Church Tax Developments in 2001

 

1. 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 2001. 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 2001, the maximum wages subject to the “old‑age, survivor and disability” (OASDI) portion of self‑employment taxes (the 6.2% amount) increases to $80,400—up from $76,200 in 2000. Stated differently, employees who receive wages in excess of $80,400 in 2001 will pay the full 7.65% tax rate for wages up to $80,400, and the “HI” tax rate of 1.45% on all earnings above $80,400. Employers pay an identical amount.

 

2. 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.

 

3. Charitable contributions. In 2001 the IRS released the advance text of a special publication entitled "Disaster Relief: Providing Assistance Through Charitable Organizations," that contains the following information:

 

Charitable contributions are tax-deductible if made to a qualified organization. Qualified organizations include charitable organizations that the IRS has determined are exempt from federal income tax [and] churches, their integrated auxiliaries, and conventions or associations of churches . . . . Persons can help victims of disaster or hardship by giving gifts directly to individual victims or through non-qualified organizations. This type of assistance does not qualify as tax-deductible contributions since a qualified organization is not the recipient. However, individual recipients of gifts are not subject to tax on the value of the gift, unless an employer provides the assistance for the benefit of an employee.

 

The publication contains the following example:

 

Jim, a college student and a counselor at a summer camp, accidentally rolls his old truck into a lake. The other counselors collect several hundred dollars and give the monies directly to Jim to help with the down payment for another truck. Since the counselors are making personal gifts to a particular individual, the use of a qualified charitable organization would not be appropriate. The counselors cannot take a tax-deduction on their gifts to Jim. But, neither Jim nor the other counselors are subject to federal tax on the gift.

 

Key point. This example provides useful information for church treasurers. It is common for churches to receive donations that are earmarked for a specific individual. In many cases, these donations are prompted by an illness or personal tragedy involving the designated individual. However, the IRS publication quoted above suggests that it "would not be appropriate" for a church to accept such gifts since they clearly are not tax-deductible.

 

4. Church assistance to victims of disasters and hardship. In 2001 the IRS released the advance text of a special publication entitled "Disaster Relief: Providing Assistance Through Charitable Organizations," that contains the following information concerning the distribution of funds by a "disaster relief or emergency hardship organization." The same principles would apply to churches and other religious organizations.

 

The following sections emphasize how charitable organizations can provide assistance to disaster or emergency hardship victims in ways that accomplish charitable purposes. [A charity] may provide loans or grants in the form of funds, services or goods to ensure that victims have the basic necessities, such as food, clothing, housing (including household repairs), transportation, and medical assistance (including psychological counseling assistance). The type of aid that is appropriate depends on the individual's needs and resources. Immediately following a devastating flood, a family may be in need of food, clothing and shelter, regardless of their financial resources. However, they may not require long-term assistance if they have adequate financial resources. Persons who are needy or distressed are appropriate recipients of charity. Examples include persons who are: (1) impoverished as a result of low income and lack of resources; (2) temporarily in need of food or shelter when stranded, injured or lost because of fire, flood, accident or other disaster; (3) victims of a civil disturbance; (4) temporarily unable to be self-sufficient as a result of a sudden and severe personal or family crisis, such as victims of crimes of violence or physical abuse; or (5) refugees or immigrants experiencing language, cultural or financial difficulties.

 

The group of persons that may properly receive assistance from a charitable organization is called a charitable class. A charitable class must be large or indefinite enough that providing aid to members of the class benefits the community as a whole. Because of this requirement, a disaster relief or emergency hardship organization cannot be formed and operated to assist particular, pre-selected individuals, such as a few persons injured in a particular fire. Similarly, contributions cannot be earmarked to a charitable organization for a particular individual. When a disaster or emergency hardship occurs, a charitable organization may help persons who are needy or distressed because they are part of a general class of charitable beneficiaries, provided the organization is in control of who gets the assistance.

 

The IRS publication provides the following example to illustrate these points:

 

Linda's baby, Todd, suffers a severe burn from a fire, which will require considerable costs that Linda cannot afford. . . . [Several donors want to make contributions to a charity for the benefit Todd.] The charity must be in a position to determine whether any assistance for Todd is appropriate. Therefore, donors should be advised that, while funds may be used to assist Todd, their contributions might well be used for other children who have similar needs. Contributions earmarked for Todd, specifically, cannot be accepted by the organization.

 

Key point. This example states unequivocally that contributions earmarked for Todd "cannot be accepted" by the charity. Church treasurers should keep this example in mind when church members want to make contributions to the church for the benefit of a specific needy person or family. Since such "contributions" are not tax-deductible by the donor, the church should not receive them.

