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: m71 c0101
1. IRS revocation of church's tax-exempt status upheld. Last year a federal court ruled that the IRS had correctly revoked the tax-exempt status of a church that published full-page ads in national newspapers attacking candidate Bill Clinton during the presidential campaign of 1992. Such activity, the court concluded, violated a requirement in the tax code that tax-exempt churches not engage in any intervention in political campaigns. A federal appeals court recently upheld this ruling, rejecting the church's arguments that the revocation of its exempt status violated its first amendment right to religious freedom and amounted to "selective prosecution."
(1) First amendment. In rejecting the church's argument that the revocation of its exempt status violated its first amendment right to religious freedom because it "will have to close due to the inability of congregants to deduct their contributions from their taxes," the court observed that such a burden "is not constitutionally significant." Further, the court noted that if the church does not intervene in future political campaigns, "it may hold itself out as a 501(c)(3) organization and receive all the benefits of that status. All that will have been lost . . . is the advance assurance of deductibility in the event a donor should be audited. Contributions will remain tax deductible as long as donors are able to establish that the church meets the requirements of section 501(c)(3)."
(2) Selective prosecution. The church alleged that the IRS violated the "equal protection clause" of the fifth amendment by engaging in "selective prosecution." In support of its claim, the church submitted hundreds of pages of newspaper excerpts reporting political campaign activities by churches that retained their tax-exempt status. The church complained that despite this widespread and widely reported involvement by other churches in political campaigns, it is the only one to have ever had its tax-exempt status revoked for engaging in political activity. It attributed this alleged discrimination to the IRS's anti-conservative bias, since most of the newspaper accounts involved "liberal" churches supporting democratic candidates.
The IRS conceded that if some of the church-sponsored political activities cited by the church were accurately reported, they were in violation of section 501(c)(3) and could have resulted in the revocation of those churches' tax-exempt status. But the court concluded that the church had failed to demonstrate a case of unlawful selective prosecution because it was not in the same situation as the churches described in the newspaper articles since "none of the reported activities involved the placement of advertisements in newspapers with nationwide circulations opposing a candidate and soliciting tax deductible contributions to defray their cost." The court concluded that "if there was no one to whom defendant could be compared in order to resolve the question of [selective prosecution], then it follows that defendant has failed to make out one of the elements of its case. Discrimination cannot exist in a vacuum; it can be found only in the unequal treatment of people in similar circumstances." Branch Ministries v. Rossotti, 2000 USTC ¶50,459 (D.C. Cir. 2000).
2. The Tax Court ruled that a minister could not deduct contributions he made to a religious ministry for whom he worked because some of the ministry's resources "inured" to his personal benefit as a result of personal expenses paid by the charity on his behalf. Churches and other public charities are exempt from federal income tax so long as they comply with certain requirements. One of these requirements is that none of the charity's resources "inure" to the benefit of a private individual other than as compensation for services rendered. However, another consequence of "inurement" is the potential disqualification of a church to receive tax-deductible charitable contributions. A religious ministry paid for a minister-employee's personal expenses, including scholarship pledges made in the minister's name and a season ticket for a local college football team. The Tax Court noted that the tax code allows a charitable contribution deduction for contributions made to a charity "no part of the net earnings of which inures to the benefit of any private shareholder or individual." The court noted that the minister received payments from his employer (football tickets and scholarship pledges), and that these payments "inured" to his benefit. In addition, the minister failed to establish that these payments were compensation. Accordingly, the minister was not allowed to deduct contributions he made to his employer. Whittington v. Commissioner, T.C. Memo. 2000-296 (2000).
3. Congressional committee issues report on IRS bias against "conservative" churches. Beginning in 1996, allegations appeared in various media reports that the IRS was engaged in "politically targeted" examinations of conservative religious organizations and leaders who generally were opposed to the Clinton administration. There were allegations that the IRS conducted examinations of conservative religious organizations for engaging in certain political and other activities while ignoring such conduct on the part of pro-Clinton organizations. Certain members of Congress wrote the Congressional Joint Committee on Taxation (the "Joint Committee") to express concern about these reports, and directed the Joint Committee staff to conduct an investigation. The Joint Committee released its findings recently. They include the following conclusions:
There is no credible evidence that tax-exempt organizations were selected for examination, or that the IRS altered the manner in which examinations of tax-exempt organizations were conducted, based on the views espoused by the organizations or individuals related to the organization.
There is no credible evidence of intervention by Clinton Administration officials (including Treasury Department and White House officials) in the selection of (or the failure to select) tax-exempt organizations for examination.
There is no credible evidence that the IRS used information items (such as media reports, letters from members of Congress, letters from taxpayers, etc.) to identify for examination tax-exempt organizations that espouse views that are opposed to the political views of the Clinton Administration. JCT Press Release 00-02.
4. The IRS warned churches not to intervene in elections. An organization that violates the prohibition against political campaigning "could lose its tax-exempt status," the IRS cautioned in a recent news release. The news release lists the following activities that could jeopardize a church's tax-exempt status: Endorsement of any candidates; making donations to a candidate's campaign; fundraising on behalf of a candidate; distribution of statements or becoming involved in any other activities that may be beneficial or detrimental to any candidate; or "partisan" voter education activities. Internal Revenue News Release IR-2000-47.
5. IRS simplifies payroll tax reporting for small employers. Beginning January 1, 2001, many small employers will be allowed to make employment tax payments on a quarterly basis, not monthly. Under the new rules, the IRS will allow employers to make payments every three months if they have less than $2,500 in quarterly employment taxes. It replaces the current standard, which allows quarterly payments only if employers have less than $1,000 in quarterly employment taxes. Most employers above these threshold levels must make payments on a monthly basis. The difference between the $1,000 and $2,500 thresholds affects payment requirements for about 1 million employers, including many churches. Smaller employers with employment taxes that are less than $2,500 per quarter may pay the employment taxes when they file Form 941 (Employers Quarterly Federal Tax Return). Beginning in 2001, only employers with employment taxes of $2,500 or more per quarter must deposit the taxes with an authorized financial institution.
