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.

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.

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.

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.

My colleague, Lisa Potter, wrote part 2 of 2 for in-kind donations for her blog, www.990taxhelp.com. Many of the issues she discusses for nonprofit organizations also apply to churches and ministries.

Read In-kind donations, part 2 of 2.

It’s not uncommon for churches to let other, outside groups use the church’s facilities for meetings, banquets, sporting events, etc. In fact, most churches encourage such usage as a way to further their reach into the community. However, there are certain federal tax issues of which to be aware when allowing someone to use your facilities. Read the rest of this entry »