By Richard R. Hammar, J.D., LL.M., CPA
© Copyright 2004 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: m69 m94 c0104
Congress enacted a number of tax law changes that will impact the preparation of 2003 tax returns by ministers and lay church employees in 2003, and tax reporting by churches. In addition, a number of court decisions and IRS rulings provided clarification on a number of important tax issues. Nearly 70 of the most important changes and clarifications are summarized in this library.
Congress enacted major tax bills in 2001 and 2003 containing several provisions that will affect tax reporting by both churches and ministers for 2003 and future years.
Key point. An unprecedented feature of EGTRRA is a "sunset" provision that revokes all of the hundreds of tax law changes at the end of 2010 unless Congress votes to extend them. If Congress fails to take action, then the tax law in effect in 2001 will be reinstated. Because many taxpayers, in all income brackets, will increasingly rely on many of the tax law changes in the new law, it is inconceivable that Congress will allow all of the changes to expire at the end of 2010. It is reasonable to assume that many of the changes will be permanently adopted by Congress, but not necessarily all of them.
Tax Law Changes Made by Congress
Tax Changes of Interest to Churches
1. Privacy rules apply to some cafeteria plans and flex plans. Does your church have a cafeteria plan or "flex plan" that allows employees to pay for medical expenses with pre-tax dollars through salary reductions? If so, you may be subject to new privacy rules that took effect on April 14, 2003. The Health Insurance Portability and Accountability Act of 1996 (HIPAA) required the federal Department of Health and Human Services (HHS) to publish rules for the electronic exchange, privacy and security of health information. HHS published the final version of its so-called "Privacy Rule" in 2002, and it took effect on April 14, 2003 (or April 14, 2004 for "small" health plans with less than $5 million in annual receipts). The Privacy Rule applies to health plans and health care providers ("covered entities") that transmit health information in electronic form. Covered entities include employer-sponsored group health plans, and church-sponsored health plans. There is an exception for a group health plan with less than 50 participants that is administered solely by the employer (and not a third party administrator). HHS ruled in 2003 that cafeteria plans and flexible spending arrangements are covered entities for purposes of the Privacy Rule, if they meet the definition of an "employee welfare benefit plan" under ERISA (a federal pension regulation law). This is a very broad definition that will apply to most cafeteria plans and flexible spending arrangements established by churches. Again, there is an exception for plans with less than 50 participants that are administered solely by the employer.
If your church meets the definition of a covered entity, and operates a cafeteria plan or flex plan, then you are required to comply with the various privacy protections spelled out in HIPAA's Privacy Rule. These protections are complex, and so you should consult with an attorney for assistance. Basically, they limit the ways you can use your employees' personal medical information. Key provisions of these new standards include employee access to medical records; employer notification of employees of their privacy rights under the new law; a prohibition of using employee medical information for any purpose other than health care; written employee consent required before an employer can release medical information to a life insurer, a bank, a marketing firm or another outside business for purposes not related to their health care; written privacy policies and procedures must be adopted by employers; and, special privacy training for employees who will have access to medical information. There are civil and criminal penalties for covered entities that misuse personal health information or violate the privacy requirements.
Tip. To help covered entities find out information about the new privacy rules, HHS has established a toll-free information line. The number is (866) 627-7748.
Tip. The March-April 2003 issue of Richard Hammar's Church Law & Tax Report newsletter has a feature article entitled "Are Prayer Lists Illegal" that addresses the application of HIPAA to pastors and church members.
2. Tax Court addresses employer-paid tuition. An employer paid an employee ("Jon") an $8,000 "commission" in addition to his regular salary. Throughout his employment, Jon was enrolled at a local university earning an undergraduate degree. He had a verbal agreement with his employer that he would be reimbursed for certain educational expenses he incurred. Jon did not report the $8,000 as taxable income because he considered it to be a nontaxable "educational grant." The IRS audited Jon, and determined that the entire $8,000 was taxable. Jon appealed, claiming that the $8,000 commission was not taxable on three separate grounds: (1) The commission was in reality a nontaxable qualified scholarship; (2) the commission represented employer-provided educational assistance; and (3) the commission represented an accountable reimbursement of a legitimate business expense (education). The Court rejected each of these arguments, and concluded that the commission was fully taxable.
qualified scholarship
The Court noted that the tax code excludes from taxable income "any amount received as a qualified scholarship by an individual who is a candidate for a degree" at certain educational institutions. However, a "qualified scholarship" does not include any amount received by a student which represents compensation for past, present, or future employment services. The Court concluded that the $8,000 was "a form of compensation and not the result of disinterested generosity," and therefore it was not a nontaxable qualified scholarship.