 

Example. Amy is a young mother who recently was diagnosed with a rare kidney disease that will require expensive and continuing treatment in excess of her insurance coverage. Her father hands the treasurer of Amy's church a check in the amount of $10,000, payable to the church, with the stipulation that it be used for Amy's medical expenses. According to the IRS publication "Disaster Relief: Providing Assistance Through Charitable Organizations," this check "cannot be accepted" by the church since it is not a tax-deductible contribution.

 

Example. The Smith family loses its home in a fire. The home was not insured adequately for this loss. The family's church has a benevolence fund, and several members make contributions to this fund assuming that their contributions will be distributed to the Smith family. Members' contributions may be tax-deductible if they are advised that while their contributions may be used to assist the Smith family, their contributions might be used for other individuals or families who are in need. Contributions earmarked for the Smith family, specifically, "cannot be accepted" by the church.

 

5. IRS addresses Form 8282 reporting requirement. The tax code requires churches that receive a donation of noncash property (other than publicly traded stock) valued by the donor at more than $5,000 to file an information return (Form 8282) with the IRS, and to provide a copy of the return to the donor, if the church sells, exchanges, or otherwise disposes of the donated property within 2 years after its receipt. A church must list its name, address, taxpayer identification number, and a description of the donated property on Form 8282. It also must list the donor's social security number, the date the property was donated, and the amount received from the sale or other disposition of the property. The IRS recently addressed the question of the penalty, if any, that should be assessed against a church or other charity that does not list the donor's social security number on Form 8282. It concluded that section 6721 of the tax code imposes a penalty in such a case of $50 for each return that does not contain a donor's social security number. The IRS pointed out, however, that this penalty can be reduced to $30 per return if a return is filed with the correct information within 30 days following the due date of the return. Further, the instructions to Form 8282 state that the form does not have to be filled out completely if, for example, the information is not available to the church because it does not have the donor’s appraisal summary (Form 8283). IRS Letter Ruling 200101031.

 

6. Tax Court denies deduction for a member's contributions to his church. The Tax Court denied a church member's charitable contribution deductions to his church for lack of substantiation. The taxpayer claimed that his bank savings account register proved that he made charitable contributions of $7,500 in one year and $7,810 in another year because it showed withdrawals in these amounts. The court disagreed. It noted that the name of the charity must be shown on the reliable written record and that John did not list the name of the church for these withdrawals. While the register showed the dates and amounts of the withdrawals, it did not show the dates and amounts of the alleged contributions. The court also rejected the taxpayer's claim that most of his contribution deductions were "carryovers" from contributions that he had made, but not deducted, in prior years. While in some cases a taxpayer who contributes more than can be deducted in one year may be able to "carry over" the excess to the next year, this option was not available to the taxpayer in this case since he "failed to show that any amounts qualified as charitable contributions in prior years, or that any excess charitable contributions existed from prior years that were available to be carried over to 1994, 1995, and 1996." Jennings v. Commissioner, T.C. Memo. 2000-366 (2000).

 

7. Estimating charitable contributions. A taxpayer claimed charitable contribution deductions of $5,400 in one year and $2,700 in the next year. The IRS disallowed both deductions on the basis of insufficient substantiation, and the taxpayer appealed to the Tax Court. The taxpayer attempted to provide an estimate of a portion of these contributions by multiplying an approximate number of times he attended church each year by his average weekly contribution, but he was uncertain of even this estimate. The court conceded that in certain circumstances taxpayers may estimate the amount of their charitable contributions if they "provide a sufficient basis to estimate the amount of the contributions, such as showing regular church attendance and regular cash contributions thereto." But the court concluded that the taxpayer in this case was not entitled to any deduction for his estimated contributions since he "failed to establish any regularity in occurrence or extent of the donations from which we could estimate an amount, or to present any reliable evidence indicating he actually made these or other contributions." Ekeh v. Commissioner, T.C. Summary Opinion 2001-50 (2001).

