By Richard R. Hammar, J.D., LL.M., CPA
© Copyright 2001 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 c0103
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 2002. 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 2002, the maximum wages subject to the OASDI portion of selfemployment taxes (the 6.2% amount) increased to $84,900—up from $80,400 in 2001. Stated differently, employees who receive wages in excess of $84,900 in 2002 will pay the full 7.65% tax rate for wages up to $84,900, and the HI tax rate of 1.45% on all earnings above $84,900. 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. IRS publication addresses individuals’ gifts to benevolence needs. The IRS issued an updated Publication 3833 (Disaster Relief) in March of 2002. This publication provides charities with helpful information on how to handle contributions from individuals that designate a specific benevolence recipient. Here is the key excerpt:
Individuals can also help victims of disaster or hardship by making gifts directly to victims. This type of assistance does not qualify as a tax-deductible contribution since a qualified charitable organization is not the recipient. However, individual recipients of gifts are generally not subject to federal income tax on the value of the gift.
The publication then provides the following example which will be useful to many church treasurers in evaluating the tax-deductibility of contributions to the church that designate a particular needy person.
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 gifts to a particular individual, the use of a qualified charitable organization would not be appropriate. The counselors cannot claim tax deductions for their gifts to Jim. However, Jim is not subject to federal income tax on the gift amount. (emphasis added)
4. Church assistance to victims of disasters and hardship. IRS Publication 3833 (Disaster Relief), issued in March of 2002, contains 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. Here are the key excerpts that are directly relevant to many kinds of benevolence gifts made to churches:
Disaster relief or emergency hardship organizations may provide assistance in the form of funds, services, or goods to ensure that victims have the basic necessities, such as food, clothing, housing (including repairs), transportation, and medical assistance (including psychological counseling).The type of aid that is appropriate depends on the individual’s needs and resources. For example, 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. Individuals who are financially needy or otherwise distressed are appropriate recipients of charity. Financial need and/or distress may arise through a variety of circumstances. Examples include individuals who are:
The group of individuals 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 tax-exempt disaster relief or emergency hardship organization cannot target and limit its assistance to specific individuals, such as a few persons injured in a particular fire. Similarly, donors cannot earmark contributions to a charitable organization for a particular individual or family. When a disaster or emergency hardship occurs, a charitable organization may help individuals who are needy or otherwise distressed because they are part of a general class of charitable beneficiaries, provided the organization selects who gets the assistance. (emphasis added)
The publication provides the following example:
Linda’s baby, Todd, suffers a severe burn from a fire requiring costly treatment that Linda cannot afford. Linda’s friends and co-workers form the Todd Foundation to raise funds from fellow workers, family members, and the general public to meet Todd’s expenses. Since the organization is formed to assist a particular individual, it would not qualify as a charitable organization.
Consider this alternative case: Linda’s friends and co-workers form an organization to raise funds to meet the expenses of an open-ended group consisting of all children in the community injured by disasters where financial help is needed. Neither Linda nor members of Linda’s family control the charitable organization. The organization controls the selection of aid recipients and determines whether any assistance for Todd is appropriate. Potential donors are advised that, while funds may be used to assist Todd, their contributions might well be used for other children who have similar needs. The organization does not accept contributions specifically earmarked for Todd or any other individual. The organization, formed and operated to assist an indefinite number of persons, qualifies as a charitable organization.
The publication cautions charities that “an organization must maintain adequate records that demonstrate the victims’ needs for the assistance provided. These records must also show that the organization’s payments further charitable purposes.” It clarifies that documentation should include:
However, the publication concedes that “a charitable organization that is distributing short-term emergency assistance would only be expected to maintain records such as the type of assistance provided, criteria for disbursing assistance, date, place, estimated number of victims assisted (individual names and addresses are not required), charitable purpose intended to be accomplished, and the cost of the aid. Examples of such short-term emergency aid would include blankets, hot meals, electric fans, or coats, hats, and gloves. An organization that is distributing longer-term aid should keep the above more-detailed records.”
5. Proposed legislation addresses church political activities. Federal law prohibits tax-exempt churches from (1) intervening or participating in any political campaign on behalf of or in opposition to any candidate for public office at the local, state, or federal level, and (2) engaging in substantial efforts to influence legislation. Many churches violate either or both of these restrictions, but the IRS has been reluctant to respond. The “Houses of Worship Political Speech Protection Bill” (H.R. 2357) was introduced in the House of Representatives by Congressmen Camp (MI) and Kennedy (MN). If enacted, it would have allowed churches to engage in some political activities without loss of their tax-exempt status. On October 2, 2002, the House rejected this bill by a vote of 178-239. A similar bill (H.R. 2931) was introduced in the House of Representatives by Rep. Philip Crane (R-IL). If enacted, the bill would allow churches to engage in efforts to influence legislation without jeopardizing their tax-exempt status so long as their total expenditures for such activities are less than 20% of the church’s annual gross revenue. The bill also would allow churches to engage in political campaign activities without jeopardizing their tax-exempt status so long as their total expenditures for such activities are less than 5% of the church’s annual gross revenue. This bill was pending at the time of publication of this text (with only 20 cosponsors).
