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5 Reasons Why a 501(c)(3) is a Good Idea for Churches

Tag Archives: federal tax law

5 Reasons Why a 501(c)(3) is a Good Idea for Churches

Many churches view having a 501(c)(3) as being ‘worldly.’  After all, churches are tax exempt anyway, right? As a tax advisor. I’ve seen the complications that arise from the lack of having a 501(c)(3). Our firm recommends taking the steps needed to be an official tax-exempt organization. Here’s why:

  1. Your donors can have confidence that you’re meeting the requirements for a tax-exempt organization. You must meet the compliance regulations that oversee a 501(c)(3) to ensure integrity. Such regulations are a watchdog and provide transparency about your church’s
    financial standing.
  2. You are able to offer donors a confident tax deduction. Actually, donations to churches are already tax deductible. However the 501(c)(3) gives you the ability to offer tax-deductible receipts for all cash and non-cash donations. While not important to some contributors, the ability to deduct charitable contributions is still a viable tax strategy for many people.
  3. You receive the protection of limited liability for directors and officers for operations of the organization, assuming you have incorporated.
  4. You avoid a recently popular scam known as a ‘corporate sole.’ This is promoted as the ultimate way to detach yourself and your church from ‘the world,’ yet maintain a legal entity. However, the assets that are transferred to the corporate sole end up in someone else’s pocket.
  5. You qualify for nonprofit postal rates when mailing over 250 of the same mail piece.

In addition to accounting and consulting for churches, Salmon Sims Thomas specializes in accounting and consulting for nonprofit organizations. We’ll be happy to walk you through the steps you need if your church is not already a 501(c)(3). Or, talk with us if you have questions regarding your tax status.

June Tax Reminders for Pastors

2013 is flying by, and deadlines can sneak up on you. Be ready to prepare for these two dates in June:

June 15

Since most ministers are considered self-employed (for FICA and Medicare purposes), they have to file and pay estimated taxes quarterly. If you ask your church to withhold these taxes through withholding, then this doesn’t apply to you. However, if you pay all of your taxes independently, then make a payment by June 15.

Also, although now common,  quarterly unrelated business income tax (UBIT) is due on June 15th if you expect the total tax for the year to be $500 or more. You receive unrelated business income from sources like rent from certain types of property and income from a regularly carried on trade or business operation.

June 30

Mid-year is a perfect time to review policies to make sure that you’re following what you need to do. If there are discrepancies, it’s easier to make
corrections now before getting too far into the year. For example, look at your expense reimbursement policy and make sure that it meets the IRS criteria for an accountable plan. Lack of a qualified reimbursement policy can result in having to 1099 employees for reimbursements that would
otherwise be nontaxable. Another policy to address and confirm is your minister’s housing allowance. Is the current amount still meeting the minister’s needs? If not, it can be adjusted during the year.

I’ve written a lot about tax reporting rules for churches. Scan the tags at the right of this post for your specific areas of interest.

New (and Old) Rules for Home Offices

While simplifying the filing procedure to claim a home office deduction, the IRS criteria for claiming the deduction unfortunately eliminates the
possibility for most ministers. The criteria to claim the deduction isn’t new. If you’re looking ways to save on 2013 taxes, see if these requirements fit your situation:

  1. Exclusive use of the home office for business. To qualify, the room you use for an office cannot be used for any other purpose than business. So, your family members can’t share that space with you for the room to qualify.
  2. Ongoing, as opposed to occasional, use for business. The business conducted in the home office must be the primary place of work for the minister, not a place to fill in at the end of the day.
  3. Convenience for the employer, not the employee. If your church is short of space available for offices, then your home office provides a convenience for the employer and you can qualify for the deduction. However, if you (the employee) simply like to work from home, then it is not considered a convenience for the employer.

Therefore, if you have no other option than to office at home, then you satisfy the criteria for a home office, as long as the room you use is exclusively for your job as a minister and it is used regularly.

Starting in 2013, you can claim a safe harbor computation for your home office deduction as long as you meet the criteria. Instead of multiple calculations for expenses and depreciation, you can claim a flat rate per square foot. The deduction is capped at a maximum 300 square feet x $5 per square foot. You can still claim allowable mortgage interest, real estate taxes, and any casualty losses on Schedule A, and those deductions do not need to be designated as personal vs. business use. So, if you meet the criteria, the simplified calculations make the deduction easily worthwhile.