 

8. Tax Court denies a donor's charitable contribution deductions. A taxpayer ("Jack") claimed the following charitable contribution deductions on his tax return: (1) $16,000 of cash contributions to his church, and (2) $5,000 for the gift of his car to the president of a parachurch ministry ("Gene"). Jack had no written records to substantiate the cash gifts he allegedly made to his church. The Tax Court noted that "without written records, a deduction for charitable contributions generally is not allowed." However, the Court noted that in certain circumstances it had allowed a deduction "even without written records where a taxpayer provides a sufficient basis to estimate the amount of the contributions, such as showing regular church attendance and regular cash contributions thereto." While the Court conceded that Jack attended church every Sunday and often donated cash, even when he traveled, "he failed to establish any regularity in occurrence or extent of the donations from which we could estimate an amount." Therefore, the Court reduced Jack's contribution deduction to $6,300 for the cash contributions made to the church. With respect to the car, the Court acknowledged that Gene was the president of a parachurch ministry. But it noted that the car was titled solely in Gene's name and not in the name of the ministry. Therefore, "it is clear that the car was transferred to Gene individually and not to the charitable organization. Thus, the [gift of the car] was not made to a qualified [charitable] organization" as required in order for Jack to be entitled to a charitable contribution deduction. The Court noted that while Jack's actions "may have been entirely altruistic and intended to benefit [the ministry], the contributions are not deductible." Barck v. Commissioner, T.C. Summary Opinion 2001-51.

 

9. IRS simplifies payroll tax reporting for small employers. Beginning January 1, 2001, many small employers can 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. The change from monthly to quarterly payroll tax deposits has a number of advantages for smaller churches, including the following: (1) IRS notices to small employers are expected to decrease by 70% because there will be fewer deposits; (2) because this change will reduce the frequency of deposits, smaller employers will encounter fewer mistakes and fewer penalties; (3) payments on a quarterly rather than a monthly basis will help smaller employers with cash flow issues. IRS News Release IR-2000-83.

 

10. IRS announces electronic verification of taxpayer identification numbers. Look for the IRS web site (www.irs.gov) to allow employers to verify the accuracy of taxpayer identification numbers next year. This development will help churches verify that the social security numbers provided by employees and self-employed persons are correct.

 

11. Tax Court addresses backup withholding. A construction company hired several subcontractors over the course of the year. When subcontractors were hired for a project, the company would send them a letter requesting them to fill out an enclosed Form W-9. A Form W-9 is used to obtain another person's social security number so that a Form 1099 can be issued to the person at the end of the year. In fact, the company failed to obtain the social security numbers of several workers, and issued 1099 forms without entering a social security number. The company failed to engage in backup withholding on these workers. The IRS ruled that the company was liable for a penalty and interest on the amounts of backup withholding that it failed to deduct from the workers' compensation. The company claimed that the workers in fact provided their social security numbers to the company after the IRS initiated its audit, and it voluntarily provided this information to the IRS. Therefore, the company argued that no penalties or interest were owed. The Tax Court ruled that the company had to pay the penalties and interest on amounts it failed to withhold. The court observed that an employer is required to engage in backup withholding for any payment "if the payee fails to furnish his taxpayer identification number . . . either orally or in writing." Further, "payments that are subject to the backup withholding are treated as if they were wages paid by the employer to an employee" and so the employer is required to file quarterly Forms 941 and pay withheld taxes. Backup withholding is required "for the period of time any reportable payment is made by the payor and the time in which the taxpayer identification number has not been furnished. Therefore, backup withholding should occur at the time of payment to the employee; and if an employer does not have an employee’s taxpayer identification number at the time of payment, backup withholding is required." The court concluded that several subcontractors had not furnished their taxpayer identification numbers at the time the company made payments to them, and therefore the company was required to engage in backup withholding. The tax code specifies that "if a payor fails to deduct and withhold the taxes, but the payor can show that the payee reported the payment on his or her federal income tax, the monies will not be collected from the employer." However, the payor is not relieved from liability for any penalties or additions to the tax otherwise applicable for such failure to deduct and withhold. As a result, the court ruled that the company was liable for penalties and interest for failing to engage in backup withholding even though the workers correctly reported their taxes. Churches that fail to implement backup withholding may be subject to a penalty, as this case illustrates. V & V Construction Company v. United States, 2001-1 USTC ¶50,403  (N.D. Ill. 2001)

 

