Last week’s blog gave you the IRS’ rules regarding income tax exclusions for housing allowances.

It’s the minister’s responsibility to maintain written records that document 1) fair market rental value, 2) agreed upon amount, and 3) actual amount needed to provide a home. The church is responsible for recordkeeping and reporting, but the minister is ultimately responsible for the housing allowance taken. The minister’s tax return is subject for audit for up to three years after filing.

The church needs to keep updated records that detail how the designated housing allowance was determined. This documentation belongs in the minutes of the meeting when the amount is decided, which should be prior to January 1^st. Many churches will be liberal in calculating the designated amount since the minister will only be able to take the lower of the three options.

Ministers can claim a portion of income tax-free as a housing allowance. But, you must follow specific guidelines and then report and maintain the allowance. Reporting and maintenance will be covered in next week’s post as Part 2.

The rules regarding housing allowances are:

• Housing (also called parsonage or rental) allowance for ministers is excludable from gross income for income tax purposes, but is not excludable from the self-employment tax which affects ministers.
• The amount excludable is the least of these three amounts:
  • Fair market rental value (including furniture, utilities, garage, etc.)
  • Agreed upon/designated allowance
  • Actual allowable costs incurred
  • Whether renting or owning, the exclusion amount cannot be more than what is considered reasonable pay for ministerial services.
  • The amount of allowance that is not eligible for exclusion is considered part of wages for income tax purposes (Form 1040, line 7).

Housing allowances for ministers are one of the red flags for the IRS. Failure to follow the rules exactly can result in taxes, penalties and interest.

By stated purpose, most churches are tax exempt. but there are significant benefits to churches who apply for a 501(c)(3). Read about how to qualify.

Even though churches don’t file Form 990, by filing Form 990-T on or before November 15, 2011, you may qualify for up to 25% refund on health insurance premiums paid. See the 990taxhelp blog for more details.

Some churches state that they are opposed to paying FICA taxes on employees for religious reasons. If the church feels strongly about these taxes, they are able to elect exemption from the employer portion of the Social Security tax. Here are a few important considerations before filing Form 8274 and enacting the exemption:

-         Employees affected by the church’s exemption are required to pay the full amount of FICA, in essence a self-employment tax on the income on their personal tax return. (This applies to income of $108.28 or more for the tax year, and excludes business expense deductions.)

-         Individuals affected by this election are considered employees for all other purposes, including federal income tax withholding.  The church must continue to file Form 941 or 944 to report the wages covered by the exemption and the federal income tax withholding.

-         The exemption takes effect when the next quarterly employment tax is due; it’s not pro-rated.

-         The exemption can be revoked if the church fails to file Form W-2 for two years in a row, and fails to report requested information to the IRS. Then, the amount due would include the previous two-year period.

Qualified church-controlled organizations may also apply for the exemptions who also claim religious reasons for abstaining from the tax. Such organizations have a 501(c)(3) and are controlled by churches, but do not receive more than 25% of support from a combination of governmental sources and sales of goods or services that are unrelated business income. They also do not regularly offer goods, services or facilities for sale for more than a nominal charge. The Qualified church-controlled organization must meet both tests in order to qualify for the exemption.

The IRS’ standard business mileage rate for 2011 was 51 cents per mile for the first half of the year, and 55.5 cents per mile from July 1 through December 31. Many churches reimburse employees for number of miles driven using the IRS rate, but some choose to reimburse at rates higher or lower than the standard. It’s important to understand the differences to remain compliant with the IRS.

Employees must provide adequate logs or diaries to substantiate business miles and submit the records within a reasonable period of time.  This means at least every 60 days of incurring the expense if the employee is being reimbursed.  However, if the employee is given an advance, the records substantiating the expense should be provided at least every 30 days.  Adequate records include the date, place, business purpose and number of miles driven. Parking fees and tolls need to be reported separately.

If reimbursed at an amount greater than the IRS-approved rate: The excess amount reimbursed above the standard is subject to withholding tax and must be reported as income on the employee’s W-2 form.

If reimbursed at an amount less than the IRS standard: The employee is eligible for a business deduction for the difference in the IRS standard and the amount reimbursed.

If employees do not provide adequate records within 60 days, then the church must report the reimbursement as income to the employee. The employee is eligible to claim a business expense deduction on their personal return for the business miles driven, if adequate records can substantiate the mileage.

As a reminder, employee business expenses are deductible only if they exceed 2% of the employee’s adjusted gross income.

Other mileage rates for 2011:

-         Medical purposes and moving: 19 cents/mile (2.5 cents more than in 2010)

-         Charitable mileage deduction (unreimbursed miles while driving for a church or charity): 14 cents/mile (unchanged)

Churches need to be aware of unrelated business income tax (UBIT). Here’s some information about UBIT related to real estate, such as rental income from church-owned property.

If there is a private school associated with your church that is exempt under 501(c)(3) of the Internal Revenue Code,  then Revenue Procedure 75-50 (Rev. Proc.) requires that the school have a racially nondiscriminatory policy as to its students.

This Rev. Proc. further requires that the school make an annual nondiscrimination statement in a local newspaper and/or radio.  The statement should be made in a forum that potential students and their parents would use; that is you should post your nondiscrimination statement in a place that you’d expect your potential students to frequent.

The Rev. Proc. gives specific wording, type and size of font for an acceptable notice.  Additionally, the Rev. Proc. also provides the record keeping requirements related to racial composition of the student body, faculty and administrative staff for each academic year, brochures, catalogues and advertising dealing with student admissions, programs, scholarships and other financial assistance awarded on a racially nondiscriminatory basis.

Failure to follow this guidance will result in loss of tax exempt status for the school.

One of our accountants, Lisa Potter, works extensively with nonprofit organizations. Her blog post, Maintaining transparency beyond the Form 990, has application for churches and ministries, even though the Form 990 is not required.

From my colleague, Lisa Potter:

Donor relationships and engagement are a high priority for our nonprofit clients. The United States Postal Service is offering a 3% postage discount for July and August, 2011 when mobile marketing and direct mail are combined. Here’s how it works: organizations print mail pieces (envelope or contents) with a QR code (Quick Response code – a two-dimensional code that users can scan with a mobile device that takes them directly to a specified landing page on a smartphone). The qualifying First Class Mail® cards, letters and flats, and Standard Mail® letters and flats bearing a QR code will receive a 3% discount on the total postage cost.

Promotion guidelines:

-         The QR code must be used for consumer interaction and be relevant to the mail piece. The two-dimensional barcode must have a marketing purpose, not administrative (such as links to online payment or internal operations) or educational.

-         Co-mingled, co-mailed and combined mailings are allowed, but the QR-coded mail must have a separate postage statement.

-         The QR code 3% promotional discount cannot be combined with any other postal incentive, except the full-service Intelligent Mail® barcode discount.

-         Effective dates for the promotion are July 1 – August 31, 2011.

For nonprofit organizations with an online presence, the USPS mail promotion can add up to worthwhile savings to connect with donors and potential donors.