On May 17, 2010, the IRS began revoking the tax-exempt statuses of nonprofits that failed to file three consecutive annual returns (Form 990-N, 990-EZ, or 990-PF).  As a result, as many as 300,000 nonprofits may lose their tax-exempt status, effectively shrinking the nonprofit sector by 25%.

On July 26, 2010, the IRS released a guidance on filing relief for Form 990-N and 990-EZ filers in danger of losing their tax exemptions.  However, this one-time relief is ONLY available to small organizations whose filing deadlines fall on or after May 17, 2010, and before October 15, 2010.  (All returns filed under this program are due no later than October 15, 2010.) 

These events beg the question:  Why is it important to preserve an organization’s tax-exempt status? 

A nonprofit organization has numerous benefits that will help it to survive economically.  There are also benefits to the contributors, which make a donation to the organization more attractive.  Some of the benefits of being a nonprofit organization include:

• Exemption from paying federal income tax.
• May receive tax-deductible gifts.
• May receive tax-deductible contributions.
• Eligibility to receive grants from foundations.
• Contributions to a nonprofit are tax deductible for donors to the organization.

Protecting the organization’s tax-exempt status is vitally important to a nonprofit organization.  But, what happens to a nonprofit that loses its exemption?  What happens if a donor gives to a charity that has lost its exemption?

Contact the Church Law Group at 972-444-8777 to find out the answers to these questions and more!

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THE QUESTION: WHAT HAPPENS WHEN A PASTOR . . .

• Determines his compensation at his own direction with no input from the Board of Directors or approval from the congregation?

• Tries to prevent the finance committee from issuing him a Form 1099?

• Instructs the church finance committee not to include “love offerings” in his compensation?

• Receives such high levels of compensation that the church is forced to deplete its building fund to make payroll?

• Instructs the church finance committee to “doctor” the financial report given to the congregation so that it appears that the church is in the “black” when the church is really in the “red?”

• Uses one of the church’s credit cards to make personal expenditures and for which no receipts of other accounting was provided?

• Has unrestricted use of gas credit cards in the name of the church and cell phones paid for by the church without any requirement to account for personal use of the cards and phones;

• Receives payments from the church to fund a retirement plan?

• Has a travel allowance of almost $25,000.00 in one year and also submits requests for reimbursements for travel expenses?

• Receives payments for his child’s school tuition of more than $30,000.00?

• Has unlimited use of a Mercedes-Benz leased by the church with a value of nearly $83,000.00?

• Fails to report more than $2.3 million in taxable income to the IRS?

THE ANSWER:  A WHOLE LOT OF TROUBLE

Bishop Anthony Jinwright, Pastor at Greater Salem City of God, a church in Charlotte, North Carolina, was recently convicted on federal tax evasion and mail fraud charges.  Both Bishop Jinwright and his wife were convicted of tax evasion and can anticipate spending many years in prison.  The Jinwrights are scheduled for sentencing later this year.

The conviction of Bishop Jinwright provides a picture perfect example of how your church or ministry should not handle compensation issues.

At first glance, you may think that there is no reason why you should be concerned about these issues as they relate to compensation—your salary is set by the church’s board of directors and there is no way you would even consider using the church’s credit card without accounting for it.  However, you need to consider these issues for the simple reason that the Internal Revenue Service is considering whether your compensation is reasonable or whether it is excessive.

In recent years, the IRS has expressed concern with the level of compensation that nonprofit organizations provide to their employees, and it has enacted penalties against organizations that “overly compensate” their employees.  The following two concerns have been specifically identified by the IRS with respect to compensation issues:

(1) Excessive Compensation: For purposes of computing compensation, the IRS considers every benefit an individual receives from the organization as part of that individual’s total compensation.  Therefore, salary is only one component that the IRS will consider when determining if compensation is excessive.  The IRS is clearly concerned about the payment of excessive compensation by exempt organizations.  Tax-exempt organizations must be aware that payments of any kind and for any reason that direct the resources of the organization toward an individual are also considered in the calculation of an individual’s compensation.

(2) Fringe benefits: The IRS has expressed concern over the failure by many exempt organizations to recognize that some fringe benefits constitute taxable income to their employees.  Fringe benefits include enrichments such as the private use of a vehicle that is owned or leased by the organization, payment of an individual’s automobile insurance premiums, payment of a child’s school tuition, and an organization’s payment of an employee’s personal expenses, including some household expenses, country club dues, maid services, and vacations.