6. IRS reissues tax guide for churches. In 1994, the IRS published a "Tax Guide for Churches" containing basic information on a variety of tax issues relevant to church leaders. The publication was discontinued a few years later. In 2002, the IRS issued a new and updated Tax Guide for Churches. Relevant provisions of the new IRS publication are discussed throughout this text.
7. IRS addresses qualified tuition reductions. Many churches operate schools and offer “tuition discounts” to employees of both the school and church whose children attend the school. For example, a church operates a private school (K-12). The annual tuition is $2,500. The school allows the children of its employees to attend at “half” tuition. The same rate applies to the children of church employees. For 2002, tuition reductions are provided to the children of five school employees, and four church employees. Are there tax consequences to these tuition discounts? Do the tuition “reductions” represent taxable income to the parents, or are they nontaxable? Section 117(d) of the tax code specifies that "qualified tuition reductions" are not taxable. To be "qualified," however, certain conditions must be met. Among other things, the tuition reduction must be provided to an employee of an "organization described in section 170(b)(1)(A)(ii)" of the tax code. This section refers to "an educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on." In the past, it has not been clear whether the IRS or the courts would consider an employee who works directly for a church to be an employee of an educational institution, even if the church operates a private school.
A recent IRS ruling addressed the eligibility of church employees for qualified tuition reductions, and concluded that they are not eligible for the exclusion. The IRS noted that nontaxable qualified tuition reductions must be provided by an educational organization described in section 170(b)(1)(A)(ii), which refers to schools. The IRS conceded, however, that a school that is "operated as an activity or function of" a church may qualify as an "educational organization" for purposes of section 117(d), even though not separately organized or incorporated. However, the IRS concluded that “an excludable [qualified tuition reduction] could not be extended to church employees who were not employed within the context of the school function, or educational organization. Thus, for example, a diocese operating a school system may not properly exclude from reportable wages as qualified tuition reductions . . . the value of tuition reduction benefits it might provide to employees of a hospital it also operates.” IRS Private Letter Ruling 200149030.
8. Congress considers church employees’ tuition discounts. In 2002 the “Equity in Education Act” (H.R. 4950) was introduced in the House of Representatives by Congressmen Camp (MI) and Kennedy (MN). If enacted, this bill would amend the tax code to clarify that church schools can provide nontaxable tuition discounts to employees of both the school and church. This bill was pending at the time of publication of this text (with only 26 cosponsors).
9. IRS suspends Form 5500 filing requirement for fringe benefit plans. Effective immediately, the IRS has indefinitely suspended the requirement for employers to file Schedule F of Form 5500 (Fringe Benefit Plan Annual Information Return). The filing suspension applies to all plan years, including years prior to 2001. During the suspension period, the IRS will review reporting requirements and electronic filing options. Before this announcement, sponsors of certain fringe benefits (including churches) were required to file the annual information return, Schedule F (Form 5500) for cafeteria plans, educational assistance programs, and adoption assistance programs. The IRS has stated, "Sponsors of fringe benefit plans who have not filed required Forms 5500, Schedule F, for plan years prior to 2001 should not seek relief under the Department of Labor’s Delinquent Filer Voluntary Compliance Program (DFVC). There is also no need to request relief from the IRS for failure to file these forms." The IRS cautioned, however, that its action "did not relieve administrators of employee benefit plans from any obligation to file a Form 5500 and any required schedules (other than the Schedule F). Internal Revenue News Release IR-2002-43 (April 4, 2002).
