt-financed income unless another exception in the law applies.

Sale of debt-financed property not used for exempt purposes

A church can incur a significant tax liability if it sells debt-financed property that is not used for exempt purposes and generates a gain from the sale. This is an often-overlooked area of the law.

Example: Oak Church buys a vacant parcel of land for $1 million in Year One, incurring debt in the amount of $800,000, with the intent of using the property for exempt purposes at some time in the future. The church never uses the property for exempt purposes. In Year Ten, Oak Church sells the property for $10 million at a time when the remaining acquisition indebtedness is $500,000. Oak Church will incur a substantial tax liability related to its $9 million gain.

Exception for property used in certain activities

Debt-financed property does not include property that is used to conduct any of the following activities for which the income is exempt from unrelated business income (See Section 2 for descriptions of these activities):

• A trade or business in which substantially all of the work is performed by persons who are not compensated for their work (the “volunteer exception”);
• A trade or business conducted primarily for the convenience of the church’s members, students, officers, or employees (the “convenience of members exception”); or
• A trade or business that consists of selling merchandise, substantially all of which was received by the church as gifts or contributions (the “donated goods exception”).

The neighborhood land rule exception

If a church acquires property with debt financing and intends to use the land for exempt purposes within fifteen years of the acquisition date, the property will not be considered debt-financed property. This special rule applies only if the plan to use the property for exempt purposes requires demolition of any buildings or structures on the property. A church relying on the neighborhood land rule to exclude rental income from debt-financed income may not abandon its plan to convert the land to exempt use. In the event the church does abandon its plan, the neighborhood land rule exception fails to apply from that point forward.

Additionally, if the church has not converted the land to exempt use within five years of the acquisition date, the church must notify the IRS that it is relying on the neighborhood land rule at the end of the fifth year and provide to the IRS information and documents supporting its claimed intent. The IRS will rule as to whether the church may continue to rely on the neighborhood land rule for the remainder of the allowable period (up to a total of fifteen years). Even if the IRS does not rule favorably on the request, if the church ultimately does convert the land to exempt use within the allowable period in conformity with the neighborhood land rule, the rule will apply retroactively as if the IRS issued a favorable ruling at the end of the fifth year.

Special note regarding unique treatment for churches

The neighborhood land rule is so-named because in order for it to apply to exempt organizations other than churches, the property acquired must be in the “neighborhood” of the organization’s existing exempt-use property. That rule does not apply to churches. Additionally, the maximum allowable period for which the neighborhood land rule can apply for non-church organizations is ten years, instead of the fifteen-year period that applies to churches.

As is the case with other aspects of the debt-financed income rules, the neighborhood land rule involves a number of technical requirements and conditions that should be assessed by knowledgeable tax counsel.

Example: Pine Church acquires an office building with debt financing at the beginning of Year One and rents the office space to commercial tenants. Pine Church intends to demolish the office building before the end of Year Fifteen and construct a new education building on the property to be used exclusively for exempt purposes. At the end of Year Five, Pine Church notifies the IRS of its intent and provides the IRS with plans and drawings showing its progress toward using the property for exempt purposes within the allowable fifteen-year period.

The IRS issues a ruling stating that Pine Church may continue to rely on the neighborhood land rule through Year Fifteen. At the beginning of Year Twelve, the office building is demolished and Pine Church builds an education building on the property which is used exclusively for exempt purposes. The rental income received by Pine Church for the entire eleven-year period prior to demolition is not debt-financed income because of the neighborhood land rule.

Example: Pine Church acquires an office building with debt financing at the beginning of Year One and rents the office space to commercial tenants. Pine Church intends to demolish the office building before the end of Year Fifteen and construct a new education building on the property to be used exclusively for exempt purposes. At the end of Year Five, Pine Church notifies the IRS of its intent and provides the IRS with plans and drawings showing its progress toward using the property for exempt purposes within the allowable fifteen-year period.

The IRS does not issue a favorable ruling stating that Pine Church may continue to rely on the neighborhood land rule through Year Fifteen. Pine Church begins to treat its rental income from the property as debt-financed income beginning in Year Six. At the beginning of Year Twelve, the office building is demolished and Pine Church builds an education building on the property which is used exclusively for exempt purposes. The rental income received by Pine Church for the entire eleven-year period prior to demolition is not debt-financed income because of the neighborhood land rule. Since the church treated the income as debt-financed income for Years Six through Eleven, the church may file amended returns and obtain a refund of all taxes paid on the income during that period.

Stay tuned for part 5 where we will continue discussing taxes and alternative revenue. To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Does Your Church Owe Taxes on Alternative Revenue? – Part 3

Does Your Church Owe Taxes on Alternative Revenue? – Part 2

Does Your Church Owe Taxes on Alternative Revenue? – Part 1

Key Tax Dates August 2023

Tax News for July 2023 . . .

Smart Budgeting for Tech Purchases

Designating a Housing Allowance for 2023 – Part 2

Tax reporting & Amendments – Posted 7/26/23

Tax reporting

Most churches reduce the pastor’s W-2 by the amount the church designated as a housing allowance. But remember that the allowance is not necessarily nontaxable for income tax reporting purposes. For ministers who own or rent their home, the allowance is nontaxable only to the extent that it does not exceed actual housing expenses or the annual rental value of the home (furnished, plus utilities). It is the minister’s responsibility to report any excess housing allowance as taxable income on his or her tax return.

IRS Publication 517 states:

You must include in gross income the amount of any [housing, rental, or parsonage] allowance that is more than the smallest of

• Your reasonable salary,
• The fair rental value of the home plus utilities, or
• The amount actually used to provide a home.

Include this amount in the total on Form 1040, line 1. On the dotted line next to line 1, enter “Excess allowance” and the amount.

Example. At the end of 2022, a church board determined that Pastor T’s compensation for 2023 would be $50,000. It designated $20,000 of this amount as a housing allowance. At the end of the year the church treasurer issues Pastor T a W-2 that reports taxable income of $30,000 (salary less housing allowance). However, Pastor T only has $17,000 of housing expenses in 2023. As a result, taxable income is understated on his W-2 by $3,000. It is Pastor T’s responsibility to report this $3,000 as additional income on line 7a of Form 1040.

Church treasurers should be sure that their pastor is aware of this reporting responsibility. Many pastors erroneously assume that they can reduce their taxable income by the full amount of the church-designated housing allowance. This will be true only if the allowance is less than the pastor’s actual housing expenses and the annual rental value of the home (including utilities).

Amending the housing allowance

What if the housing allowance designated for your pastor turns out to be too low? For example, the pastor has to pay for unanticipated home repairs, or begins to prepay part of the home mortgage loan. Can the church amend the pastor’s housing allowance? Yes it can, but note that the amendment only operates prospectively—from the date of the amendment forward.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Designating a Housing Allowance for 2023 – Part 1

Is Your Church Buried by Debt?

What should Churches do if they are struggling to make debt payments? – Posted 7/21/23

1. The very first thing you should do when you see a financial problem is to do something. The natural human tendency is to avoid things and think it’ll get better. You’ve got to face the problem head on.
2. After you’ve done that, evaluate your financial management. Review cash management policies and procedures to be sure funds are being handled best, examining cash flow, liquidity, and stewardship of other ministry assets.
3. Review all expenses and consider reductions in all discretionary line items. Evaluate facilities, land, and other assets. Perhaps you need to consider selling under-used portions of your property.
4. Talk to your lenders. Don’t wait until you can’t make your payments. Share the expense cuts made to date, additional planned cuts, board involvement, and plans to contact key donors. The board should also know, and discuss with the bank, the collateral value of the church property, and the possibility of marketing it to salvage equity prior to a foreclosure. This assures the lender that the church leadership is looking at all scenarios. Lenders will be more willing to work with a borrower when they can see a good management team is fully engaged and communicating.
5. Implement monthly board meetings for the foreseeable future to primarily focus on year-to-date actual contributions and budget performance.
6. Finally, talk to your congregation. Why not allow your congregation to make a “fully informed” decision about their participation in resolving the financial situation of the church? There is nothing more heartening than watching God’s Spirit miraculously move within a congregation in situations like these.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Debt campaign or not?

Pros and cons for churches considering a debt-elimination campaign – Posted 7/19/23

Pros:

1. It can teach the congregation sound biblical principles. Proverbs 22:7 says: “The rich rule over the poor, and the borrower is slave to the lender.”
2. It can allow money to go into ministry rather than to a creditor.
3. It can model good stewardship.

Cons:

1. It can be a difficult sale. “It’s a lot easier to raise funds for ongoing construction or a building project, for something new and exciting,” explains CPA Vonna Laue.”It’s harder to get people excited about paying down for something we already have.”
2. It can result in prepayment penalties. “Some lenders do include prepayment penalties in their loans that they make to churches, and yes, that’s definitely going to be a consideration,” says Dan Mikes, executive vice president and national division manager of religious institution banking for Bank of the West, based in San Francisco, California.
3. It can hurt operational funding. “Periodically, folks just shift their (normal) giving toward a campaign … and some of their operating giving goes down,” says Mike Boblit, vice president of ministry relationship banking for the Evangelical Christian Credit Union, based in Brea, California.

Practical steps

What are some practical steps Churches can take to tackle debt?

Some churches hire consulting firms, such as Generis and RSI, to lead debt-elimination campaigns while others seek assistance directly from their congregation.

Regardless of which approach a congregation takes, experts stress that communication is key. Generis’s Sheppard says he always recommends that church leaders meet individually with three important constituencies: major donors, key leaders, and the congregation itself.

RSI’s Mikell adds “total openness and transparency” are essential and that six questions must be answered clearly and concisely:

1. Why does the church have debt?
2. How much does the church owe?
3. How much is being spent to service the debt?
4. How much interest would be paid over the life of the loan?
5. How long would it take to retire the current debt if the church maintained the status quo?
6. How will the money currently being spent on debt service be re-appropriated for ministry?

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

Laying Your Church’s Debt Burden Down

How Ratios Can Strengthen This Year’s Finances

Some Churches Keep Their Budgets Rolling

Three Questions to Ask About Your Church’s Financial Management

Tax News for June 2023 . . .

Correcting Improper FICA Withholdings

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

What is a group exemption and why is it helpful?

-Posted 6/28/23

The IRS sometimes recognizes a group of organizations as tax-exempt if they are affiliated with a central organization—such as a denomination covered by the group ruling. This avoids the need for each of the organizations to apply for exemption individually. A group exemption letter has the same effect as an individual exemption letter except that it applies to more than one organization.

Group exemptions are an administrative convenience for both the IRS and organizations with many affiliated organizations. Subordinates in a group exemption do not have to file, and the IRS does not have to process separate applications for exemption. Consequently, subordinates do not receive individual exemption letters.

Exempt organizations that have, or plan to have, related organizations that are very similar to each other may apply for a group exemption. Groups of organizations with group exemption letters have a “head” or main organization, referred to as a central organization. The central organization generally supervises or controls many affiliates, called subordinate organizations. The subordinate organizations typically have similar structures, purposes, and activities.

To qualify for a group exemption, the central organization and its subordinates must have a defined relationship. Subordinates must be:

• Affiliated with the central organization;
• Subject to the central organization’s general supervision or control; and
• Exempt under the same paragraph of IRC 501(c), though not necessarily the paragraph under which the central organization is exempt.

To view this article online, please visit the Church Tax & Law Website . For more information on this subject or any other tax related questions, please contact our office.

The Two Most Confusing Aspects of Classifying Your Minister for Tax Purposes

A Peek Inside How Churches Spend Their Money

Housing Allowances

Six Insights About Summer Slump

Reporting Financial Crime as a Matter of Stewardship

Every Church Is at Risk for Fraud. Here’s Why.

“The primary types of financial misconduct that occurred are the most preventable with a good internal control structure,” Laue said.

Yet many churches do not install simple safeguards out of a perceived high level of trust among their ranks, a noted frustration among the financial experts who reviewed Church Law & Tax’s results and provided comment.

“It will never happen here”

Two-thirds of survey respondents who said they weren’t aware of fraud in their churches also said they believe the problem is unlikely or “will never” happen in their churches. Ironically, among those who endured misconduct, half said they shared a similar “it-will-never-happen” sentiment before uncovering a case—and 80 percent then implemented several basic measures after the fact.

“This is one of the most important takeaways from this study,” noted Rollie Dimos, a Certified Fraud Examiner (CFE) and author of Integrity at Stake: Safeguarding Your Church from Financial Fraud. “Most people think that their church is immune from the risk of fraud because [their] staff and volunteers are trustworthy. . . . We trust people to do the right thing, but we can fail them if we don’t hold them accountable or provide controls to protect them.”

Nathan Salsbery, a CFE and a partner and executive vice president for nonprofit CPA firm CapinCrouse, said many congregations “do not implement effective internal controls until they feel the pain of fraud firsthand.”

Salsbery is currently assisting fraud investigations at three different churches. “Had these churches implemented a few basic internal controls, they would have either prevented the fraud or would have detected it much sooner,” he added.

A costly toll

The failure to prevent or quickly detect financial misconduct exacts heavy tolls on congregations. In a 2022 study, Gordon-Conwell Theological Seminary’s Center for the Study of Global Christianity estimates church fraud globally will total $70 billion a year by 2025.

The fallout extends beyond pure dollars, though, and often with devastating effects. In an analysis of the language used by respondents to Church Law & Tax’s survey, words associated with anger and sadness appeared repeatedly among respondents who experienced fraud.

“The financial losses can be staggering,” Salsbery said. “While the financial losses are bad enough, there are usually many other losses that result from the inevitable broken trust and relationships damaged by such long-term acts.”

Such damage is understandable, given the typical identity of the perpetrator and the amounts that he or she steals.

As the Church Law & Tax research shows, the profiles of offenders frequently included treasurers, board members, and middle-aged pastors. Financial losses were the largest among perpetrators with long tenures at their churches (see “Loved and Trusted: What Shocks Us Most about Fraud Perpetrators”).

 

As for the amounts stolen, Church Law & Tax’s research showed 69 percent of those victimized said their losses measured less than $100,000. About 14 percent said the amounts topped $100,000, while another 15 percent said they did not know how much was taken.

Precise financial losses are difficult to pinpoint since the perpetrator may not know or may lie. And churches that choose not to contact law enforcement likely will miss out on learning the full extent because a thorough investigation never happens. Nearly 70 percent of victimized churches chose not to report their cases to police. Overall, only 22 percent of all respondents said their boards would contact law enforcement in the event a future suspected or actual case arose (see “Reporting Financial Crime as a Matter of Stewardship”).

Easy opportunities

Nearly 42 percent of cases involved “inappropriate expenses or inappropriate expense reimbursements,” the survey showed. Slightly more than 30 percent involved stealing contributions. Payroll fraud and inaccurate timesheets combined constituted 12 percent of the cases. And another 11 percent took tangible church property, while about 9 percent forged check signatures. (Note: Respondents to the “Types of Financial Misconduct” infographic were asked to check all that apply.)

While the type of theft men and women committed against their churches varied, according to the survey, it generally boiled down to one thing: easy opportunities.

“While TV shows often depict fraud as grand and complicated schemes, most fraud committed in the church is simply an individual taking advantage of a situation where no one is looking,” Salsbery observed.

Just assigning another set of eyes to monitor a variety of financial activities could greatly reduce easy opportunities. For instance, the leading “red flag” for persons who committed fraud was excessive control over his or her duties or an “unwillingness to have others cover his/her job duties.”

“Nearly half of fraud schemes found were detected as a result of another employee performing a person’s duties” in their absence, noted CPA Michael Batts, another Church Law & Tax senior editorial advisor who reviewed the results. “The rotating duties of workers performing certain financial duties is, itself, an effective internal control mechanism, especially where adequate segregation of duties for a particular position is not in place.”

Encouraging signs—but much room for improvement

While the ease with which perpetrators stole from their churches is troubling, many of the practices best positioned to thwart such efforts do not require extensive time or expense.

On an encouraging note, many respondents indicated at least some best practices are already in place.

About 86 percent of all respondents regularly generate and review financial statements, and 83 percent make certain two unrelated people work together to handle financial tasks.

Around three-quarters of those who had experienced fraud said they use separate individuals—the “segregation of duties” in accounting parlance—for authorizing cash disbursements, maintaining custody or control over cash, and handling accounting responsibilities. (Note: Most of those who responded to the question about “segregation of duties” were in churches that had experienced fraud. Respondents highlighted in the “Top measures churches take to prevent financial misconduct” infographic were asked to check all that apply.)

Still, the responses for these categories show between 17 percent and 25 percent of churches are not performing these basic measures.

The percentages worsen when considering other areas of financial accountability or internal controls recommended by experts. For instance:

• Slightly more than half of respondents said one person in their church has the ability to perform all aspects of cash disbursements without requiring another individual’s involvement. “That is a staggering statistic,” Laue noted.

Dimos said this problem, along with improper expenses or expense reimbursements—the leading type of fraud found in the survey—can be easily prevented by “[r]equiring a second person to review and approve all credit card purchases or reviewing invoices or reimbursement requests before signing checks.”

Additionally, “disciplined monthly reviews of cancelled checks (or images) and reviews of monthly credit card statements and related documentation and support [can] significantly reduce risk,” Salsbery said.