For example, the pastor in the above real-life example allegedly received a compensation package that approximately included all of the following benefits:

• $300,000.00 annual salary  +

• $160,000.00 housing allowance +

• $45,000.00 vehicle allowance +

• $52,000.00 annual bonuses +

• $44,000.00 for vacations +

• $130,000.00 in federal income tax liability and social security payments +

• $30,000.00 tuition payments for his daughter +

• And a variety of other “fringe benefits.”

What are the Penalties?

When a pastor receives excessive compensation, as determined by the IRS, he will also face “intermediate sanctions.”  Federal law imposes a series of intermediate sanctions on individuals who are involved in any transaction that results in any disqualified person receiving an excess benefit from a nonprofit organization.  A disqualified person receives an excess benefit if that person directly or indirectly receives an economic benefit from a tax-exempt organization that exceeds the value of the consideration received by the organization.  A “disqualified person” is any person in a position to exercise substantial influence over the affairs of the organization at any time.

For example, if the IRS were to determine that the salary of the pastor in our real-life scenario should only be $100,000.00, then our pastor has received an “excess benefit” of approximately $661,000.00.  Under existing law, the pastor must repay the $661,000.00 excess benefit to his church.  In addition, he must pay an excise tax to the IRS equal to 25% of the excess benefit.  If the pastor does not or cannot repay the excess benefit to his church within the same tax period (defined as the date of the transaction to the date of the assessment or notice of deficiency), then a 200% excise tax on the excess benefit is further imposed on the pastor by the IRS.

It is important to note that in addition to the penalties that will be levied against the pastor who receives the excess compensation, the nonprofit organization’s managers (i.e. the Board of Directors) who were aware of and participated in the excess benefit transaction will also be personally liable for paying an excise tax equal to 10% of the excess benefit, up to a maximum of $10,000.00, to the IRS for each excess benefit transaction that took place.

What should a Church do?

To avoid encountering problems with executive compensation, a nonprofit organization must establish good compensation practices.  Such practices include:

• Having your Board of Directors appoint an independent compensation committee to conduct a compensation study;

• Setting compensation in advance using appropriate comparability data;

• Making sure the Board of Directors has appropriate oversight of compensation; and

• Documenting all decisions on compensation;

If you have specific questions regarding the topic of compensation issues, contact The Church Law Group for more extensive legal advice.

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The IRS wants to know if your organization is practicing “good governance,” so it recently released its new Governance Check Sheet that its agents will use to gather information about the governance practices of nonprofit organizations, including churches and ministries.   The release of the Governance Check Sheet is helpful to public charities because it gives nonprofit organizations a better idea of what the IRS is thinking and what the IRS considers “good governance.”  This, in turn, will help your organization make important governance decisions and implement important policies and procedures.  Specifically, in the Governance Check Sheet the IRS examines the following issues:

1)  Governing Body and Management: 

• Does the organization have a written mission statement that articulates its exempt purpose?
• Do the bylaws of the organization include information about who has the right to vote, qualifications, etc?

2)  Compensation:

• Does an authorized independent body establish compensation procedures, in advance, for all high level employees?
• Is comparability data used to determine compensation?

3)  Organizational Control:

• Are related family members serving on the Board of Directors?
• Do any directors have business relationships with other directors, officers, or key employees?

4)  Conflicts of Interest:

• Does the organization have a written conflict-of-interest policy?
• Is the policy followed?

5)  Financial Oversight:

• What type of policies and procedures are in place to ensure assets are properly used for exempt purposes?
• How often are financial reports provided to the organization’s Board of Directors?
• Is the Form 990 (if applicable) reviewed by the entire Board of Directors prior to submission?

6)  Document Retention:

• Does the organization have (and follow) a policy for document retention and destruction?
• Does the Board of Directors contemporaneously document its meetings (i.e. minutes) and retain such documentation?

Some have wondered why the IRS is becoming involved in corporate governance issues when its role is really to ensure tax compliance.  However, it appears as though the IRS is reviewing the governance practices of charities to determine the connection between a charity’s tax compliance and corporate governance practices.  The thought is that the better governance procedures that an organization has in place, the more likely that the organization is also going to comply with all applicable tax rules and standards for exempt organizations.

