TAX CHANGES OF INTEREST TO MINISTERS IN 1999

By Richard R. Hammar, J.D., LL.M., CPA

© Copyright 2000 by Church Law & Tax Report.  All rights reserved.  This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service.  If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m27 c0100

TAX CHANGES OF INTEREST TO MINISTERS IN 1999

1. Tax rate adjustments. For 1999, the income tax rates for married couples filing jointly are 15% for the first $43,050 of taxable income, 28% for taxable income from $43,050 to $104,050, 31% for taxable income from $104,050 to $158,550, 36% on taxable income from $158,550 to $283,150, and 39.6% on taxable income in excess of $283,150. For 1999, the income tax rates for single individuals are 15% for the first $25,750 of taxable income, 28% for taxable income from $25,750 to $62,450, 31% for taxable income from $62,450 to $130,250, 36% on taxable income between $130,250 and $283,150, and 39.6% on taxable income in excess of $283,150. The new income tax rate structure is summarized in the two tables on the following page.

Example. Rev. B is married and for 1999 he and his wife report gross income of $50,000 on their income tax return. Their taxable income, after deducting itemized deductions, personal exemptions, and a housing allowance, is $35,000. According to Table 1, they will pay an income tax rate of 15% on their entire taxable income, since it is below $43,050.

Example. Same facts as the previous example, except that Rev. B and his wife report gross income of $75,000, and taxable income of $50,000. According to Table 1, some of this taxable income will be subject to the higher 28% tax rate. The couple computes their income taxes as follows: (1) $6,457 in taxes on the first $43,050 of taxable income (taxed at 15%); and (2) a 28% tax on taxable income above $43,050 (and below $104,050), or $1,946 ($50,000 - $43,050 x 28%). The combination of these amounts is $8,403. This is in addition to Rev. B's self-employment tax, which is an additional 15.3% multiplied times his net earnings from self employment (note that this amount will include his housing allowance).

TABLE 1 - 1999 INCOME TAX RATES
MARRIED PERSONS FILING JOINTLY

TABLE 2 - 1999 INCOME TAX RATES
SINGE PERSONS

2. Increase in earnings subject to the self-employment tax. The self-employment tax rate (15.3%) did not change in 1999. However, the amount of earnings subject to tax increased. The 15.3% tax rate consists of two components: (1) a Medicare hospital insurance (HI) tax of 2.9%, and (2) an "old-age, survivor and disability" (OASDI) tax of 12.4%. There is no maximum amount of self-employment earnings subject to the Medicare hospital insurance (the 2.9% "HI" tax rate). The tax is imposed on all net earnings regardless of amount. For 1999, the maximum earnings subject to the "old-age, survivor and disability" (OASDI) portion of self-employment taxes (the 12.4% amount) increases to $72,600-up from $68,400 in 1998. Stated differently, persons who receive compensation in excess of $72,600 in 1999 will pay the 15.3% tax rate for net self-employment earnings up to $72,600, and the "HI" tax rate of 2.9% on all earnings above $72,600. These rules directly impact ministers, who always are considered self-employed for social security purposes with respect to their ministerial services. Ministers should take these rules into account in computing their quarterly estimated tax payments.

Example. Rev. L has net earnings from self-employment for 1999 of $72,600 (the maximum amount subject to the self-employment tax). His self-employment tax will be $11,108. Note that the housing allowance is not excluded when computing this tax. If Rev. L earned $70,000, he would pay the 12.4% "old-age, survivor and disability" (OASDI) tax up to the limit of $72,600, and the 2.9% Medicare tax on his entire taxable earnings.

3. The standard mileage rate for business miles was 32.5 cents per mile from January 1 to March 31, 1999. It decreased to 31 cents per mile from April 1 to December 31, 1999. The standard mileage rate can be used to compute the cost associated with the business use of a car, provided that it is used in the first year the car is used for business purposes. In addition, employers can use the standard mileage rate to reimburse clergy and church workers for their business use of a car. Of course, clergy are free to deduct the actual costs associated with the business use of a car. Most do not use the "actual cost method, since it is much more time-consuming and inconvenient. The new standard mileage rate applies to all business miles driven in 1999.

IRS Approved Standard Mileage Rates for 1999

4. Inflation adjustments. For 1999, the following three "inflation adjustments" took effect:

Tax rates. The amounts of income you need to earn to boost you to a higher tax rate were adjusted for inflation. This means that additional income you earn due to inflation will not automatically put you in a higher tax rate bracket. To illustrate, married persons filing jointly do not move from the 15% to the 28% tax rate in computing their 1999 taxes until they have at least $43,050 of taxable income (up from $42,350 in 1998). Single persons do not move from the 15% to the 28% tax rate until they have $25,750 of taxable income (up from $25,350 in 1998). As noted elsewhere in this summary, additional tax rates apply to higher income taxpayers in 1999.

Personal exemptions. The "personal exemption amount" (the amount you can deduct for yourself, your spouse, and each dependent) was adjusted for inflation. For 1999, the amount increased to $2,750 per person (up from $2,700 in 1998).

Standard deduction. The "standard deduction" (the amount you can deduct if you cannot itemize your deductions) increases to $7,200 for married couples filing jointly-up from $7,100 in 1998. It increases to $4,300 for single taxpayers-up from $4,250 in 1998. Single taxpayers who are 65 years of age or older, or blind, get a $1,050 increase in their standard deduction for 1999. Married taxpayers who are 65 years of age or older, or blind, get an $850 increase in their standard deduction for 1999.