employer-paid educational assistance
Section 127 of the tax code excludes from taxable income "amounts paid by the employer for educational assistance to the employee," but only if the assistance is furnished pursuant to an "educational assistance program." An "educational assistance program" is a "separate written plan of an employer" which meets certain requirements. The Court concluded that the $8,000 was not tax-free employer-paid educational assistance since "the amounts at issue were not provided pursuant to a written plan maintained by the employer as required by the statute."
accountable business expense reimbursement
Jon argued that the $8,000 commission was nontaxable because it represented an accountable reimbursement of his education expenses. The Court conceded that an employer's reimbursements of an employee's business expenses are nontaxable to the employee so long as the expenses are substantiated under an accountable plan. Further, education can be a business expense, but only if it (1) maintains or improves skills required by the employee in his or her employment, or (2) meets the express requirements of the employer, or of applicable law or regulations, in order for the employee to retain his or her job. The Court noted that Jon had not proven that his education met either of these conditions. In addition, expenses which fall within either of these two categories are not deductible if the education (1) is required in order to meet the minimum educational requirements for qualification in the taxpayer's employment, or (2) qualifies the taxpayer for a new trade or business. The undergraduate education which Jon obtained "clearly qualified him for a new trade or business," and therefore his education expenses were not business expenses that his employer could reimburse under an accountable plan.
It is common for churches to pay some or all of the education expenses of an employee. This case illustrates that such payments are not necessarily a tax-free fringe benefit. To be nontaxable, they generally must meet the requirements for (1) a qualified scholarship; (2) employer-provided educational assistance; or (3) reimbursement of a business expense under an accountable plan. As the Tax Court noted in this case, each of these options has specific requirements that must be met. Since Jon met none of them, the $8,000 was fully taxable. This is an important lesson for church treasurers to keep in mind. Lewis v. Commissioner, T.C. Sum. Op. 2003-78 (2003).
3. The IRS ruled that teachers and administrative staff employed by a church school were not eligible for a housing allowance. A church operates a private school for kindergarten through eighth grade. All of the teachers are certified by the state, and the school is accredited with the state department of education. The school's teachers and administrative staff are not required to attend a Bible college, seminary, or other theological program. Membership in the church is not required to be employed in either teaching or administrative positions, but employees are required to attend a church. The school's board adopted a resolution granting teachers and administrative staff a housing allowance. The school later asked the IRS for a private letter ruling confirming that the teachers and administrative staff were eligible for a housing allowance. The IRS ruled that the teachers and administrative staff were not eligible for a housing allowance, since (1) they were not required to attend a Bible college, seminary, or other theological training program; (2) membership in the church was not required to be employed in either teaching or administrative positions; (3) all of the services they performed were "of a secular nature"; and (4) "none of the prescribed duties of the teachers and administrative staff were equivalent to the services performed by a church minister." IRS Letter Ruling 9126048.
4. Department of Labor redefines "exempt employees." The minimum wage and overtime pay requirements of the federal Fair Labor Standards Act (FLSA) do not apply to "exempt employees." Unfortunately, the definition of an exempt employee is complex. Basically, an exempt employee is someone who meets the FLSA definition of an executive, administrative, or professional employee. To be exempt, employees must meet certain tests related to their primary job duties and be paid on a salary basis at not less than a specified minimum amount. Under the proposed regulations, the minimum compensation required to qualify for exemption from the minimum wage and overtime requirements as an executive, administrative, or professional employee would be increased from $155 per week to $425 per week. The proposed regulations define "compensation" to include salary, bonuses, and other non-discretionary compensation. However, the regulations specify that "board and lodging" provided by an employer to an employee are not included in annual compensation. Many churches allow a pastor, or a lay employee, to live in a church-owned parsonage. The value of such lodging will not count as "compensation" in deciding if the employee is exempt from the FLSA minimum wage and overtime pay requirements.
5. No Form 1099 to benevolence recipients, says IRS. Many church treasurers have wondered if they need to issue a Form 1099 to persons who receive distributions of $600 or more from the church benevolence fund. The IRS addressed this question in a recent ruling, and concluded that no Form 1099 is required under these circumstances. The ruling addressed a charity that provided financial assistance to "distressed individuals" affected by a natural disaster for such items as medical and transportation expenses and temporary housing that were not compensated by insurance or otherwise. The IRS concluded that this financial assistance was not taxable compensation for which a Form 1099 would be required, but rather was a "gift" to the recipients. It observed, "In general, a payment made by a charity to an individual that responds to the individual's needs, and does not proceed from any moral or legal duty, is motivated by detached and disinterested generosity" and therefore is a tax-free gift. IRS Revenue Ruling 2003-12.