10. A New York court ruled that a donor's widow had the legal authority to enforce the terms of a charitable contribution her husband had made to a charity. A recovered alcoholic devoted the last 40 years of his life to the treatment of alcoholism. In 1971 he announced his intention to make a gift to a hospital of $10 million for the establishment of an alcoholism treatment center. With $1 million from the first installment of the gift the hospital purchased a building for the rehabilitation program. According to the donor's widow, the hospital sought to avoid its obligations under the terms of the gift, and its relationship with the donor was an uneasy one. A year after the donor's death in 1994 the hospital informed his widow that it planned to move the treatment center into a hospital ward and sell the building. The hospital's plans aroused the suspicions of the donor's widow, and she demanded an accounting of the treatment center's finances. The hospital at first resisted disclosing its financial records, but the widow persisted, and in 1995 the hospital disclosed that it had been misappropriating monies from the endowment fund (funded by the donor's original gift) and transferring them to its general fund where they were used for purposes unrelated to the treatment center. The widow notified the state attorney general who investigated the hospital's finances and confirmed that it had transferred restricted assets from the endowment fund to its general fund in what it called "loans." The attorney general demanded the return of these assets and the hospital returned nearly $5 million to the endowment fund, although it did not restore the income lost on those funds during the intervening years. The widow was still convinced that the hospital was not fully honoring her husband's gift, and so she filed a lawsuit in which she asked a court to compel the hospital to honor the terms of the gift. The state attorney general asked the court to dismiss the widow's lawsuit on the ground that donors lack "standing" (judicial authority) to enforce the terms of their gifts. The attorney general insisted that standing to enforce the terms of a charitable gift is limited to the attorney general.
The court concluded that a donor (or, in this case, a donor's widow acting on his behalf) does have the legal authority to enforce the terms of a charitable contribution. It explained,
The donor of a charitable gift is in a better position than the attorney general to be vigilant and, if he or she is so inclined, to enforce his or her own intent. . . . To hold that, in her capacity as her late husband's representative [the donor's widow] has no standing to institute an action to enforce the terms of the gift is to contravene the well-settled principle that a donor's expressed intent is entitled to protection and the longstanding recognition under New York law of standing for a donor. We have seen no New York case in which a donor attempting to enforce the terms of his charitable gift was denied standing to do so. . . . Moreover, the circumstances of this case demonstrate the need for co-existent standing for the attorney general and the donor. The attorney general's office was notified of the hospital's misappropriation of funds by [the donor's widow]. Indeed, there is no substitute for a donor, who has a special, personal interest in the enforcement of the gift restriction. . . . We conclude that the distinct but related interests of the donor and the attorney general are best served by continuing to accord standing to donors to enforce the terms of their own gifts concurrent with the attorney general's standing to enforce such gifts on behalf of the beneficiaries thereof.
It is common for churches to receive contributions from donors that are designated for a specific purpose. For example, donors contribute money to the church's building fund, or a scholarship fund or missions fund. Can these donors legally enforce their designations if the church decides to divert these contributions to other purposes? This court concluded that they can, even if they retained no right to do so in a written agreement. The attorney general also is authorized to enforce the conditions of a designated gift, but the attorney general's authority is not exclusive. It is "concurrent" with the authority of the donors themselves. Church leaders should keep this principle in mind when considering a diversion of designated funds to a purpose not specified by a donor. Smithers v. St. Luke's-Roosevelt Hospital Center, 723 N.Y.S.2d 426 (2001).
11. Electronic payment of taxes. The IRS has announced that it will now accept federal tax payments from individuals, as well as from employers, through a newly launched website. The site is the newest offering of the Electronic Federal Tax Payment System (EFTPS), a program that currently permits tax payments to be made through the use of special software programs or via telephone. "EFTPS-OnLine" allows employers and individuals to pay all federal taxes through a secure web site on the Internet. EFTPS was originally introduced in November 1996, and since that time employers have used it to pay more than $5.7 trillion in federal taxes. Employers and individuals can enroll for EFTPS-OnLine via the Internet. After enrollment, taxpayers will receive a confirmation kit by mail with instructions for obtaining an Internet password. A unique Personal Identification Number (PIN) will be mailed separately, to new EFTPS users, for added security.
For more information, visit www.eftps.gov or call 1-800-555-4477 or 1-800-945-8400. IRS Publication 966 describes the EFTPS options in detail. Some employers are required to use EFTPS because their total deposits of designated federal taxes exceed $200,000 during a calendar year. These employers are required to use EFTPS beginning in the second succeeding calendar year. Each year the IRS notifies taxpayers who are required to pay through EFTPS.
12. Leave-based donations programs. In the aftermath of the September 11, 2001 terrorist attacks, a number of employers have adopted (or are considering adopting) leave-based donation programs. These programs allow employees to forgo their vacation, sick, or personal leave in exchange for their employers’ contributing the value of that leave to charity. The IRS has announced that employees will not be taxed on donated leave for any payments made to charities before January 1, 2003. Many churches have members who fail to use all of their vacation leave during the year. In some cases, they forfeit some or all of the leave that is not taken. They now have another option--asking their employer to donate the cash value of their unused leave to their church. By doing so they not only provide their church with a contribution, but they do not have to report the value of their unused leave as taxable income. Treasury Department News Release PO-720.