6. Tax Court denies charitable contribution deduction. A taxpayer claimed that she made cash contributions totaling $1,100 to her church during a particular year. The IRS audited her tax return, and denied any deduction for these contributions on the ground that they were not adequately substantiated. The taxpayer appealed, claiming that she made weekly cash contributions of $20 to her church. As proof, she presented a calendar marked with the notation "church" and a dollar amount (usually $20) on each Sunday, along with two handwritten letters from two persons stating that the taxpayer attended church regularly. The court was not impressed. It noted that a cash contribution of less than $250 must be substantiated by a canceled check, a receipt from the church showing the date and amount of the contribution, or "other reliable written records" showing the name of the church and the date and amount of the contributions. The court concluded: "The notations on the calendar do not indicate the churches to which the contributions were made. Moreover, we are not convinced that the notations were made [at the time of the contributions]. The letters do nothing to support the taxpayer's claims as they do not identify a church or indicate that she made any contributions." Aldea v. Commissioner, T.C. Memo. 2000-136 (2000).
7. The IRS ruled that a corporation could not deduct a contribution it made to a charity since it failed to properly substantiate the contribution. A corporation made a sizeable contribution to a charity for the care of the needy. The charity issued the corporation a receipt acknowledging the contribution. The IRS ruled that the corporation was not entitled to a charitable contribution deduction for three reasons.
(1) A timely receipt. The income tax regulations require that a charity's written acknowledgment of a contribution be furnished on or before the earlier of the date on which the taxpayer files a return for the taxable year in which the contribution was made or the due date for filing such return. The IRS concluded that this requirement was not met.
(2) The charity's written acknowledgment. The charity's written acknowledgment did not comply with the substantiation requirements for contributions valued at $250 or more since it did not indicate whether the charity provided any goods or services in return for the contributed property.
(3) Form 8283. Since the corporation donated property that it valued at more than $5,000, it was required by the income tax regulations to obtain a qualified appraisal of the property and enclose a "summary" of the appraisal (on IRS Form 8283) with the tax return on which the contribution deduction was claimed. A Form 8283 was not enclosed with the corporation's tax return. When asked by an IRS agent about the missing Form 8283, the corporation furnished the missing form, but the IRS concluded that this was too late since the form did not accompany the corporation's tax return.
This case demonstrates the importance of church treasurers being familiar with the substantiation requirements that apply to charitable contributions. While the responsibility for complying with these rules is on donors, the fact remains that many donors (and their advisors) are not familiar with these rules. Church treasurers can play a vital role in helping donors comply with these rules by being familiar with them. This case suggests the following specific actions that church treasurers can take: (1) Issue receipts soon after the close of a calendar year. (2) Advise donors (in church newsletters, bulletins, or letters) not to file their tax returns until they have received their receipt from the church. (3) Confirm that receipts issued to donors comply with the requirements of the income tax regulations. (4) Have several current copies of Form 8283 (with instructions) on hand, and give a copy to each donor who contributes noncash property to the church. Note that donors who contribute publicly traded stock are not required to complete Form 8283. IRS Letter Ruling 200003005.
8. Tax Court denies deduction for gifts to a church. A taxpayer claimed a deduction of $950,000 for contributions of several items of property he made to a church. The donated items included historical books and paintings. The taxpayer completed a Form 8283 on which he listed the donated items and his estimate of their market value, but he did not obtain an appraisal for any of the items. The IRS audited the taxpayer, and allowed a charitable contribution deduction of only $12,900. On appeal, the Tax Court agreed with the IRS. It noted that the taxpayer failed to obtain a qualified appraisal of the donated items within the time limits specified by law. In general, persons who donate property valued at more than $5,000 must obtain a qualified appraisal no later than the date they file the tax return on which the contribution deduction is claimed. The taxpayer retained an appraiser only after his tax return was audited. Further, the court noted that the appraiser's valuations were not credible, since "he gave no persuasive explanation of his methodology, made no reference to comparable sales or a valuation rationale, and made no reference to any experience he had that would support the values at which he arrived. Without any reasoned analysis, his report is useless. His opinions are so exaggerated that his testimony is not credible." The court also pointed out that the appraiser's valuation was not supported by the donor's actions: "The contributed property was stored in boxes on pallets for many years in a bakery warehouse that only had limited security. The warehouse had a rodent problem and was described as being extremely hot during the summer. The contributed property was not insured, nor was any special precaution taken to preclude loss due to deterioration, theft, or fire." Such behavior, the court concluded, "renders implausible his claim that the property had substantial value," since "if the contributed property had a value of $950,000 or anything approaching that value . . . [the donor] would have treated it with more care." Jacobson v. Commissioner, T.C. Memo. 1999-401 (1999).