• Only one-third of churches store their collections in a safe and secure manner and require dual controls for access when they cannot be immediately deposited at the bank (again, stolen contributions constituted the second-highest type of fraud in the survey).
• Only one-third of churches have their payroll approved by someone other than the preparer and then reconciled to the church’s accounting system.
• Only 22 percent apply accounting procedures to tangible property susceptible to theft, such as electronic equipment or bookstore inventories.

“The addition of internal controls to protect your church will not cost the church anything,” Dimos observed. “Having a second person—like a staff member, trusted volunteer, or board member—be responsible to review the bank reconciliation and bank statements, or review a general ledger detail report, can provide a great deal of accountability, but not add any extra expense for the church.”

Audits and assessments

Financial audits and fraud risk assessments offer additional protections for churches, although unlike the previously mentioned preventive steps, these typically come with a cost.

An ongoing audit process “can help a church greatly reduce the risk of misappropriation and embezzlement,” Batts said. Dimos agreed, adding the use of fraud risk assessments can go one step further and “help a church test their controls and identify potential weaknesses and risk areas.”

In the survey, about 24 percent of respondents conducted outside audits with a CPA, which involves documentation and third-party support of the financial information, Laue said. Thirty percent hired a CPA or financial expert to perform a less intensive outside review, which relies on inquiries and analytical procedures, Laue noted. Almost 38 percent said they perform internal audits using church staff and volunteers.

In terms of fraud risk assessments, nearly 51 percent said they do not use them at all.

Learning from “hard lessons”

Church Law & Tax’s survey “presents a strong case for churches to be proactive in preventing fraud,” Dimos said.

The fact that 30 percent of churches reported experiencing financial misconduct at some point, and that the possibility exists even more experience it without realizing it, reveals “the risk of fraud is very real in all churches,” Salsbery said.

While many will think the steps are unnecessary, or shouldn’t be necessary because people should know better, Salsbery pointed to examples of fraud contained in the Bible—including Judas’s thefts from Jesus and the disciples’ ministry account or Ananias and Sapphira’s attempt to deceive Peter—as reminders that anyone can succumb to temptation.

“Just as policies are put in place to help prevent other sins from damaging the church, controls are needed to protect churches from the sin of fraud,” Salsbery said.

And taking time now to review practices and strengthen them—especially when no apparent problem exists—only ensures church leaders are stewarding resources well, Laue added.

“Let’s learn from the hard lessons of others,” Laue said. “I strongly encourage churches to take the step and carefully review internal controls or even hire someone to help assess and implement better internal controls now. Even if fraud was never to occur, it won’t hurt for us to operate with good processes in place.”

Monetary Gifts for Pastors Who Leave

When Ministry Becomes Business

Clerical Errors Cost Church Its Tax Exemption

Key Tax Dates June 2023

Tax News for May 2023 . . .

Where to Find Reliable Financial Data

Q&A: Should We Start Digging into Our Reserves?

I generally believe and espouse the view that having three months’ worth of operating expenses in cash reserves is sound. And having six months’ worth of operating expenses in cash reserves would be strong.

Churches that begin to utilize their reserves—and deplete them going forward—must remember that the fundamentals regarding reserves don’t change. And while we don’t know what the future is going to look like in terms of our financial operations, we still need to keep in mind that cash reserves have a place for unexpected developments that can still be coming.

Once you prudently use cash reserves to help the church through a challenging time, then begin consistently and intentionally restoring the reserves to sound or strong levels over a reasonable period of time.

For many churches, it can reasonably take a year to add one month’s worth of operating expenses to cash reserves. In my opinion, that is a reasonable time frame. So, if reduced your reserves during the pandemic from six months of operating expenses to three, it is reasonable to expect that it might take three years to restore the reserves to their former level.

Of course, the specific time frame will be unique to each church, taking into consideration the priority that the church assigns to restoring reserves.

How Do We Budget During This Time of Rapid Change and Uncertainty?

**Posted 5/15/23

Here’s some fairly radical advice as it relates to budgeting—radical in the sense that this is not conventional church financial management wisdom: Stop focusing on your regular annual budget. For churches experiencing rapid changes in their giving levels, the annual budget developed months ago is largely irrelevant.

I realize that as a matter of church governance and policy, you might have to have a budget. But what you planned when you developed that budget is no longer reality. Your spending levels and spending categories most likely have changed. Your revenue levels may be very different. So, what do you do?

Stop focusing on what you’re calling the budget and start doing what I call dynamic cash-flow forecasting and planning. That may sound like a fancy term. Dynamic just means it’s changing. It’s moving. And cash-flow forecasting and planning means estimating what’s going to happen, as best you can, and continuously updating your estimate based on new developments as they unfold.

Forecast this way each week over the next few months. Estimate as best you can, and adjust the forecast frequently based on new developments.

What weekly cash-flow forecasts look like

Weekly cash-flow forecasts could start with a spreadsheet in which you start with your beginning cash and then project your expected cash inflow and your expected cash outflow. Put simply: cash inflow, which might include borrowing, is cash that’s coming into your church. And then cash outflow, including debt service—is whatever cash is going out for whatever purpose. And then, of course, the difference between your expected inflow and your expected outflow is your expected net cash flow. Add your beginning cash to your expected net cash flow; this would be your expected ending cash.

Forecasting also includes modeling different scenarios with different assumptions. If giving for your church so far is relatively flat, you should model one scenario that shows your giving level staying flat. You might also want to model a scenario of your giving level going down by 10 percent or 15 percent, or whatever makes sense to you depending on your current circumstances and trending. You might want to run various scenarios and update them each time as you have better information about what seems to be happening.

Weekly cash-flow forecasts should be developed for a reasonable and appropriate period of time in the future. I would suggest at least eight to ten weeks out. A forecast much shorter than that has little value for cash-flow planning and strategic decision-making. And in a highly dynamic environment, a forecast much longer than that is likely to have less reliability.

Rolling budgets

Rolling budgets are an alternative to annual budgets suitable for some churches to use as their regular approach to budgeting. Maintaining weekly cash-flow forecasts is an accelerated version of maintaining rolling budgets. Maintaining rolling budgets is not a “do it once a year” approach to budgeting. (I discuss this process on pages 18 and 19 of Church Finance: The Church Leader’s Guide to Financial Operations and also in another article.)

Churches that are experiencing rapid growth are good candidates for rolling budgets, since their revenue and expense levels change more rapidly than a full-year budget is typically designed to address. Normally, for churches that utilize rolling budgets, I would recommend updating the rolling budget approximately quarterly. But these are not normal times. For this reason, I recommend updating it weekly—or every time you learn or observe something new and different. Doing this allows you to better manage cash and financial activities during a dynamic or very challenging, rapidly changing season.

To view this article online, please visit the Church Tax & Law Website . For more information budgeting strategies or any other tax related questions, please contact our office.

Key Tax Dates May 2023

Workers’ Compensation: Who Is—and Isn’t—Covered?

Top 3 Most Confusing Tax Issues for Clergy

What new—and veteran—ministers and treasurers need to know to file taxes correctly and receive maximum tax benefits. – Posted 5/4/23

Ministers and treasurers must be familiar with the tax rules that apply to clergy. Unfortunately, seminary training rarely equips new ministers with this information, and church treasurers often don’t know about the unique tax laws that apply to clergy. This information gap means ministers and treasurers frequently handle clergy income and the payment of related taxes incorrectly, and they fail to take advantage of the tax benefits that are available to ministers.

For instance, ministers are eligible for five special tax rules with respect to services they perform in the exercise of their ministry. These include (1) not paying federal income taxes on the portion of their church compensation designated in advance by their church as a housing allowance (limitations apply), (2) not paying federal income taxes on the annual rental value of a parsonage provided by their church, (3) being exempt from “self-employment taxes” (Social Security taxes paid by the self-employed) if several conditions are met, (4) being considered self-employed for Social Security (if not exempt), and (5) having ministers’ wages exempt from income tax withholding.

In order to qualify for these tax savings, however, you must meet the IRS’s definition of a “minister.” The IRS applies a five-factor test to determine whether an individual qualifies as a minister for federal income tax purposes. In general, for individuals to enjoy the five special tax rules summarized above, they must satisfy two main requirements: they must be a minister, and they must be engaged in the exercise of ministry.

Assuming you clear these IRS hurdles for establishing whether or not you’re a minister for federal tax purposes, you then need to know how to file taxes properly to ensure you receive the benefits available to you.

In this article, we focus on three of the most perennially perplexing tax issues for clergy. While there are many more we could cover, these are the three that pose confusion and uncertainty for many ministers and church treasurers, new and seasoned.

1. Should a Minister Report Income Taxes as an Employee or as Self-Employed?

The question of whether ministers should report their federal income taxes as an employee or as self-employed is a significant one. Most new ministers should report their federal income taxes as employees, because they will be considered employees under the tests currently used by the IRS and the courts. Most clergy will be “better off” reporting as employees, since (1) the value of various fringe benefits will be excludable, including the cost of employer-paid health insurance premiums on the life of the minister, (2) the risk of an IRS audit is substantially lower, and (3) reporting as an employee avoids the additional taxes and penalties that often apply to self-employed clergy who are audited by the IRS and reclassified as employees.

2. Should a Minister Report Social Security Taxes as an Employee or as Self-Employed?

There is one provision in the tax code that has caused more confusion for ministers and church treasurers than any other, and it is this: ministers are always treated as self-employed for Social Security with regard to services they perform in the exercise of their ministry (except for some chaplains). This is true even if they are employees for federal income tax reporting. This is sometimes referred to as the “dual tax status” of ministers.

Many new (and even veteran) ministers are surprised to learn that their employment status for income tax purposes has no bearing on their employment status for Social Security taxes. This often creates confusion. Ministers are always self-employed for Social Security with respect to their ministerial services. This is true even if you are treated as an employee for federal income tax purposes. This means you pay the self-employment tax, not “Social Security” and “Medicare” taxes. Your employing church must not treat you as an employee for Social Security, even though it issues you a W-2 for income taxes.

The most important consequence of this dual tax status is that ministers pay the so-called “self-employment tax.” This is the Social Security tax that is paid by self-employed workers. It amounts to 15.3 percent of a minister’s taxable earnings. Employees and employers pay “Social Security” and “Medicare” taxes (sometimes collectively referred to as “FICA” taxes). Like self-employment taxes, these taxes amount to 15.3 percent of a minister’s taxable earnings. But there is a big difference. Employers and employees split the 15.3 percent tax rate, with each paying 7.65 percent. Self-employed persons pay the entire self-employment tax. Many churches pay half, or even all, of a minister’s self-employment tax. This is perfectly appropriate, but any amount paid by the church must be reported as taxable income to the minister.

3. How Does a Minister Pay Taxes?

Many churches erroneously withhold the employee’s share of Social Security and Medicare taxes from ministers’ compensation, and then pay the employer’s share. In other words, they treat their minister as an employee for Social Security. This is understandable, especially when the church treats the minister as an employee for purposes of federal income taxation. But, it is always incorrect for a church to treat a minister as an employee for Social Security. Self-employment taxes for ministers are computed on Schedule SE of Form 1040.

The federal income tax is a “pay as you go” tax. This means that you must pay your tax as you earn income during the year. There are two ways to do this—quarterly estimated tax payments and tax withholding.

Ministers must prepay their income taxes and self-employment taxes using the estimated tax procedure, which can be confusing. Nonetheless, it’s important to understand how to calculate and pay estimated taxes to avoid significant tax liabilities.

Generally, you should make estimated tax payments if your estimated tax for this year will be $1,000 or more and the total amount of income tax that will be withheld from your income will be less than the lesser of (1) 90 percent of your tax liability for the current year, or (2) 100 percent of your tax liability for the previous year (if it covered all 12 months of the year). If you are required to pay estimated taxes, but fail to do so, you will be subject to an “underpayment penalty.” Since the penalty is figured separately for each quarterly period, you may owe a penalty for an earlier payment period even if you later paid enough to make up the underpayment. If you did not pay enough tax by the due date of each of the payment periods, you may owe a penalty even if you are due a refund when you file your income tax return!

The 4-step procedure for paying estimated taxes

Complying with the estimated tax procedure is easier than it seems. Here are the four steps you need to follow:

Step 1–Obtain a copy of IRS Form 1040-ES prior to April 15 of the current year.

Step 2–Compute estimated taxes.

Calculate your estimated tax for the current year by estimating adjusted gross income and then subtracting estimated adjustments, deductions, exemptions, and credits. Multiply estimated taxable income times the applicable tax rate contained in the Tax Rate Schedule reproduced on Form 1040-ES. Include your estimated Social Security tax on the worksheet if you are not exempt, and include your housing allowance exclusion in computing your estimated earnings subject to the self-employment tax.

Step 3–Pay estimated taxes in quarterly installments.

If estimated taxes (federal income taxes and self-employment taxes) are more than $1,000 for the current year, and the total amount of taxes to be withheld from your compensation is less than the lesser of (1) 90 percent of your tax liability for the current year, or (2) 100 percent of your tax liability for the previous year, then you must pay one-fourth of your total estimated taxes in four quarterly installments (by April 15 for January 1 to March 31; by June 15 for April 1 to May 31; by September 15 for June 1 to August 31; and by January 15 for September 1 to December 31). If the due date for making an estimated tax payment falls on a Saturday, Sunday, or legal holiday, the payment will be on time if you make it on the next business day.

Payment vouchers. You must send each payment to the IRS, accompanied by one of the four payment vouchers contained in Form 1040-ES.

Starting a job in mid-year. A minister who becomes liable for estimated tax payments midway through a year should submit a payment voucher by the next filing deadline accompanied by a check for a prorated portion of the entire estimated tax liability for the year.

Changing your quarterly payments. Changes in your income, deductions, credits, or exemptions may make it necessary for you to refigure your estimated tax and adjust your remaining quarterly payments accordingly.

Step 4–Compute actual taxes.

After the close of the year, compute your actual tax liability on Form 1040. Only then will you know your actual income, deductions, exclusions, and credits. Estimated tax payments rarely reflect actual tax liability. Most taxpayers’ estimated tax payments are either more or less than actual taxes as computed on Form 1040 (usually less).

Overpayment. If you overpaid, you can elect to have the overpayment credited against your first quarterly estimated tax payment of the following year or spread out in any way you choose among any or all of your next four quarterly installments. Alternatively, you can request a refund of the overpayment.

Underpayment. If you underpaid your estimated taxes you may have to pay a penalty. The penalty is computed separately for each quarterly payment period. Contrary to popular belief, payment of your entire estimated tax liability with your Form 1040 will not relieve you of the penalty if you did not pay the estimated income tax due earlier in the year.

Form 2210. You can use Form 2210 to see if you owe a penalty and to figure the amount of the penalty. If you owe a penalty and do not attach Form 2210 to your Form 1040, the IRS will compute your penalty and send you a bill. You do not have to fill out a Form 2210 or pay any penalty if either of two conditions apply: (1) your total tax less income tax withheld is less than $1,000, or (2) you had no tax liability last year and you were a United States citizen or resident for the entire year. The IRS can waive the underpayment penalty if the underpayment was due to casualty, disaster, or other unusual circumstance and it would be inequitable to impose the penalty.

Special rule for high-income taxpayers. A high-income taxpayer with adjusted gross income for the previous year of at least $150,000 cannot avoid the underpayment penalty by paying estimated taxes for the current year of at least 100 percent of last year’s tax. For such persons, the “100 percent rule” is replaced with a 110 percent rule, meaning that they will be subject to an underpayment penalty unless they have paid estimated taxes for the current year of at least the lesser of (1) 90 percent of the current year’s actual tax liability, or (2) 110 percent of last year’s actual tax liability.

Voluntary withholding

Ministers who report their income taxes as an employee may request “voluntary withholding” of their income taxes and self-employment taxes by filing a Form W-4 with the church. A self-employed minister is free to enter into an “unofficial” withholding arrangement whereby the church withholds a portion of his or her compensation each week and deposits it in a church account, and then distributes the balance to the minister in advance of each quarterly estimated tax payment due date.

To view this article online, please visit the Church Tax & Law Website . For more information regarding clergy tax issues or any other tax related questions, please contact our office.

Can Pastors and Staff Deduct Expenses Incurred While Working from Home?

**Posted 5/3/23

The Tax Cuts and Jobs Act of 2017 changed what’s allowed for tax purposes—but employer reimbursements of certain employee business expenses is still a tax-advantaged practice.

That’s because of provisions contained in the Tax Cuts and Jobs Act of 2017.

But that doesn’t mean churches can’t help pastors and staff with their home office expenses.

Two key points come to mind:

First, for ministers, remember that they are treated uniquely under the tax code. They have “dual tax status,” meaning they are treated as employees for income tax purposes, but they are treated as self-employed for purposes of Social Security and Medicare (the Self Employed Contributions Act, or SECA).

Because of this unique status, ministers still may be able to deduct their unreimbursed business expenses in arriving at their net income subject to self-employment tax. They should consult with qualified tax counsel to further explore this possibility.

And second, churches that allow, or perhaps even require, ministers and staff members to work from home in some capacity should recognize that the costs for equipment and supplies used by these individuals may constitute valid business expenses.

Expenses incurred by an employee for supplies and equipment used exclusively in connection with his or her employment are typically valid business expenses that can be reimbursed tax-free by the employer under an accountable reimbursement arrangement.