5. Child tax credit. If you have one or more children under 17 years of age (at the end of 1998), and you earn less than a specified amount of income, then you will be able to claim a $500 credit on your 1999 tax return for each child (up from $400 in 1998). To qualify for the credit, you must have a child who (1) is under 17 years of age; (2) is your child, descendent, stepchild, or foster child; and (3) is claimed by you as a dependent on your tax return. The child care credit is reduced by $50 for each $1,000 of adjusted gross income in excess of $110,000 for married couples filing jointly. For single persons, the credit is reduced by $50 for each $1,000 of adjusted gross income in excess of $75,000. These amounts are not adjusted for inflation. The child tax credit is in addition to the personal exemption amount ($2,750 for 1999) that can be claimed for each dependent child. In the case of a taxpayer with three or more qualifying children, if the amount of the allowable child credit exceeds the taxpayer's regular tax liability before the computation, then the excess is a refundable tax credit.

6. Revoking an exemption from Social Security. Ministers are allowed by federal law to exempt themselves from social security (self-employment) taxes by filing a timely exemption application (Form 4361) with the IRS. To qualify for exemption, ministers must meet several requirements, including the filing of a timely application form in which they certify that they are opposed on the basis of religious convictions to the acceptance of public insurance benefits, including social security. The tax code further provides that ministers who exempt themselves from self-employment taxes cannot revoke their exemption. The decision to become exempt from self-employment taxes is "irrevocable." Form 4361 itself warns that "once the application is approved, you cannot revoke it." On two occasions in the past, Congress has enacted special legislation giving ministers a brief "window" of time to revoke an exemption from self-employment taxes. Congress allowed ministers who were exempt as of December 20, 1977, to revoke their exemption by the due date of their federal income tax return for 1977 (April 15, 1978) by filing a Form 4361-A. The Tax Reform Act of 1986 gave exempt ministers another limited opportunity to revoke an exemption from self-employment taxes, by filing a Form 2031 with the IRS by the due date for their federal income tax return for 1987 (April 15, 1988). Congress provided this limited opportunity for ministers to revoke an exemption from self-employment taxes because of a recognition that many of these ministers did not qualify in the first place. Ministers who revoked an exemption by April 15, 1988 did not become liable for self-employment taxes all the way back to the date of their original exemption. Rather, they were required to pay self-employment taxes effective January 1, 1986 or January 1, 1987. This meant, for example, that a minister who revoked an exemption by April 15, 1988 had to pay not only the first quarter's estimated self-employment tax for 1988 by that date, but also (1) the entire social security tax liability for 1986 and 1987, or (2) the entire social security tax liability for 1987. The minister elected on the Form 2031 whether to pay taxes for both 1986 and 1987, or just for 1987. Very few exempt ministers revoked their exemption. The reason is simple. Most ministers who were seriously considering revoking their exemption waited until the deadline, only to discover that pursing the revocation of their exemption would make them liable for at least five quarters of self-employment tax. Even on modest income, this was a crushing liability that few could afford. As a result, very few ministers revoked their exemption.

In 1999, the "Work Incentive Improvement Act of 1999" (S. 331) was introduced in the United States Senate. The bill was designed to assist disabled adults to participate in vocational training and employment programs. The bill also contained the following provision allowing ministers to revoke an exemption from social security:

[A]ny exemption . . . by a duly ordained, commissioned, or licensed minister of a church, a member of a religious order, or a Christian Science practitioner, and which is effective for the taxable year in which this Act is enacted, may be revoked by filing an application therefore . . . if such application is filed no later than the due date of the federal income tax return (including any extension thereof) for the applicant's second taxable year beginning after December 31, 1999. Any such revocation shall be effective . . . as specified in the application, either with respect to the applicant's first taxable year beginning after December 31, 1999, or with respect to the applicant's second taxable year beginning after such date, and for all succeeding taxable years; and the applicant for any such revocation may not thereafter again file application for an exemption . . . . If the application is filed after the due date of the applicant's federal income tax return for a taxable year and is effective with respect to that taxable year, it shall include or be accompanied by payment in full of an amount equal to the total of the taxes that would have been imposed . . . with respect to all of the applicant's income derived in that taxable year which would have constituted net earnings from self-employment . . . . except for the exemption . . . .

The Work Incentive Improvement Act passed the Senate by a vote of 99-0. An almost identical bill passed the House of Representatives by a vote of 410-1. As of the date of publication of this text, the bills had not been reconciled by conference committee or signed into law by the President. However, these actions are formalities that will happen soon. As a result, ministers should be reviewing their options at this time. Here are some questions to ask:

"Am I am exempt from self-employment tax? You are if you filed a timely Form 4361 in triplicate with the IRS, and received back one of the forms marked "approved."

"Was I eligible for exemption at the time I filed Form 4361? When you filed your exemption application, were you opposed on the basis of your religious convictions to the acceptance of social security benefits? This is an extraordinary claim that very few ministers can make.

"Do I want to revoke my exemption? Some ministers will want to revoke an exemption because they now realize that they were not eligible. It is an ethical matter for them. For others, the inducement to revoke an exemption may be to qualify for Medicare coverage and the other benefits of social security.

