Transcription
Hi, my name is Andy Way with AG Financial Solutions. With me today is Dr. Richard Hammer, legal counsel for the Assemblies of God, CPA, Harvard Law Grad, Dal Mechanic, and I believe a fifth grade Sunday school teacher, right? Good.
Well, we wanted to talk today because I know Rich, you get a lot of calls; we get a lot of phone calls at AG Financial from ministers related to tax. And so, I think there's an opportunity to talk about some of the most common questions and things that I know that you feel ministers need to know related to tax. So, thanks for taking the time with us to do this today.
And uh, so, just to really even start it out related to tax law, how do you define a minister?
Well, that's a good question. The term minister is used many times in the 88,000-page tax code. And so it has to be defined, and the way the IRS and the courts have defined that term for tax purposes is that to be a minister, you must be ordained, commissioned, or licensed. That's number one. Uh, number two, you must uh be compensated for performing religious worship or sacred functions. You must be considered a spiritual leader by your church in the sense that you can vote at church meetings and things like that. And finally, you must be engaged in the conduct, control, or maintenance of your church. That's a technical term, but basically it means management-level responsibility.
So let me give you a common example. Many churches have volunteer youth pastors. They're not on staff. Maybe they become staff members and are compensated. Can a church treat a youth pastor as a minister prior to that person being ordained, commissioned, or licensed? They're performing the functions of a pastor. Isn't that enough? And the answer is no. At a minimum, you must be ordained, commissioned, or licensed. So the definition is very important.
Okay, that's good. What about the self-employment tax? What is that? A lot of confusion on that. Uh, social security is funded by two tax systems. FICA, or the federal insurance contributions act, is a tax imposed on employers and employees. Then there's a self-employment tax, or SEA, the self-employment contributions act, which is a tax assessed against self-employed people that don't have an employer to pay part of that tax liability. Ministers, by definition, according to the tax code, are treated as self-employed for social security. So you have this this situation where the vast majority of ministers would be treated as employees for income tax purposes, but they're self-employed for social security. That has caused untold confusion on the part of church treasurers around the country. How can you treat somebody as self-employed for social security that we treat as an employee for income taxes? But that's the way it is.
Well, so while we're on that subject, what are what would you say are the major differences between self-employed and being an employee? And are there benefits of either?
Well, it's illusory the benefits because the vast majority of ministers would be deemed employees by the IRS under all the prevailing tests. Now, if a person if you could find a minister that in fact was self-employed for income tax purposes, uh, yes, I think that the one benefit of that status is you can deduct your business expenses on Schedule C whether you can itemize expenses or not. But that benefit is eliminated if a church simply has a mechanical reimbursement arrangement where they reimburse substantiated business expenses.
Okay, another question. Are ministers' wages exempt from tax withholding?
Well, they are. Uh, wages they receive for performing ministerial functions. Uh, many people get excited and think that means ministers' wages are exempt from tax. That's not the That's not the point. They're exempt from income tax withholding. And so ministers have to use the quarterly tax estimated tax procedure that's that's explained on IRS 1040-ES. Yes. Where you have to make your estimate by April 15th of what your tax liability will be for the whole year and pay a quarter of it on April 15th, June 15th, September 15th, and the following January 15th. And by the way, many ministers just lump it all together on that final April 15th payment for the previous year. And you're going to run into payment penalties if you do it that way. So it's best to do it on a quarterly basis.
Okay. And then what about exemption for self-employment tax?
Yes. Uh, ministers are given an opportunity to opt out of the self-employment tax if they meet various conditions. One of which is you must file the exemption application, which is IRS Form 4361, on a timely basis. Generally, that's within two years of the time you are first credentialed as a minister in the assembly of God; beyond that would be when you're certified. So you can't wait 10 years and apply; the the clock has run out. So that's one one example of a requirement. Another one is you must be opposed on the basis of your religious principles to receiving public insurance benefits, including social security, and you know, so the person that qualifies for the exemption is someone that can say, I'm not opposed to paying the tax, self-employment tax. But when I receive that first retirement check in the mail when I retire, my religious convictions well up with me, and I I can't bring myself to cash that check. That's an extraordinary uh requirement that very few people It was designed for the Amish who can make that statement. A third of all ministers have opted out of a self-employment tax, and the vast majority didn't qualify.
