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.

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.

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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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 high school English teacher would frown on my choice of word order… and I don’t want any of you to think I’m talking about raffling off a church.)

Seriously, many churches have various fundraisers – typically called “special events.”  These special
events can take different forms, including a dinner, a golf tournament, an auction and a raffle – to name a few.  Let’s talk about a raffle for a moment, particularly the required reporting by the church for its contributors/supporters/donors.

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