"If I decide to revoke my exemption, when should I do so? The law states that ministers can begin revoking their exemption from social security as of January 1, 2000, and may do so up to the deadline of April 15, 2002. However, when revoking an exemption, a minister must choose to begin paying self-employment taxes as of January 1, 2000 or January 1, 2001. As a result, ministers who wait until the deadline of April 15, 2002 to revoke their exemption will have to pay "back taxes" from either January 1, 2000 (nine quarters) or January 1, 2001 (5 quarters). Even on modest incomes, either choice can result in a crushing tax liability. If you decide to revoke your exemption, consider doing so as soon as the law allows. This will minimize the financial impact of your decision, and make it more "affordable" by avoiding a large "back taxes" liability.

7. The President again rejects tax relief for parents with children in private elementary and secondary schools. The Parent and Student Savings Account PLUS Bill (HR 2646) would have provided tax relief for parents who send their children to private elementary and secondary schools. President Clinton expressed his unalterable opposition to the concept of school choice, despite being pressed by Republican lawmakers who pointed out that the tax code currently provides tax relief to parents who send their children to private colleges.

8. Social security benefits. The maximum social security benefit for workers retiring at age 65 on January 1, 1999 increases to $1,373 per month ($16,476 per year). The average benefit is $780 per month ($9,360 per year) for all retired workers; $1,310 per month ($15,720 per year) for a retired couple who each receive benefits; $1,554 per month ($18,684 per year) for a widowed mother with two minor children; and $733 per month ($8,796 per year) for a disabled worker.

9. IRS audit statistics. In 1999 the IRS released its "Data Book" for fiscal year 1997 (the most recent version available). The publication contains a number of interesting facts about IRS audits. Here are some of the highlights:

(1) Drop in audit rate. The IRS rate for individual income tax returns dropped from 1.67% in both 1995 and 1996 to 1.28% in 1997.

(2) Geographic areas with highest audit rates. The IRS Western Region had the most audits (296,000) for 1997, followed by the Southeast Region (217,000) and Midstates Region (204,000). The lowest number of audits was in the Northeast Region (193,000).

(3) Tax Court results. What are your chances if you appeal an adverse IRS audit decision to the United States Tax Court? In 1997, cases disputing some $3.5 billion in taxes were resolved by the Tax Court. Of this amount, the Court ruled that $1 billion in taxes were owed.

(4) Tax revenues. Individual income taxes comprised 48% of the $1.6 trillion in taxes collected by the IRS in 1997. The remaining taxes were mostly payroll taxes (35%) and corporate taxes (12%).

(5) Electronic filing. More than 19 million taxpayers filed their income tax returns electronically in 1997 (including 4.6 million TeleFile returns).

(6) IRS telephone support. The IRS received 104 million telephone inquiries in 1997. The IRS estimates that callers received "accurate" responses 96% of the time. The General Accounting Office gives a much lower figure.

10. IRS enforcement actions plummet. IRS-imposed liens, levies, and seizures of taxpayer property have dropped significantly for fiscal year 1999-in response to the hand-slapping the IRS received last year in congressional hearings and in the "IRS Restructuring and Reform Act of 1998." Still, the figures are startling. Half way through fiscal year 1999, IRS seizures of taxpayer property are down a whopping 95 percent. IRS-imposed liens on the property of "noncompliant" taxpayers for the first half of fiscal year 1999 total 98,000-way off the pace of 383,000 liens in fiscal year 1998 and 544,000 in fiscal year 1997.

11. No parsonage allowance without advance designation. A minister reduced his taxable income by a "parsonage allowance." The IRS audited the minister and determined that he was not eligible for a parsonage allowance since there was no evidence that the church had ever designated one. The Tax Court agreed. It noted that the minister had the "burden of proving that the amount at issue was properly designated as a rental allowance by official church action before payment," and concluded that "the record is devoid of any such evidence." Logie v. Commissioner, T.C. Memo. 1998-387.

12. Using checks as receipts. Here's an interesting scenario. A church member donated checks to his church to be held as "collateral" for a few days until he came back with cash, at which time the church returned the checks marked as a "receipt." The member used this unusual arrangement because "the church did not have a receipt program of their own." For each check that he donated, he would say, "Hold the check, I'm going to bring you the money in just a couple of days to help you. Then you can stamp the check paid that I gave you the money, and I'll take my check. It will act as our receipt. And that's the way we did our business." The Tax Court was not convinced, and ruled that the donor could not deduct any of these alleged contributions since the scheme did not provide sufficient substantiation that any contributions in fact were made, or the amounts of the alleged contributions. Butler v. Commissioner, T.C. Memo. 1998-355.

13. Paying income taxes with a credit card. Beginning this year, taxpayers have a new way to pay their federal income taxes-by putting the balance due on a credit card. There are two ways to do so:

(1) Phone option. Once they have determined the amount owed, taxpayers may make a toll-free call to 1-888-2PAY-TAX and arrange payment of their 1998 taxes with a MasterCard, Discover, or American Express card. Visa cards are not eligible.

(2) Computer option. The computer option for paying by credit card is available only for those using Intuit tax preparation software to file from home. Under an arrangement between Intuit and Discover Card, e-filers will be able to charge their balance due to a Discover Card. The payment information will be part of the electronic file they send. This option began February 28.