Advantages to reimbursements

There may be additional advantages to reimbursing some of these expenses. Requiring a certain type of computer or laptop may make sense for cybersecurity and productivity purposes.

Covering all or part of the monthly internet service may make sense for ensuring minimum speeds required by the employer for video calls and other activities requiring large bandwidth.

Other costs that may qualify include office supplies, a printer, a scanner, and, depending on the circumstances, office furniture.

For more information or to view this article online, please visit the Church Tax & Law Website . For more recommendations regarding the deadline for form 5578 or any other tax related questions, please contact our office.

But two cautions should be noted:

Pastors and employees: Remember that if the employer pays or reimburses the cost for furniture or equipment, the employer owns the items purchased. So, individuals have a responsibility to steward these items well—and recognize that they will need to return them if their employment ends.

Churches: Remember that reimbursements have a budgetary impact. But also remember that reimbursing employees for costs they incur for required elements of their job is very helpful to them financially … and generally not taxable.

To view this article online, please visit the Church Tax & Law Website . For more information regarding at home work expenses or any other tax related questions, please contact our office.

Tax News for April 2023 . . .

Church-Run Schools Face Annual Deadline for Federal Form

Leaders should not overlook the Form 5578, an oft-forgotten IRS requirement. – Posted 4/28/23

Churches and other religious organizations that operate, supervise, or control a private school must file a certificate of racial nondiscrimination (Form 5578) each year with the Internal Revenue Service (IRS).

The certificate is due by the 15th day of the fifth month following the end of the organization’s fiscal year. This is May 15 of the following year for organizations that operate on a calendar-year basis. For example, the Form 5578 for 2022 is due May 15, 2023.

What is a “private school?”

A private school is defined as an educational organization that normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly conducted. The term includes primary, secondary, preparatory, or high schools, as well as colleges and universities, whether operated as a separate legal entity or an activity of a church.

Key point. The term school also includes preschools, and this is what makes the reporting requirement relevant for many churches. As many as 25 percent of all churches operate a preschool program.

Key point. Independent religious schools that are not affiliated with a church or denomination and that file Form 990 (see above) do not file Form 5578. Instead, they make their annual certification of racial nondiscrimination directly on Form 990 (Schedule E).

Filing the certificate of racial nondiscrimination is one of the most ignored federal reporting requirements.

Churches that operate a private school (including a preschool), as well as independent schools, may obtain Form 5578 through the IRS website.

Completing Form 5578 is easy

Form 5578 is not complicated. A church official simply identifies the church and the school and certifies that the school has “satisfied the applicable requirements of sections 4.01 through 4.05 of Revenue Procedure 75-50.”

The applicable requirements are:

(1) The school has a statement in its charter, bylaws, or other governing instrument, or in a resolution of its governing body, that it has a racially nondiscriminatory policy toward students.

(2) The school has a statement of its racially nondiscriminatory policy toward students in all its brochures and catalogs dealing with student admissions, programs, and scholarships.

(3) The school makes its racially nondiscriminatory policy known to all segments of the general community served by the school in one of the following ways:

• publishing a notice of its racially nondiscriminatory policy at least annually in a newspaper of general circulation,

• utilizing broadcast media, or

• displaying a notice of its racially nondiscriminatory policy on its primary, publicly accessible Internet homepage at all times during its taxable year (excluding temporary outages due to website maintenance or technical problems) in a manner reasonably expected to be noticed by visitors to the homepage. IRS Revenue Procedure 2019-22.

The IRS has clarified that “a publicly accessible homepage is one that does not require a visitor to input information, such as an email address or a username and password, to access the homepage.

Factors in determining whether a notice is reasonably expected to be noticed by visitors to the homepage include the size, color, and graphic treatment of the notice in relation to other parts of the homepage, whether the notice is unavoidable, whether other parts of the homepage distract attention from the notice, and whether the notice is visible without a visitor having to do anything other than simple scrolling on the homepage.

A link on the homepage to another page where the notice appears, or a notice that appears in a carousel or only by selecting a dropdown or by hover (mouseover) is not acceptable. If a school does not have its own website, but has webpages contained in a website, the school must display a notice of its racially nondiscriminatory policy on its primary landing page within the website.”

The IRS has drafted the following statement that satisfies the publicity requirement:

Notice Of Nondiscriminatory Policy As To Students

The (name) school admits students of any race, color, national and ethnic origin to all the rights, privileges, programs, and activities generally accorded or made available to students at the school. It does not discriminate on the basis of race, color, national and ethnic origin in administration of its educational policies, admissions policies, scholarship and loan programs, and athletic and other school-administered programs.

The publicity requirement is waived if one or more of the following exceptions apply:

• During the preceding three years, the enrollment consists of students at least 75 percent of whom are members of the sponsoring church or religious denomination, and the school publicizes its nondiscriminatory policy in religious periodicals distributed in the community.

• The school draws its students from local communities and follows a racially nondiscriminatory policy toward students and demonstrates that it follows a racially nondiscriminatory policy by showing that it currently enrolls students of racial minority groups in meaningful numbers.

(4) The school can demonstrate that all scholarships or other comparable benefits are offered on a racially nondiscriminatory basis.

For more information or to view this article online, please visit the Church Tax & Law Website . For more recommendations regarding the deadline for form 5578 or any other tax related questions, please contact our office.

10 Key Tax Developments Affecting Churches and Pastors in 2023

What you need to understand for 2022 filing and 2023 compliance. – Posted 4/27/23

Several recent developments affect tax reporting by ministers, church staff, and churches in 2022 and beyond. Ten of them are addressed here and are also found in the 2023 Church & Clergy Tax Guide (order yours today – it will ship in January)which covers other key developments.

Tip: The 2023 Church & Clergy Tax Guide is also available for download in .pdf form.

1. Status of the housing allowance

In March 2019, a federal appeals court rejected an atheist group’s challenge to the constitutionality of the ministers housing allowance. Gaylor v. Mnuchin, 919 F.3d 420 (7th Cir. 2019). The atheist group did not appeal this ruling, and there have been no further legal challenges.

Tip: Be sure and check out Church Law & Tax’s update on Designating a House Allowance for 2023 to include recommendations for a variety of situations.

2. Revoking an exemption from Social Security

Once a minister seeks and receives an exemption from Social Security, it is generally irrevocable. 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 2022 that would have authorized ministers to revoke an exemption from Social Security.

However, in 2020 the Internal Revenue Service (IRS) amended its Internal Revenue Manual (the “Manual”) by adding a section addressing the revocation of an exemption from self-employment taxes that was obtained for economic rather than religious reasons. The section notes that applications “made solely for economic considerations rather than religious opposition” mean the “taxpayer wasn’t qualified for the exemption from self-employment tax … effectively allow[ing] for revocation.”

The Manual then says a minister who notifies the agency about his or her wish to revoke a previously granted exemption because the application was solely based upon economic considerations will be advised the exemption has been revoked. The agency then will notify the Social Security Administration and it will note the change in the minister’s permanent file, along with including copies of all relevant material related to the change.

The section also notes that a minister who sought and received an exemption based on more than economic considerations will not be able to receive a revocation.

3. Charitable contribution deduction for non-itemizers

The CARES Act (2020) encouraged Americans to contribute to churches and charitable organizations by permitting them to deduct up to $300 of cash contributions, whether they itemize their deductions or not. Congress extended this deduction through 2021 and increased it to $600 for married couples filing a joint return. However, the deduction expired at the end of 2021 and Congress has not extended it, meaning it is unavailable for 2022 federal income tax returns.

4. No further private letter rulings on certain matters

According to the IRS, a “private letter ruling (“PLR”) is a written statement issued by the IRS to a taxpayer that interprets and applies tax laws to the taxpayer’s specific set of facts.” The IRS will issue a PLR “to establish with certainty the federal tax consequences of a particular transaction before the transaction is consummated or before the taxpayer’s return is filed.” The taxpayer must request a PLR in writing, and if the IRS responds with a PLR, it is binding on the agency—assuming the taxpayer does not deviate from the facts and circumstances described about the transaction in the request.

A PLR may not be relied on as precedent by other taxpayers or IRS personnel. However, the information can be helpful for understanding how the IRS views different issues, especially when taxpayers may face situations with similar facts and circumstances.

In 2022, the IRS announced that it will no longer issue PLRs under any of the following circumstances involving churches, clergy, and charities:

• “Whether an individual is a minister of the gospel for federal tax purposes.” This means taxpayers will not be able to obtain clarification from the IRS in a letter ruling on their status as a minister for any one or more of the following matters: (1) eligibility for a parsonage exclusion or housing allowance, (2) eligibility for exemption from self-employment taxes, (3) self-employed status for Social Security, or (4) exemption of wages from income tax withholding. Revenue Procedure 2022-3.

• “Whether amounts distributed to a retired minister from a pension or annuity plan should be excludible from the minister’s gross income as a parsonage allowance.” Revenue Procedure 2022-3.

• “Whether a taxpayer who advances funds to a charitable organization and receives therefore a promissory note may deduct as contributions, in one taxable year or in each of several years, amounts forgiven by the taxpayer in each of several years by endorsement on the note.” To illustrate, a church member transfers $5,000 to her church and in return receives a promissory note from the church promising to pay back the note in annual installments over the next five years. Each year, on the due date of the annual installment, the note holder “forgives” the payment. Can the note holder treat the forgiven installment as a charitable contribution deduction? The IRS will no longer address such a question in a PLR. Revenue Procedure 2022-3.

• “Whether a transfer is a gift within the meaning of section 102” of the tax code. To illustrate, a pastor retires after many years of service to the same church. The church presents him with a check in the amount of $10,000. Is this check taxable compensation or a tax-free gift? This is a question the IRS will no longer address in PLRs. Revenue Procedure 2022-3.

• “Whether a compensation of property transaction satisfied the rebuttable presumption that the transaction is not an excess benefit transaction as described in § 53.4958-6 of the Excess Benefit Transactions Excise Tax Regulations.” Revenue Procedure 2022-3.

• Whether material changes will affect an organization’s tax-exempt status. Generally, tax-exempt organizations are required by the tax code to inform the IRS of “material changes” in their activities or operations. The IRS will no longer send PLRs to exempt organizations to address whether changes in activities or operations will jeopardize their exempt statuses. Revenue Procedure 2022-3.
  
  Whether a compensation or property transaction satisfies the rebuttable presumption that the transaction is not an excess benefit transaction as described in section 4958 of the tax code. Revenue Procedure 2022-3.

5. Simplified definition of a “highly compensated employee”

A number of tax-favored provisions in the tax code do not apply to “highly compensated employees” if they are treated more favorably than other employees. These include:

• simplified employee pensions (SEPs),
• 403(b) tax-sheltered annuities (churches and qualified church-controlled organizations are exempt from this nondiscrimination rule),
• qualified employee discounts,
• cafeteria plans,
• flexible spending arrangements,
• qualified tuition reductions,
• employer-provided educational assistance, and
• dependent-care assistance.

A highly compensated employee in 2022 was one who (1) was a 5 percent owner of the employer at any time during the current or prior year (this definition will not apply to churches) or (2) had compensation for the previous year (2021) in excess of $135,000 and, if an employer elects, was in the top 20 percent of employees by compensation.

6. Large drop in audit rates

On May 17, 2022, the U.S. Government Accountability Office (GAO) reported that the audit rate declined 44 percent between fiscal years 2015 and 2019, including a drop in the audit rate of 75 percent for individuals with incomes of $1 million or more, raising concerns about the potential for a decline in taxpayers accurately reporting their tax liability. (GAO-22-104960.)

The GAO Report found that, from tax years 2010 to 2019, audit rates of individual income tax returns decreased for all income levels. On average, the audit rate for these returns decreased from 0.9 percent to 0.25 percent. IRS officials attributed this trend primarily to reduced staffing caused by decreased funding.

Audit rates decreased the most for taxpayers with incomes of $200,000 and above. According to IRS officials, these audits are generally more complex and require a staff’s review. Lower-income audits are generally more automated, allowing the IRS to continue these audits even with fewer staff.

The report noted that, although there was a sharper decrease in audit rates for higher-income taxpayers, the IRS generally audited such taxpayers at higher rates compared to lower-income taxpayers. However, the audit rate for lower-income taxpayers claiming the earned income tax credit (EITC) was higher than average.

According to IRS officials, EITC audits require relatively few resources and prevent ineligible taxpayers from receiving the EITC.

With the passage of the Inflation Reduction Act (IRA) in August of 2022, the IRS and related agencies will receive nearly $80 billion through 2031 for tax enforcement activities, such as hiring more enforcement agents, providing legal support, and investing in “investigative technology.”

7. A trio of noteworthy court cases involving tax fraud, tax liens, and tax bills

1. The Tax Court rejected a minister’s tax arguments, subjecting him to back taxes, interest, and a penalty for filing a frivolous return.
2. A Florida case underscored the power of the IRS to impose tax liens on ministries.
3. The Virginia Supreme Court sided with a church in a local tax delinquency case.

8. Inflation adjustments relevant for 2022 tax-filing season

Some tax benefits were adjusted for inflation for 2022. Key changes affecting 2022 returns include the following:

• The mileage rate for miles driven for business increased to 65.5 cents per mile on January 1, 2023.
• The mileage rate for miles driven for medical purposes, and for moving, remained 22 cents per mile on January 1, 2023.
• The charitable mileage rate remains at 14 cents for all of 2023.
• The Alternative Minimum Tax exemption amount for tax year 2022 increases to $75,900 for single taxpayers and $118,100 for married persons filing jointly. The exemption amount for single persons (and heads of household and married persons filing separately) begins to phase out at $539,900 and the exemption amount for married couples filing jointly begins to phase out at $1,079,800.
• For estates of any decedent passing away in calendar year 2022, the basic exclusion amount is $12,06,000.
• For 2022, the foreign earned income exclusion will be $112,000.
• The maximum earned income credit amount will be $6,935 for taxpayers with three or more qualifying children for 2022.

9. Working after retirement

Many churches employ retired persons who are receiving Social Security benefits. Persons younger than full retirement age may have their Social Security retirement benefits cut if they earn more than a specified amount.

Full retirement age (the age at which you are entitled to full retirement benefits) for persons born in 1943 to 1954 is 66 years. 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 2023, that limit is $19,560.

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 2023, that limit is $51,960, but only earnings before the month you reach full retirement age are counted.

10. New per diem rates for substantiating the amount of travel expenses

The IRS allows taxpayers to substantiate the amount of their business expenses by using per diem (daily) rates. Taxpayers still must have records substantiating the date, place, and business purpose of each expense. Separate rates are set for meals and lodging, with separate rates for high-cost localities and all other communities. See the IRS website for applicable rates.

In some cases, using the per diem rates will simplify the substantiation of meals and lodging expenses incurred while engaged in business travel. However, a number of restrictions apply, and these are explained further in the latest Church & Clergy Tax Guide.

For more information or to view this article online, please visit the Church Tax & Law Website . For more recommendations regarding the 10 key tax developments for 2023 or any other tax related questions, please contact our office.

Keeping Your Church’s Deposits Safe in a Jittery Bank Environment

Silicon Valley Bank’s failure shows we never really know whether a bank is truly safe and sound. – Posted 4/26/23

Many church and nonprofit leaders are wondering if their organizations’ bank deposits are safe in the current banking environment. And for good reason.

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Immediately before Silicon Valley Bank (SVB) was taken over by the FDIC on March 10, 2023, one major ratings agency had an “A” rating outstanding for the bank, and another had a “B” rating outstanding.

SVB’s failure was the second largest in US history, according to The Wall Street Journal, which offered a truly remarkable observation about it: “The bank was in sound financial condition on Wednesday, the regulator said. A day later, it was insolvent.”

When a bank with “A” and “B” ratings is considered by regulators to be sound one day, and taken over by the FDIC two days later, it’s only logical to wonder how any reasonable, prudent person can know whether any bank is in healthy financial condition.

Fortunately for SVB’s depositors, federal banking officials have indicated that all SVB depositors will be made whole, even beyond the $250,000-per-depositor FDIC coverage cap because of SVB’s systemic importance.

But a logical corollary is that one cannot assume that the same will be true for the next bank that fails. Another bank, Signature Bank, also recently failed.

Assessing where your organization banks

Given the practical limitations on the ability to know whether any bank is truly safe and sound, what can–and should—church and nonprofit leaders do to ensure that their organizations’ bank cash deposits are safe?

Some people are suggesting that perhaps the only safe banks are the very largest banks in the country … those that many believe regulators deem are “too big to fail.” It is important to note that the assumption that regulators would make all depositors of a very large bank whole in any failure scenario is just that…an assumption. There is no federal guarantee of regular deposits in any bank beyond the FDIC’s $250,000 per depositor insurance coverage.

Additionally, If all depositors decided to bank only with the largest banks, smaller local and regional banks would be wiped out, and local banking relationships could be more difficult to maintain. And depending on the size of your organization’s deposit balances, it may not be practical to try to spread deposits among multiple banks keeping balances below the FDIC coverage cap of $250,000 per depositor.

So, let’s turn to the topic of making deposits in the banking system.