13. IRS addresses employer-provided health insurance. Many employers provide health insurance for their employees. This is a nontaxable fringe benefit under section 106 of the tax code. But what if an employer pays for this insurance by reducing the salaries of its employees? Must the employer report the salary reductions as taxable income, or are the reductions nontaxable? The IRS addressed this question in a recent ruling. An employer provided health coverage for its employees through a group health insurance policy. The employer reduced its employees' salaries and applied the salary reduction amounts to the payment of the health insurance premiums for the employees. In other words, employees received lower salaries in exchange for employer-provided health coverage. The IRS concluded that the amount by which an employee's wages were reduced to cover the employer's payment of health insurance premiums was nontaxable. It based this conclusion on section 106 of the tax code, which states that "gross income of an employee does not include employer-provided coverage under an accident or health plan." The IRS noted that when the employer "applies the amount of employees’ salary reduction to pay health insurance premiums, the premium payments are paid by the employer, not the employees, and are excludable from the employees’ gross income under section 106 because they are paid by the employer." But the IRS ruled that "reimbursements" made by the employer to its employees in the amount of their salary reductions (so their after-tax pay was the same as if there were no salary reductions) had to be reported as taxable income to the employees. The IRS observed that section 106 "allows an employee to exclude employer reimbursements for health insurance premiums, but only if those premiums are actually paid by the employee." Here, however, "there is no employee-paid premium for the employer to reimburse, and therefore the reimbursement payments that the employer makes to employees are not excluded from gross income under section 106."
Churches often provide ministers and lay employees with accident or health insurance coverage, and pay some or all of the premiums for such coverage. Here are some helpful rules for church treasurers to keep in mind:
• Church employees’ health insurance premiums paid directly to the insurer by the church are excludable from the employees’ gross income for federal tax reporting purposes.
• Church employees’ health insurance premiums paid directly to employees are excludable from the employees’ gross income for federal tax reporting purposes if the church requires proof that the employees in fact paid the premiums themselves. In other words, the church treats this arrangement like an “accountable” business expense reimbursement arrangement, and only reimburses those expenses for which it receives adequate substantiation.
• If a church provides employees with cash in lieu of paying their health insurance premiums, the exclusion does not apply and the amount of cash distributed to employees is fully taxable. However, the cash provided to the employees can be taxfree if the church adopts a type of “cafeteria plan” called a “health flexible spending arrangement" or "flex plan." Such an arrangement gives employees the right to receive cash or certain fringe benefits including employerpaid premiums under an accident and health plan. This important fringe benefit is explained in Chapter 5 of Richard Hammar’s 2003 Church & Clergy Tax Guide.
14. Obtaining refunds of excess payroll tax payments. It can happen to any church. The church treasurer inadvertently remits excess payroll taxes to a local bank. The church claims that the excess payment was sent in error and would like the excess refunded right away, before the Form 941 (Employer’s Quarterly Tax Return) is filed for the quarter. Is the church entitled to an "expedited refund" before it files a Form 941 for the quarter in which the excess payment was made? No, concluded the IRS in a recent ruling. Section 6413 of the tax code states that if more than the correct amount of tax is paid, then "proper adjustments" shall be made, without interest, in such manner and at such times as the income tax regulations prescribe. The IRS ruled that employers generally cannot obtain a refund until after they file the Form 941 for the quarter in question. It observed, “An overpayment is the amount by which a payment of tax exceeds the correct total amount of the taxpayer’s liability for a tax period or any amount that was assessed or collected after the expiration of the applicable period of limitations. The tax regulations contemplate quarter year tax periods for taxes under FICA and withholding from wages even though these tax payments are required to be made each deposit period within the quarter. These types of deposits are prepayments, and as such, an overpayment of such prepayments cannot be determined in the absence of the close of the quarter and the filing of a quarterly Form 941. The regulations do not indicate that the IRS is authorized to grant an expedited refund [prior to the due date of the applicable Form 941]. Therefore, under existing refund procedures, a refund of overpaid withholding tax cannot usually be granted until after the close of the quarter and after a quarterly Form 941 claiming the refund has been filed.” The IRS did concede, however, that if an overpayment of payroll taxes creates a "significant hardship," then an employer may apply for relief by submitting Form 911. Here are the points to keep in mind:
If you pay your payroll taxes electronically using the EFTPS system, then in some cases you may be able to "reverse" an erroneous overpayment of payroll taxes if you act promptly, using the so-called "automated clearinghouse rules" (ACH). Check with your depository bank for details. Refunds cannot be paid using the EFTPS system. If you miss the deadline for reversing an erroneous overpayment, then you can use the existing tax refund procedures outlined above which usually do not authorize the IRS to grant a refund until after the close of the quarter and after a quarterly return claiming the refund has been filed. If, however, an overpayment results in a significant hardship, the church may contact the IRS directly for assistance or file a Form 911 with the Taxpayer Advocate.