With either method, private sector companies will process the credit card transactions and report the payment amounts-but not the credit card numbers-to the IRS. Users will pay convenience fees. The IRS is not involved in the setting or collection of such fees. The law allowing tax payments by credit card prohibits the government from paying fees to the credit card companies. Although these credit card programs were designed to facilitate paperless "e-filing," the IRS has emphasized that the "phone option" is not linked to the manner of filing. Taxpayers who file a paper tax return may call the toll-free number to charge a tax payment.

14. Substantiating cash contributions. A donor claimed charitable contribution deductions totaling $26,000 on his 1993 tax return. The donor claimed that he had made contributions to two churches, and two church-affiliated colleges. The amount of the charitable contribution deduction was estimated by the donor and given to the tax return preparer who prepared his 1993 return. The donor did not maintain any documentation supporting the contributions claimed. The IRS audited the donor's 1993 tax return, and allowed a charitable contribution deduction of only $1,300. The donor appealed to the Tax Court. The Court noted that in 1993 a donor could claim a charitable contribution deduction for cash contributions that were substantiated with any one or more of the following items: (1) a canceled check; (2) a receipt, letter, or other communication from the charity acknowledging receipt of the contribution and showing its name, the date of the contribution, and the amount of the contribution; or (3) in the absence of a canceled check or receipt from the charity, any other reliable written records showing the name of the charity and the date and amount of the contribution. These requirements still apply to individual cash contributions of less than $250. Since 1994, however, new substantiation requirements apply to cash contributions of $250 or more. The Court noted that the taxpayer has the burden of proving entitlement to a charitable contribution deduction, and that the donor in this case did not meet this burden. It observed:

In this case, [the donor] did not substantiate the charitable contributions claimed on his 1993 return in excess of those allowed by [the IRS]. He kept no records regarding his 1993 contributions. In addition, his testimony regarding his charitable deductions was not credible. He testified at trial that he made a cash contribution of $5,000 to [his church] during a stewardship dinner in January 1993 and that the funds to make the contribution were withdrawn from his bank account at [a credit union] the day before the dinner. However, [the church] had no record of any charitable contribution, much less a substantial one, from the donor during 1993. Similar claims were made concerning alleged contributions to [the other church and church-affiliated colleges]. The donor testified that he made a cash contribution of $5,000 to [one college] in November 1993 and a cash contribution of $5,000 to [another church] in December 1993. He also testified that, the day before each contribution was made, he withdrew the cash to make the contribution from his bank account at [the credit union]. However, [the college], one of the alleged donees, had no record of any charitable contribution, much less a substantial one, from the donor during 1993, and the record contains nothing to substantiate his testimony regarding the alleged $5,000 gift to [the second church]. We hold, therefore, that the donor has failed to prove that he is entitled to any charitable deduction for 1993 in excess of that allowed by the IRS. Gomez v. Commissioner, T.C. Memo. 1999-94.

15. Tax Court addresses a minister's "secular" earnings. A pastor of a local church also operated a private business as a "handyman." The pastor, who had filed for exemption from self-employment taxes, assumed that the exemption applied to his handyman income. As a result, he did not pay self-employment tax on these earnings. The IRS audited his tax return and determined that the secular earnings were subject to the self-employment tax. The Tax Court agreed, noting that "although the income [the pastor] derived from his handyman business may have enabled him to sustain his ministry at [his church] and to fulfill the obligation of supporting his family, those reasons or motives do not cause the handyman business to be integral to the conduct of his ministry." The court acknowledged that ministers can exempt themselves from self-employment taxes if they meet several conditions, but the exemption applies only to "services performed in the exercise of ministry." Such services did not include the pastor's work as a handyman. Williams v. Commissioner, T.C. Memo. 1999-105.