6. House of Representatives passes bankruptcy reform legislation. On March 20 the House overwhelmingly passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2003 (H.R. 975). If enacted into law, the Act would make it harder for debtors to obtain relief through bankruptcy. The legislation does not affect two provisions in the current bankruptcy law of special relevance to churches. First, bankruptcy trustees cannot recover charitable contributions made by a bankrupt debtor to a church or other charity within a year prior to filing for bankruptcy if the contributions amount to 15% or less of the debtor’s gross annual income (or a higher percentage if "consistent with the debtor’s giving practices"). Second, bankruptcy courts cannot reject a bankruptcy plan on the ground that the debtor proposes to make charitable contributions to a church or other charity so long as the contributions do not exceed 15% of the debtor's annual income (or a higher percentage if "consistent with the debtor's giving practices"). The proposed bankruptcy reform legislation pending in Congress would not affect either of these two provisions.
7. Designated gifts. The IRS was asked to issue a ruling in a case involving the deductibility of a designated contribution made to a charity that was organized to promote music. The charity accomplished its charitable purpose by hosting composer events, placing composers in residencies with professional arts institutions, funding recordings of new American music, and by entering agreements with professional arts institutions to commission works. A married couple (the "donors") informed the charity of their desire to support the work of a particular composer (the "composer"), and a few months later they donated a substantial amount to the charity. At the time of the contribution, the charity did not make any commitment to use the funds to commission the work of the composer, and there was no representation that the funds would be used for that purpose. The charity informed the donors that the funds would be used at its discretion in furtherance of its charitable purpose, and the donors understood this. In a letter to the donors, the charity thanked them for the contribution. The letter stated that there "can be no assurance that the funds contributed will be used to support the work of the composer" and that the funds would be used by the charity "in carrying out its charitable purpose and will not be returned to the donors." A short time later, the charity paid the composer a "commissioning fee" to compose a new musical work, and it also agreed to reimburse the expenses incurred by the composer in appearing at the premier of his work. The composer agreed to complete a musical work of specified type and duration in a timely manner.
The charity asked the IRS to issue a ruling that the donors’ contribution to the charity was tax-deductible, and was not affected by the donors’ "earmarking" of their contribution for the support of the composer. The IRS began its ruling by noting that the tax code allows a tax deduction for charitable contributions, and that a charitable contribution "is a contribution or gift to or for the use of an organization operated exclusively for charitable purposes." The IRS concluded that the donors’ contribution to the charity was tax-deductible, despite their expressed interest in benefiting a specific composer (and the charity’s use of the donated funds for that same composer). The IRS observed,
A charitable contribution deduction is not allowed if a charity is used as a conduit, and a payment to a qualifying charity is "earmarked" or designated for the benefit of a particular individual, even if the individual is a member of the class the charity is intended to benefit. The organization must have control and discretion over the contribution, unfettered by a commitment or understanding that the contribution would benefit a designated individual. The donor’s intent must be to benefit the organization and not the individual recipient. In this case donors made a payment to a recognized charity, and expressed an interest in supporting the work of a particular composer. This expression of interest raises the issue of whether the contribution was impermissibly earmarked for this composer. No commitment or understanding existed between the donors and charity that the contribution would benefit the composer. The donors understood that any funds contributed to the charity would be distributed according to the discretion of the charity, and that the charity’s officers select the composers. Although the donors expressed an interest in the selection of a particular individual to compose a work for the charity, the common understanding was that the contribution would become part of the general funds of the charity, and would be distributed in the manner chosen by the charity’s officers. Therefore, the contribution by the donors to the charity was not impermissibly earmarked for the composer, and therefore is a charitable contribution.
The ruling provides useful information on the correct handling of contributions that suggest or recommend a particular recipient. This issue frequently arises in churches when members want to donate funds for a particular needy person or family, or a student or missionary. In the past, the IRS has been adamant that such contributions do not qualify as charitable contributions. This ruling suggests that the IRS may be taking a more flexible approach in such cases, if the following conditions exist: (1) The church has control and discretion over the contribution, "unfettered by a commitment or understanding that the contribution would benefit a designated individual." (2) No commitment or understanding exists between a donor and the church that a contribution will benefit a person or persons specified by the donor. (3) The donor understands that any funds contributed to the church would be distributed according to its discretion.