3 Forms Due on February 28

This time of year brings many IRS deadlines. Churches have three action items that are due on February 28. Make sure that you complete these on time:

–         Submit Copy A of each Form W-2 issued to employees, along with the accompanying Form W-3 which summarizes the Form W-2s. This is the ‘paper’ deadline date for submitting to the Social Security Administration. If you file electronically, you can wait until March 31, 2013.

–         Submit Copy A of each Form 1099-MISC that you issued to self-employed contractors, along with the accompanying Form 1096 which summarizes the Form 1099. This is the ‘paper’ deadline, and the documents should be sent to the IRS (not the Social Security Administration). The electronic filing deadline is March 31, 2013.

–         File Form 1098-C if you sold or used a vehicle donated to your church. This form should be sent to the IRS.

Because you had to issue Form W-2 to employees and Form 1099 to contractors by January 31, the February 28 deadline gives recipients time to notify you about discrepancies.

Setting Up a Reimbursement Policy

Like all businesses, churches need a written reimbursement policy. It needs to meet the IRS’ criteria as an ‘accountable plan’ if your employee is to exclude the reimbursement from taxable income. A written policy sets standards for business expenses and minimizes the gray areas for what is and what is not a qualified business expense. Examples of expenses to make decisions on and document are:

–         Mileage reimbursement (We recommend you reimburse at the standard amount approved by the IRS.)

–         Parking and tolls

–         Travel expenses (including transportation, lodging, and meals)

–         Per diem amount for meals while traveling (if applicable)

–         Cell phones

–         Professional membership dues and periodical subscriptions

Additional decisions are required for the process of reimbursement:

–         Which expenses are reimbursable vs. expenses that should be paid directly

–         Acceptable time frame for submitting expenses (60 days per IRS rules)

–         Amount that needs a hard copy receipt (IRS standard is $75; your amount may be lower)

–         Whether or not cash advances are available, and the time frame for returning excess advance payment

–         Whether pre-authorization is required to qualify for reimbursement

Include in your policy the required documentation to meet IRS standards:

–         Type of purchase

–         Date, place, amount of purchase

–         Business nature of the expense

For nonprofit organizations, including churches with a 501(c)(3) designation, provide employees with a form or certificate that shows your tax exemption. If someone makes a purchase for your church that is reimbursable, then they do not need to pay sales tax. (Check your specific state for its rules.) But the place of purchase will need to see proof of tax exempt status.

One more thing – determine who approves expenses for each department or program area. Without proper approval, the reimbursement should not be made.

The Fine Print for Ministers’ Form W-2

magnifying glassHappy New Year! One of the most important action items for churches (and businesses) will be to distribute Form W-2s for all employees by January 31, 2013. For staff who are classified as ministers, the calculations are different from other employees. Here are guidelines for a minister’s Form W-2:

–         Ministers are almost always classified as employees for federal tax purposes and therefore receive a Form W-2, not a Form 1099.

–         However, for social security purposes, ministers are considered self-employed, and they pay the full burden of social security taxes. If your church gives a minister a stipend to cover the ‘employer’ portion of social security tax, then the stipend amount must be considered regular income, not a reimbursement.

–         Housing allowances are reported separately on the Form W-2, but not included in federal income. Other allowances, such as a car allowance, count as regular income.

–         Reimbursed business expenses do not have to be reported on Form W-2 (assuming an acceptable policy exists).

–         Make sure that you have not inadvertently withheld social security or Medicare funds during the year.

–         You must report the amount of employee health insurance costs paid by the employer on the Form W-2. This is new for 2012 as a reporting requirement of the Patient Protection and Affordable Care Act of 2010. There is no tax effect associated with this reporting.

Remember, if you do provide a housing allowance, you must have documentation regarding the responsible committee’s decision for the amount. For reimbursements, you also need a written reimbursement policy for the minister and all employees. If you are not sure whether other employees should be considered employees vs. independent contractors for income tax purposes, then please see the IRS explanation of independent contractor or employees.