16. The IRS ruled that parents could not deduct tuition expenses they incurred in sending their children to a private religious school. In 1999 the IRS released an internal memorandum (a "field service advisory") addressing the question of whether parents can claim a charitable contribution deduction for tuition payments they make for their children who attend an Orthodox Jewish school. The parents cited the following facts in supporting their claim that tuition payments they made on behalf of their children were deductible as charitable contributions: (1) The act of religious study for Orthodox Jews is an observance of their religion that begins at an early age and continues for life. As a result, tuition payments they make to Jewish religious schools are in furtherance of this religious function and are deductible as charitable contributions. (2) For the Orthodox Jew, the obligation to study the Torah and the Talmud is a matter of duty and adherence to Jewish law, a lifelong commitment ranking aside the obligation to pray. The observance of such duties primarily benefits the community, not the individual. (3) The primary purpose of Jewish schools is religious study. A significant portion of a student's time at a Jewish school is devoted to religious study. (4) The payment of tuition to Jewish religious schools yields only an incidental benefit to the parent, and a direct benefit to members of the Jewish religion. Tuition payments to Jewish religious schools, the parents argued, provide the students with the religious observance of their religion through religious study, but this benefit is only incidental to both students and their parents. The primary beneficiaries are the Jewish people who have had their religion preserved for thousands of years through careful adherence to the study of Judaism by members of the faith. The IRS rejected all of the parents' arguments, and concluded that the tuition payments were not deductible as charitable contributions. It relied primarily on the Supreme Court's opinion in the Hernandez case. Hernandez v. Commissioner, 490 U.S. 680 (1989). In Hernandez, the Supreme Court ruled that "contributions" made to the Church of Scientology for spiritual "auditing" services were not deductible as charitable contributions. The Court noted that the Church charges fixed "donations" for specified auditing and training sessions (the charges are set forth in published schedules). The Court concluded that payments made to the Church for auditing and training sessions were a non-deductible reciprocal exchange-specific benefits in exchange for specific fees: "The Church established fixed price schedules for auditing and training sessions in each branch church; it calibrated particular prices to auditing or training sessions of particular lengths and levels of sophistication; it returned a refund if auditing and training services went unperformed; it distributed account cards on which persons who had paid money to the Church could monitor what prepaid services they had not yet claimed; and it categorically barred provision of auditing or training services for free. Each of these practices reveals the inherently reciprocal nature of the exchange." In other words, "contributions" to the Church (1) were mandatory, in the sense that no benefits or services were available without the prescribed payment, and (2) represented a specified fee for a specified service. The IRS, in commenting on the Hernandez case, observed: "The Scientology 'training' at issue in Hernandez involved the intensive study of the writings and tenets of Scientology. This training did not involve secular education, and was a means of progressing up the Scientology 'Bridge.' There seems to be no relevant distinction between such training and the intensive study of Jewish writing and tenets. The parents stress the amount of time spent in study by students at Orthodox Jewish schools. Even if it is true that they devote more time to the activity than students of Scientology, this is simply a question of degree, and we see no reason why this distinction supports a result different from the result in Hernandez. Thus, whether the payment involved is in consideration for training to become a good Scientologist, Christian or Jew, we conclude that, under Hernandez, such payments do not qualify as charitable contributions . . . ."

The IRS memorandum concludes by noting that the parents in this case "are required to make specific payments in return for which they receive a benefit-religious and secular education for their children. Under the rationale postulated in Hernandez, the parents are not entitled to a charitable contribution deduction for tuition payments made to Jewish religious schools." FSA 9999-9999-201.

17. IRS audit rate continues to plummet. The IRS audit rate for individual taxpayers dropped in 1998 to its lowest level in modern history-0.46 percent (46 out of every 1,000 tax returns). The rates vary somewhat depending on a number of variables. For example, the audit rate for taxpayers with income over $100,000 was 1.13 percent. While this number is more than twice the overall audit rate, it is still quite low by historical standards (it is half the 1992 rate). Where you live also affects your audit rate. Audit rates in 3 of the IRS's 33 districts (Illinois, Midwest, and North Central) have increased, while the audit rates in the Northern Florida and Carolinas districts have dropped sharply.

18. Prosecutions for tax fraud are down. The Department of Justice brought tax fraud prosecutions against only 766 taxpayers in 1998, down from 1,190 in 1989.

19. Tax Court denies donor's cash contributions to his church. On his 1993 federal income tax return, a taxpayer claimed a deduction in the amount of $3,767 for contributions he allegedly made to his church. This amount represented several individual contributions, each of which was less than $250. The IRS audited the taxpayer, and determined that he had not substantiated a charitable contribution deduction in an amount greater than $267. The taxpayer appealed to the Tax Court. The Tax Court noted that cash contributions of less than $250 are deductible only if substantiated with one or more of the following: (1) a canceled check; (2) a receipt from the charity; or (3) other reliable written records. The only evidence that the taxpayer presented to substantiate his cash contributions to the church was an unsigned document entitled, "Quarterly Report of Giving," and a letter from his church. The court concluded that neither document was sufficient proof of the taxpayer's alleged contributions. It noted that "the document entitled 'Quarterly Report of Giving' was not signed by a church official, even though it provided space for a signature. The church letter does not even state a definite contribution amount." Taylor v. Commissioner, T.C. Memo. 1999-323.

20. Gifts to Canadian charities. The United States-Canada Income Tax Convention specifies that recognized religious and charitable organizations that are organized under the laws of either the U.S. or Canada will automatically receive recognition of exemption without application in the other country. Further, recognized charitable organizations in one country will be eligible to receive deductible charitable contributions from residents of the other country. IRS Cumulative Bulletin Notice 99-47.

21. The IRS ruled that three "ordained deacons" in a Methodist church, who served as the ministers of education, music, and stewardship, were "ministers" for federal tax purposes. After twenty years of study, the United Methodist Church voted to establish the status of ordained deacon. Prior to this decision, elders were the only ordained members of the clergy. To qualify for ordination as either a deacon or an elder, an individual must meet the requirements set by the Church that are specified in its governing document. In addition, to be ordained, the individual must be recommended by the regional Conference and receive the affirmative vote of the ministerial members of the Conference. Through ordination, the ordained individual is given the approval of the Church to serve as an ordained minister and the authority to carry out those acts reserved to members of the clergy. As a result, following ordination, an ordained elder or deacon has the authority to exercise the responsibilities and duties of an ordained minister. According to the Church's governing document, an ordained deacon is permitted to give leadership in teaching and proclaiming the gospel, forming and nurturing disciples, performing marriages and funerals, and assisting the ordained elder in administering the sacraments. An ordained deacon has full right of voice and vote in the regional Conference where membership is held, may serve or hold office as a member of the clergy on the boards, commissions, or committees of the Conference, may be elected as a clergy delegate to the national Conference, must attend all sessions of the regional Conference, and, with the elder, is responsible for all matters of ordination, character, and Conference relations with members of the clergy. An ordained deacon is accountable to his or her regional Conference and bishop for the fulfillment of his or her call. An ordained elder is appointed to a position by a bishop. However, unlike an elder, an ordained deacon does not itinerate, nor does the Church guarantee an ordained deacon a position, salary, or place of employment. Ordained deacons are permitted to participate in the Church retirement plan for members of the clergy.