15. Congress considers charity relief legislation. In 2002, Congress considered legislation that would encourage charitable giving by providing individuals and businesses with a variety of tax incentives and by making it easier for smaller, faith-based social service providers to qualify for federal aid. The Charity Aid, Relief, and Empowerment (CARE) Bill of 2002 contains, among other provisions, several temporary tax provisions that would expire after two years. Church leaders should be familiar with the following provisions in this bill:
1. Charitable contribution deduction for nonitemizers. The CARE bill would allow nonitemizers to deduct their charitable contributions up to $400 for single taxpayers ($800 for married taxpayers filing joint returns) during 2002 and 2003. Allowing nonitemizers to deduct charitable contributions would provide an incentive for all taxpayers to give to charity (compared to current law, which only rewards giving by itemizers). Currently, only one-third of taxpayers can deduct their charitable contributions.
2. Tax-free distributions from IRAs for charitable purposes. The CARE bill would provide tax-free treatment of distributions made from IRAs for charitable purposes after the beneficiary reaches age 67. Tax-free treatment would apply to distributions made (in 2002 and 2003) directly to charitable organizations or "indirectly" through charitable remainder trusts, pooled income funds, or the purchase of charitable gift annuities. This proposal would encourage donations of otherwise taxable IRA assets to charity, by eliminating the need for taxpayers first to include the taxable amounts in income, and then claim an offsetting charitable contribution deduction. Because not all taxpayers can deduct the full amount of their charitable contributions, current law effectively discourages some taxpayers from donating IRA assets to charity.
3. An increase in the percentage limit for corporate charitable contributions. The CARE bill would raise the deduction limit (currently 10% of taxable income) to 13% for 2002 and 15% for 2003. Raising the limit on corporate charitable contributions would provide an incentive for corporations to increase their support for charitable organizations. For 2002-2003, the CARE bill would allow all businesses (not just C corporations) to claim an enhanced deduction for donated food equal to the lesser of fair market value or two times cost.
4. Individual Development Accounts. After 2002 and before 2008, the CARE bill would allow up to 900,000 eligible lower income Americans to create "individual development accounts" (IDAs). For each account, the financial institutions sponsoring the IDA program would match up to $500 per year in account holder contributions. Neither the matching amounts nor earnings on those amounts would be subject to income tax. Withdrawals of these matching amounts and earnings would have to be for higher education expenses, first-time home purchase expenses, and business capitalization expenses. A withdrawal from the main account for other purposes may result in a forfeit of some or all of the matching account. The program would be funded through 2009 by allowing the sponsors both an income tax credit for the matching amounts and an annual $50 per account credit to cover the costs of administration and participant education.
At the time of publication of this article this legislation had not yet been enacted.
16. IRS addresses substantiation of charitable contributions. The IRS issued Publication 1771 in 2002. This publication explains the substantiation requirements that apply to certain charitable contributions. The publication contains helpful information for both churches and donors. Consider the following:
17. Substantiation requirements relaxed. Generally, taxpayers must receive a "contemporaneous written acknowledgement" from a charitable organization before claiming an itemized deduction for contributions of $250 or more. The written acknowledgement gives donors a statement of the amount of cash or description of property contributed; whether the charity provided goods or services in consideration for the cash or property; and the value of those goods or services. A written acknowledgment must be "contemporaneous," which means that a donor must receive the acknowledgment by the earlier of (1) the date on which the donor actually files his or her individual federal income tax return for the year of the contribution, or (2) the due date (including extensions) of the return. However, because of the outpouring of contributions after the September 11, 2001 terrorist attacks, some charities were unable to supply donors with the required acknowledgements in a timely manner. In 2002 the IRS has announced that, as a result of the September 11, 2001, terrorist attacks, it had relaxed the substantiation requirements for certain charitable contribution deductions. Taxpayers who made charitable contributions of $250 or more after September 10, 2001, and before January 1, 2002, had until October 15, 2002, to obtain the required written acknowledgement from charities or get evidence of a good-faith effort to obtain it. Donors who did not receive documentation of their contributions could demonstrate good-faith effort by requesting a written acknowledgement from the charity either by letter or e-mail, a copy of which could be used as evidence of a good-faith effort. IRS News Release IR-2002-38.