9. Tax Court denies deduction for a gift of property. In 1993 a married couple (the "taxpayers") donated property having a fair market value of $10,000 to their local Boys and Girls Club. In 1994, they donated a truck having a fair market value of $14,850 to their church. The taxpayers failed to obtain qualified appraisals for both charitable contributions prior to the due date of their 1993 and 1994 tax returns. They were audited by the IRS, and only then did they produce letters from two appraisers (dated after the taxpayers filed their tax returns). The IRS disallowed any deduction for either of these contributions, and the taxpayers appealed. The Tax Court noted that the tax code specifies that a taxpayer must obtain a "qualified appraisal" for donated property (except money and certain publicly traded securities) in excess of $5,000. In addition, the income tax regulations require that the taxpayer attach an "appraisal summary" to the tax return, and the IRS has prescribed Form 8283 to be used as the appraisal summary. The Tax Court concluded: "Although we have not demanded that the taxpayer strictly comply with the reporting requirements of [the regulations] we have required that the taxpayer substantially comply with the regulations in order to take the deduction for a charitable contribution. Based on the record, we find that [the taxpayers] did not timely obtain qualified appraisals and failed to include complete appraisal summaries with their 1993 and 1994 tax returns. Because [they] failed to comply substantially with [the regulations] we hold that [they] are not entitled to deduct the noncash charitable contributions." The Tax Court further ruled that the IRS could assess an "accuracy-related penalty" against the taxpayers. Section 6662 of the tax code permits the IRS to assess a penalty of 20 percent on the amount of underpayment of tax attributable to a "substantial understatement" of tax. A substantial understatement of tax is defined as an understatement of tax that exceeds the greater of 10 percent of the tax required to be shown on the tax return or $5,000. The understatement is reduced to the extent that the taxpayer has (1) adequately disclosed his or her position or (2) has substantial authority for the tax treatment of the item. The court concluded that neither the taxpayers nor their accountant "provided an explanation why timely qualified appraisals were not conducted for the noncash charitable contributions and why the appraisal summaries on Form 8283 were not fully completed. We, therefore, sustain [the] imposition of the accuracy-related penalty with regard to the underpayment associated with the . . . noncash charitable contributions." Jorgenson v. Commissioner, 79 T.C.M. 1444 (2000).
10. Issuing 1099 forms to benevolence recipients. Churches frequently make cash distributions to needy persons. Must they issue a 1099 form to such persons? The IRS addressed this question in a recent ruling. A state asked the IRS if it needed to issue 1099 forms to persons who received funds under a state program designed to assist persons in relocating from their flood-damaged homes to other residences. The IRS ruled that no 1099 forms were necessary. IRS Private Letter Ruling 200013031.
11. The Tax Court rejects the deductibility of a couple's cash contributions to their church. A husband and wife claimed a charitable contribution deduction for cash contributions they made to their church. The IRS audited the couple and allowed a deduction of only $81. The couple appealed to the Tax Court. The husband testified that part of the cash gifts consisted of his estimate of amounts that he and his wife contributed when they went to church on Sundays. He conceded that he and his wife maintained no records of their contributions, and did not participate in the church's "envelope system," which would have provided the church with a record of the alleged donations. The husband estimated that he "gave no less than a $20 bill" each time he attended the church. No single cash contribution was for $250 or more. The Tax Court agreed with the IRS that the couple had failed to adequately substantiate their contributions. The court noted that charitable contributions are deductible only if properly substantiated, and that contributions of money (of less than $250 per contribution) must be substantiated with one of the following: (1) A canceled check; (2) a receipt from the charity showing the name of the charity, the date, and the amount of the contribution; or (3) in the absence of a canceled check or receipt, other "reliable written records" showing the name of the charity, the date, and the amount of the contribution. The court concluded that the couple failed to substantiate their alleged cash contributions with any of these categories of evidence, and so it denied a tax deduction. Coffman v. Commissioner, T.C. Memo. 2000-7 (2000).
12. Tax Court denies deduction for gifts to church. A church member claimed a charitable contribution deduction of $2,500 for contributions made to her church. The IRS audited the member's tax return, and denied the deduction on the basis of a lack of substantiation. The member offered no proof other than her own testimony. She testified that she attended church "maybe every other Sunday, sometimes during the winter maybe once a month or every other month or so." She further testified that "I just drop in the basket maybe somewhere between $5 and $10 and as far as tithes, I don't faithfully put in 10 percent tithes every pay period, I do put in 10 percent tithes. I can't attest to how frequently I do it-maybe every month, every other pay period or so." The court was not impressed. It allowed a deduction of $260. Jackson v. Commissioner, 77 T.C.M. 2203 (1999).
13. IRS addresses rental income received by a charity. A charity purchased land in 1997 to build a facility to carry out its charitable and educational functions. It planned on renting some of the building to the public for wedding receptions and other functions. The charity represented that all rent and fees would be at fair rental value for the property, as recommended by an independent expert in the real estate appraisal business. Services provided in connection with the rental of facilities would be only the usual and customary services, including janitorial services. The rent and fees were expected to exceed the operating expenses of the facility. The excess revenue would be used by the charity to support its charitable activities. The IRS noted that the tax code imposes a tax on the "unrelated business taxable income" of tax-exempt organizations. The code defines the term "unrelated business taxable income" to mean the gross income derived by any organization from any unrelated trade or business that is regularly carried on by it, less allowable deductions. An "unrelated trade or business" is defined as any trade or business that is not "substantially related" to the exercise or performance of a charity's exempt purposes. The IRS acknowledged that the tax code excludes rents from real estate from the unrelated business income tax. But this exception does not apply if the rented property is "debt-financed." The code defines the term "debt-financed property" to mean any property "which is held to produce income and with respect to which there is an acquisition indebtedness at any time during the taxable year." An "acquisition indebtedness" means the unpaid amount of the indebtedness incurred by the organization in acquiring or improving the rented property. The IRS noted that the charity in this case purchased the land, and planned on constructing its building, without having to incur any debt. As a result, it concluded that "the rental income . . . is excludable from the unrelated business tax." IRS Letter Ruling 199940034.
14. Contributing rebates to charity. A company offers rebates on the sale of certain products, and gives consumers the choice of receiving the rebates themselves or donating them to a designated charity. The IRS ruled that consumers who elect to have their rebates donated to charity are entitled to a charitable contribution deduction in the amount of the rebate. IRS Letter Ruling 199939021. In reaching this conclusion, the IRS referred to two previous rulings that will be of interest to church treasurers: (1) A utility company's customers are entitled to deductions for charitable contributions for payments to the company in excess of their monthly bills for a program designed to help elderly and handicapped persons meet their emergency energy-related needs. Since the utility company is acting as the "agent" for the charity, the deduction is allowed in the taxable year that the payment is made to the utility company. Rev. Rul. 85-184. (2) A rebate received directly from a seller is a reduction in the purchase price of the item that is not includible in the buyer's taxable income. Rev. Rul. 76-96. The IRS cautioned that the special substantiation rules that apply to contributions of $250 or more will apply to rebates (of $250 or more) that a buyer donates to charity. But it is the charity, not the seller, that must comply with these rules by issuing the donor an appropriate written receipt.
