The IRS scrutinizes churches and ministries, so it’s imperative that you run a ‘tight ship’ in the finance department. Over time, ships get leaky if you don’t maintain them, so here are indicators that your ship may be ‘leaky’ and need fixing:

1. Not reporting all taxable income for church staff. Examples include love offerings, gifts of property, expense allowances (such as for a car or entertainment), reimbursements for self-employment social security for pastors, and paid benefits (such as life insurance). All of the examples must be treated as regular taxable income. 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.
2. Unsubstantiated expenses. Expenses reimbursed on an expense report must include the place, time, amount, business purpose and business relationship of all present. If expenses are reimbursed but unsubstantiated, then the amount needs to be reported as taxable income to the person who received the reimbursement.
3. Not accounting correctly for special events. If the church awards prizes for raffle drawings, a Form 1099 or W-2G is needed if the amount of the prize exceeds $600 and is at least 300x the wager. You need to get a payment from the winner that’s treated as withholding and deposited with the IRS if the prize amount is greater than $5,000. (These are general rules; please talk with us or refer to the IRS for specifics.) If the church issues a receipt for a dinner fundraiser, a distinction is needed regarding the hard cost of the dinner in relation to the entire ticket cost.
4. Not having detailed records for housing allowances for ministers. It’s important to keep updated records regarding fair market rental values and agreed upon housing allowance amounts. The church is responsible for record keeping with regard to the designation, but the minister is ultimately responsible for record keeping of the actual expenses and the non-taxable portion.

Compliance is an ongoing task. Be sure to stay on top of your recordkeeping and talk with your CPA whenever you have questions.

Many churches offer the option of electronic giving. Just like cash and checks, you need a procedure in place to keep integrity with electronic contributions.

Here’s an example:

Jane Smith indicates on her pledge card that she wants an automatic charge to her credit card on the 15^th of each month for $200. Your church business manager inputs the credit card information into the credit card processor that you use. On the 15^th of the month, the credit card processor charges the credit card account $200 and deposits the contribution to the designated church bank account.

James Nash, a senior auditor with our firm, suggests the following solution for internal controls with electronic contributions:

Access to inputting or changing information into the credit card processor should be segregated from the access to donor records and reconciliation of amounts charged.

The church needs to establish a procedure to regularly review electronic contributions. The Church should reconcile the batch report from the credit card processor to the bank deposit.  A process to ensure that the donors receive contribution credit on their giving statements should also be implemented.

All changes (new automatic authorization requests and termination of giving) should be kept separate and reviewed to ensure that the request was properly completed.

More importantly, the Church should review various credit card processors and review the Service Organization Controls Report (SOC 1, formerly SAS 70).  This report will give the Church or ministry the comfort that the processor has the proper controls in place to safeguard the information of their donors.

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).

Churches are often relaxed about a very important fraud-prevention duty – opening mail and copying checks. To help eliminate temptation and any opportunity for misappropriation, procedures must be in place for handling checks and mail that contains checks. It is best to have one person, such as an administrative assistant or receptionist, open all the mail,  copy the checks received, and restrictively endorse those checks.  They can also prepare the deposit slip and ultimately make the deposit, if that helps. That person would have no further duties regarding checks received via mail. Specifically, the following duties must be kept separate:

-         Maintaining the cash receipts journal

-         Posting journal entries to the general ledger

-         Reconciling the bank account

-         Investigating discrepancies related to cash

Another duty of the administrative assistant or receptionist is receiving cash donations from mid-week walk-ins. For receipt of such donations, we recommend putting the money in an envelope and putting the envelope in a drop safe. The person receiving the cash should note the date, amount and his or her name on a log sheet.   If cash/currency (not checks) is received, a receipt book should be maintained with a copy to the donor being required. Cash must be protected at all times.

An alternative to completely separate duties is to have two people present for the opening of mail and copying of checks. However, these two people should rotate duties so that collusion is not a likely possibility.

Additionally, the person who investigates discrepancies related to cash should be someone not connected to the day-to-day cash/check receipt and bank account responsibility.

Internal controls can make or break a church. One of the most important internal controls is proper segregation of duties. We’ve seen many churches miss the fact that money is going out the door instead of into the bank account due to a lack of standard procedures. To protect your church’s Sunday collection cash and donations, follow these guidelines:

Segregate the duties between individuals who collect, count, prepare the deposit slip, take the deposit to the bank and post entries to the contribution module and general ledger.

1. Ask ushers to place the collected cash and checks in a sealed envelope. Two ushers should sign the envelope and not the service date and time. Put the envelope in a locked safe.
2. Place a log sheet on the safe for individuals to sign their name and purpose each time money is placed or removed from the safe. (Use a drop safe for higher security, to prevent many people from having the combination or key.)
3. Rotate counters (minimum of two) each week. Counters take the cash and checks to the business manager’s office and double-count the cash, recording the amounts on a count sheet. Make a copy of each check and retain with the counting tape. Counters sign the count sheet and prepare a deposit slip.
4. Place cash, checks and deposit slip in a pre-numbered bank bag. A copy of the deposit slip is kept with the check copies.
5. Designate who will take the deposit to the bank.
6. Ask the Treasurer to review and confirm a rotation of counters to deter collusion.
7. Provide a copy of the deposit slip to the business manager, who will reconcile the amount with the count sheet and note reconciliation. This can be done by adding a line to the count sheet to sign once the funds have proof of deposit.

Paying attention to a high level of detail, combined with redundant accountability, prevents fraud and the resulting trauma to your church body.

Ministers are able to claim many housing expenses as exclusions for income tax purposes. If you’re gathering information for your tax return or to provide to a tax preparer, here are 11 exclusions you can take:

• Mortgage payments (interest and principal)

• Real estate taxes

• Property insurance

• Utilities (gas, water, electricity, sewer, garbage pickup, local telephone service)

• Appliances and furniture (purchase, rent and repairs)

• HOA dues

• Pest control

• Yard maintenance and improvements

• Maintenance items (household cleaners, light bulbs, etc.)

• Down-payment on a home

• Remodeling expenses

There are also some housing expenses that are denied. Avoid claiming these five:

• Cleaning service

• Food

• Domestic help

• Expenses on a second home or vacation home

• Home equity loan payments (unless used to pay for housing expenses such as remodeling)

Please remember your claimed housing allowance is the lesser of these actual expenses or the church-approved amount. Therefore, our recommendation is to estimate a little high for the amount you submit to, and what’s ultimately approved by, the church.

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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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.