Note that a "commitment or understanding" is not the same as a mere "expression of interest" in a particular individual. A commitment or understanding connotes some compulsion on the part of the church to distribute donated funds to a person designated by the donor, and in that sense removes any control by the church over the funds. As a result, such a donation was not "to or for the use of" the church. On the other hand, mere "expressions of interest" by the donor do not bind a church to distribute donated funds to the person designated by the donor. Instead, the church is left with the discretion to determine how the donated funds are spent, and may completely disregard the donor's "expression of interest" in a specified individual.
The IRS ruling was a private letter ruling. As such, it cannot be used as precedent in other cases. However, such rulings are commonly viewed by tax attorneys are indications of the thinking of the IRS on specific issues, and in this sense they are relevant. IRS Letter Ruling 200250029.
8. Returning building fund contributions to donors. A married couple donated $4,000 to their church's "new building fund" in 1998. The congregation planned on constructing a new church in 1999, but these plans were put on hold when the church received an unused school building. The couple sued their church, seeking a return of their building fund donation on the basis of the church's "breach of contract." Church leaders noted that the church had $500,000 in its new building fund, and insisted that it still planned on building a new sanctuary as soon as the fund grew to $6 million. A Michigan appeals court dismissed the case. It concluded that the civil courts are barred by the first amendment guaranty of religious freedom from intervening in such internal church disputes:
It is well-settled that courts, both federal and state, are severely circumscribed by the first amendment [and the Michigan constitution] in resolution of disputes between a church and its members. Jurisdiction is limited to property rights which can be resolved by application of civil law. Whenever the trial court must stray into questions of ecclesiastical polity or religious doctrine the court loses jurisdiction. . . . We hold that this dispute involves a policy of the church for which our civil courts should not interfere. Because the decision of when and where to build a new church building is exclusively within the province of the church members and its officials, the trial court erred in not dismissing the couple's lawsuit.
Very few courts have ever addressed the issue in this case, and so the court's opinion may be given consideration in other jurisdictions. The court concluded that the civil courts are barred by the first amendment guaranty of religious freedom from resolving demands by church members to have their donations to a church "building fund" refunded because the church has not begun the construction of a new building as quickly as the donors wanted. Such disputes involve the fundamental decision of "when and where to build a new church building," and such a decision is "exclusively within the province of the church members and its officials." McDonald v. Macedonia Missionary Baptist Church, 2003 WL 1689618 (Mich. App. 2003).
9. Backup withholding. Recent tax legislation changed the backup withholding rate to 28% retroactive to January 1, 2003. If a self-employed worker performs services for your church (and earns at least $600 for the year), but fails to provide you with his or her social security number, then the church is required by law to withhold 28% of the amount of compensation as "backup withholding." The backup withholding is reported to the IRS on Form 945. Of course, a self-employed person can avoid backup withholding by providing the church with a correct social security number. The church will need the correct number to complete the worker's Form 1099-MISC. Churches can be penalized if the social security number they report on a Form 1099-MISC is incorrect, unless they have exercised "due diligence." A church will be deemed to have exercised due diligence if it has self-employed persons provide their social security numbers on IRS Form W-9. It is a good idea for churches to present self-employed workers (e.g., guest speakers, contract laborers) with a W-9 form, and then to "backup withhold" unless the worker completes and returns the form.
10. A Washington court addresses taxation of parsonages. A church's senior pastor began living in the church parsonage in 1993. In 2000, the pastor purchased a vacant lot and began construction of a new home. The pastor and his family moved into the new home in March of 2001, even though construction continued for several months and the family kept much of their belongings in the parsonage until 2002. Parsonages are exempt from property tax under Washington law, and the church claimed that the parsonage should remain exempt through 2001 because the pastor's family kept many of their personal belongings in the parsonage for much of that year. A tax assessor insisted that the parsonage ceased to qualify for exemption when the family moved out in March of 2001. A state board of tax appeals agreed with the assessor. It noted that the property tax law defined a parsonage as "a residence, owned by a church, that is occupied by a clergy person designated for a particular congregation and who holds regular services for that congregation." The board concluded that when the pastor and his family moved out of the parsonage in March of 2001, it no longer qualified as a tax-exempt parsonage even though the pastor's family stored many of their personal belongings there. Faith Tabernacle Open Bible Church v. State of Washington, Wash. Bd. of Tax Appeals, Docket No. 57097 (2002).