Housing allowance for a parsonage vs. a pastor-owned home

With a continuing trend of low interest rate mortgages, a pastor may want to purchase a personal home for the long term, after he or she moves out of a church-owned parsonage. Since housing allowances are such a hot button for an IRS audit, I want to make sure that you are very clear about the rules regarding a personal home vs. parsonage.

No part of a housing allowance may be used for any home other than the pastor’s actual residence. So if a pastor lives in a church-owned parsonage, the value of that benefit to the pastor is not taxable (for federal income tax purposes). Or, if the pastor is given an allowance, the amount is not taxable to the extent used by him to rent or pay for a home such that it does not exceed the fair rental value. Furnishings and the cost of utilities may be included in the housing allowance amount.

The housing allowance frequently comes up for discussion from non-religious groups that want to fight the clergy’s existing tax exemption. But for now, the housing allowance continues to be a safe, non-taxable benefit for pastors.

A pastor may still want to purchase a home for future use. However, the housing allowance may not be used for the [future] home if the pastor continues to live in a church-owned parsonage.

Talking about politics

Two things we’re told to not discuss are religion and politics. Of course, churches are going to talk about religion. But can they talk about politics, according to the IRS?

With elections coming soon, here’s what churches CAN do and still maintain tax-exempt status:

–          Insubstantial lobbying – To keep your tax-exempt status, lobbying activity must be kept to a minimum expenditure and must not be a substantial part of the church’s activities. ‘Not substantial’ would be a very low percentage of activities. Unfortunately, the IRS has failed to define ‘insubstantial,’ so consult an attorney if you have a question.   Examples of lobbying that may be allowable by a church, are attempting to influence legislation considered by Congress, state legislature, or at local and municipal levels.  Also keep in mind that anyone who feels the church has violated these requirements may file a complaint with the IRS on Form 13909.

–         General advocacy on issues – Examples of safe topics include community involvement, responsible citizenship, and non-partisan voter education activities. However, churches must not mention specific elections or candidates.

–         Candidate appearances – If a church wants to hear from candidates, all must be given an equal opportunity to participate, and they must not give political speeches. This is a tricky area, so it’s best to seek legal advice before proceeding to invite candidates running for office.

And, here’s what churches CAN’T do: (more…)

Follow these internal controls to minimize risk

In our work with churches and ministries, our firm sees many similar issues that need to be addressed. We put together an eBook to make it easy for you to scan the top three topics: internal controls, minister and staff compensation and necessary administration. See if your church is in line with all you need to do by downloading How to avoid cash crunches and compliance complications. Please feel free to share it with other individuals and groups that can also benefit from the information.


The ‘friendly’ Neighborhood Land Rule for churches

Tax-exempt organizations are able to take advantage of the IRS’ Neighborhood Land Rule which offers protection from unrelated business income tax (UBIT) for debt-financed property when certain conditions apply. Here are the rules as they specifically apply to churches:

–         A church may purchase property to use for tax-exempt purposes and has up to 15 years to develop the property.

–         If the property is debt-financed and invokes the Neighborhood Land Rule, the church is not subject to unrelated business income tax on any rent or royalty income earned on the property. (The church may earn income from the existing structures or mineral rights without UBIT if the property will be used for tax-exempt purposes within 15 years of acquisition.)

–         The property does not have to be in the same ‘neighborhood’ as the church. (For non-church tax-exempt organizations, the property must be within a mile of the present location.)

–         The church must provide written intent for tax-exempt purposes to the IRS. Notification must happen at least 90 days prior to five years after acquisition of the property. A ruling must be requested from the IRS with regard to specific improvements and anticipated completion dates.

–         The church must remove or demolish existing structures on the property if they are not suitable for church use prior to development. If structures are not removed or demolished for the furtherance of the church’s purpose, then the Neighborhood Land Rule does not apply.

–         The Neighborhood Land Rule does not apply to structures erected on the land after acquisition. The intent is to ‘protect’ the church during the holding time between purchase and development.

–         If the church purchases property for income purposes and later uses the property for exempt purposes, they can apply for a refund or tax credit for a prior tax year.

The key to tax-exemption is preventing the property from being considered debt-financed land.  By being aware of the Neighborhood Land Rule criteria, churches can plan for future expansion and reduce tax burden at the same time.