15. When is a gift of a promissory note deductible? Churches occasionally receive gifts of promissory notes. For example, during a church building campaign this year Bob gives his church a promissory note in which he promises to pay the church $10,000 over a 3-year term. How much does the church treasurer report as a charitable contribution for year 2000? The full amount of the note? Some other amount? The Tax Court addressed this question in a recent case. An attorney gave his church a promissory note for a substantial amount, and then claimed a charitable contribution deduction for the entire face amount of the note even though very little had been paid that year. The court ruled that the attorney could claim a charitable contribution deduction only for amounts he actually paid on the note in the year in question, and not for the entire amount of the note. Investment Research Associates v. Commissioner (2000).
16. The IRS targets donor-directed contributions. The IRS Exempt Organizations Director served notice recently that the IRS will be focusing on donor-directed contributions this year. A donor-directed contribution is a contribution that a donor controls after it is given. An example would be a "contribution" by a donor to a college for the exclusive benefit of his daughter, who is a student. A charitable contribution, to be tax-deductible, must be "to or for the use of" the donee charity. With a donor-directed contribution, it often is not clear that the charity exercises any control over the contribution and as a result the contribution is not really "to or for the use of" the charity. The issue of donor-directed contributions is of direct relevance to most churches. Any future developments with regard to this important issue will be reported promptly in future editions of this newsletter.
17. A Connecticut court ruled that an undeveloped tract of land owned by a church was not entitled to exemption from property taxation since it was not used exclusively for religious purposes. The church property was an unimproved, wooded lot that contained no structures or buildings other than a volleyball court. The court noted that the state property tax law exempts property belonging to a religious organization that is not in actual use for religious purposes because of "the absence of suitable buildings and improvements thereon, if the construction of such buildings or improvements is in progress." Despite the church's assertion that the property was used for religious purposes in that "prayer walks" were occasionally conducted on the property, the court ruled that the property was not exempt because it "contains neither any building or other improvement used for charitable purposes, nor such improvements in the process of being constructed." Grace n' Vessels of Christ Ministries, Inc. v. City of Danbury, 733 A.2d 283 (Conn. App. 1999).
18. An Illinois court ruled that a building owned by a church did not lose its tax-exempt status as a result of being leased to a local charity for a nominal fee. A church "leased" a building that it owned to a local charity for a one-time payment of $1. The charity used the property three days each week to accept, distribute, and sell donated furniture, clothing, and household goods. The charity was staffed by volunteers and individuals performing community service work by order of a local probation department. The church's application for a property tax exemption for the property leased to the charity was denied by the local tax assessor, and the church appealed. A state appeals court upheld the exempt status of the property. The court noted that Illinois law exempts from taxation "all property used exclusively for religious purposes . . . and not leased or otherwise used with a view to profit." The court concluded that the property was used exclusively for religious purposes. It acknowledge that the exemption statute requires that property that is used exclusively for religious purposes not be "leased or otherwise used with a view to profit." The court concluded that the property met this test as well: "Whether property is used with a view toward profit depends on the intent of the owner in using the property. It is clear that [the church] did not use the property for profit. [The charity] paid the sum total of one dollar for its use of the property. [The church] uses the property for religious purposes, fulfilling its missions to provide charity to the community through distribution of food, clothing, furniture, and Christmas gifts to those in need. While some revenues are generated through the sales of clothing and furniture, this is not the primary purpose in using the property. [The church's] use of the property falls within the [requirements of the statute]. Therefore, the property should be exempt from taxation." First Presbyterian Church v. Zehnder, 715 N.E.2d 1209 (Ill. App. 1999).
19. An Indiana court ruled that a church's property was entitled to exemption from property tax even though it did not have legal title to the property. A church purchased property under a "contract for deed" that is used for religious purposes. Under this arrangement, the seller retained title to the property to secure payment of the purchase price from the church. The church's application for a property tax exemption was denied on the ground that the church was not the legal owner of the property. Under Indiana law, property is eligible for exemption from property tax if it is "owned, occupied, and used" by a church or other religious entity for religious purposes. A state tax board conceded that the property in question was occupied and used for religious purposes, but it insisted that the property was not "owned" by the church and therefore was not entitled to exemption. The state tax court disagreed, noting that "there is no requirement that the same entity own, occupy, and use the property for religious or charitable purposes. Rather, it is sufficient that the property is owned, occupied, and used for religious or charitable purposes." The court concluded that the property "was in fact owned, occupied, and used for religious purposes, and, therefore . . . was exempt from property taxation." The state board of taxation also argued that the property was not entitled to exemption since the church rather than the legal title holder applied for exemption. Under Indiana law the legal title holder (the seller in this case) is required to apply for exemption. The tax court agreed that the legal title holder is the party that must apply for a property tax exemption. However, the court pointed out that the tax board did not base its denial of the exemption on the fact that the church was not the proper party to apply for the exemption. This argument was raised for the first time on appeal, and therefore could not be considered. This case illustrates a couple of important points. First, property that is occupied and used for church purposes may qualify for exemption from property tax even though the church does not hold legal title to the property. Second, an exemption from property tax may not be granted if the wrong party applies for it. In some states, only the legal title holder of property can apply for an exemption from property tax. If the church is not the legal title holder of property that it occupies and uses, then it may not be the proper party to apply for a property tax exemption. These issues will be determined by the provisions of the property tax exemption law in each jurisdiction. Word of His Grace Fellowship, Inc. v. State Board of Tax Commissioners, 711 N.E.2d 875 (Ind. Tax Court 1999).
