We recently received a question about state unemployment tax, and I want to pass on Senior Tax Associate Carla Medrano’s answer in the interest of all readers. Here is the question:

“Are religious non-profits in the state of Texas exempt from state unemployment tax?  My experience is that non-profits [501(c)(3)s] are not exempt from state unemployment tax even if they are religious organizations.  An example might be a school that is a 501(c)(3), based on a particular denomination, but legally not part of a particular church or owned by a denomination.  (Churches are exempt from state unemployment in the state of Texas, correct?)”

Nonprofit organizations with a 501(c)(3) tax exemption are subject to state unemployment tax, unless they are a church or religious organization. In the example above, the school would be subject to paying state unemployment tax, but the church would not. From the Texas Workforce Commission:

The Texas Unemployment Compensation Act (TUCA) requires liable Texas employers – including sole proprietorships, partnerships, corporations, and other entities registered with the Secretary of State – to pay UI tax. Employers become liable if they:

• Pay at least $1,500 in wages in any one calendar quarter during the current or preceding calendar year, or
• Employ at least one worker for part of a day or more each week for 20 weeks during a year, or
• Acquires or otherwise receives, through any means, all or part of the organization, trade, business, or workforce of a subject employer, or
• Are a 501(c)(3) nonprofit organization (excluding churches and religious organizations) and have at least four employees for part of a day or more each week for 20 weeks, or
• Elect to become a subject employer, or
• Have Texas employees and are subject to the Federal Unemployment Tax Act (FUTA), or
• Are a state political subdivision or instrumentality, or
• Pay $1,000 or more wages one calendar quarter for domestic service, or
• Employs three (3) employees for 20 weeks in a calendar year or pays $6,250.00 in cash wages in a calendar quarter, or
• Employ a seasonal worker on a truck farm, orchard or vineyard, or
• Employ a migrant or a seasonal worker(s) who works for a farmer, ranch operator, or labor agent who employs migrant worker(s).

In June, 2011, I wrote a blog post about a minister who claimed two residences with his parsonage allowance – a primary residence and a lake house. The IRS wanted to deny the exclusion for two residences, even though both residences met the criteria. The Tax Court had cross-referenced the Dictionary Act, arguing that the definition of a ‘home’ could also mean ‘homes’ if the condition for residence is met. The Tax Court supported the minister’s exclusions and so the ruling stood that both residences qualified for excluding the allowance from income.

On February 8, 2012, the Court of Appeals for the Eleventh Circuit reversed the Tax Court decision, siding with the IRS. The Eleventh Circuit Panel cited that cross-references to the Dictionary Act are made for convenience and do not constitute law. They also stated that the legislative history of the Internal Revenue Code referring to the housing allowance at the applicable time period (Code Sec. 107 applying to 1996-1999) repeatedly referred to a dwelling as a singular entity.

Obviously, these challenges can continue for years before resolution since it appears that the minister will appeal the Panel’s ruling.  Obviously, the more conservative approach is to claim only one home in the housing allowance calculation.

For more detail about housing allowances, refer to a complete description in two blog posts – part 1 and part 2.

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.

Read the rest of this entry »

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.

Misclassification of employees is a widespread issue, especially among small businesses. Studies in the Obama administration estimate that improper classification may occur in as many as 10-30% of all companies.  However, there’s good news from the IRS. A new initiative, the Voluntary Worker Classification Settlement Program, is in place for a limited time to correct classification without interest or penalties. The only fee will be about 1% of wages paid in the past year to cover payroll taxes. Qualifications for companies to participate in the program are:

-         Treating workers as nonemployees

-         Having filed Form 1099 on the workers for the past 3 years

-         Be free of an ongoing audit regarding worker classification

After the current ‘amnesty’ program, the IRS will be more attentive to the issue of misclassification and there will be penalties and interest to pay. To participate, employers must file Form 8652 at least 60 days prior to treating workers as employees. So, check your payroll and make sure that you are compliant. Because the distinction between the categories can be vague, call your tax advisor if there are any questions.

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.