Here at the Church Law Group, we strongly recommend making sure that your organization’s governance documents–including articles of incorporation, bylaws, and other basic policies and procedures–are compliant with state and federal laws, as well as with the current standards for tax-exempt organizations.  Determining the effectiveness of your organization’s governance practices will help ensure the long term success and viability of your organization.  Remember, as Benjamin Franklin stated so long ago, “an ounce of prevention is worth a pound of cure.”  Contact us today at 972-444-8777 to learn more about how the Church Law Group can help you evaluate the effectiveness of your organization’s governance procedures.

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Entitlement to a clergy housing allowance is not as straightforward as is often imagined.  Right now, religious nonprofit organizations are under heavy assault by the IRS, so a conservative approach is warranted.

The Internal Revenue Code allows a tax-free housing benefit for a “minister of the gospel” in two situations.  First, the employer can allow the minister to live rent-free in a home (parsonage) owned by the church.  The minister can exclude this benefit from gross income up to the home’s fair rental value.  The value of the parsonage must be clearly distinguished from other compensation, and includes items such as furniture, insurance, utilities, and taxes.  Second, if a parsonage is not provided to the minister, a nontaxable housing allowance can be provided so that the minister can rent or buy a home.  This is the option used most frequently.  It provides ministers with the freedom to choose their preferred type of housing.  The allowance covers items such as mortgage payments (principal and interest), insurance, repairs, utilities, and other expenses to keep the home in working order.

Although the term “minister” is not defined in the Internal Revenue Code, the IRS and courts have specified five factors that should be used to identify a minister.  The factors include:

• Performing sacerdotal functions (i.e. weddings and funerals, etc.);
• Conducting worship services;
• Controlling or maintaining the organization;
• Considered a spirtual leader; and
• Ordained, licensed, or commissioned.

Only the last factor is required in all cases: the individual must be ordained, licensed, or commissioned.  Although it is clear from existing caselaw that the remaining four factors need not all be present for a person to be considered a minister for tax reporting, it is unclear how many of the remaining four factors must be met.

It is not uncommon for an employee’s job duties to include both ministerial and nonministerial functions.  However, if more than 50% of an employee’s time is devoted to nonministry (i.e. secular) duties, the church will be put in a tenuous position if it grants a housing allowance to the employee.  Many churches think it seems unfair to exclude employees from the benefits of a housing allowance if part of their job involves performing the typical duties of a minister.  However, the church cannot ignore the fact that if most of the employee’s duties are secular, in the eyes of a court they will fail to meet the definition of a minister. 

The Church Law Group has released a Guide to Executive Compensation (with forms) that is now available for purchase. Email churchlawgroup@amlawteam.com or call 972-444-8777 if you have any questions about clergy housing allowances or are interested in the Church Law Group Guide to Executive Compensation.

You can also visit us on You Tube to hear David Middlebrook speak about some important  information on housing allowances!!!

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Churches that meet the requirements of the Internal Revenue Code section 501(c)(3) are automatically considered tax exempt.  This means that churches are not required to apply for and obtain recognition of tax-exempt status from the IRS.

Even so, many churches seek tax-exempt recognition from the IRS simply because it provides assurance that financial contributions to the church would generally be tax-deductible.

The term church is found, but not specifically defined, in the Internal Revenue Code.  The IRS has compiled a list of certain characteristics that are generally attributed to churches.  They include:

• Distinct legal existence
• Recognized creed and form of worship
• Definite and distinct ecclesiastical government
• Formal code of doctrine and discipline
• Distinct religious history
• Membership not associated with any other church or denomination    Organization of ordained ministers
• Ordained ministers selected after completing prescribed courses of study Literature of its own
• Established places of workshop
• Regular congregations
• Regular religious services
• Sunday schools for the religious instruction of the young
• Schools for the preparation of its members

Recently, the IRS denied several organizations church status when the organizations applied for tax-exempt recognition as a church.  The IRS concluded that the organizations failed to meet the legal definition of “church.”

One of the organizations that applied for recognition as a “church” was denied because its worship services were conducted solely by teleconference.  The IRS concluded that worship by teleconference does not bring people together for worship, and that “sitting at home holding a ‘service’ over the telephone does not meet the more restrictive definition of a ‘church.’”

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