20. The Minnesota Tax Court ruled that a church-owned rectory was exempt from property tax even though it was no longer occupied by the parish priest. A Catholic church owned a rectory consisting of living quarters and office space next door to the church. The rectory was previously used as the residence for the priest assigned to the church. Although the priest no longer resides in the rectory, he regularly conducts church business in the rectory's office. This business includes clerical and administrative business, as well as providing instruction to converts, marriage counseling, and marriage instruction. A married couple resides in the rectory living quarters. The couple is responsible for performing janitorial, general maintenance, lawn care, supervision and security duties to both the rectory and the church in exchange for residing in the rectory. A tax assessor determined that the property was no longer exempt from property tax, and the church appealed. The tax court concluded that the property was exempt. State law exempts from property taxation "all churches, church property, and houses of worship." The court concluded, "The . . . test is whether the property is devoted to and reasonably necessary for the accomplishment of church purposes. Upon the record before us, we conclude that the property is reasonably necessary to the accomplishment of church purposes. . . . [T]he couple resides in the rectory in exchange for providing custodial and security services for the church. Furthermore, there are additional uses of the rectory by the church priest, including clerical and administrative business, as well as providing instruction to converts, marriage counseling and marriage instruction. The [assessor's] only contention is that the couple is also employed outside the church and this outside employment is not church related. We find no support for this contention under case law or the exemption statute. We find the rectory is exempt because its use is reasonably necessary for the accomplishment of church purposes." This case suggests that church-owned parsonages may qualify for exemption from property tax even if they are not occupied by a minister, so long as the property is "reasonably necessary for the accomplishment of church purposes." In this case, this test was met because of the activities that the priest conducted in the rectory's office. Sacred Heart of Brewster Catholic Church v. County of Nobles, 1999 WL 832408 (Minn. Tax 1999).
21. Infrequent or minimal religious use of church property does not result in loss of property tax exemption. The New Jersey Tax Court ruled that two church properties were entitled to exemption from property tax despite their minimal use for religious purposes. Weekly services were conducted at each property, but only two persons usually attended these services. A tax assessor insisted that neither church property was entitled to exemption from property tax because the degree of "religious use" was insufficient. The court disagreed: "To measure the quantum of religious use of a completed building as a condition of granting a tax exemption would engage the courts in an improper evaluation of religious practice. . . . Religious institutions are entitled to the exemption . . . if they demonstrate that the property is actually used for a religious purpose, and the amount of use in this case, though minimal, is sufficient to sustain the exemption." This case will be a useful precedent for churches to cite when confronted by zealous tax assessors attempting to place church-owned property on the tax rolls because of the infrequency of religious use. This is a very important development that will be of direct and immediate assistance to many churches. Roman Catholic Archdiocese v. City of East Orange, 17 N.J. Tax 298 (Tax Court 1999).
22. A New York court ruled that an employee who had been dismissed for proselytizing coworkers was not eligible for unemployment benefits since his behavior constituted "misconduct." In general, employees who are terminated for misconduct are not eligible for unemployment benefits. An employee was terminated from his employment as a computer project specialist after offending a co-worker by admonishing him about his personal life because it was not in accordance with the employee's religious beliefs. As a result of complaints from several coworkers, the employee had previously been counseled by his employer to refrain from espousing his religious beliefs in the workplace. The court concluded that the employee knew that "continued injection of his religious beliefs in the workplace could lead to his termination," and so his behavior amounted to misconduct that disqualified him from unemployment benefits. In re Harvey, 689 N.Y.S.2d 789 (Sup. Ct. 1999).
23. A New York court ruled that a woman employed by a church-operated child care facility was entitled to unemployment benefits following her termination. A woman (the "employee") was employed at a day-care center operated by a church. She worked 6 hours per day, caring for 10 to 12 children ranging in age from 14 to 24 months. Her principal duties were changing diapers, feeding the children and keeping them clean, supervising their play and taking them for walks. The church's rules required that the children were to say grace before meals and have a half hour per day of Bible study and singing. The employee testified that she did not spend any time engaged in these religious activities; rather, her time was spent in "regular taking care of babies as a daycare." The employee's employment was terminated, and she sought unemployment benefits. The church claimed that it was exempt from paying unemployment benefits under a state law exempting any "person employed at a place of religious worship . . . for the performance of duties of a religious nature." The church asserted that because the day-care center was established in furtherance of the church's religious mission, and its primary purpose was to inculcate Biblical teachings at the earliest possible age, the employee's duties, while including the basic care of the children, were primarily religious in nature. A state court rejected the church's position, and ruled that the employee was entitled to unemployment benefits. It concluded, "We find that the record contains abundant evidence that [the employee's] duties were primarily secular and thus not excluded from coverage. It is uncontroverted that most, if not all, of [her] working day was spent tending to the basic needs of these young children, all of whom were still in diapers. For a portion of each day, she alone was responsible for the supervision and care of at least 10 children 24 months old and younger. That [her] services were rendered on behalf of a religious organization does not alter their essential secular character." Jones v. Center Road Baptist Church, 689 N.Y.S.2d 284 (Sup. Ct. 1999).
24. An Ohio court ruled that a former teacher at a church-affiliated school was not eligible for unemployment benefits. A state law denies benefits to persons "[i]n the employ of a church or convention or association of churches, or in an organization which is operated primarily for religious purposes and which is operated, supervised, controlled, or principally supported by a church or convention or association of churches." The court noted that school employees are ineligible for unemployment benefits if (1) the school is an organization "operated primarily for religious purposes," and (2) the school is "supervised, controlled, or principally supported by a church." The court concluded that both tests were met. As to the first test, it noted that "[the] reason for creating and operating a school affiliated with a religious denomination is to offer a learning experience dominated by a religious environment; a situation distinctly different than that offered in public schools. Consequently . . . the primary purpose of operating a school of this type is religious in nature, regardless of whether the school or the local church [is a teacher's] employer." As to the second test, the court noted that "the only individuals authorized to sign paychecks for the school were the principal and the church's pastor," and "the pastor of the church exercised substantial control over the operations and spending of the school, as his consent was required to hire new teachers and to purchase supplies." Miller v. Saints Peter and Paul School, 711 N.E.2d 311 (Ohio 1999).