Interesting. Another question that I know that you get that we get a lot uh is in related or it's in relation to the tax deduction, tax exemptions, credits. There's a lot of confusion. Uh, what what would you define how would you define those and what are the differences?
That is a very good question. Uh, an exclusion is simply income that's not taxable. Uh, an example is the housing allowance. The housing allowance is not taxable. So if you get a $15,000 housing allowance from your church to start your compensation, that's just not taxable income. Whereas a deduction is is an amount that reduces taxable income, and a credit reduces taxes dollar for dollar. So, for example, if you have a $1,000 credit, that reduces your tax liability dollar for dollar by $1,000. That's the best thing you you can have of what you've mentioned. Uh, whereas a deduction reduces taxable income. So if you're in the 22% tax bracket, it reduces tax by $220, the $1,000 deduction. So a credit is the most valuable.
Sure. You had touched on housing allowance, and I know a lot of the ministers watching right now would love to hear an update. Is there an update on the housing lottery?
There's not an update other than to say this; it's under attack, and now it's going to be it's been heard by a federal district court in Wisconsin for the second time around and deemed to be an unconstitutional benefit for for pastors. That's an appeal to a federal appeals court in Chicago. And sometime this year in 2018, that court will render a ruling on whether the housing allowance is an unconstitutional benefit for ministers. And if they whatever they say, that case is going to be appealed to the US Supreme Court, and the problem is the Supreme Court took 60 out of 10,000 appeals two years ago. That's so they take very few; nobody can assume we're going to the Supreme Court. Whether they would pick up this case or not, it's anybody's guess. So ministers need to realize that this is a benefit that may be lost. And so what does that mean? You need to be prepared to adjust your 1040-ES quarterly estimated tax payments because it's going to be affected. And churches out there need to be thinking about increasing compensation perhaps by some amount to offset this development. You know, many have purchased housing in reliance on the housing allowance, and all of a sudden you jerk it out from under them. It's going to be very difficult for thousands of ministers in this country, and many churches are going to want to step up and and help ease that transition.
Sure. It's a big deal, and I know you'll keep us in the loop and up to date with all the information throughout the year. So let's talk about love gifts, and I've heard a lot of ministers, pastors receiving gifts from the church. Um, it could just be out of a desire to give appreciation to a pastor. So when a pastor or minister receives a love gift, is that taxable?
Yes, it is. Almost always it's taxable. People think by calling it a love gift, it's not taxable. But the fact is that love gift is made in the context of compensation for services. What are you doing? You're trying to you're trying to compensate that pastor more fully for service rendered. It's tied to services. And so as far as the tax court and the IRS are concerned, that is taxable income.
So what if it's not income? Are there any exceptions? So, for instance, if a pastor receives a love gift that is non-cash, maybe they want to send the pastor and their spouse somewhere. So they give them airfare, accommodations overseas, whatever. Is that taxable?
Yes, it is. That's a taxable fringe benefit. In-kind transfers, which include the value of trips, the property, cars, etc., even though they're not cash, they're still a taxable transaction.
Okay, that's that's a big deal to know. Okay. Uh, you know, similar to that, don't blame me.
Right. Right. Similar to that is when a minister speaks at another church, maybe they visit um, you know, whatever at another church and speaks there, and the church similarly wants to bless them and show appreciation. So, they give them an honorarium. Are honorariums taxable?
Yes, absolutely. Because again, it's payment for service, and that is compensation.
Okay. And taxable. You're the messenger. I understand. Um, are designated contributions tax-deductible?