18. Can bankrupt debtors make contributions to their church? A couple with $100,000 of debt filed for bankruptcy, but their petition was opposed by a bankruptcy trustee on the ground that the plan allowed them to donate 10% of their income to their church. The trustee insisted that the proposed charitable contributions were not "reasonably necessary for the debtors' maintenance and support" and therefore constituted disposable income that should be paid to their creditors. A federal bankruptcy court ruled that the plan could not be denied on the basis of the debtors' proposed contributions to their church. While all of a debtor's disposable income ordinarily must be applied to creditors in order for a bankruptcy plan to be approved, there are exceptions. Congress enacted the Religious Liberty and Charitable Donation Act in 1998 in order to clarify that a bankruptcy plan no longer can be rejected because a debtor wants to make charitable contributions that do not exceed 15% of his or her gross annual income for the year in which the contributions are made (or a higher percentage if consistent with the debtor’s regular practice in making charitable contributions). Congress intended for the Act to "protect the rights of debtors to continue to make religious and charitable contributions after they file for bankruptcy relief." The court noted that the contributions the couple wanted to continue making to their church were less than 15% of their annual income, and so their bankruptcy plan could not be rejected on the basis of these contributions. This was so despite the enormous size of their debt. However, the court agreed that the couple should be required to prove to the bankruptcy court that they in fact are making the contributions to their church. It concluded, "The court concludes that it is appropriate to mandate that debtors provide documentation of their charitable giving to trustee in order to ensure that they are not fraudulently using the income allocated for charitable contributions as discretionary funds. . . . For example, debtors could request that their church provide them with a receipt for their contributions, as it provides a receipt for those seeking tax deductions for charitable giving." In re Kirschner, 259 B.R. 416 (M.D. Fla. 2001).
19. Court denies $500,000 stock contribution for lack of substantiation. A couple made a gift of privately-held corporate stock to a charity, and claimed a charitable contribution deduction in the amount of $500,000. The couple based this amount on the opinion of a stock broker who occasionally traded the stock. The Tax Court ruled that the couple could not deduct any amount for the gift of stock because they failed to comply with the substantiation requirements that apply to gifts of privately-held stock. In brief, gifts of privately-held stock (valued at more than $10,000) are not deductible unless (1) the donor obtains a qualified appraisal of the donated shares no earlier than sixty days prior to the date of the contribution; and (2) the donor completes a "qualified appraisal summary" (IRS Form 8283) and encloses it with the Form 1040 on which the contribution deduction is claimed. Note that the donee (church or other charity) must sign this appraisal summary. In this case, the couple did not obtain a qualified appraisal, and did not attach a Form 8283 appraisal summary to their tax return. The court concluded, "We find that the couple failed to meet the substantiation requirements. Accordingly . . . no charitable deductions are allowed to them on account of the transfer of the shares." Todd v. Commissioner, 118 T.C. No. 19 (2002).
20. IRS addresses rental of meeting space. The IRS ruled that the rental of meeting space by a public museum did not affect its tax-exempt status and did not generate unrelated business income. The IRS concluded that the museum's rental of its meeting space furthered its exempt purpose since it attracted visitors and produced income used to fund the museum. The IRS also concluded that the rental income was not subject to the unrelated business income tax since rental income generally is "excluded in determining unrelated business taxable income so long as any services [the exempt organization] might render in connection with the rental of the meeting space are those usually and customarily rendered in connection with the rental of rooms or other space for occupancy only." IRS Letter Ruling 200222030 (2002).
21. Tax Court addresses contributions of noncash property. A married couple claimed charitable contribution deductions for cash, clothing, and other household items they donated to their church on their 1998 and 1999 tax returns. They valued their cash donations for each year at about $5,000, and their property donations at $400. Their tax returns were audited, and the IRS concluded that the actual value of the property donated to the church was about $5,000 in 1998 and $3,800 in 1999, and that their cash contributions were only a few hundred dollars in both years. The IRS claimed that the couple grossly understated the value of their property donation so that they would not have to comply with the substantiation requirements that apply to donations of property valued at more than $500 (Form 8283, Section A) and more than $5,000 (a qualified appraisal, and a qualified appraisal summary on Form 8283, Section B). The Tax Court agreed. It concluded that the couple’s tax return preparer deliberately listed their noncash charitable contributions on the returns at less than $500 and inflated the cash contributions to avoid the need for appraisals and written acknowledgments from the church. As a result, the court concluded that the couple was not entitled to any deductions for their noncash contributions for the two years at issue. It allowed a $300 deduction for cash contributions in each year. This case is important for two reasons. First, it illustrates that donors may lose a deduction for contributions of noncash property valued at more than $500 if they fail to complete Form 8283, Section A, and include this form with their tax return. Section A is easy to complete, and does not require a formal appraisal. Second, donors will lose a deduction for noncash property valued at more than $5,000 if they fail to obtain a “qualified appraisal” of the donated property and include an appraisal summary (Form 8283, Section B) with their tax return. Satriana v. Commissioner, T.C. Sum. Op. 2002-84.