25. An Oregon court ruled that a church's constitutional rights were not violated by an award of unemployment benefits to a dismissed youth pastor. In 1993 a youth minister (the "minister") was employed by a local church. Several months later, the minister was dismissed. His supervisor later testified that the minister had been dismissed because he "disrupted the cohesiveness of the church's staff, and support of the congregation was decreasing significantly." The minister filed a claim for unemployment compensation benefits. The church resisted this claim on the ground that constitutional guarantees of religious freedom prohibited the state from including ministers in the unemployment compensation system. After protracted hearings before a state agency, the minister was awarded unemployment benefits. The church immediately appealed that ruling in court. A state appeals court began its opinion by noting that the state unemployment compensation law excluded services performed for a "church" and services performed by a minister of a "church." The court ruled that this exemption was invalid since it improperly singled out ministers who performed services for a "church," or who had been credentialed by a church, and excluded ministers employed or credentialed by other kinds of religious organizations. As such, the law violated the "constitutional rule that Oregon must treat all religious organizations similarly whether or not they would qualify as churches."
The church also asserted that the state unemployment law denied benefits to employees who are dismissed because of misconduct, and that the church's determination that the youth pastor had been dismissed for misconduct could not be questioned by the government since this would amount to an unconstitutional interference with a church's selection of its clergy. The court conceded that "the unfettered ability to choose and control a minister goes to the heart of a religious organization's ability freely to practice its faith," and that several federal court decisions "stand for the principle that the application of federal employment laws to the hiring and firing of ministers constitutes an excessive burden on religious freedom that outweighs the important state interest of prohibiting discrimination in employment." However, the court concluded that the interests asserted by the church were embodied in the first amendment guaranty of religious freedom, and that this guaranty was not violated by awarding unemployment benefits to a dismissed minister even if that meant that the employing church would have to prove "misconduct" in order to avoid liability. The court noted that "even by including ministers in the unemployment compensation system, a church retains substantial discretion to choose and control its ministers. That is so because, despite the outcome of the benefits process, the [state] has no authority in any case to change or modify a church's discharge decision. . . . In the absence of direct coercion, church's claimed right to free exercise is best described as concerning generally its right to remain free of any requirement that it explains to the state its ministerial employment decisions. We agree that such an explanation is offensive to principles of church autonomy. However, because the inquiry does not by itself have the power to change a church's decision as to a minister's work status, it is in that sense reasonably characterized as an incidental burden on church's free exercise rights." As a result, the court concluded that the church's first amendment rights were not violated by the award of unemployment benefits to the dismissed youth minister. Newport Church of the Nazarene v. Hensley, 983 P.2d 1072 (Ore. App. 1999).
26. A Washington state appeals court ruled that the exemption of churches from the state unemployment compensation law did not violate state or federal constitutional provisions prohibiting the establishment of religion. A woman was employed as a counselor in a drug treatment program administered by a church. She applied for unemployment benefits following her termination. When benefits were denied on the ground that the church was exempt from coverage under the state unemployment compensation law, the woman challenged the constitutionality of the exemption. The court applied the United States Supreme Court's so-called Lemon test in determining whether the church exemption constituted an impermissible establishment of religion. Under this test, first announced in a 1971 decision (Lemon v. Kurtzman), a government law or practice challenged as an establishment of religion will be valid only if it satisfies the following three conditions-a secular purpose, a primary effect that neither advances nor inhibits religion, and no excessive entanglement between church and state. The court concluded that all of these tests were met. Saucier v. Employment Security Department, 954 P.2d 285 (Wash. App. 1999).
27. Increase in wages subject to FICA tax. The FICA tax rate (7.65% for both employers and employees, or a combined tax of 15.3%) did not change in 2000. However, the amount of earnings subject to tax increased. The 7.65% tax rate is comprised of two components: (1) a Medicare hospital insurance (HI) tax of 1.45%, and (2) an "old-age, survivor and disability" (OASDI) tax of 6.2%. There is no maximum amount of wages subject to the Medicare hospital insurance (the 1.45% "HI" tax rate). The tax is imposed on all wages regardless of amount. For 2000, the maximum wages subject to the "old-age, survivor and disability" (OASDI) portion of self-employment taxes (the 6.2% amount) increases to $76,200-up from $72,600 in 1999. Stated differently, employees who receive wages in excess of $76,200 in 2000 will pay the full 7.65% tax rate for wages up to $76,200, and the "HI" tax rate of 1.45% on all earnings above $76,200. Employers pay an identical amount.
28. Verifying social security numbers. The Social Security Administration (SSA) is urging employers to be sure that amounts reported on Form W-3 correspond to amounts reported on quarterly 941 forms. The SSA also noted that the main reason that W-2 forms are rejected is the use of incorrect social security numbers. Churches and other employers can verify the accuracy of social security numbers of up to 5 employees by calling the SSA at 1-800-772-1213. If you have more than 5 employees, you will need to contact your nearest SSA office for assistance in verifying names and social security numbers.
29. Due date for certain information returns. Employers are required to file an "information return" (Form W-3) by February 28 of each year reporting the amount of employee wages paid during the previous year. In addition, employers are required to file Form 1096 by February 28 of each year reporting the amount of nonemployee compensation paid during the previous year (to persons who received $600 or more). Under present law, the due date for filing information returns with the IRS is the same whether such returns are filed on paper, on magnetic media, or electronically. Congress enacted legislation in 1998 that provides an incentive to filers of information returns to use electronic filing by extending the due date for filing such returns from February 28 to March 31 of the year following the calendar year to which the return relates. This provision applies to information returns required to be filed after December 31, 1999.
The new law also requires the Treasury Department to issue a study evaluating the merits and disadvantages, if any, of extending the deadline for providing taxpayers with copies of information returns from January 31 to February 15 (Forms W-2 would still be required to be furnished by January 31).