Clearly, there are ways to protect cash outside of the banking system in an investment portfolio, such as investing (with the help of a properly credentialed investment advisor) in short-term US Treasury securities or in appropriate investment funds that hold such securities. But what about cash that your organization simply wants to keep in the bank?

It is probably true that the larger the bank, the more likely it is that federal regulators would deem it too big to fail.

So, if your organization wants to bank with a big bank, that could be an appropriate strategy. Bankrate offers a list of the 15 largest banks in the US. It is interesting to note, however, that #14 on the list, First Republic Bank, recently had a severe challenge. Bankrate’s website includes an update on First Republic Bank dated March 17, 2023, which states:

It’s also important to note that First Republic recently faced turmoil that threatened its solvency following the collapse of Silicon Valley Bank and Signature Bank. However, 11 of the largest US banks came together to save the bank, depositing $30 billion into First Republic to keep it afloat.

Just know the fact that a bank is large–even very large–is not, in and of itself, assurance of the bank’s financial health.

A word of caution: Any organizations or persons considering any strategy to manage the risk of their bank deposits or other assets should perform their own due diligence before taking action.

Tapping into IntraFi

Is there a way to ensure that an organization’s bank cash deposits are safe, even with a local or regional bank?

Many such banks would answer that question with a resounding “Yes!,” and a number of them would point to their participation in programs offered by IntraFi Network, LLC (IntraFi). IntraFi’s website describes its two main programs, ICSand CDARS, as follows:

Using IntraFi Cash Service℠, or ICS, and CDARS you can access millions in FDIC insurance for cash deposits from IntraFi® network banks and enjoy the simplicity of banking with just one trusted, local institution. Conveniently and easily secure funds placed into demand deposit accounts, money market deposit accounts, or CDs.

Banks that participate in the IntraFi network allow customers to maintain a relationship with one bank and have FDIC insurance coverage for deposits well beyond the standard FDIC coverage cap of $250,000 per depositor per bank. The network allows for the larger deposits to be spread among multiple banks in the network in amounts below the $250,000 FDIC cap while maintaining one point of contact with one participating bank.

IntraFi offers programs for demand deposit (checking) accounts, money market accounts, and CDs. Participation in the IntraFi program with a participating bank can carry a cost or fee . The cost can apply as a reduction in the interest rate you earn on your deposit balances. For example, in another alert about earning interest on your organization’s excess checking account funds, I quoted Texas Security Bank president, Craig Scheef, who stated that his bank reduces the interest rate it pays on money market accounts (currently, approximately 4% annualized) by 0.15% for deposits that participate in the IntraFi program.

The IntraFi website, which says that thousands of financial institutions across the country participate in its programs, has a web page that allows you to find banks that participate in the program as well as an FAQ page. In the current environment, interest in the IntraFi program has increased significantly, according to Scheef.

For more information or to view this article online, please visit the Church Tax & Law Website or if you have any further questions regarding the safekeeping of your Church’s deposits, especially during uncertain economic conditions, please contact our office.

Tax News for February 2023 . . .

Accountable Reimbursement Arrangements

Review the four specific requirements for business expense reimbursements. – Posted 2/2/23

Most ministers and lay church employees incur expenses when performing their duties. The tax treatment of these expenses depends on whether a person is an employee or self-employed, whether the expenses are reimbursed by the church, and whether any reimbursed expenses are paid under an accountable or a nonaccountable reimbursement plan.

Here are a few important details to understand about business expense reimbursements.

Unreimbursed business expenses

These expenses were no longer deductible by employees as itemized expenses on Schedule A (Form 1040) after 2017.

Employee business expenses reimbursed under a nonaccountable arrangement

These expenses were no longer deductible by employees as itemized expenses on Schedule A (Form 1040) after 2017.

Avoid limitations with an accountable arrangement

The limitations on the deductibility of employee business expenses (summarized above) can be avoided if the church adopts an accountable reimbursement plan. An accountable plan is one that meets all of the following requirements:

1. Only business expenses are reimbursed.
2. No reimbursement is allowed without an adequate accounting of expenses within a reasonable period of time—not more than 60 days after an expense is incurred.
3. Any excess reimbursement must be returned to the employer within a reasonable period of time—not more than 120 days after an excess reimbursement is paid.
4. An employer’s reimbursements must come out of the employer’s funds and not by reducing the employee’s salary.

Under an accountable plan, an employee reports to the church rather than to the IRS. The reimbursements are not reported as income to the employee, and the employee does not claim any deductions. This is the best way for churches to handle reimbursements of business expenses.

If the requirements of an accountable reimbursement arrangement are not met, then the church’s reimbursement of an employee’s business expenses must be reported by the church as taxable income to the recipient.

For more information or to view this article online, please visit the Church Tax & Law Website . For more recommendations regarding the 2023 business use mileage rate or any other tax related questions, please contact our office.

Tax News for January 2023 . . .

Tracking Expenses During Mission Trips

What church leaders should know about documenting expenses in foreign countries – Posted 1/27/23

Many foreign countries have no sophisticated system of receipting expenditures and many mission trip leaders fail to understand the documentation standards placed on a US exempt organization. The trip leader should understand the following:

• The dollars he or she cannot specifically account for will be his or her responsibility to return to the church at the end of the trip. There is no presumption of exempt purpose;
• Where possible, receipts must be obtained for expenditures;
• A detailed log of all the trip’s expenditures must be maintained, indicating dates, identities of those who received the money, amounts, and purposes of the expenses;
• If funds are given to individuals for benevolent purposes, the trip leader will have the recipient sign that they received the funds and will document the benevolent need that necessitated the support.

At this time, the IRS is very focused on exempt organizations’ activities in foreign countries. It is always best to remember that the IRS never presumes any expense is spent on exempt purposes until it is proven, and with expenses in foreign countries, the IRS tends to presume that the money was personally spent by the trip leader.

For more information or to view this article online, please visit the Church Tax & Law Website . For more information on Accountable Reimbursement Arrangements or any other tax related questions, please contact our office.

IRS Bumps 2023 Business Use Mileage Rate to 65.5 Cents per Mile

No change to charitable mileage and qualified medical, moving mileage rates left alone. – Posted 1/13/23

The Internal Revenue Service (IRS) has released the 2023 optional standard mileage rates used to calculate the deductible costs of operating an automobile for business, charitable, medical or moving purposes.

Effective January 01, 2023, the rates are:

• 65.5 cents per mile driven for business use, an increase of 3 cents from the rate set in mid-2022.
• 22 cents per mile driven for medical or moving purposes, consistent with the rate set in mid-2022.
• 14 cents per mile driven in service of charitable organizations—the rate remains unchanged and can only be changed by an act of Congress.

Note: The rates apply to electric and hybrid-electric automobiles, as well as gasoline and diesel-powered vehicles.

Under the Tax Cuts and Jobs Act of 2017, taxpayers cannot:

• claim a miscellaneous itemized deduction for unreimbursed employee travel expenses and,
• cannot claim a deduction for moving expenses, unless they are members of the Armed Forces on active duty moving under orders to a permanent change of station. See Moving Expenses for Members of the Armed Forces for more details

According to the IRS, taxpayers always have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates. Taxpayers can use the standard mileage rate but generally must opt to use it in the first year the car is available for business use and then, in later years, choose either the standard mileage rate or actual expenses. Leased vehicles must use the standard mileage rate method for the entire lease period (including renewals) if the standard mileage rate is chosen.

Are you a Church Law & Tax Advantage Member? If so, read on to learn more about other key tax developments affecting pastors and church leaders heading into 2023.

What does the business mileage rate increase mean for churches?

It’s a pinch, for sure.

Increased amounts of reimbursement represent increased budget expenses, and that means adjusting budgets in ways that affect other ministry spending.

Conversely, attempts to minimize budget impacts by reimbursing only a portion of the rate—or not reimbursing at all—creates increased burdens for pastors and employees who use their vehicles for church-related business.

And because unreimbursed employee business expenses are not deductible under the Tax Cuts and Jobs Act of 2017, pastors and employees with unreimbursed mileage cannot seek any tax relief when they file next year’s federal income tax returns.

As you and your leaders navigate how to handle this increased expense, you may want to review some wise guidance provided by CPA and Church Law & Tax Senior Editorial Advisor Michael Batts.

In this Q&A, he answers this question: How does our church adjust its budget during times of rapid change and uncertainty?

One final note:

Church employees who drive their personal vehicles for church-related business (visitations, special events, and so on) can be reimbursed by the church, if the church has an accountable reimbursement arrangement and employees and pastors properly track and document their business miles. Since unreimbursed employee business expenses are currently not deductible, employees can no longer calculate a mileage deduction on their annual tax returns. Current law allows for a reinstatement of the deduction for unreimbursed employee business expenses in 2026.

For more information or to view this article online, please visit the Church Tax & Law Website . For more recommendations regarding the 2023 business use mileage rate or any other tax related questions, please contact our office.

Key Tax Dates January 2023

Noting the key tax forms due this month, along with other recurring deadlines. – Posted 1/12/23

Monthly requirements

If your church or organization reported withheld taxes of $50,000 or less during the most recent lookback period (for 2023, the lookback period is July 1, 2021, through June 30, 2022), then withheld payroll taxes are deposited monthly. Monthly deposits are due by the 15th day of the following month.

Tip: The 2023 Church & Clergy Tax Guide is out—preorder your copy today (it will ship in January) or download the .pdf version now.

Note, however, if withheld taxes are less than $2,500 at the end of any calendar quarter (March 31, June 30, September 30, or December 31), the church need not deposit the taxes.

Instead, it can pay the total withheld taxes directly to the IRS with its quarterly Form 941. Withheld taxes include federal income taxes withheld from employee wages, the employee’s share of Social Security and Medicare taxes, and the employer’s share of Social Security and Medicare taxes.

For more information or to view this article online, please visit the Church Tax & Law Website or if you have any questions regarding these key January dates, please contact our office.

When Expenses Are Higher than Your Budget

Does your policy have the answer on what to do? – Posted 1/11/23

For churches that view the operating budget as an expense control mechanism, the matter of how to deal with expenditures in excess of budgeted amounts is an important element of policy that is poorly developed in many churches.

For example, a church operating budget will typically include line items for each of the church’s main areas of ministry operations. Line items will exist for worship activities, educational activities, children and youth ministries, missions, and so on.

Suppose a church develops and approves an operating budget for the year reflecting total expenses of $1.5 million, of which $200,000 relates to educational activities. Also suppose that, due to unexpected developments, it appears the church’s expenses for its educational activities will exceed the amount budgeted by $50,000 for the year. Consider these questions:

• Is it acceptable for the church’s staff leadership to make the additional expenditures for the educational ministries, so long as total expenses do not exceed the total amount of expenses budgeted for the church of $1.5 million?
• Even if church staff leaders are permitted to reallocate budget line items so long as the total amount spent remains within the amount of total expenses authorized by the budget, who on the church staff leadership has the authority to make such a reallocation decision?
• Or should church staff leaders be required to obtain specific authorization to incur expenses that exceed the amount budgeted for the educational ministries?
• If authorization is required in order to exceed expenses for an individual line item or for the budget as a whole, who must provide that authorization? If the congregation approved the annual budget, must the congregation be involved in an authorization for such a variance?
• Or, may such approval be granted by the governing body of the church or by some other group?
• Would the answer to these questions change, depending on the amount by which actual expenditures are expected to exceed budgeted amounts?

Many churches do not have good answers to these questions. For churches that view the operating budget as an expense control mechanism, it is essential to have an appropriate budget policy that clearly addresses such matters and leaves little room for misunderstanding.

For more information or to view this article online, please visit the Church Tax & Law Website . For more recommendations dealing with expenditures in excess of budgeted amounts or any other tax related questions, please contact our office.

Mastering Seventeen End-of-Year Tasks

Use this to-do list to finish the year well and start 2023 right. – Posted 1/6/23

Various critical financial tasks should be completed before January 1, 2023. To help church treasurers navigate this, Church Law & Tax asked tax and accounting experts to review and update our list of tasks that might affect a treasurer’s year-end to-do list.

Here, then, is an updated list that should help you finish 2022 strong and get started right in 2023.

1. Designate a housing allowance

The board or congregation should designate a housing allowance for 2023 for ministers who own or rent their home (and for ministers who live in a parsonage and who pay some of their housing expenses from their own funds). Find sample housing allowance and parsonage allowance resolutions in chapter 6 of Richard Hammar’s annual Church & Clergy Tax Guide.

“Because housing allowances can only be provided prospectively (that is, after they have been approved by the board or the board’s designee), obtain approval from the board prior to January 1,” advised Rob Faulk, a CPA and partner with CapinCrouse.

2. Review W-4 forms

All employees should review their W-4 form and submit a new form if circumstances have changed. This will ensure accurate tax withholding.

“Many employees are surprised when they complete their tax return and find they owe money,” said Elaine Sommerville, a CPA and senior editorial advisor for Church Law & Tax. “Employees may be caught short on taxes paid if both spouses are working.”

She explained that the tax withholding tables “don’t appropriately take a dual-earner household into consideration. It is advisable for employees who owed money with their 2021 Form 1040 to complete a new Form W-4 at this time.”

And don’t leave out ministers, stressed Frank Sommerville, a CPA, tax attorney, and senior editorial advisor for Church Law & Tax. Unfortunately, “many ministers just go to the treasurer and say, ‘Withhold such-and-such from a paycheck,’” he said. “But the pastor should also fill out a W-4 or provide other written documentation for withholding income tax.” (For more information on this aspect of the topic, see #9 below.)

Tip. Visit irs.gov/publications to download the 2023 edition of IRS Publication 15 for the new withholding tables. (This publication is regularly updated each December for the upcoming year.)

3. Provide a notice to donors

Donors should be advised in the church bulletin or newsletter, on the church website, or in a letter or email from the church, not to file their federal income tax return before they receive their contribution summary from the church. Donors may not be able to deduct individual contributions of $250 or more if they file a tax return before receiving a qualified contribution receipt from their church.

Churches should also double check software used for preparing charitable contributions receipts to confirm that the vital “no goods or services other than intangible religious benefits were provided” statement will be included when the receipts are prepared.

“Making sure donors have those contribution acknowledgements prior to filing is definitely important,” added Kaylyn Varnum, a partner and assistant national director for tax services for the accounting firm Batts Morrison Wales & Lee, and an advisor-at-large for Church Law & Tax.

While deductions may be available to fewer donors, it’s still important to notify all donors, Frank Sommerville stressed, because churches simply don’t know who might qualify for a deduction.

Tip. Answer many of your members’ questions about charitable giving and tax law with the Charitable Contributions Tax Reminder (for their 2022 returns).

4. Determine if contributions are effective for 2022 or 2023

The general rule is that a contribution is effective when delivered. A check deposited in the church offering in January of 2023 cannot be deducted in 2022, even if it is backdated to 2022. One exception—checks that are mailed and postmarked in 2022 are deductible in 2022, even if they are not received until 2023.

IRS Publication 526 offers these guidelines for three other types of giving (adapted):

• Text message. Contributions made by text message are deductible in the year the donor sends the text message if the contribution is charged to the telephone or wireless account.
• Credit card. Contributions charged on the donor’s bank credit card are deductible in the year the donor makes the charge.
• Pay-by-phone account. Contributions made through a pay-by-phone account are considered delivered on the date the financial institution pays the amount. This date should be shown on the statement the financial institution sends the donor.

5. Correctly handle gifts and noncash/cash benefits to staff and volunteers

Consider these two categories of gifts:

• Cash Christmas gifts to employees. Be sure to correctly handle any Christmas gifts made by the church or congregation to a minister or lay staff member. In most cases, these transfers represent taxable income and not a tax-free gift and must be reported as income on the recipient’s W-2. “If the gifts are paid through accounts payable, the value of the gifts will need to be submitted to the payroll system prior to the end of the year to allow for correct reporting on the recipient’s W-2 and on the church’s fourth-quarter Form 941,” Elaine Sommerville explained.
• Noncash gifts to employees and volunteers. Noncash gifts may also create income requiring payroll reporting. A gift of property having a value so small “as to make accounting for it unreasonable or administratively impracticable” is a nontaxable “de minimis fringe benefit” (see Section 132(e)(1) of the tax code). This exception does not apply to cash or “cash equivalents” (such as gift certificates). “Information on noncash gifts that may not be considered as ‘de minimis’ will need to be provided to the payroll system prior to the end of the year to allow for correct reporting on the recipient’s Form W-2 and the church’s Form 941,” Elaine Sommerville said.

Monetary gifts (including gifts cards) to volunteers of any amount should be avoided, said Frank Sommerville. “Once you give people money, they are no longer volunteers,” he said. “They are employees. Once you compensate them, then you’re getting into all kinds of issues. Does employment law apply? Does workers’ comp apply? Once you give them anything of value, they no longer qualify as a volunteer under many, many statutes.”

6. Be careful about accepting certain types of end-of-the-year noncash donations

Near the end of the year, churches should be wary of a noncash donation of significant value, such as an antique car or a gift of real estate. Some gifts might be hard to sell. With land, there could be unresolvable zoning issues or issues with toxic soil. With a building, there could be structural issues or a problem with lead or asbestos.

“You don’t want to be rushed into making a decision,” said Frank Sommerville. “If a gift comes in near the end of the year, you don’t have the time to do your due diligence.” He stressed that the gift could end up costing you a lot more than it is worth. An exception: publicly traded stock. “Stock is pretty easy to address appropriately as a year-end gift,” he said.