12.  A District of Columbia appeals court ruled that property owned by a religious organization but used by a school was exempt from property tax. A religious organization leased a portion of its facilities to a nonprofit music school. The lease provided that the religious organization would pay any real estate taxes on its property resulting from the lease, and that the school would reimburse any such payments. The religious organization filed an application seeking to have its leased property declared exempt from property taxes. This request was denied by a local taxing authority, and this decision was upheld by a trial court. The court explained that "the property is owned and operated by two different types of nonprofit entities . . . [a religious organization and an educational organization]. Each entity is guided by different subsections of the exemption statute. There is no question that if the property was owned and operated by [the school] the property would be exempt. The same would be true if [the religious organization] was a nonprofit school, college or university, that recognized the generally recognized relationship of teacher and student. . . . [T]he court concludes that the [taxing authority] was reasonable in interpreting that concurrence of ownership and use by the same type of entity is required to obtain exempt status . . . ." The religious organization appealed, arguing that the property was tax‑exempt because it was owned by a nonprofit religious organization and operated by a nonprofit school. It insisted that the property tax exemption statute did not compel the interpretation that concurrent ownership and operation by the same type of nonprofit entities are required for exemption and that such an interpretation is unreasonable. The appeals court agreed, concluding that limiting the property tax exemption to property that is both owned and operated by the same kind of nonprofit organization "would be an anomaly and contrary to the legislative intent to permit nonprofit charitable organizations, schools, and religious groups to operate in the District of Columbia without the burden of taxation. . . . There is nothing in the legislative history which would show [an intent] to deny a tax exemption where the property is both owned and used by the types of entities exempt from taxation under the statute simply because the owner and user would qualify ordinarily under different sections of the statute." Many churches allow their property to be used by other nonprofit organizations. This case suggests that church property that is used by a non-religious charity may still be exempt from property taxation. There is no requirement that the property be used or operated by another religious charity. Sisters of the Good Shepherd v. District of Columbia, 746 A.2d 310 (D.C. App. 2000).

 

13. Property tax exemption denied for vacant land. In 1999 a congregation purchased a one-acre tract of unimproved land adjacent to its existing property. Within 90 days of purchase the congregation filed an application for exemption from property tax (for 1999) with the county tax assessor. The application contained the question, "Are buildings planned or under construction?" The congregation marked an "X" in the "No" response. The congregation approved plans in 2000 to construct a building containing an educational facility with administrative offices and a library and chapel on the newly acquired land. A Washington court ruled that the property was not exempt from taxation in 1999. The court noted that "the burden rests on the congregation to show clearly that the property is within the exempting statutes during the time at issue (1999)." It concluded that the congregation had failed to meet this burden of proof. State law exempts from property taxation "all churches, personal property, and the ground, not exceeding five acres in area, upon which a church of any nonprofit recognized religious denomination is or shall be built." The property tax statute further provides that "to be exempt the property must be wholly used for church purposes." The court concluded, "Language in a statute must be given its ordinary meaning if not defined otherwise in the statute. . . . The language of the statute is clear. The 'shall be built' exemption applies only to land and buildings which will become 'churches' upon completion. The parcel was acquired in 1999. The decision on how to use the new parcel was not taken until the year 2000. . . . We conclude that for assessment year 1999 (taxes payable in 2000) there were ideas but no decision on how this parcel would be used." Herzl-Ner Tamid Conservative Congregation v. State of Washington, Bd. of Tax Appeals Dec. 55611 (2001).

 

14. Are unaccredited church schools exempt from property tax? Yes, concluded a Washington court. A church operated a private school for children in grades K-12. The church opened the school in 1986 as part of its ministry. The school ceased operations for a four-year period in the 1990's, but was reopened and has an enrollment of 58 full time students. In addition, the church uses the school building to minister to the religious and instructional needs of some 300 children each week on a part-time basis. All of the school's teachers hold at least a B.A. degree, but none is certified as a K-12 teacher by the state. The school is not accredited by the state or any other accrediting institution. However, its graduates have been accepted by various colleges without question. Students who have transferred to public schools in the area have had their credits accepted. The church applied for a property tax exemption for its school for the 1999 assessment year. A tax assessor ruled that the school was not entitled to exemption because it was not accredited by the state. A court reversed this decision and ruled that the school property was exempt. The court noted that state law exempts "property owned or used for any nonprofit school or college in this state for educational purposes." The court concluded, "A non-profit school is eligible for the exemption if it offers an educational program of a general academic nature and its students' credentials are accepted without question or examination by Washington's public schools. It is not necessary that the school or its teachers be accredited. The school . . . although integrated with a religious-based curriculum, is nevertheless clearly an educational program of a general academic nature." Faith Baptist Church v. State of Washington, Bd. of Tax Appeals Dec. 55710 (2001).

 

15. IRS issues new Form W-9. Many churches use Form W-9 to obtain the social security numbers of self-employed persons so that a Form 1099 can be prepared and issued. Church treasurers should be aware that the IRS revised Form W-9 in December 2000, and that the new form must be used after June 30, 2001. The major change is that self-employed persons must now certify that they are a "U. S. person" (including a U.S. resident alien). The new forms are available by calling the IRS at 1-800-TAX-FORM, or by visiting the IRS web site at www.irs.gov.