30. The IRS issues statistical data on estates. There were 78,000 federal estate tax returns filed for 1995 decedents, according to a recently released IRS Statistics of Income Bulletin. Gross estates totaled $136.1 billion and the estate tax, $14.3 billion. The average gross estate was $1.7 million. Investments in corporate stock represented the largest share of portfolios of both male and female decedents, with bonds (primarily tax-exempt state and local government bonds) representing the second largest share of portfolios of women, and real estate representing the second largest share of portfolios of men. Nearly $110 billion in assets were distributed by these estates. The IRS data reveal that 9 percent of estate distributions went to charities, 38 percent to surviving spouses, and 53 percent to children and other individuals.
31. Employer not liable for complying with IRS levy. An employer began withholding additional taxes from an employee's wages pursuant to a "levy" it received from the IRS. The employee later sued his employer, and a federal court ruled that the employer had acted properly. The court concluded that the tax code shields employers from liability for withholding taxes. Section 3403 of the code states that "the employer shall be liable for the payment of the tax required to be deducted and withheld under this chapter, and shall not be liable to any person for the amount of any such payment." The court observed: "The statutory language is clear and unambiguous. Furthermore, there are a number of cases in which the courts have held that [the code] provides employers with absolute immunity from liability to their employees for any taxes withheld from wages. . . . It would be against public policy and senseless to penalize [the employer] for simply obeying the law." Schiaffino v. Genuardi's Family Markets, 2000-2 USTC ¶ 50,605 (D. Pa. 2000).
32. The "Right-to-Know National Payroll Bill." The House of Representatives passed the "Right-to-Know National Payroll Bill" (HR 164) on July 18. The legislation, if enacted by the Senate and signed into law by the President, would require W-2 forms to disclose the employer's share of Social Security and Medicare taxes. Currently, the W-2 only shows Social Security and Medicare taxes withheld from employees' wages. What is the reason for the proposed change? To let employees know the true cost of the Social Security and Medicare entitlement programs. "For too long, the government has taken taxes from employers and hidden this information from employees," says the bill's principal sponsor, Rep. Peter Hoekstra, (R-Mich.). Hoekstra adds that the bill would help workers understand "the constraints employers face when seeking to create jobs, increase pay and compete effectively in a global economy." President Clinton opposes the legislation.
33. Hiring workers wWithout Social Security numbers. An applicant for employment was not hired because he did not have a social security number. The applicant sued the employer, claiming that his decision not to have a social security number was based on his religious belief that such numbers represent the "mark of the beast" in the Book of Revelation, and therefore the employer's decision not to hire him amounted to unlawful religious discrimination. A federal appeals court concluded that an employer that hires an employee without a social security number is in "violation of federal law," since section 6109 of the tax code requires that employers list employees' social security numbers on W-2 forms. An employer's duty to accommodate an employee's religious beliefs does not require that it violate the law, the court concluded. The court acknowledged that the tax code specifies that no penalty is imposed on an employer for failing to report an employee's social security number on a W-2 form if it is able to demonstrate that "such failure is due to reasonable cause and not to willful neglect." However, the court concluded that "even if a waiver could be obtained, we think that the expense and trouble incident to applying for it imposes a hardship" and that the waiver provision "does not exist to benefit employees who caused the penalties to be imposed." The court also rejected the applicant's argument that the employer could have accommodated his religious beliefs by hiring him as an independent contractor. According to this case, churches are free to deny employment to persons who do not have a social security number. This is so for 2 reasons: First, churches are free to discriminate on the basis of religion in their employment decisions under federal law and the laws of most states. As a result, they generally cannot be sued for "religious discrimination" in their employment decisions. Second, as this case demonstrates, employers are legally required to report employees' social security numbers on W-2 forms, and they need not ignore this mandate (or seek a waiver of it) because of the religious beliefs of an employee or an applicant for employment. Seaworth v. Pearson, 2000-1 USTC ¶ 50,244 (8th Cir. 2000).
34. A federal appeals court ruled that a church was not "exempt" from paying more than $5 million in unpaid payroll taxes. The church was founded in 1950 and operated as a not-for-profit corporation until 1983, when it began operating as an unincorporated religious society. In 1986, the church renounced its status as an unincorporated religious society, opting instead to define itself as a "New Testament Church," based on its belief that the exclusive sovereignty of Jesus Christ over the church required it to disassociate itself from secular government authority. Around the same time, and for the same reason, the church stopped filing federal employment tax returns and paying the federal employment taxes for which it was responsible. There are three federal employment taxes-the social security tax, the medicare tax, and the income tax. Employers must pay half of the applicable social security and medicare taxes and must withhold from employees' wages the other half of the applicable social security and medicare taxes, as well as all of the applicable normal income tax. Employers are liable for both the taxes imposed directly on them and the taxes they are required to withhold from employees. Since sometime before 1987, the church has paid none of these taxes. Eventually, the IRS contacted the church about its failure to file employment tax returns, but the church offered no indication that it would file returns. As a result, in early 1994, the IRS prepared quarterly returns for the church beginning in 1987 and continuing through 1993. The IRS then sent the forms to the church so that it could check the accuracy of the amounts on the returns, but the church submitted no corrections. After the time for submitting corrections had passed, the IRS calculated an assessment of tax, interest, and additions totaling some $3.5 million and sent a notice and demand for payment to the church. With accrued interest and penalties, the church's obligation increased to $5.3 million by 1998. The IRS asked a federal court to enter a summary judgment in its favor and against the church for the full $5.3 million, and to foreclose on a tax lien the IRS had imposed on the church's property. In defense of its failure to pay, the church argued that the first amendment guarantees of religious freedom and nonestablishment of religion, as well as the Religious Freedom Restoration Act, protected it from liability. A trial court ruled summarily in favor of the government, and the church appealed. A federal appeals court summarily rejected all of the church's claims, upheld the IRS position, and authorized the sale of church property to cover the unpaid payroll taxes.