Additional resources: “Gifts of Property: Help Donors Get It Right” offers tips on handling noncash gifts of real property (buildings and land) while “Tax Rules for Gifts of Personal Property” offers tips on handling noncash gifts of personal property (such as cars, household items, and stock).

7. Review classification of employees for US Department of Labor (DOL) purposes

“Now is the time to decide if employees are properly classified for wage and hour purposes,” Elaine Sommerville said. “Job descriptions should be reviewed to determine if employees qualify for the ministerial exception. And for all employees not qualifying under the ministerial exception, job descriptions and salary amounts should be reviewed to determine if the employee is exempt or nonexempt.

Past year determinations may be affected by the current minimum weekly salary requirement of $684 for exempt employees. While this change was effective January 1, 2020, many churches still are not aware of its implications. Churches may find that employees previously classified as exempt employees must be moved to the nonexempt classification due to the higher minimum weekly salary requirement. For further guidance, see Elaine Sommerville’s article “The Right Way to Handle Wage Classifications.”

8. Make sure ministers are properly classified for paying into the Social Security system

Separate from applying the DOL’s ministerial exception discussed above, a church must also determine who is a minister for IRS and Social Security purposes.

Many churches incorrectly report ministers as employees for paying into the Social Security system by withholding Social Security and Medicare taxes from their wages. This is incorrect, since the tax code classifies ministers as self-employed for purposes of paying into the Social Security/Medicare system with respect to services they perform in the exercise of ministry. As a result, they pay the self-employment tax with their individual income tax returns and not through withholding and employer matching of Social Security and Medicare taxes.

Now is also a good time to provide information to ministers regarding their unique tax classifications to make them aware of the unusual filing requirements.

Caution. Ministers who are incorrectly classified for Social Security and Medicare jeopardize their ability to receive the tax-free housing allowance. The ideal time to reclassify these ministers as self-employed for Social Security is January 1 and the prior year’s reporting should be corrected to preserve the other benefits afforded to ministers.

9. Voluntary withholding

Since ministers’ wages are exempt from Social Security, Medicare, and federal income tax withholding (with respect to services performed in the exercise of their ministry), they use the quarterly estimated tax procedure to prepay their federal taxes.

However, ministers who report their income taxes as employees can enter into a voluntary withholding arrangement with their employing church by submitting written authorization—such as a letter, email, or a W-4 form—to the appropriate church representative. Under such an arrangement, the employing church withholds income taxes as it would for any other employee, and also can withhold an additional amount of income taxes to cover the minister’s self-employment tax liability.

Tip. The ideal time to start voluntary withholding is January 1. However, Ted Batson, a CPA and tax attorney with CapinCrouse, and an advisor-at-large for Church Law & Tax, said adjustments in voluntary withholding can be made at any time during the year.

In addition, some churches have filed a Form 8274 with the IRS exempting themselves from the employer’s share of Social Security and Medicare taxes. Lay employees of such churches are treated as self-employed for Social Security, meaning that they must pay self-employment taxes. These taxes must be paid by making quarterly estimated tax payments to the IRS unless additional voluntary withholding is requested. Under such an arrangement, the church withholds an additional amount of federal income taxes to cover their estimated self-employment tax liability.

“For ministers who prefer to make estimated tax payments rather than allowing the church to withhold federal income tax, it is beneficial to enroll in the IRS Electronic Funds Transfer Payment System (EFTPS),” Elaine Sommerville suggested. “Making tax payments through the EFTPS system provides the minister with the ability to preschedule estimated tax payments and to receive immediate confirmations of the payments. The 2020 pandemic raised awareness of the benefits of the system as the IRS continues to struggle in the timely processing incoming mail.”

10. Review plans for compensation in 2023

Review compensation and benefits for employees for the upcoming year. Doing so will “provide for the proper documentation of compensation packages and proper taxation of benefits provided to employees,” said Elaine Sommerville.

Additional resource: Find help for your various compensation issues in Elaine Sommerville’s book , Church Compensation – 2nd Edition: From Strategic Plan to Compliance.

11. Have applicable employees fill out various required elections

Certain benefit plans require elections to be completed by the beginning of the plan year. These include benefit elections for a church’s cafeteria plan or Section 125 plan, enrollment in insurance plans that begin on January 1, and the required health insurance opt-out election certificates required by large employers.

For any church that’s an applicable large employer—and currently in its annual benefit enrollment period—Rob Faulk from CapinCrouse offers this guidance: Ensure that any employee who chooses to opt out of the health benefit plan completes an opt-out election certificate [or waiver] and furnishes proof of enrollment in another qualified group health benefit plan from a source other than your church’s plan before coverage is terminated.

12. Review payments to any independent contractors

Preparations for filing the annual Forms 1099-NEC should include a review of payments to unincorporated independent contractors, including LLCs, and their related W-9 forms. (Any payment made via a credit card or PayPal is not reported on the Form 1099-NEC.)

“If a Form W-9 hasn’t been obtained for a contractor, determine if the church has the correct address and Social Security/employer identification number for the contractor,” Elaine Sommerville stressed. “And don’t forget to include payments to attorneys even if paid to a law firm that is incorporated.”

Tip. The Form 1099-MISC is still used for other reportable payments, so make sure the church orders the right forms to report all necessary payments. For example, payments made to unincorporated lessors are still reported in Box 1 of Form 1099-MISC. Forms 1099-NEC are due to the IRS and the recipients by January 31, 2023, and Forms 1099-MISC are due to recipients by January 31, 2023, and to the IRS by February 28, 2023.

13. Report all taxable fringe benefits on W-2 forms

Did your church give a low-interest or interest-free loan to your pastor this year? Did you forgive interest or principal on a loan to your pastor during the year? Did you allow children of employees to attend your summer camp without charge? Did you provide employees with free memberships to the local gym?

The value of such benefits needs to be reported on your employees’ W-2s “and included on your Form 941 with tax withholdings and payroll taxes paid as applicable,” Batson said.

“Whenever possible, taxes for fringe benefits should be withheld throughout the year and at the time the fringe benefit was received,” Batson said. “But in cases where that has not happened, the value of the fringe benefit should still be included on the W-2s at the end of the year.” Elaine Sommerville added that “taxes associated with the fringe benefits may still be calculated and paid through additional withholding from employees’ final paychecks this year, if not calculated at the time the benefit was provided.”

“Fringe benefit plans should be reviewed to determine the plan documents are still in compliance with applicable law and the church is operating within the boundaries of the applicable benefit plan,” Elaine Sommerville said.

“A church that provides its minister a car should download IRS Publication 15-B and review the Fringe Benefit Valuation Rules to ensure the proper amount for personal use is included in the pastor’s W-2”, Batson said.

14. Prepare for proper filing of Forms W-2 and 1099

The Taxpayer First Act of 2019 requires electronic filing for employers filing 10 or more Forms W-2 starting with the filings in January 2023. However, this new law is pending enforcement until the IRS issues the related regulations. Until the IRS updates these regulations, the current threshold for mandatory electronic filing is 250 Forms W-2. Electronic filing requirements may be confirmed in January at irs.gov.

For filing Forms 1099, electronic filing is required for filers of 250 or more forms. This may be lowered to 100 forms, so churches should also verify this requirement in January of 2023 at irs.gov.

There are many easy systems allowing for electronic filing of payroll reports. The Social Security Administration maintains a portal for filing Forms W-2 electronically for smaller employers. Congress has charged the IRS to create a similar portal for filing Forms 1099, and it may be available for the 2023 filing season. Hard copy forms may be obtained from local office supply stores. While many forms may be downloaded at irs.gov/forms, Form 1096, Form 1099-MISC, and Form 1099-NEC still require original, red-colored forms to be used if filing paper forms.

The IRS is still struggling to timely process any paper returns, so it is a good time to see how all payroll tax filings can be moved to a method of electronic filing for 2022 returns due in 2023.

15. Finalize 2023 budgets and take care of any budgeting issues

If your current budget year ends on December 31, finalize your 2023 budget before then, Faulk advised. Further, he said to perform a variance review of income statement (actual vs. budget). “This process may affect decisions about next year’s budget and may be particularly challenging due to the changes caused by the pandemic,” Faulk explained. “To help, CapinCrouse offers a free e-book, How to Budget Effectively in Changing Times.”

Additional resource: “Managing Tough Financial Times,” offers several helpful articles and a video on budgeting and financial management for churches.

16. List and take care of any additional year-end items

Sit down and list any additional items that could easily slip through the cracks, which are particular to your church, then take care of them before the end of the year. Faulk mentioned the following items:

• Reconcile your church’s donor system to your general ledger, and then investigate any significant differences. This is an important internal control to help detect any errors and to prevent fraud.
• If your church has a loan, talk to your lender about instances of noncompliance before the end of the year.
• Learn more about how many of these year-end steps are effective tools for preventing financial fraud in your church.
• Get annual conflict-of-interest forms signed and reviewed.
• Reconcile detailed property and equipment depreciation listings to the general ledger.
• Record destroyed items in accordance with document retention and destruction policies.
• Review insurance policies and update as appropriate.
• Document a list of authorized check signers and update bank records.
• Document a list of those authorized to approve expenditures.
• Document a list of approved bank accounts and close any that are not needed.
• If your church will have an audit or review, your finance or audit committee should be in the process of selecting the independent auditors.
• Make sure the church has adopted an accountable expense reimbursement plan and makes it available to all employees, especially those with church-issued credit cards.
• Confirm the church is still in good standing with the state where it formed and make sure the name and address for the registered agent is current.

17. Update your church’s resource guides

If you have not already done so, now is a good time to order Church Compensation – 2nd Edition: From Strategic Plan to Compliance by Elaine Sommerville and preorder the 2023 edition of Richard Hammar’s Church & Clergy Tax Guide. These resources will help you properly answer the various tax, payroll, and compensation questions that will invariably arise throughout the coming year.

For more information or to view this article online, please visit the Church Tax & Law Website . For more recommendations regarding your end of year tax to-do-list or any other tax related questions, please contact our office.

Tax News for December 2022 . . .

Don’t Be Blindsided by Three “Unexpected Expenses”

Planning ahead can keep you from being caught off guard. – Posted 12/27/22

Year End Planning For Businesses

**Posted 12/23/22

With year-end approaching, it is time to start thinking about moves that may help lower your business’s taxes for this year and next. This year’s planning is more challenging than usual due to recent changes made by the Inflation Reduction Act of 2022 and the potential change in congressional balance of power resulting from the midterm elections.

Whether or not tax increases become effective next year, the standard year-end approach of deferring income and accelerating deductions to minimize taxes will continue to produce the best results for most small businesses, as will the bunching of deductible expenses into this year or next to maximize their tax value.

If proposed tax increases do pass, however, the highest income businesses and owners may find that the opposite strategies produce better results: Pulling income into 2022 to be taxed at currently lower rates, and deferring deductible expenses until 2023, when they can be taken to offset what would be higher-taxed income. This will require careful evaluation of all relevant factors.

We have compiled a list of actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all of them will apply to you or your business, but you may benefit from many of them. We can narrow down specific actions when we meet to tailor a particular plan for your business, In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves might be beneficial:

• Taxpayers other than corporations may be entitled to a deduction of up to 20% of their qualified business income. For 2022, if taxable income exceeds $340,100 for a married couple filing jointly, (about half that for others), the deduction may be limited based on whether the taxpayer is engaged in a service-type trade or business (such as law, accounting, health, or consulting), the amount of W-2 wages paid by the business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the business. The limitations are phased in; for example, the phase-in applies to joint filers with taxable income up to $100,000 above the threshold, and to other filers with taxable income up to $50,000 above their threshold.
• Taxpayers may be able to salvage some or all of this deduction, by deferring income or accelerating deductions to keep income under the dollar thresholds (or be subject to a smaller deduction phaseout) for 2022. Depending on their business model, taxpayers also may be able increase the deduction by increasing W-2 wages before year-end. The rules are quite complex, so don’t make a move in this area without consulting us.
• More small businesses are able to use the cash (as opposed to accrual) method of accounting than were allowed to do so in earlier years. To qualify as a small business a taxpayer must, among other things, satisfy a gross receipts test, which is satisfied for 2022 if, during a three-year testing period, average annual gross receipts don’t exceed $27 million (next year this dollar amount is estimated to increase to $29 million). Not that many years ago it was $1 million. Cash method taxpayers may find it a lot easier to shift income, for example by holding off billings till next year or by accelerating expenses, for example, paying bills early or by making certain prepayments.
• Businesses should consider making expenditures that qualify for the liberalized business property expensing option. For tax years beginning in 2022, the expensing limit is $1,080,000, and the investment ceiling limit is $2,700,000. Expensing is generally available for most depreciable property (other than buildings) and off-the-shelf computer software. It is also available for interior improvements to a building (but not for its enlargement), elevators or escalators, or the internal structural framework), for roofs, and for HVAC, fire protection, alarm, and security systems.
• The generous dollar ceilings mean that many small and medium sized businesses that make timely purchases will be able to currently deduct most if not all their outlays for machinery and equipment. What’s more, the expensing deduction is not prorated for the time that the asset is in service during the year. So expensing eligible items acquired and placed in service in the last days of 2022, rather than at the beginning of 2023, can result in a full expensing deduction for 2022.
• Businesses also can claim a 100% bonus first year depreciation deduction for machinery and equipment bought used (with some exceptions) or new if purchased and placed in service this year, and for qualified improvement property, described above as related to the expensing deduction. The 100% write-off is permitted without any proration based on the length of time that an asset is in service during the tax year. As a result, the 100% bonus first-year write-off is available even if qualifying assets are in service for only a few days in 2022.
• Businesses may be able to take advantage of the de minimis safe harbor election (also known as the book-tax conformity election) to expense the costs of lower-cost assets and materials and supplies, assuming the costs aren’t required to be capitalized under the UNICAP rules. To qualify for the election, the cost of a unit of property can’t exceed $5,000 if the taxpayer has an applicable financial statement (AFS, e.g., a certified audited financial statement along with an independent CPA’s report). If there’s no AFS, the cost of a unit of property can’t exceed $2,500. Where the UNICAP rules aren’t an issue, and where potentially increasing tax rates for 2023 aren’t a concern, consider purchasing qualifying items before the end of 2022.
• A corporation (other than a large corporation) that anticipates a small net operating loss (NOL) for 2022 (and substantial net income in 2023) may find it worthwhile to accelerate just enough of its 2023 income (or to defer just enough of its 2022 deductions) to create a small amount of net income for 2022. This allows the corporation to base its 2023 estimated tax installments on the relatively small amount of income shown on its 2022 return, rather than having to pay estimated taxes based on 100% of its much larger 2023 taxable income.
• Year-end bonuses can be timed for maximum tax effect by both cash-and accrual-basis employers. Cash-basis employers deduct bonuses in the year paid, so they can time the payment for maximum tax effect. Accrual-basis employers deduct bonuses in the accrual year, when all events related to them are established with reasonable certainty. However, the bonus must be paid within 2½ months after the end of the employer’s tax year for the deduction to be allowed in the earlier accrual year. Accrual employers looking to defer deductions to a higher-taxed future year should consider changing their bonus plans before year-end to set the payment date later than the 2.5-month window or change the bonus plan’s terms to make the bonus amount not determinable at year end.
• To reduce 2022 taxable income, consider deferring a debt-cancellation event until 2023.
• Sometimes the disposition of a passive activity can be timed to make best use of its freed-up suspended losses. Where reduction of 2022 income is desired, consider disposing of a passive activity before year-end to take the suspended losses against 2022 income. If possible 2023 top rate increases are a concern, holding off on disposing of the activity until 2023 might save more in future taxes.

These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you.

Very truly yours,

Barbara

Year End Planning For Individuals

With year-end approaching, it is time to start thinking about moves that may help lower your tax bill for this year and next. This year’s planning is more challenging than usual due to recent changes made by the Inflation Reduction Act of 2022 and the potential change in congressional balance of power resulting from the midterm elections.

Whether or not tax increases become effective next year, the standard year-end approach of deferring income and accelerating deductions to minimize taxes will continue to produce the best results for all but the highest income taxpayers, as will the bunching of deductible expenses into this year or next to avoid restrictions and maximize deductions.

If proposed tax increases do pass, however, the highest income taxpayers may find that the opposite strategies produce better results: Pulling income into 2022 to be taxed at currently lower rates, and deferring deductible expenses until 2023, when they can be taken to offset what would be higher-taxed income. This will require careful evaluation of all relevant factors.

