It’s January, so administrators everywhere are scrambling to prepare Form W-2 for employees. For ministers, there are two items that can be easily overlooked as income: love offerings and allowances that are not housing-related.  So, before you issue your pastor’s Form W-2, ask questions about these items:

Love offerings – What is the amount of monetary gifts given directly to the pastor from church members and attendees? Was the pastor given tangible gifts, such as airline tickets, vacation home usage, property such as a car, televisions or computers? If yes, the value of the gift is considered taxable income.

Allowances – The housing allowance is tax-free. Read about the rules of housing allowances to make sure that your church is in compliance. Other allowances are considered taxable income. Examples include car payment, maintenance and gasoline, utility bills, cell phone, insurance and gifts purchased for others.

Failure to report allowances as income can result in a 200% fine on the allowance amount, (an excess benefit transaction) plus penalties and interest. And, board members who approved the allowance are subject to personal fines of up to $10,000.

The taxable allowance can be partially offset with a reimbursement policy that documents church-only usage of the item, such as a car and related costs. Such an accountable reimbursement policy requires strict documentation, but can benefit the pastor with non-taxable reimbursements. This reimbursement policy is not retroactive, so such a policy may need to be put in place for expenses going forward, but the allowances need to be reported as income for the previous tax year(s).

Churches are rarely busier than the months of December and January. In addition to preparing for Christmas services, your administration needs to take care of some action items. Hopefully, some items on the list below are already complete.  Here’s the list to check:

Donations/gifts received

-         Remind members that for donations to be deductible, the church must receive the gift prior to midnight on December 31. (If mailed, it must be postmarked on or before December 31.)

-         Prepare receipts for contributions of $250 or more.

-         File Form 8282 for receipt of donated non-cash items valued at $5,000 or more and disposed of by you within three years.

-         Identify love offerings and gifts given to the pastor by the church or approved for giving to the pastor. The amount needs to be included in the pastor’s W-2 form.

-         Request Form 1098-C from the IRS if you received a donation of a car, boat or plane. (Call 800-829-3676 and ask for five copies.)

Employee-related

-         Make sure that you have a file for each employee with pertinent personnel records and forms. (For ministers, be sure to include housing allowance information.)

-         Ask employees to review W-4 forms for accuracy of name, address, SSN and to check withholding status.

-         Prepare W-2 information

-         Prepare the 4^th quarter 941 report, due January 31^st. (This is the quarterly federal tax form that reports employment taxes.)

-         Review reimbursements for substantiation. (This should be an ongoing practice.)

-         Prepare a 1099-misc form for all independent contractors and service providers who you have paid $600 or more in 2011. This includes all of the companies you hire to consult or do maintenance work on your buildings.

-         Review payments of health insurance for employees. You may qualify for a 25% refund of the cost if you have less than 25 employees, the average annual salary is less than $50,000 and if your organization pays at least 50% of the group insurance premium. Then, you’ll need to file form 990T and Form 8941.

-         Be aware of excess benefit transactions by reviewing IRS section 4958.

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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.

In 2010, a Tax Court ruled that a minister is not limited to one principal residence for purposes of the housing/parsonage allowance exclusion.

The minister excluded the parsonage allowance paid by his employer on two primary residences.  In contrast, the IRS had said the minister could only exclude a parsonage allowance, paid by the minister’s employing ministry, on his primary residence even though the minister/taxpayer had a second home at a nearby lake.   This second home met the use criteria, as defined in the Internal Revenue Code (Code), to otherwise be considered a personal residence.

The Tax Court sided with the minister, and in a divided opinion, said the IRS sought to substitute the phrase “a single home” or “one home” for the phrase “a home” that is currently in the Code.  The Court found no basis for the IRS’ position; in fact to the contrary, it said the Code talks about words in the singular which can and do have the connotation of a plural meaning.

The finding will likely be appealed to the applicable Circuit Court of Appeals by the IRS and then to the Supreme Court if it does not prevail in the Circuit’s Court of Appeals. However, ministers can rely on the Tax Court’s opinion, for now, if they want to claim a housing or parsonage allowance on applicable personal residence(s).

Obviously, a thorough discussion with one’s legal and tax counsel is highly recommended given the IRS’ position on this topic.