22. No deduction for gift of BMW to pastor, says court. The Tax Court ruled that a church member could not deduct a contribution of a BMW automobile to his pastor, for two reasons. First, the “contribution” was to an individual rather than to a charity, and “such gifts are not deductible as charitable contributions.” Second, the donor failed to obtain a qualified appraisal of the donated car and attach a “qualified appraisal summary” (Form 8283) to his tax return, as is required for any contribution of noncash property (other than publicly traded stock) with a claimed value of more than $5,000. Brown v. Commissioner, T.C. Summary Opinion 2002-91 (2002).
23. Risk of criminal penalties for noncompliance with payroll taxes. Compliance with federal payroll tax reporting is hard enough. It is even more difficult for church treasurers who must be familiar with the special tax rules that apply to churches and church staff. Many have wondered if they could face criminal penalties for inadvertent noncompliance. Recently released IRS statistics suggest that church leaders need not be concerned about criminal penalties, for two reasons. First, criminal penalties are assessed by the IRS only if there is an attempt to evade withholding or payment of payroll taxes. Innocent mistakes made while attempting to comply with the law will not result in criminal penalties. Second, the IRS pursues criminal prosecution against a very small number of employers for noncompliance with payroll tax reporting. Out of some 25 million employers that filed Form 941 (Employer's Quarterly Tax Return) in fiscal year 2002, the IRS launched criminal investigations against only 85 of them. These investigations resulted in 54 prosecutions and 36 convictions. While the IRS boasts that this is greater than a 50% conviction rate (which is true), it must also be noted that only about 1 in 500,000 employers were prosecuted for criminal violation of the payroll reporting rules.
24. Form 941 may now be filed electronically. For more information, visit the IRS website at www.irs.gov/efile/article/0,,id=98368,00.html or call 1-800-829-1040.
25. Filing Form W-2 electronically. There have been three important developments pertaining to Form W-2: (1) If your employees give their consent, you may be able to furnish Copies B, C, and 2 of Form W-2 to your employees electronically. See IRS Publication 15-A for additional information. (2) If you file your 2002 Forms W-2 with the Social Security Administration electronically (not by magnetic media), the due date is extended to March 31, 2003. For information on how to file electronically, call the SSA at 1-800-772-6270 or visit the Social Security Administration website (www.ssa.gov/employer). (3) You may file a limited number of Forms W-2 and W-3 online using the SSA website at www.ssa.gov/employer. The site also allows you to print out copies of the forms for filing with state or local governments, distribution to your employees, and for your records.
26. A New York court ruled that a church-owned residence occupied by a non-ordained choir director was exempt from property taxes, not because it qualified as a "parsonage" but because of the many religious functions that occurred there. For many years, two homes owned by a church were exempt from property taxes on the ground that they qualified as "parsonages." The church's senior pastor occupied one of the homes, and the church's music director occupied the second home. After many years, a local tax assessor questioned the exemption of the home occupied by the choir director. The choir director was a non-ordained layman with special liturgical music training who used the home as a residence in exchange for his services. The choir director was considered part of the church's liturgical staff, and he participated in all worship services. In addition, he participated in various sacramental needs, including baptisms, marriages, and funerals. The choir director had a secular job in addition to his church duties. The home occupied by the choir director also was used for choir rehearsals, weekly Bible studies, youth retreats, and as occasional housing for visiting clergy. A state court ruled that the church-owned home occupied by the choir director qualified for exemption. However, the court concluded that the home was exempt not as a parsonage, but as property used for religious purposes. It did not qualify as an exempt parsonage since it was not occupied by an "officiating clergyman" as required by state law. The court concluded that while the choir director had numerous religious duties, and often assisted in the administration of the sacraments, he "could not officiate at weddings or funerals and his responsibility was to provide liturgical music for these ceremonies." On the other hand, the property qualified as exempt on the basis of the many religious uses that occurred there. Holy Trinity Orthodox Church v. O'Shea, 720 N.Y.S.2d 904 (2001).