We have compiled a list of actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all of them will apply to you, but you (or a family member) may benefit from many of them. We can narrow down specific actions when we meet to tailor a particular plan for you. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves might be beneficial:

• Higher-income individuals must be wary of the 3.8% surtax on certain unearned income. The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of MAGI over a threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case).
• As year-end nears, the approach taken to minimize or eliminate the 3.8% surtax will depend on the taxpayer’s estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to reduce MAGI other than NII, and some individuals will need to consider ways to minimize both NII and other types of MAGI. An important exception is that NII does not include distributions from IRAs or most other retirement plans.
• The 0.9% additional Medicare tax also may require higher-income earners to take year-end action. It applies to individuals whose employment wages and self-employment income total more than an amount equal to the NIIT thresholds, above. Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Selfemployed persons must take it into account in figuring estimated tax. There could be situations where an employee may need to have more withheld toward the end of the year to cover the tax. This would be the case, for example, if an employee earns less than $200,000 from multiple employers but more than that amount in total. Such an employee would owe the additional Medicare tax, but nothing would have been withheld by any employer.
• Long-term capital gain from sales of assets held for over one year is taxed at 0%, 15% or 20%, depending on the taxpayer’s taxable income. If you hold long-term appreciated-in-value assets, consider selling enough of them to generate long-term capital gains that can be sheltered by the 0% rate. The 0% rate generally applies to net long-term capital gain to the extent that, when added to regular taxable income, it is not more than the maximum zero rate amount (e.g., $83,350 for a married couple; estimated to be $89,250 in 2022). If, say, $5,000 of long-term capital gains you took earlier this year qualifies for the zero rate then try not to sell assets yielding a capital loss before year-end, because the first $5,000 of those losses will offset $5,000 of capital gain that is already tax-free.
• Postpone income until 2023and accelerate deductions into 2022 if doing so will enable you to claim larger deductions, credits, and other tax breaks for 2021 that are phased out over varying levels of AGI. These include deductible IRA contributions, child tax credits, higher education tax credits, and deductions for student loan interest. Postponing income also is desirable for taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may actually pay to accelerate income into 2022. For example, that may be the case for a person who will have a more favorable filing status this year than next (e.g., head of household versus individual filing status), or who expects to be in a higher tax bracket next year. That’s especially a consideration for high-income taxpayers who may be subject to higher rates next year under proposed legislation.
• If you believe a Roth IRA is better for you than a traditional IRA, consider converting traditionalIRA money invested in any beaten-down stocks (or mutual funds) into a Roth IRA in 2022 if eligible to do so. Keep in mind that the conversion will increase your income for 2022, possibly reducing tax breaks subject to phaseout at higher AGI levels. This may be desirable, however, for those potentially subject to higher tax rates under pending legislation.
• It may be advantageous to try to arrange with your employer to defer, until early 2023, a bonus that may be coming your way. This might cut as well as defer your tax. Again, considerations may be different for the highest income individuals.
• Many taxpayers won’t want to itemize because of the high basic standard deduction amounts that apply for 2022 ($27,700 for joint filers, $13,850 for singles and for marrieds filing separately, $20,800 for heads of household), and because many itemized deductions have been reduced or abolished, including the $10,000 limit on state and local taxes; miscellaneous itemized deductions; and non-disaster related personal casualty losses. You can still itemize medical expenses that exceed 7.5% of your AGI, state and local taxes up to $10,000, your charitable contributions, plus mortgage interest deductions on a restricted amount of debt, but these deductions won’t save taxes unless they total more than your standard deduction.
• Some taxpayers may be able to work around these deduction restrictions by applying a bunching strategy to pull or push discretionary medical expenses and charitable contributions into the year where they will do some tax good. For example, a taxpayer who will be able to itemize deductions this year but not next will benefit by making two years’ worth of charitable contributions this year. The COVID-related increase for 2022 in the income-based charitable deduction limit for cash contributions from 60% to 100% of MAGI assists in this bunching strategy.
• Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2022 deductions even if you don’t pay your credit card bill until after the end of the year.
• If you expect to owe state and local income taxes when you file your return next year and you will be itemizing in 2022, consider asking your employer to increase withholding of state and local taxes (or make estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2022. But this strategy is not good to the extent it causes your 2022 state and local tax payments to exceed $10,000.
• Required minimum distributions RMDs from an IRA or 401(k) plan (or other employer-sponsored retirement plan) have not been waived for 2022. If you were 72 or older in 2022 you must take an RMD. Those who turn 72 this year have until April 1 of 2023 to take their first RMD but may want to take it by the end of 2022 to avoid having to double up on RMDs next year.
• If you are age 70½ or older by the end of 2022, and especially if you are unable to itemize your deductions, consider making 2022 charitable donations via qualified charitable distributions from your traditional IRAs. These distributions are made directly to charities from your IRAs, and the amount of the contribution is neither included in your gross income nor deductible on Schedule A, Form 1040. However, you are still entitled to claim the entire standard deduction. (The qualified charitable distribution amount is reduced by any deductible contributions to an IRA made for any year in which you were age 70½ or older, unless it reduced a previous qualified charitable distribution exclusion.)
• Take an eligible rollover distribution from a qualified retirement plan before the end of 2022 if you are facing a penalty for underpayment of estimated tax and increasing your wage withholding won’t sufficiently address the problem. Income tax will be withheld from the distribution and will be CHECKPOINT PLANNING 34 applied toward the taxes owed for 2022. You can then timely roll over the gross amount of the distribution, i.e., the net amount you received plus the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2022, but the withheld tax will be applied pro rata over the full 2022 tax year to reduce previous underpayments of estimated tax.
• Consider increasing the amount you set aside for next year in your employer’s FSA if you set aside too little for this year and anticipate similar medical costs next year.
• If you become eligible in December of 2022 to make HSA contributions, you can make a full year’s worth of deductible HSA contributions for 2022.
• Make gifts sheltered by the annual gift tax exclusion before the end of the year if doing so may save gift and estate taxes. The exclusion applies to gifts of up to $16,000 made in 2022 to each of an unlimited number of individuals. You can’t carry over unused exclusions to another year. These transfers may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.
• If you were in federally declared disaster area, and you suffered uninsured or unreimbursed disaster-related losses, keep in mind you can choose to claim them either on the return for the year the loss occurred (in this instance, the 2022 return normally filed next year), or on the return for the prior year (2021), generating a quicker refund.
• If you were in a federally declared disaster area, you may want to settle an insurance or damage claim in 2022 to maximize your casualty loss deduction this year.

These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you.

Very truly yours,

Barbara

Top Tips to Prepare for the 2023 Tax Filing Season

With a little preparation, taxpayers can approach the upcoming tax filing season with confidence. Here are some things taxpayers can do to prepare for the 2023 tax filing season. ( IR 2022-203 )

1. Gather tax records.  First, taxpayers should gather all their tax records. Taxpayers who have all their tax documentation gathered and organized, are in the best position to file an accurate return and avoid processing or refund delays or receiving IRS letters.

Note. Tax records include copies of filed tax returns for at least the last three tax years and all supporting documents for those returns. These old returns will help the taxpayer to prepare their 2022 return. 

2. Taxpayers should consider financial transactions that occurred in 2022 to determine if they are taxable and how they should be reported. Taxpayers should have an electronic or paper record-keeping system to store tax-related information in one place for easy access.

Note.  Taxpayers should remember most income is taxable. This includes unemployment income, refund interest, and income from the gig economy and/or digital assets. Taxpayers should report all the income they’ve earned, including from tips, part-time work, side jobs, or the sale of goods and services or digital assets, unless its specifically tax-exempt.

3. Before year’s end.  Taxpayers should confirm their employer, bank, and other payors have the taxpayer’s current mailing address and email address. This will ensure that they receive their year-end tax statements.

4. Typically, year-end tax forms start arriving by mail or are available online in mid-to-late January. Taxpayers should carefully review each income statement for accuracy and contact the issuer to correct information that needs to be updated.

Reminder. Taxpayers who are paid for goods or services through a third-party payment network (i.e., Paypal, Venmo) will now receive a reporting form (Form 1099  – K , Payment Card and Third-party Network Transactions) once the amount of their business transactions exceeds $600.

5. Remember, money received through third-party payment networks from friends and relatives as personal gifts or reimbursements for personal expenses is generally not taxable. Those who receive a 1099  -K  reflecting income they didn’t earn should call the issuer.

Note. The IRS can’t change the amounts listed on a reporting form such as Form W-2 or Form 1099-NEC. If the taxpayer finds incorrect information on a reporting form, they must contact the issuer to get the form corrected. Taxpayers who receive a Form 1099  -K  for money received from friends or family as a gift or reimbursement for personal expenses should contact the issuer to get a corrected Form 1099  -K.

6. Withholding and estimated payments.  Taxpayers who had life changes in 2022, like getting married, divorced, welcoming a child, or taking on a second job, should take advantage of the IRS’ Tax Withholding Estimator on IRS.gov before the end of the year. This tool is designed to help taxpayers determine the right amount of tax to have withheld from their paycheck. A taxpayer with insufficient withholding should consider making an estimated payment to avoid penalties.

Taxpayers who need to make estimated tax payments on non-wage income from unemployment, self-employment, or who have annuity income or digital asset income should calculate their estimated payment soon. The last quarterly payment for 2022 is due on January 17, 2023.

7. Renew ITINs.  Taxpayers who have individual tax identification numbers (ITINs) should be sure that their number hasn’t expired before filing their 2022 return. Taxpayers who need to renew their ITIN to file a tax return should submit a Form W-7, Application for IRS Individual Taxpayer Identification Number, now. Applying now will allow the taxpayer to avoid the Spring rush to get an ITIN as well as refund and return processing delays.

For more information about how taxable income is computed, see Checkpoint’s Federal Tax Coordinator ¶ A-1000 . or call our office for further details.

Mastercard Rolls Out New Standards for Recurring Billing

Understanding these standards is important for churches and church-run schools with sustainer donor programs. – Posted 12/15/22

Common Church Finance Department Mistakes and How to Remedy Them

Seven ways church finances can go awry and the guidance needed to keep them on track. – Posted 12/14/22

Romans 12:4 notes that the body is made up of many parts, and they all have different functions. We use this analogy in many contexts, and it is appropriate when considering the workings of a church. Your church needs ministries such as preaching, discipleship, and worship, but you also need support ministries. These can include IT, facilities, administrative . . . and financial operations.

A church’s finance department is one of the most significant of its support ministries, as well as being one of the most misunderstood and overlooked. Yet church leaders rely on the information their finance departments provide, and if that information is inaccurate, significant—or even catastrophic—results can occur.

In the work I have done for churches and ministries as a certified public accountant, I’ve seen personnel layoffs, ministry reductions or discontinuations, and lack of debt compliance as results of improper financial management.

Even if a church finds itself in a difficult economic position, options are available through access to accurate and timely information. But the longer the problem continues without proper attention, the worse the consequences will be.

If you’ve lapsed in one or more of the following seven areas, it’s important to recognize why any lapses need to be remedied for the good of your ministry.

1. Proper internal controls

As a career auditor and consultant, I would be remiss if I didn’t note the most common mistake I see affecting ministries of all sizes. Weak internal controls not only leave the church vulnerable to financial losses, weak controls also leave individual staff and volunteers vulnerable to allegations that they may not be able to defend. To provide basic protection for the church’s financial assets, it’s critical to have segregation of duties over cash receipts. It’s also vital for disbursements to involve at least two people in the custody of the asset, record keeping, and authority of transactions.

2. Competent Staffing

It is not uncommon to “settle” for someone when filling a paid or volunteer position, but the resulting lack of competence can be frustrating for both the individual and the ministry and can certainly diminish the capacity of the role. Management of the church’s finances provides the foundation on which the rest of ministry happens. Allowing someone to serve in a role for which he or she is not qualified is not helpful, even if you are doing it to help an individual in need of a job or a relative of another employee. Having the right people in the right positions is crucial.

3. Adequate training

Try to name something a person can be successful at without training. Whether it is a hobby or a career, everyone needs to have the proper training in order to do his or her best. Training, however, is often overlooked or cut from budgets as a “perk.” That mindset needs to change, because a well-trained, proactive finance team will make better decisions, provide better information, and become a crucial element in the ministry’s success.

4. Financial reporting

There are two aspects of financial reporting: preparation of the reports and understanding the information reported. Financial managers need to help with both. You should consider the information and format of the report to be certain it is accurate, timely, relevant, and succinct. You should also help the individuals who use the information to understand what the report means and how to apply the information. Just as the finance department needs training, church leadership and the board will need training, as well. The finance department can provide this training or help find others who can.

5. Documented processes and procedures

Documenting processes and procedures is not something that should be done once and checked off a list forever. Every church needs to have a processes and procedures manual in place and review and update it at least annually. People, processes, and software change, and information can quickly become outdated when that happens. Churches should also have a record retention and document destruction policy in place. This will notify individuals of the requirements necessary to maintain and destroy financial information.

6. Succession planning

More ministries are becoming aware of the need for succession planning for the senior pastor. If your church has not done this, or you feel you have several years before your leader retires, please consider the importance of taking this step now. Things can change unexpectedly, and a well-considered and thorough plan takes time. Considering succession planning for other roles within the church—both paid and volunteer positions—is also important. You should always be considering the next person in line for any key position.

7. Staying updated

It’s a true saying that “The one thing you can count on in life is change.” If you are reading this, you likely have some responsibility for or interest in the finances of your church. It’s an environment that is constantly changing. It is critical that someone in your ministry be tasked with understanding the implications of changes in state legislation, accounting standards, and the regulatory environment (such as tax laws and employment regulations).

Providing support, serving the kingdom

This list of areas covered in this article is not comprehensive, but it certainly provides key areas to consider as you conduct your various financial operations. Your church is most likely better at some of these items than others. I encourage you to go back to the links offered in this article for additional information on areas that may not be as strong. And keep turning to Church Law & Tax for other practical articles and books and downloadable resources on finance-related topics that will help you do your job well as you seek to support your church and serve God’s kingdom purposes.

For more information or to view this article online, please visit the Church Tax & Law Website . To learn more about how you can avoid making financial mistakes or any other tax related questions, please contact our office.

Reduce Your Church’s Expenses

How to strengthen your bottom line and eliminate activities that miss your mission. – Posted 12/13/22

An interesting phenomenon developed during the Great Recession of 2008. Faced with sudden revenue decreases of 30 percent or more, some churches were forced to quickly make dramatic expense reductions. These churches reduced or eliminated multiple programs, ministries, and staff positions to avoid catastrophic cash flow deficits.

In some cases, when the churches informed their congregations of the massive expense reductions, members remarked that the expense cuts had “no noticeable impact.” Such perceptions on the part of congregations raised some interesting questions such as:

• How was a church able to reduce its operating expenses by 30 percent with no noticeable effects on the key elements of the church’s activities?
• Was the church previously wasting that money?
• Why can’t the church ordinarily operate with a lower level of expenses?

Church leaders should contemplate the answers to such questions as part of their overall evaluation of the effectiveness of the church’s spending. They should also evaluate whether a particular program, activity, or initiative contributes to the church’s mission and purpose before committing funds to it.

Mission and purpose

Clearly identify your church’s specific mission and purpose. Next, critically evaluate each program, activity, and initiative through the filter of your mission and purpose. Doing so can ferret out waste or marginally beneficial expenses. Coupled with a zero-based budgeting approach (see chapter 1 in Church Finance), such an exercise can help identify areas that are prime candidates for expense reductions. It can also assist church leaders in reallocating expense priorities toward activities that more effectively accomplish the church’s mission and purpose.

Obvious places to look

Churches looking to reduce expenses will typically look first at these rather obvious areas for cost savings:

• Reducing or eliminating specific programs, activities, and initiatives
• Reducing staff work hours and compensation
• Reducing employer-paid staff benefits
• Renegotiating costs with vendors
• Renegotiating debt terms
• Deferring maintenance on property and equipment
• Eliminating staff positions

Think carefully before eliminating staff

Church leaders who consider terminating employees for expense reduction purposes should remember churches are exempt from both the federal and state unemployment compensation tax and benefit systems. Accordingly, terminated employees will not be eligible for unemployment benefits. Church leaders may wish to consider offering a severance package to terminated employees. Of course, the cost of any severance benefits must be considered when evaluating savings associated with terminations.

Four not-so-obvious places to look

Here are four less-obvious ways churches may be able to reduce expenses:

1. Streamline processes and systems
A Wall Street Journal article stated that a business check costs between $4 and $20 to fully prepare and process, and that the cost of writing a check can be as much as 5 times the cost of an e-payment. Or, consider a staff member who must leave her desk and go to a centralized scanner (as opposed to using a scanner at her desk) every time a document requires scanning may spend 3 to 5 extra minutes on that process. Multiply that 3 to 5 extra minutes by 10 times a day and the result is an extra 30 to 50 minutes per staff member per day. Churches typically have many processes and systems that have not been seriously evaluated for efficiency. A church that wishes to reduce expenses should consider streamlining its processes and systems.

Addressing the following questions (and others like them) can help a church streamline its processes and systems and, as a result, operate more efficiently and at a lower cost.

• How much does it cost for your church to pay a bill with a check? (Not the bill itself, but the process of paying the bill.)
• Does your staff use computerized bank account reconciliation applications? How much time does the account reconciliation process take?
• Are expense reports submitted on paper with receipts attached? How much collective staff time (all staff) is spent preparing and addressing paper expense reports for reimbursement?
• How much collective staff time does your church spend completing, approving, and otherwise addressing purchase orders and similar authorizations?
• Have you actively encouraged your congregation to give electronically? Is giving to your church as easy as buying a book on Amazon.com? How much time does your staff spend processing check-based offerings?
• How much time does your staff spend filing documents and retrieving (or searching for) documents in paper files?
• Do you still have a person answering your telephones?