Uh, generally, yes. Uh, if they are for a project or a pre-approved project of the church, for example, a building uh plan; we're going to we're going to build a new church, and we have a building fund we've established. Yes, $5,000 to that. Even though it's designated, that's taxable. The problem is designated contributions that designate a person, like, here's a thousand dollars I'll give to my church for the Jones family that just had their house burned down uh or is unemployed, is facing catastrophic medical expenses. All of those are not actually deductible that that are given by the church or by the individual to the church for that specified need. That's a designated contribution because you're depriving the church of control over that contribution. And that's the that's the quintessence of a charitable contribution. It's got to be too subject to the control of the church. And if you deprive the church of that control, it's not tax-deductible. So it's no different. The IRS would say they're making $10,000 to give directly to the Jones family that had their house burn down. Why don't you just give it directly to them? That's what that's what's happening.
That makes sense. Lastly, when it comes to charitable contributions, what kind of requirements are in place for those?
Well, uh, I mean every year it's it is uh disheartening for me to read many many cases by the tax court in which they deny a charitable contribution deduction to a donor that's made in many cases substantial contributions to a church or other charity. I've seen cases of millions of dollars uh contribution to the church that have been denied as a contribution deduction because the church failed and the donor failed to comply with the substantiation requirements that apply to charitable contributions. I just mentioned two of them. One of them is any gift, cash or property, of $250 or more. There are there are strict substantiation rules that apply. And, for example, the contribution receipt issued by the church in writing must be contemporaneous; you must provide that receipt to the donor uh by the later of the earlier of the date the contribution is made or the due date of that that return. So it's got to be fairly quick; you can't wait years and when the person's audited and issue a receipt at that point. Um, the the contribution receipt from the church must state whether goods or services were provided by the church in exchange for this contribution and if so a a rough estimate of the value. And so what I recommend is that the receipt say, if this is true, no goods or services were provided in exchange for your contribution other than intangible religious services. The IRS says you can add that language. So if you don't have that statement, and by the way, those of you many of you have software programs where receipts for contributions are just kicked out automatically, that language should be on every receipt you issue. You don't have to so you have to worry about it in case is this one; do we need for this donation or this, and it has to be done on an individual basis. Uh, although you can you can combine, for example, if you have a quarterly or semi-annual receipt that you give to donors, you can put that statement there that applies to everything. But in determining the $250 requirement, you don't add individual. So if somebody makes a $10 contribution every week, you say, well, after 25 weeks I get $250. It doesn't work that way. It only applies to individual contributions of $250 or more. So you need to make that magic state. Many of these cases where huge deductions were denied by the IRS and the courts were because of the failure by the church to put that language on this receipt. No goods or services were provided in exchange for your contribution other than religious benefits. It's just stunning to me how many times I see this and and the interesting thing is the tax court acknowledges as the IRS does. We agree that the contribution is made. No question about that. But you don't get a deduction because you can put that language on the receipt. That's yeah. And then the second thing is this. Donors that give property valued at more than $5,000 need to get an appraisal and fill out an appraisal summary on IRS Form 8283 in order to substantiate that contribution, with a few exceptions. So churches need to be aware when people are giving land, uh, you know, any gift of property, a house that exceeds $5,000 in value claimed by the donor as a donation. There are very significant uh substantiation requirements of life. So I recommend the churches download a copy of IRS Form 8283 with the instructions. There are two different documents on the IRS website, IRS.gov, and provide those documents to anybody that's contemplating the gift of property to the church.
That's great because I know that happens a lot. A lot of churches will do capital campaigns, other initiatives like that. And a lot of people come to the table with non-cash gifts. So that's great to know and very important for all of you watching to make sure that the receipts that you give for those donations that they do contain the legal language that Richard mentioned.
Thank you once again. I appreciate your time, and you have done a great job. Every year you update the tax guide, the annual tax guide, and it's a huge benefit to our ministers. You can get that tax guide for free at AG Financial's website by going to agfinancial.com/taxguide. We hope you enjoy that resource and, of course, as always, thank you very much.
It's a pleasure.