27. The Maryland Court of Appeals ruled that 16 acres of undeveloped land owned by a church was exempt from property taxation. Maryland law exempts from taxation property that is "owned by a religious group or organization" if the property "is actually used exclusively for (1) public religious worship; (2) a parsonage or convent; or (3) educational purposes." A church purchased a 27-acre tract of property in order to construct a sanctuary. A local zoning board limited construction on the property to a 7.5-acre "envelope" except that "the construction of driveways, road improvement, storm water management, utilities or other such improvements" could take place outside of the development envelope. A tax assessor determined that only 11 acres were exempt from property tax (the 7.5-acre envelope plus 3.5 acres that were used for storm water management and a septic system). The assessor concluded that the remaining 16 acres, consisting of undeveloped land, were subject to tax. The church appealed this decision to the Maryland Court of Appeals (the highest state court in Maryland). The court concluded that the entire 27 acres was entitled to exemption from property tax, including the undeveloped 16 acres. It observed, “The 16 acres are part of the land on which the church sits and that parcel is not subject to another, non-church use. The applicable covenants and zoning restrictions prohibit that property from being put to other than open space use; there simply can be no commercial, residential, or other non-worship related development on that property. The land, then, may be used only for church purposes, either in tangible, such as the construction of a prayer garden, or in non-tangible, i.e. reflective or spiritual, ways. . . . A church is more than four walls built of stone, marble or concrete . . . . In the present case, it does not follow that, merely because the church has been required, or decided, to leave a large portion of the church property undeveloped, the property is not being used--it clearly is as the site of the church--or that the congregation will not use the property in its natural state to enrich its worship experience. . . . Nor is there any merit to the argument that the use of the 16-acre tract is not related to the furtherance of public worship. . . . The primary purpose of the non-developed land is to preserve the environmental aesthetics of the neighboring community and present the primary structure in a visually pleasing and understated manner. The development envelope is balanced by the open space, non-use area, much as a garden, lawn, or yard balances many residential parcels. . . . In this case the 16 acres provide a natural setting for the church and, thus, the religious worship use. As such, they are being actively used by the church for religious worship.” Supervisor of Assessments v. Keeler, 764 A.2d 821 (Md. 2001).
28. The New Hampshire Supreme Court ruled that a church-operated campground did not qualify for exemption from property tax, except for a small chapel. A regional denominational organization (the "church") owns and operates a campground and conference center that contains lodging, dining, chapel, meeting, and recreational facilities. The lodging includes "condominium-type townhouse units with kitchens" and free standing cabins. There are campsite areas that accommodate up to 100 trailers or recreational vehicles, with water supply hook-ups and bathroom facilities for all sites, and electricity for one half of the sites. There is also a dining hall, where meals are prepared and served to guests. Recreational amenities including tennis courts, a golf course, a basketball court, a swimming beach, boating and fishing access and cross-country skiing trails. The property also includes staff quarters, maintenance buildings, a preschool, administrative office space and tracts of undeveloped land. During the summer months the camp is host to weeklong "camp programs" for families and adults. These programs have Christian-based themes and are run by pastors. The programs include worship services, Bible study groups and recreation opportunities. Guests are informed that they are expected to participate in the services. Guest registration check-in forms require indication of church affiliation, and approximately 60% of guests are members of the regional church. During non-summer months, the camp is rented to church-approved groups. Renters include a variety of church groups (from other denominations) and non-religious groups. The local tax assessor determined that the entire camp, except the chapel, was subject to property tax. The church appealed. The state supreme court ruled that the campground did not qualify for exemption from property tax (other than the chapel). It based this conclusion on the fact that the operation of the campground did not benefit "the general public or a substantial and indefinite segment of the general public" because of the following factors: (1) the church's organizational documents state that the camp was to be used for members of the church; (2) the camp's own rules specify that "our programs and facilities are primarily reserved for the members of our [church]”; (3) no advertisements for the camp are sent to those outside of the church's membership; (4) while the camp is used by secular groups, this use is only "occasional and infrequent"; (5) people who stay at the camp, even those associated with "secular" groups, must agree with the basic beliefs of the church. The court concluded, "Where an organization makes efforts to limit its services, and targets its benefits only to its members, that organization is not obligated to serve an indefinite segment of the population . . . and is not eligible for a charitable tax exemption." The court also ruled that the camp did not qualify for exemption based on its religious nature, except for the chapel and "those portions of the administrative offices, maintenance center, barn and workshop that are reasonably related to the function of the chapel." The court concluded that for property to qualify for exemption on the basis of religious use, "the land must be directly used for religious purposes," and that the lodging and dining facilities and other camp facilities and property not exempt because they were "not specially adapted to religious uses or purposes nor was the property so used." East Coast Conference of the Evangelical Covenant Church of America v. Town of Swanzey, 786 A.2d 88 (N.H. 2001).
29. IRS recognizes “health reimbursement arrangements.” The IRS issued guidance in 2002 clarifying the tax treatment of health reimbursement arrangements (HRAs). HRAs are funded solely by the employer and not through salary reduction, and may only reimburse employees for substantiated medical care expenses incurred by the employee and the employee's spouse and dependents. Employees’ purchase of medical insurance qualifies as a medical care expense. If employees can elect cash or any benefit other than medical expenses, it is not an HRA and all amounts paid by the plan are taxable (unless they are made nontaxable by some other provision of the tax code). If an HRA provides reimbursements up to a maximum dollar amount, any unused funds at the end of the year are carried forward to increase the maximum reimbursement amount in the following year (the cafeteria plan “use it or lose it” rule does not apply).Distributions of HRA funds to pay an employee’s medical expenses do not represent taxable income.