2. Energy studies and adaptations
Many churches have hired experts to perform energy usage analyses. Experts will typically recommend adaptations to equipment, fixtures, insulation, lighting, software, and usage management systems—all with the goal of operating with greater energy efficiency. The changes necessary to generate significant energy savings may require a substantial initial investment. Of course, a church must evaluate its expected return on that investment. A church interested in pursuing an energy study should reach out to other churches for referrals to a reputable service provider. The church may also wish to consult its own electrical utility company to identify energy analysis options.

3. Outsourcing
Many churches outsource certain aspects of their operations. Why do they choose to do so? In many cases, outsourcing places work in the hands of experts who can perform a given function or activity more effectively, more efficiently, and less costly.

For example, churches commonly outsource the administration of their employee retirement plans, cafeteria (Section 125) plans, and other employee benefit plans. Many churches with investment portfolios outsource the asset management function for those portfolios. Churches commonly outsource the processing and disbursement of their payrolls. Other services commonly outsourced include grounds maintenance, information technology (IT) services, vehicle maintenance, and security. Churches also may outsource:

• Regular accounting and financial reporting activities
• Bill-paying activities
• Human resources (or some aspects of it, such as employee screening; the service provider must be fully aware of the unique legal attributes that apply to churches in the HR arena)
• Document printing, preparation, and graphic design
• Document editing and proofing
• Website and social media management
• Public relations

4. Collaboration
To more effectively and efficiently carry out their mission and purpose, churches sometimes collaborate with each other or with other Christian ministries. While collaboration with international missions and humanitarian relief activities is common, collaboration with domestic ministry activities is also an area of growing interest. Collaboration can take forms similar to outsourcing and can offer many of the same advantages. The primary differences between collaboration and outsourcing are that:

• In collaboration arrangements, the church often participates directly alongside another church or ministry.
• Outsourcing is most commonly a contractual arrangement with a vendor or service provider, whereas some aspects of collaboration may not involve formal contractual agreements.

Here is an example of collaboration:

Elm Church desires to meet the needs of homeless people in its area. Rather than start its own ministry to the homeless, Elm Church collaborates with a Christian homeless ministry in the same community. One of Elm Church’s staff members works with the staff of the local Christian homeless ministry as part of his duties for Elm Church. Elm Church also provides volunteers to serve at the homeless ministry center, and Elm Church makes grants to the homeless ministry to help fund its operations.*

A church that considers collaborating with other churches or ministries should make sure that the expectations of all parties involved are clearly spelled out. Depending on the nature and extent of the collaboration, a legal agreement may be appropriate and necessary. Collaboration agreements can take various forms. However, it is wise for a church considering such an arrangement to consult with its legal counsel in order to ensure that a proposed collaboration arrangement and its related agreements are appropriate for the church and do not subject the church to unintended risks or other unanticipated consequences.

Consider the possibilities

As a normal part of the budgeting process, churches find themselves wishing to conduct more programs, activities, and initiatives than available funds will allow. By reducing certain expenses, they may be able to fund viable ministries that fulfill their mission. Additionally, churches that wish to improve their liquidity and financial position may need to reduce expenses in an effort to generate reasonable and appropriate cash flow surpluses to reach their targets.

For more information or to view this article online, please visit the Church Tax & Law Website . For more advice on cutting Church expenses or any other tax related questions, please contact our office.

Lunch Expenses for Church Staff—Business or Personal?

How to determine what your church should be paying for. – Posted 12/12/22

Key Tax Dates December 2022

Housing allowance designations, year-end transactions, 2022 donations, and more – Posted 12/9/22

Monthly requirements

If your church or organization reported withheld taxes of $50,000 or less during the most recent lookback period (for 2022, the lookback period is July 1, 2020, through June 30, 2021), then withheld payroll taxes are deposited monthly. Monthly deposits are due by the 15th day of the following month.

Note, however, that if withheld taxes are less than $2,500 at the end of any calendar quarter (March 31, June 30, September 30, or December 31), the church need not deposit the taxes. Instead, it can pay the total withheld taxes directly to the IRS with its quarterly Form 941. Withheld taxes include federal income taxes withheld from employee wages, the employee’s share of Social Security and Medicare taxes, and the employer’s share of Social Security and Medicare taxes.

Semiweekly requirements

If your church or organization reported withheld taxes of more than $50,000 during the most recent lookback period (for 2022, the lookback period is July 1, 2020, through June 30, 2021), then the withheld payroll taxes are deposited semiweekly.

This means that for paydays falling on Wednesday, Thursday, or Friday, the payroll taxes must be deposited on or by the following Wednesday. For all other paydays, the payroll taxes must be deposited on the Friday following the payday.

Note further that large employers having withheld taxes of $100,000 or more at the end of any day must deposit the taxes by the next banking day. The deposit days are based on the timing of the employer’s payroll. Withheld taxes include federal income taxes withheld from employee wages, the employee’s share of Social Security and Medicare taxes, and the employer’s share of Social Security and Medicare taxes.

December 15, 2022

• Complete all year-end transactions to be sure that they are reportable on your income tax return.
• A church must make quarterly estimated tax payments if it expects an unrelated business income tax (UBIT) liability for the year to be $500 or more. Use IRS Form 990-W to figure your estimated taxes.
• For 2022, quarterly estimated tax payments of one-fourth of the total tax liability are due by April 18 (April 19 if you live in Maine or Massachusetts), June 15, September 15, and December 15, 2022, for churches on a calendar-year basis. Deposit quarterly tax payments using Electronic Federal Tax Payment System (EFTPS).

December 31, 2022

• Churches must designate a portion of each minister’s compensation as a housing allowance by this date in order for ministers who own or rent their homes to receive the full benefit of a housing allowance exclusion for calendar year 2023. The designation should be adopted during a regular or special meeting of the church board and should be contained in the written minutes of the meeting.
• Churches should designate a parsonage allowance for any minister who lives in a parsonage and who is expected to pay some of the expenses of maintaining the parsonage (e.g., utilities, furnishings, repairs, improvements, yard care, insurance).
• Donors must deliver checks on or by this date to claim a charitable contribution deduction for 2022. Checks that are placed in the church offering during the first worship service in 2023 will not qualify for a charitable contribution deduction in 2022, even if the check is predated to 2022 or was written in 2022. However, checks that are written, mailed, and postmarked in 2022 will be deductible in 2022 even though they are not received by a church until 2023.
• An employee’s marital status on this date determines his or her filing status for the year.
• If you have a minister or lay worker who is treated as self-employed for federal income tax reporting purposes, but who you would like to reclassify as an employee, the ideal time to make the change is on January 1, 2023.

For more information or to view this article online, please visit the Church Tax & Law Website . If you have any questions regarding these deadlines or any other tax related questions, please contact our office.

Responding to the Elimination of the Business Expense Deduction

This tax reform change might mean it’s time to start an accountable reimbursement plan. – Posted 12/8/22

Top 3 Most Confusing Tax Issues for Clergy

What new—and veteran—ministers and treasurers need to know to file taxes correctly and receive maximum tax benefits. – Posted 12/7/22

Ministers and treasurers must be familiar with the tax rules that apply to clergy. Unfortunately, seminary training rarely equips new ministers with this information, and church treasurers often don’t know about the unique tax laws that apply to clergy. This information gap means ministers and treasurers frequently handle clergy income and the payment of related taxes incorrectly, and they fail to take advantage of the tax benefits that are available to ministers.

For instance, ministers are eligible for five special tax rules with respect to services they perform in the exercise of their ministry. These include (1) not paying federal income taxes on the portion of their church compensation designated in advance by their church as a housing allowance (limitations apply), (2) not paying federal income taxes on the annual rental value of a parsonage provided by their church, (3) being exempt from “self-employment taxes” (Social Security taxes paid by the self-employed) if several conditions are met, (4) being considered self-employed for Social Security (if not exempt), and (5) having ministers’ wages exempt from income tax withholding.

In order to qualify for these tax savings, however, you must meet the IRS’s definition of a “minister.” The IRS applies a five-factor test to determine whether an individual qualifies as a minister for federal income tax purposes. In general, for individuals to enjoy the five special tax rules summarized above, they must satisfy two main requirements: they must be a minister, and they must be engaged in the exercise of ministry.

Assuming you clear these IRS hurdles for establishing whether or not you’re a minister for federal tax purposes, you then need to know how to file taxes properly to ensure you receive the benefits available to you.

In this article, we focus on three of the most perennially perplexing tax issues for clergy. While there are many more we could cover, these are the three that pose confusion and uncertainty for many ministers and church treasurers, new and seasoned.

1. Should a Minister Report Income Taxes as an Employee or as Self-Employed?

The question of whether ministers should report their federal income taxes as an employee or as self-employed is a significant one. Most new ministers should report their federal income taxes as employees, because they will be considered employees under the tests currently used by the IRS and the courts. Most clergy will be “better off” reporting as employees, since (1) the value of various fringe benefits will be excludable, including the cost of employer-paid health insurance premiums on the life of the minister, (2) the risk of an IRS audit is substantially lower, and (3) reporting as an employee avoids the additional taxes and penalties that often apply to self-employed clergy who are audited by the IRS and reclassified as employees.

2. Should a Minister Report Social Security Taxes as an Employee or as Self-Employed?

There is one provision in the tax code that has caused more confusion for ministers and church treasurers than any other, and it is this: ministers are always treated as self-employed for Social Security with regard to services they perform in the exercise of their ministry (except for some chaplains). This is true even if they are employees for federal income tax reporting. This is sometimes referred to as the “dual tax status” of ministers.

Many new (and even veteran) ministers are surprised to learn that their employment status for income tax purposes has no bearing on their employment status for Social Security taxes. This often creates confusion. Ministers are always self-employed for Social Security with respect to their ministerial services. This is true even if you are treated as an employee for federal income tax purposes. This means you pay the self-employment tax, not “Social Security” and “Medicare” taxes. Your employing church must not treat you as an employee for Social Security, even though it issues you a W-2 for income taxes.

The most important consequence of this dual tax status is that ministers pay the so-called “self-employment tax.” This is the Social Security tax that is paid by self-employed workers. It amounts to 15.3 percent of a minister’s taxable earnings. Employees and employers pay “Social Security” and “Medicare” taxes (sometimes collectively referred to as “FICA” taxes). Like self-employment taxes, these taxes amount to 15.3 percent of a minister’s taxable earnings. But there is a big difference. Employers and employees split the 15.3 percent tax rate, with each paying 7.65 percent. Self-employed persons pay the entire self-employment tax. Many churches pay half, or even all, of a minister’s self-employment tax. This is perfectly appropriate, but any amount paid by the church must be reported as taxable income to the minister.

3. How Does a Minister Pay Taxes?

Many churches erroneously withhold the employee’s share of Social Security and Medicare taxes from ministers’ compensation, and then pay the employer’s share. In other words, they treat their minister as an employee for Social Security. This is understandable, especially when the church treats the minister as an employee for purposes of federal income taxation. But, it is always incorrect for a church to treat a minister as an employee for Social Security. Self-employment taxes for ministers are computed on Schedule SE of Form 1040.

The federal income tax is a “pay as you go” tax. This means that you must pay your tax as you earn income during the year. There are two ways to do this—quarterly estimated tax payments and tax withholding.

Ministers must prepay their income taxes and self-employment taxes using the estimated tax procedure, which can be confusing. Nonetheless, it’s important to understand how to calculate and pay estimated taxes to avoid significant tax liabilities.

Generally, you should make estimated tax payments if your estimated tax for this year will be $1,000 or more and the total amount of income tax that will be withheld from your income will be less than the lesser of (1) 90 percent of your tax liability for the current year, or (2) 100 percent of your tax liability for the previous year (if it covered all 12 months of the year). If you are required to pay estimated taxes, but fail to do so, you will be subject to an “underpayment penalty.” Since the penalty is figured separately for each quarterly period, you may owe a penalty for an earlier payment period even if you later paid enough to make up the underpayment. If you did not pay enough tax by the due date of each of the payment periods, you may owe a penalty even if you are due a refund when you file your income tax return!

The 4-step procedure for paying estimated taxes

Complying with the estimated tax procedure is easier than it seems. Here are the four steps you need to follow:

Step 1–Obtain a copy of IRS Form 1040-ES prior to April 15 of the current year.

Step 2–Compute estimated taxes.

Calculate your estimated tax for the current year by estimating adjusted gross income and then subtracting estimated adjustments, deductions, exemptions, and credits. Multiply estimated taxable income times the applicable tax rate contained in the Tax Rate Schedule reproduced on Form 1040-ES. Include your estimated Social Security tax on the worksheet if you are not exempt, and include your housing allowance exclusion in computing your estimated earnings subject to the self-employment tax.

Step 3–Pay estimated taxes in quarterly installments.

If estimated taxes (federal income taxes and self-employment taxes) are more than $1,000 for the current year, and the total amount of taxes to be withheld from your compensation is less than the lesser of (1) 90 percent of your tax liability for the current year, or (2) 100 percent of your tax liability for the previous year, then you must pay one-fourth of your total estimated taxes in four quarterly installments (by April 15 for January 1 to March 31; by June 15 for April 1 to May 31; by September 15 for June 1 to August 31; and by January 15 for September 1 to December 31). If the due date for making an estimated tax payment falls on a Saturday, Sunday, or legal holiday, the payment will be on time if you make it on the next business day.

Payment vouchers. You must send each payment to the IRS, accompanied by one of the four payment vouchers contained in Form 1040-ES.

Starting a job in mid-year. A minister who becomes liable for estimated tax payments midway through a year should submit a payment voucher by the next filing deadline accompanied by a check for a prorated portion of the entire estimated tax liability for the year.

Changing your quarterly payments. Changes in your income, deductions, credits, or exemptions may make it necessary for you to refigure your estimated tax and adjust your remaining quarterly payments accordingly.

Step 4–Compute actual taxes.

After the close of the year, compute your actual tax liability on Form 1040. Only then will you know your actual income, deductions, exclusions, and credits. Estimated tax payments rarely reflect actual tax liability. Most taxpayers’ estimated tax payments are either more or less than actual taxes as computed on Form 1040 (usually less).

Overpayment. If you overpaid, you can elect to have the overpayment credited against your first quarterly estimated tax payment of the following year or spread out in any way you choose among any or all of your next four quarterly installments. Alternatively, you can request a refund of the overpayment.

Underpayment. If you underpaid your estimated taxes you may have to pay a penalty. The penalty is computed separately for each quarterly payment period. Contrary to popular belief, payment of your entire estimated tax liability with your Form 1040 will not relieve you of the penalty if you did not pay the estimated income tax due earlier in the year.

Form 2210. You can use Form 2210 to see if you owe a penalty and to figure the amount of the penalty. If you owe a penalty and do not attach Form 2210 to your Form 1040, the IRS will compute your penalty and send you a bill. You do not have to fill out a Form 2210 or pay any penalty if either of two conditions apply: (1) your total tax less income tax withheld is less than $1,000, or (2) you had no tax liability last year and you were a United States citizen or resident for the entire year. The IRS can waive the underpayment penalty if the underpayment was due to casualty, disaster, or other unusual circumstance and it would be inequitable to impose the penalty.

Special rule for high-income taxpayers. A high-income taxpayer with adjusted gross income for the previous year of at least $150,000 cannot avoid the underpayment penalty by paying estimated taxes for the current year of at least 100 percent of last year’s tax. For such persons, the “100 percent rule” is replaced with a 110 percent rule, meaning that they will be subject to an underpayment penalty unless they have paid estimated taxes for the current year of at least the lesser of (1) 90 percent of the current year’s actual tax liability, or (2) 110 percent of last year’s actual tax liability.

Voluntary withholding

Ministers who report their income taxes as an employee may request “voluntary withholding” of their income taxes and self-employment taxes by filing a Form W-4 with the church. A self-employed minister is free to enter into an “unofficial” withholding arrangement whereby the church withholds a portion of his or her compensation each week and deposits it in a church account, and then distributes the balance to the minister in advance of each quarterly estimated tax payment due date.

For more information or to view this article online, please visit the Church Tax & Law Website . If you have any questions regarding these tax issues or any other non-profit tax questions, please contact our office.

What to Know About Tax Preparation Software for Pastors

Understanding the benefits and pitfalls of using tax programs for clergy. – Posted 12/6/22

Tax preparation software packages, such as TurboTax, TaxAct, H&R Block, and TaxSlayer, are becoming popular ways for individuals to prepare their own income tax returns. However, these software packages are not specifically designed to address some of the tax rules unique to ministers.

Ministers using a tax software package to prepare their income tax returns should be familiar with these unique rules, and should consider seeking the advice of a tax professional with experience in preparing ministers’ tax returns, in order to ensure that their tax returns are prepared accurately.

Software benefits

Most of the leading income tax software products are offered in boxed, downloadable, or online versions, making them easily accessible. They are also relatively inexpensive, generally in the $50 to $100 range for the federal self-employed version, with an additional cost to prepare a state income tax return (some versions are even offered free of charge to lower income individuals).