A Methodist church employs more than fifty employees, including three ordained deacons. The church asked the IRS whether these three ordained deacons are ministers of the gospel performing services in the exercise of their ministry for purposes of eligibility for a housing allowance, self-employed status for social security, and exemption from income tax withholding. The ordained deacons served as a minister of education, a minister of music, and a minister of stewardship. As integral members of the church's pastoral team, the three ordained deacons meet with the church's elder to plan the worship services, assist with the sacraments, and officiate at weddings and funerals. Each is required to preach at Sunday worship service. They participate with the elder in the weekly worship service. They also perform various other duties at the church, including confirmation preparation and membership reception.

The IRS ruled that the three ordained deacons were ministers of the gospel performing services in the exercise of their ministries. It observed:

As ordained members of the clergy in the Church [they] conduct worship and assist with the sacraments. In addition, as ordained members of the clergy in full connection they perform services in the control, conduct and maintenance of the Church. Further, [the local church and national church] consider [them] to be religious leaders who can perform substantially all of the religious functions within the scope of the Church's tenets and practices. . . . Accordingly [they] are performing services as "ministers of the gospel" . . . . Thus, [they] are eligible to have a portion of their salary designated as a parsonage allowance. Any parsonage allowance will be excluded from gross income, provided the allowance is designated and paid in accordance with [the tax code]. We further conclude that the services [they] perform are in the exercise of their ministry within the meaning of section 3121(b)(8) of the Code [which treats ministers as self-employed for social security purposes].

The IRS cautioned that this ruling does not suggest that "the Service has departed from its position in Revenue Ruling 59-270." In Revenue Ruling 59-270 (1959), the IRS ruled that a church's minister of music and minister of education who performed some of the duties of a minister of the gospel could not be treated as ministers for federal tax purposes since neither was ordained, commissioned, or licensed as a minister of the gospel. In other words, ministers of music and education who hold no ministerial credentials should not assume, based on the recent IRS ruling, that they now qualify for a housing allowance. IRS Letter Ruling 199910055.

22. The Taxpayer Refund and Relief Act of 1999. By the slimmest of margins, Congress passed the Taxpayer Refund and Relief Act in August. The Act contains many provisions of interest to clergy and church leaders. While the President vetoed the Act, a review of its major provisions is still warranted since presidential candidate George W. Bush has stated that he would sign the bill into law if elected president. If governor Bush is elected president and the Republicans hold onto their majorities in the House and Senate, it is likely that most if not all of the provisions in the Act will become law in the future. As a result, ministers should be familiar with those provisions that directly affect them. These include the following: (1) A slight reduction in income tax rates. (2) Elimination of the "marriage penalty" that taxes a married couple at a higher rate than if the couple were not married. (3) A reduction in the capital gains tax rates. (4) An increase in the amount that can be contributed annually into an IRA from $2,000 to $5,000 during a 6-year phase-in period. (5) A new above-the-line deduction (available to all taxpayers, whether or not they are able to itemize deductions on Schedule A) for a percentage of the amount paid during the year for medical insurance for the taxpayer and his or her spouse and dependents.

23. The Tax Court ruled that miles driven by a minister from his home to a pastoral call are commuting miles that cannot be deducted or reimbursed as a business expense. A taxpayer performed services as a minister for approximately 6 months each year, during the winter and spring. He was not affiliated with a particular church. His ministerial activity consisted of serving as a chaplain to a mobile home community located approximately 35 miles from his home in Florida. That community consisted of people the minister referred to as "snowbirds," which he defined as people from the northern United States who came to Florida each year for the winter and spring months. The minister conducted services there twice weekly. He also taught a weekly class at a local church and occasionally preached at various churches. On his federal income tax returns for 1993 and 1994, the minister claimed deductions for the business use of his car. The IRS audited the minister and reduced his car expense deduction. The IRS claimed that the minister improperly treated miles driven from his home to pastoral responsibilities as business miles rather than as nondeductible commuting miles. The minister appealed to the Tax Court. The Tax Court began its opinion by noting that "as a general rule, the expenses of traveling between one's home and his place of business or employment constitute commuting expenses which are nondeductible, personal expenses." The court acknowledged that a taxpayer's cost of transportation "between his residence and local job sites may be deductible if his residence serves as his principal place of business and the travel is in the nature of normal and deductible business travel." In other words, if the minister's principal place of business had been his home office, then all miles that he drove from home to any pastoral assignment would qualify as a deductible business expense. However, the court concluded that the minister did not qualify for this rule since his home office was not his principal place of business. Therefore, miles driven from his home to pastoral assignments and meetings were nondeductible personal expenses rather than deductible business expenses. Walter R. Strohmaier v. Commissioner, 113 TC 250 (1999).

24. Health insurance deduction for the self-employed. Self-employed persons can deduct health insurance costs for themselves (and their spouse and children) as follows: 60 percent in 1999 through 2001; 70 percent in 2002; and 100 percent in 2003 and thereafter. This deduction is not allowed in any year in which the self-employed person is eligible to participate in a subsidized health plan maintained by an employer of either the self-employed person or his or her spouse.