The court conceded that the first amendment guarantee of religious freedom "absolutely protects the freedom to believe and profess whatever religious doctrine one desires." However, "neutral laws of general application that burden religious practices do not run afoul" of the first amendment. Since federal employment tax laws are "neutral laws of general application" (that is, they apply to a large class of employers, and do not single out religious employers for less favorable treatment) they do not violate the first amendment. The court also concluded that the Religious Freedom Restoration Act provided no relief to the church. Under RFRA, laws that substantially burden the free exercise of religion cannot be enforced unless the burden furthers a compelling government interest and is the least restrictive means of furthering that interest. The court noted that "the Supreme Court and various courts of appeals [have] concluded both that maintaining a sound and efficient tax system is a compelling government interest and that the difficulties inherent in administering a tax system riddled with judicial exceptions for religious employers make a uniformly applicable tax system the least restrictive means of furthering that interest." The church insisted that none of these cases were relevant since each involved a "state recognized legal entity," while it was a "New Testament Church." Once again, the court dismissed this argument summarily. Finally, the court rejected the church's argument that the "excessive entanglement" between church and state created by the imposition of employment taxes in this case (and the IRS attempt to recover them) violated the first amendment's nonestablishment of religion clause by involving the government in internal church practices. The court disagreed, noting that, "While taxing religious organizations involves greater government entanglement than not taxing them does, this greater entanglement is not necessarily unconstitutionally excessive. In fact, the Supreme Court has held that the sorts of generally applicable administrative and record keeping requirements imposed by tax laws may be imposed on religious organizations without violating the [first amendment]. . . . The normal incidents of collecting federal employment taxes simply do not involve the intrusive government participation in, supervision of, or inquiry into religious affairs that is necessary to find excessive entanglement. Even the somewhat more intrusive tax foreclosure ordered in this case is a discrete event involving no inquiry into religious matters and, as such, raises no excessive entanglement concerns."
It is now clear, based on this case as well as those cases cited by the court, that any attempt by a church to avoid compliance with applicable federal payroll tax obligations (including the withholding and payment of income taxes and social security taxes) on the basis of the first amendment, its religious beliefs, or its unique structure or status, will be summarily rejected by the civil courts. Indianapolis Baptist Temple v. United States, 2000-2 USTC ¶50,663 (7th Cir. 2000).
35. A federal appeals court ruled that the revocation of a church's tax-exempt status by the IRS could not be challenged on the ground that the IRS's "examination" of the church exceeded the two-year limit imposed by the Church Audit Procedures Act. A church was started by an evangelist and recognized as tax-exempt by the IRS in 1981. In 1996, the IRS revoked the church's exempt status on the ground that the church was so closely operated and controlled by and for the benefit of its founder that it enjoyed no independent existence; that the church was formed and operated by its founder for the principal purpose of willfully attempting to defeat or evade federal income tax; and that the church was inseparable from its founder, and failed to operate for exclusively charitable purposes. The church challenged the revocation of its exempt status because of the IRS's failure to comply with section 7611(c)(1)(A) of the Church Audit Procedures Act, which requires that a church tax examination take no more than two years to complete. The IRS initiated its church tax inquiry of the church in 1989 by sending a "Notice of Church Examination," and the "Final Adverse Determination" letter revoking the church's exempt status was not issued until 1996. As a result, the inquiry took over six years. Even with a one-and-a-half-year delay that may have been agreed to by the parties, the inquiry into the church's exempt status exceeded the two year limitation by nearly three years. A federal district court rejected the church's argument, and the church appealed. The appeals court noted that section 7611(e)(2) of the Church Audit Procedures Act provides: "Remedy to be exclusive. No suit may be maintained, and no defense may be raised in any proceeding . . . by reason of any noncompliance by the [IRS] with the requirements of this section." The court noted that the entire Church Audit Procedures Act is set forth in section 7611 of the tax code, and therefore the reference to the word "section" in section 7611(e)(2) refers to all of section 7611. The court concluded: "Thus, by the plain language of the statute, a suit may not be maintained, nor may a defense be raised based on the violation by the IRS of subsection 7611(c)(1) [the two-year limit on church tax examinations]." The court also rejected the church's argument that allowing the IRS to proceed with revoking the church's exemption despite the fact that its "examination" had exceeded the two-year limit would "eviscerate all of the critical protections which Congress-in light of the requirements of the First Amendment-intended to give churches under [section 7611]." The court agreed that Congress, in enacting the Church Audit Procedures Act, "intended to convey benefits to churches in connection with their IRS affairs." But it insisted that Congress did not give churches the ability to "convert IRS lapses into anti-enforcement swords." As a result, the church could not "assert a violation of a requirement of section 7611 as a defense or as the basis of a declaratory judgment." Music Square Church v. United States, 2000-2 USTC ¶50,578 (Fed. Cir. 2000).
36. IRS reconsiders salary "restructuring" arrangements. The tax code prohibits employers from "paying" for reimbursements under an accountable business expense reimbursement arrangement out of salary reductions. Such arrangements are not "illegal." They simply cannot be "accountable." What about salary restructuring arrangements? Does the ban on using salary reduction arrangements to fund accountable expense reimbursements apply to these arrangements as well? Under a salary restructuring arrangement, an employer reduces an employee's salary in advance of the year by an amount that will be used to reimburse business expenses substantiated under an accountable arrangement. In 1999, the IRS ruled that such arrangements can be accountable if they are done in advance, and any "balance" in the reimbursement account is retained by the employer at the end of the year and not distributed to the employee. IRS Letter Ruling 199916011. However, in a 2000 ruling, the IRS announced that the whole issue of salary restructuring arrangements was under review and that the 1999 ruling was being withdrawn. IRS Letter Ruling 200035012. Therefore, church treasurers should assume that salary restructuring arrangements will not be accountable until further clarification is provided by the IRS.