The ability to import tax data from other sources (e.g., from investment accounts or from Quicken/QuickBooks);These packages also offer the ability to electronically file the federal (and sometimes the state) income tax return, which greatly speeds up the refund process. A top-notch package will also include additional features (sometimes for an additional price), such as:

• An interview interface to guide you through the preparation process;
• Error-checking of the return after it has been prepared;
• A deduction finder to alert you to income tax deductions that may be applicable;
• Easy access to IRS publications;
• Tax planning assistance;
• Audit defense (for example, in the case of an IRS audit, the manufacturer will defend the income tax filer if there is an error resulting from the use of the manufacturer’s product); and
• Financial or retirement planning assistance.

Three rules unique to ministers

While the benefits noted above can make using tax preparation software packages an attractive alternative for ministers preparing their own returns, these packages are often limited in their ability to address some of the unique tax rules applicable to ministers.

1. Social Security and Medicare taxes

Three rules, outlined below, are applicable to duly ordained, licensed, or commissioned ministers who are being paid for services performed in the exercise of their ministry. These rules are not applicable to income or wages earned by a minister outside of the ministerial context (such as for secular employment).

Under federal tax law, ministers employed by a church have a “dual tax status.”

They are considered employees for federal income tax purposes, but are considered self-employed for federal employment tax purposes. Therefore, a minister will generally receive a Form W-2 from his employing church for wages earned, but those wages are not subject to employee- and employer-paid FICA taxes (related to Social Security and Medicare). Instead, ministers are responsible for paying the full amount due into the Social Security and Medicare systems through the payment of self-employment (also known as SECA) taxes, computed on Schedule SE of their personal income tax returns.

Ministers who are conscientiously opposed to, or because of their religious principles are opposed to, the acceptance of any public insurance (such as Social Security or Medicare) with respect to their ministerial earnings may elect out of the Social Security/Medicare system by filing Form 4361 with the IRS.

The Form 4361 must generally be filed within two years of the first year that a minister has earnings from ministerial work. Ministers who have made this election would not complete Schedule SE, but would enter “Exempt-Form 4361” on the dotted line next to Form 1040, Schedule 2, line 4, and/or Form 1040, line 23 (other taxes, including self-employment tax).

Ministers using tax preparation software should check to make sure that the software accepts their Form W-2, since a properly prepared Form W-2 will not show their wages as subject to Social Security or Medicare taxes.

The minister also should make sure that their wages are properly being treated by the software package as self-employment income, for purposes of computing the self-employment tax, if applicable to the minister. For ministers electing out of the Social Security system, check to make sure that the tax software package makes the notational entry on Schedule 2, line 4, and/or line 23 of the Form 1040.

2. Parsonage or housing allowance exclusion

Ministers may exclude from their taxable income the annual fair rental value of a parsonage provided rent-free by their church as part of their compensation package.

Ministers may also exclude from their taxable income cash payments that have been properly designated by their employing church as a ministerial housing allowance, up to the lesser of: (1) the amount used to pay for housing-related expenses (such as mortgage payments or rent, utilities, repairs, furnishings, insurance, property taxes, improvements, maintenance, and homeowners’ association dues), or (2) the fair rental value of the home, including furnishings and utilities.

The parsonage/housing allowance is excludible for income tax purposes only. For ministers who have not opted out of the Social Security system, their parsonage/housing allowance must generally be included in determining their self-employment tax.

Ministers using tax preparation software should therefore check to make sure the package is properly limiting the housing allowance exclusion based on the limitations noted above, and that the package is properly including the parsonage/housing allowance amount in the calculation of self-employment income.

3. Limitation on/disallowance of business expense deductions

Many ministers may incur expenses in connection with their church employment, which are not reimbursed by the church. For tax years 2018 through 2025, such unreimbursed employee business expenses are not deductible for federal income tax purposes.

Ministers may also incur expenses, such as travel expenses, in connection with ministerial income earned outside of their employment (such as honorarium payments received for speaking engagements, weddings, or funerals). Business expenses related to ministerial income earned outside of a minister’s employment (reportable on Form 1040, Schedule C) incurred in connection with ministerial earnings are not deductible for federal income tax purposes to the extent that they are allocable to tax-exempt parsonage or housing allowances.

In order to compute the nondeductible portion, the minister should first determine his total ministerial income, including the parsonage/housing allowance. The minister should then divide the parsonage/housing allowance by the total ministerial income to determine the nontaxable percentage. This percentage should then be applied to any business expenses incurred to determine the nondeductible portion. Only the deductible portion should then be reported on Schedule C.

Many of the tax software packages do not automatically calculate the nondeductible portion of business expenses allocable to the tax-free portion of a minister’s income. Ministers will therefore need to manually adjust these expenses and input the reduced figure into the software for purposes of computing the income tax deduction. However, since the parsonage/housing allowance is included in the computation of the amount subject to the self-employment tax, the full amount of the business expenses should be used to compute the net earnings from self-employment reportable on Schedule SE.

Exercise Caution

Tax preparation software packages offer many benefits and conveniences, making them an attractive alternative for individuals wishing to prepare their own income tax returns. However, ministers who are considering using an income tax software package should carefully check their returns to ensure that the situations outlined above are addressed correctly.

For more information or to view this article online, please visit the Church Tax & Law Website . If you would like to learn more about tax preparation software and how if will benefit your ministry, please contact our office.

Housing Allowances

Understand how to properly set this significant pastoral benefit. – Posted 12/5/22

The housing allowance is the most important tax benefit available to ministers. But many ministers do not take full advantage of it because they (or their tax adviser or church board) are not familiar with the rules.

The three most commonly used housing arrangements for ministers are (1) owning a home, (2) renting a home or apartment, and (3) living in a church-provided parsonage. The tax code provides a significant benefit to each housing arrangement. The rules are summarized below.

Housing allowance: minister owns the home

Ministers who own their home do not pay federal income taxes on the amount of their compensation that their employing church designates in advance as a housing allowance, to the extent that the allowance represents compensation for ministerial services, is used to pay housing expenses, and does not exceed the fair rental value of the home (furnished, plus utilities). Housing-related expenses include mortgage payments, utilities, repairs, furnishings, insurance, property taxes, additions, and maintenance.

Housing allowance: minister rents the home

Ministers who rent a home or apartment do not pay federal income taxes on the amount of their compensation that their employing church designates in advance as a housing allowance, to the extent that the allowance represents compensation for ministerial services and is used to pay rental expenses and does not exceed the fair rental value of the home (furnished, plus utilities).

Parsonages

Ministers who live in a church-owned parsonage that is provided rent-free as compensation for ministerial services do not include the annual fair rental value of the parsonage as income in computing their federal income taxes. The annual fair rental value is not deducted from the minister’s income. Rather, it is not reported as additional income anywhere on Form 1040 (as it generally would be by most non-clergy workers).

In addition, ministers who live in a church-provided parsonage do not pay federal income taxes on the amount of their compensation that their employing church designates in advance as a parsonage allowance, to the extent that the allowance represents compensation for ministerial services and is used to pay parsonage-related expenses such as utilities, repairs, and furnishings.

How to set parsonage and housing allowances

Parsonage and housing allowances should be (1) adopted by the church board or congregation, (2) in writing, and (3) in advance of the calendar year. However, churches that fail to designate an allowance in advance of a calendar year should do so as soon as possible in the new year (though the allowance will only operate prospectively). In designating housing allowances, churches should keep in mind that the nontaxable portion of a housing allowance cannot exceed the fair rental value of a minister’s home (furnished, plus utilities). Therefore, nothing will be accomplished by designating allowances significantly above this limit.

Using “safety nets”

Many churches do not limit housing allowances to a particular cal­endar year. For example, if a church intends to designate $12,000 of its senior pastor’s salary in 2021 as a housing allowance, its designa­tion could state that the allowance is effective for calendar year 2021 and all future years unless otherwise provided. This clause may provide a “safety net,” protecting the pastor in the event that the board neglects to designate an allow­ance prior to the beginning of a future year.

A church also would be wise to have a “safety net” designation to cover midyear changes in personnel, delayed designations, and other unexpected contingencies. To illustrate, such a designation could simply state that a specified percentage (e.g., 40 percent) of the compensation of all ministers on staff, regardless of when hired, is designated as a housing allowance for the current year and all future years unless otherwise specifically provided.

Such safety net designations should not be used as a substitute for annual housing allowance designations for each minister. They are simply a means of protecting ministers against inadvertent failures by the church board to designate a timely housing allowance.

Key details

Here is a recap of some important details, along with some helpful additional information ministers should know about the housing allowance:

• A housing allowance must be designated in advance. Retroactive designations of housing allowances are not effective.
• The housing allowance designated by the church is not necessarily nontaxable. It is nontaxable (for income taxes) only to the extent that it is used to pay for housing expenses, and, for ministers who own or rent their home, does not exceed the fair rental value of their home (furnished, plus utilities).
• A housing allowance can be amended during the year if a minister’s housing expenses are more than expected. However, an amendment is only effective prospectively. Ministers should notify their church if their actual housing expenses are significantly more than the housing allowance designated by their church. But note that it serves no purpose to designate a housing allowance greater than the fair rental value of a minister’s home (furnished, plus utilities).
• If the housing allowance designated by the church exceeds housing expenses or the fair rental value of a minister’s home, the excess housing allowance should be reported on line 1 of Form 1040.
• The housing allowance exclusion is an exclusion for federal income taxes only. Ministers must add the housing allowance as income in reporting self-employment taxes on Schedule SE (unless they are exempt from self-employment taxes).
• The fair rental value of a church-owned home provided to a minister as compensation for ministerial services is not subject to federal income tax.
• Ministers should be sure that the designation of a housing or parsonage allowance for the next year is on the agenda of the church board for one of its final meetings during the current year. The designation should be an official action, and it should be duly recorded in the minutes of the meeting. The IRS also recognizes designations included in employment contracts and budget line items—assuming in each case that the designation was duly adopted in advance by the church.
• Many churches base the housing allowance on their minister’s estimate of actual housing expenses for the new year. The church provides the minister with a form on which anticipated housing expenses for the new year are reported. For ministers who own their homes, the form asks for projected expenses in the following categories: down payment; mortgage payments; property taxes; property insurance; utilities, furnishings, and appliances; repairs and improvements; maintenance; and miscellaneous. Many churches designate an allowance in excess of the anticipated expenses itemized by the minister. Basing the allowance solely on a minister’s anticipated expenses penalizes the minister if actual housing expenses turn out to be higher than expected. In other words, the allowance should take into account unexpected housing costs or underestimated projections of expenses.
• Ministers who own their homes lose the largest component of their housing allowance exclusion when they pay off their home mortgage. Many ministers in this position have obtained home equity loans—or a conventional loan secured by a mortgage on their otherwise debt-free home—and have claimed their payments under these kinds of loans as a housing expense in computing their housing allowance exclusion. The Tax Court has ruled that this is permissible only if the loan was obtained for housing-related expenses.

For more information or to view this article online, please visit the Church Law & Tax Website. To learn more about housing allowance benefits or if you have any questions, please contact our office.

Tax News for November 2022 . . .

There were several important tax developments in 2019 that affect tax reporting by ministers, church staff, and churches for the upcoming tax-filing season as well as reporting and records-keeping requirements in 2020 and beyond. For more information click here

TIPS FOR END OF YEAR PLANNING [click here for details]

See the Governance page. [click here for details]

REGARDING THE COMING INCREASE OF CHURCH AUDITS
The Internal Revenue Service (IRS) is issuing several hundred church examinations to seek out organizations that are not complying with the Affordable Care Act (ACT). While this is affecting only a fraction of churches nationwide, there are a few precautions you can take to ensure that your church is not one of them. The main practices being targeted by the IRS are 1) the incorrect processes by which full-time church employees are opting out of their church’s group health insurance plan and 2) the church’s provision of reimbursements to employees for purchasing their own health insurance.

Regarding opting-out processes: If a church offers/is required to provide group health insurance, the church must comply with the group health benefit rules outlined in the ACA. Employees of said churches are only allowed to legally opt out of this insurance by transferring to a different group plan, i.e. a spouse’s plan. They cannot purchase any form of individual health insurance; acting otherwise is a violation of IRC. Sec. 4980H(a) and will result in an ACA penalty. 

• Churches are responsible for informing their employees that they are ineligible to sign up for an insurance exchange for any individual health plan. In turn, the employee is required to represent that the church participates in an alternative group health insurance plan. This is extremely important, as the employer can be charged up to $2500 per employee over 30 employees that purchases an individual health plan.
• It is also important to note that churches with between two (2) and fifty (50) FTEs are not required to provide group health insurance. However, those that choose to must comply with the ACA’s group health benefit rules.

Regarding the use of individual health insurance: While it was once legal for churches to provide employees with reimbursements for switching health plans, the ACA no longer permits it. Many churches continue the practice today; if yours is one of them, please cease immediately to avoid penalties.

IRC Sec. 7611 requires the IRS to have concrete written evidence that a church is not complying with the ACA’s rules before they conduct an examination, and this evidence typically comes in the form of W-2s and other filings.

What to Do:
If you are unsure whether or not your church is abiding by the aforementioned rules, it is extremely important that you verify your compliance. The best ways to do so are to:

1. Perform a self-audit, or
2. Hire a professional to conduct a compliance audit.

Once you complete either of those options, immediately rectify any discovery of noncompliance.

If you are contacted by the IRS, hire a licensed tax professional as soon as possible, preferably one that specializes in helping churches. They can work with the IRS on your behalf at pre-exam conferences, help the IRS agent hone in on specific problems even before the exam begins, assist the church in identifying and rectifying problems, and keep the process as clean and professional as possible.

Please remain vigilant and do your best to abide by the ACA’s provisions– even minor violations can garner staggering financial penalties at worst, and a huge headache at best.

REGARDING INTERNAL REVENUE SERVICE RELIEVING 2019 & 2020 FAILURE TO FILE PENALTIES

The following is an article posted by the Journal of Accountancy . . .

IRS relieves penalties for 2019 and 2020

By Paul Bonner (August 24, 2022)

A broad range of tax and information returns for 2019 and 2020 tax years will receive automatic relief from failure-to-file penalties, under Notice 2022-36 released by the IRS Wednesday.

The estimated 1.6 million taxpayers who have already paid these penalties will automatically receive an estimated $1.2 billion in refunds or credits, the IRS said in the notice and announced in a news release. Abatement of the penalties is also automatic.

Taxpayers do not need to request this relief, and the IRS said it will pay most of the refunds or apply credits by the end of next month. However, any return still unfiled for the two tax years must be filed by Sept. 30, 2022, to be eligible for the relief.

Also, the notice abates penalties for failure to timely file any information return (as defined in Sec. 6724(d)(1)), such as those in the Form 1099 series, for the two tax years. To be eligible, information returns for 2019 must have been filed on or before Aug. 3, 2020, and 2020 information returns by Aug. 2, 2021.

In addition, various international information returns such as those reporting transactions with foreign trusts, receipt of foreign gifts, and ownership interests in foreign corporations will receive similar relief. However, to qualify for the relief, any eligible tax return must be filed on or before Sept. 30, 2022.

The relief measure is intended “to help struggling taxpayers affected by the COVID-19 pandemic” and to allow the Service to “focus its resources on processing backlogged tax returns and taxpayer correspondence to help return to normal operations for the 2023 filing season,” the IRS said in the release.

Another reason for the relief is that additions to tax or penalties for failure to timely file returns continued to accrue during periods of postponed filing dates for returns for both years, under the presidential emergency declaration in March 2020 in response to the pandemic, the IRS acknowledged in the notice.

The AICPA Form 3520 Penalties Task Force had requested penalty relief for Forms 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, and 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner, especially in light of the backlog, and is pleased the IRS listened and provided some blanket relief, the task force chair, Hank Alden, said Wednesday.

Tax returns eligible for the relief include specified returns in the Form 1040, 1041, and 1120 series. Also eligible are Form 1066, U.S. Real Estate Mortgage Investment Conduit (REMIC) Income Tax Return; Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Trust Treated as Private Foundation; and Form 990-T, Exempt Organization Business Income Tax Return (and Proxy Tax Under Section 6033(e).

In addition, Form 1065, U.S. Return of Partnership Income, and Form 1120-S, U.S. Income Tax Return for an S Corporation, may have penalties forgiven for failure to timely file and for failure to show required information.

The notice also covers certain international information returns, such as Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, and Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business, attached only to Forms 1065 and 1120. It does not provide relief for taxpayers filing returns with certain international information returns, e.g., Form 5471, attached to returns other than Forms 1065 and 1120, such as Form 1040 or 1041.

Penalties for fraudulent failure to file under Sec. 6651(f) or the penalty for fraud under Sec. 6663 are not eligible for relief. Any penalties included in an accepted offer in compromise, settled in a closing agreement under Sec. 7121, or finally determined in a judicial proceeding are also ineligible.

The AICPA and other groups and firms have repeatedly advocated that the IRS provide failure-to-file and other penalty relief under procedures similar to those for a first-time abatement administrative waiver but based upon the COVID-19 pandemic as reasonable cause for the failure.

“As the coronavirus is an extraordinary event unlike anything faced in recent history, penalty relief based on a coronavirus effect should not be considered first-time abate,” the AICPA said in a May 17, 2021, letter to IRS Commissioner Charles Rettig and Acting Assistant Secretary for Tax Policy Mark Mazur.

In the IRS news release, Rettig acknowledged such input.

“We’ve been working on this initiative for months following concerns we’ve heard from taxpayers, the tax community, and others, including Congress,” Rettig said.

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