25. Foreign earned income credit. United States citizens generally are subject to federal income tax on all their income, whether derived in the United States or in a foreign country. However, citizens working in foreign countries may be eligible to exclude from their income for federal income tax purposes certain foreign earned income and housing costs. To qualify for these exclusions, the individual must either (1) be a resident of the foreign country for an uninterrupted period that includes the entire tax year, or (2) be present overseas for 330 days out of any 12 consecutive month period. The maximum exclusion for foreign earned income for 1999 was $74,000. This amount increases by $2,000 each year until it reaches a maximum of $80,000 in the year 2002. In addition, the credit will be indexed for inflation beginning in 2008. This credit is claimed by many American missionaries serving in foreign countries.  

26. Estimated tax requirements. A taxpayer is subject to a penalty for underpayments of estimated taxes. For 1998, the penalty is avoided if a taxpayer made timely estimated tax payments at least equal to (1) 100 percent of the previous year's tax liability, or (2) 90 percent of the current year's tax liability. The "100 percent of last year's tax liability" rule is changed to 105 percent of the previous year's tax liability in 1999, 2000, and 2001; and 112 percent of the previous year's tax liability in 2002. The 100 percent of last year's tax liability exception is increased to 110 percent for individuals with adjusted gross income of more than $150,000 for the previous year.

27. Simplified definition of "highly compensated employee." A number of tax-favored rules do not apply if there is discrimination in favor of "highly compensated employees." These include (1) simplified employee pensions (SEPs); (2) 403(b) tax-sheltered annuities (churches and qualified church-controlled organizations are exempt from this nondiscrimination rule); (3) qualified employee discounts; (4) cafeteria plans; (5) flexible spending arrangements; (6) qualified tuition reductions; (7) employer-provided educational assistance; and (8) dependent care assistance. Unfortunately, the definition of a "highly compensated employee" has been complex and has often led to absurd results. Congress enacted legislation in 1996 making the definition of the term "highly compensated employee" much simpler and fairer. Beginning in 1997, a highly compensated employee is one who (1) was a 5 percent owner of the employer at any time during the current or prior year (this definition will not apply to churches), or (2) had compensation for the previous year in excess of $80,000, and, if an employer elects, was in the top 20 percent of employees by compensation. The new definition repeals the previous rule requiring the highest paid officer to be treated as highly compensated, no matter how little he or she was paid. The $80,000 amount is adjusted annually for inflation. However, the amount was not increased in 1998 or 1999. IRS News Release IR-97-41.

28. Increase in "section 179" deduction. It is a basic principle of tax law that if a product is purchased for business use and has a useful life of more than one year, the full cost may not be deducted in the year of purchase but rather must be allocated over the useful life of the product and an annual "depreciation" deduction claimed each year. Section 179 of the Code, however, permits taxpayers to elect to deduct most if not all of the cost of business property in the year of purchase if certain conditions are satisfied. In 1999 and future years the deduction is limited to the following amounts:

29. Extend the phaseout of the luxury tax on automobiles. An excise tax is imposed on the sale of a "luxury automobile" whose price exceeds a threshold amount ($36,000 in 1999). The excise tax for 1999 is 6 percent of the purchase price in excess of this threshold amount.

30. Senior Citizens' Right to Work Act. The amount of annual income that retired persons (from age 65 to 70) may earn without losing some of their social security benefits was increased as a result of the Senior Citizens' Right to Work Act, enacted by Congress in 1996. This is good news for those churches that employ retired persons and would like to compensate them adequately without reducing their social security benefits. Under this law, workers from age 65 to 70 could earn up to $15,500 in 1999 without a reduction in their social security benefits. Workers can earn $17,000 in 2000 without a reduction in benefits; $25,000 in 2001; and $30,000 in 2002 and later years. These tests apply only to workers who are 65 to 70 years old. Social security benefits are reduced by $1 for every $3 of income above these limits.

Workers 62 to 65 years of age could earn only $9,600 in 1999 without a reduction in social security benefits (a $1 reduction for every $2 of income in excess of the limit). This amount is indexed for inflation in future years. There is no earnings limit for workers who have reached age 70.

31. "Luxury car" limits adjusted for inflation. Ministers who use the "actual expense" method of computing their car expenses can claim a deduction for depreciation. There are limits on the amount of depreciation that you can claim in any given year. These limits are known as the "luxury car" limits. The 1999 limits are summarized in the table below, along with the limits for 1998 (for comparison purposes).

"Luxury car" depreciation limits

32. The IRS continues to target "self-employed" taxpayers. The IRS continues to target self-employed taxpayers for audits. Particularly vulnerable are persons who receive only one or two 1099 forms each year. Why all the attention on self-employed persons? A joint IRS and General Accounting Office study concluded that most taxpayers who report as self-employed, but who receive only one or two 1099 forms each year, are actually employees. Reclassifying self-employed persons as employees results in higher tax revenues for the IRS, since employees are subject to tax withholding and they often are not allowed to deduct their business expenses (unless their employer has adopted an accountable reimbursement plan). Also, the employer of a self-employed person who is reclassified as an employee by the IRS is subject to a special penalty under the tax code. Clergy who report their income taxes as self-employed are "prime targets" for IRS examination, since most of them will "fit the profile" of receiving only one or two 1099 forms. Our recommendation-most clergy should report their income taxes as employees, not self-employed. This is one very good reason.

33. Phase-out of personal exemption for high-income taxpayers. As noted elsewhere in this summary, the personal exemption deduction (that you can claim for yourself and each dependent) increased to $2,750 in 1999 (up from $2,700 in 1998). In 1999, the personal exemption amounts are phased out for certain high-income taxpayers. For married taxpayers filing jointly, the phase-out begins when adjusted gross income exceeds $189,950. For single taxpayers, the phase-out begins when adjusted gross income exceeds $126,600.

34. New per diem rates for substantiating the amount of travel expenses incurred in 1999. The IRS allows taxpayers to substantiate the amount of their business expenses by using "per diem" (daily) rates. Taxpayers still must have records substantiating the date, place, and business purpose of each expense. There are separate rates for meals and lodging, and separate rates for "high-cost localities" and all other communities. The rates for 1998 are summarized in the table below.

Per Diem Rates for 1999

In some cases using the per diem rates will simplify the substantiation of meals and lodging expenses incurred while engaged in business travel. However, a number of restrictions apply, and these are explained in chapter 7 of Richard Hammar's Church and Clergy Tax Guide.

35. Offers in compromise. The tax code permits the IRS to "compromise" a taxpayer's tax liability. An offer in compromise is an offer by the taxpayer to settle an unpaid bill for less than the full amount of the assessed balance. The IRS often makes counterproposals to these offers, and about one-fourth are eventually accepted. For example, in 1998 about 25,000 offers out of 105,000 (23.8 percent) were accepted, leading to the collection of $290 million out of $1.9 billion in outstanding tax bills. The IRS announced in 1999 that it is liberalizing its offer in compromise program to ensure that more of these offers are accepted. This is good news for taxpayers with huge tax liabilities. Here are some steps the IRS has taken: (1) In evaluating a taxpayer's ability to pay, the IRS will consider the taxpayer's own expenses, rather than using national "averages." (2) Instead of the old, stringent application guidelines that often led to immediate rejections, the IRS will now work with taxpayers to fine-tune their compromise offers-a step that will lead to the acceptance of more offers. (3) Taxpayers will be asked to provide fewer financial documents to qualify for smaller compromise offers. (4) New deferred payment procedures provide more opportunities for compromise offers to be submitted by taxpayers who may have been excluded under the old guidelines. (5) A short-term deferred payment option allows taxpayers up to two years to pay the compromise offer. (6) Specially trained IRS experts will be devoted to handling compromise offers. These new offer specialists will bring more consistency to the offer in compromise program and centralize offer processing. (7) There will be new, independent reviews for each rejected compromise offer. These reviews assess whether rejection is in the best interest of the taxpayer and the government. Many of these changes are reflected in a new version of Form 656. IRS Information release, IR-1999-30.

36. New regulations permit offers in compromise in cases of hardship or "exceptional circumstances." Under new regulations issued in 1999, the IRS for the first time will be allowed to consider economic hardship in cases where taxpayers try to settle unpaid tax debts through the offer in compromise program and where settlement would promote effective tax administration. This change expands the offer in compromise program, which allows the IRS to negotiate a settlement with people unable to pay their entire tax bill. Prior to the new regulations, the IRS could accept the taxpayer's offer in compromise only when there was doubt about whether the tax debt could ever be collected or whether it was owed. Under this new provision, taxpayers may be eligible for a compromise if collection of the entire tax liability (1) would create economic hardship, or (2) exceptional circumstances exist where collection of the entire tax liability would be detrimental to voluntary compliance. According to the regulations, an offer in compromise cannot be approved in situations where it would undermine compliance with the tax laws. To qualify, taxpayers also must have a history of paying and filing their taxes. The temporary regulations outline several possible examples where taxpayers might qualify for the new type of offer in compromise. To illustrate, economic hardship can include taxpayers and their dependents facing a long-term illness, medical condition, or disability where the person's financial resources will be exhausted while providing for care and support. An example is a parent who has assets large enough to pay the tax bill, but those assets will be needed for care of a child with a long-term illness. Economic hardship can also cover cases where the sale or liquidation of assets to pay the tax bill would prevent the taxpayer from meeting basic living expenses. An example could be a retiree with a retirement fund large enough to pay the tax bill, but using the fund would deprive the person of basic living expenses. In the second category, an offer in compromise may be granted under exceptional circumstances, such as extraordinary events beyond a taxpayer's control. An example might include someone who was hospitalized for several years, could not manage any financial affairs, and was unable to file tax returns. The IRS cautioned the new program is tailored only for taxpayers entangled in very severe circumstances. It is not designed to be a sweeping program for everyone with financial difficulties or a panacea for people with tax problems.

The IRS is nearing completion on a new application for the special offers in compromise category, which will be Form 656-A. This new form will be submitted in addition to Form 656, the standard offer in compromise application. When the taxpayer submits new 656-A applications, the IRS must first determine whether a taxpayer is eligible for one of the traditional offer in compromise options. If the taxpayer is not, then the agency will consider the application under the new economic hardship provisions. Internal Revenue News Release IR-1999-64; Treas. Reg. § 301.7122-1T.