11. Court denies tax exemption for vacant church property. Many churches own unimproved property that they are retaining for future use. Often, the property is acquired as a site for a new sanctuary. Is such property exempt from property taxes? A recent case in Florida addressed this important question. A church, which usually has 800 to 1,000 people attending Sunday services at its present rented location, purchased 47 acres of unimproved land for $4 million on which it plans to build a sanctuary. The property is not adjacent to the present location of the church. There were no church services conducted on the property before January 1, 2000. However, on two occasions in 1999 a few members of the church and staff walked around the property, discussed plans as to where things would be located, and offered some prayers (such as thanking God for the land). A tax assessor determined that the property was not entitled to exemption from tax under a state law exempting property "used predominantly for charitable or religious purposes." A state appeals court agreed, "Property is not necessarily exempt merely because small groups walked on it twice between the time the church closed on the property, and the assessment date." Palm Beach Community Church v. Nikolits, 835 So.2d 1274 (Fla. App. 2002).
12. IRS cannot deliver some refund checks. The Internal Revenue Service has announced that unclaimed tax refunds totaling $2.5 billion are awaiting 1.9 million taxpayers who failed to file a 1999 income tax return. However, in order to collect the money, a return must be filed with an IRS office no later than April 16, 2003.
13. Congress considers church employees’ tuition discounts. On March 6, 2003 the "Equity in Education Act" (H.R. 872) was introduced in the House of Representatives by Congressman Camp (MI). 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. A similar bill was introduced in 2002 but did not make it out of committee. The current bill only attracted 33 cosponsors, and so it is unlikely to be enacted.
14. Proposed legislation targets church loans. A bill (H.R. 845) introduced in Congress by Rep. Ed Royce (R-CA) would amend the tax code to make interest received by banks for loans to churches and other religious organizations nontaxable. Rep. Royce has said that the objective of this proposed legislation is to promote bank loans to "food banks, soup kitchens, battered family shelters, and other social service agencies" operated by "faith-based" institutions. If enacted, the legislation might have indirect results, such as reduced interest rates on bank loans to churches, and increased competition with denominational loan programs.
15. IRS launches "market segment" study of some religious organizations. The IRS Exempt Organizations (EO) function of the Tax Exempt and Government Entities (TE/GE) Division is conducting national market studies of "customer groups" (market segments) within the exempt organization community. Each study, which will include the examination of a statistically valid sample of exempt organizations from within the market segment, will enable the IRS to accurately assess the risks of noncompliance, identify education and outreach needs, and more efficiently use IRS resources. The IRS is currently pursuing market segment studies on five exempt organization market segments, including "religious organizations." However, the IRS has noted that this market segment includes "ministries, television and radio evangelists, religious publishing and music production, mission societies, religious instruction, and groups that do not otherwise qualify for church foundation status" under section 170(b)(1)(a)(i) of the tax code. For more information, visit the IRS website.
16. 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 2003. 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 2003, the maximum wages subject to the OASDI portion of self employment taxes (the 6.2% amount) increased to $87,000—up from $84,900 in 2002. Stated differently, employees who receive wages in excess of $87,000 in 2003 will pay the full 7.65% tax rate for wages up to $87,000, and the HI tax rate of 1.45% on all earnings above $87,000. Employers pay an identical amount.
17. 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 Free Speech Restoration Act” (H.R. 235) was introduced in the House of Representatives by Congressman Jones (NC) in January of 2003. If enacted, this bill would amend the tax code to state that churches and other houses of worship would not lose their tax-exempt status because of the content, preparation, or presentation of any homily, sermon, teaching, dialectic, or other presentation made during religious services or gatherings. It would also clarify that this amendment would not affect campaign finance laws under the Federal Election Campaign Act of 1971. This bill was pending at the time of publication of this text (with 164 cosponsors).
18. 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).
19. Senate passes charity relief legislation. In April of 2003 the United States Senate overwhelmingly passed the Charity Aid, Recovery, and Empowerment (CARE) Bill by a 95-5 vote. Similar to legislation introduced but not enacted in 2002, the CARE bill contains several provisions that will be of interest to church treasurers, including the following:
(1) Charitable contributions for nonitemizers. In the case of an individual taxpayer who does not itemize deductions, the bill allows a "direct charitable deduction" from adjusted gross income for charitable contributions paid in cash during the taxable year. This deduction is allowed in addition to the standard deduction. The deduction is available only for that portion of contributions actually made during the year that exceed $250 ($500 in the case of a joint return). The maximum deduction is $250 ($500 in the case of a joint return). The deduction would be allowed for 2003 and 2004.
(2) Tax-free distributions from IRAs to charity. The bill provides an exclusion from gross income for IRA distributions from a traditional or a Roth IRA in the case of "qualified charitable distributions." A qualified charitable distribution is any distribution from an IRA that is made directly to (1) a church or other charity ("direct distributions"), or (2) a charitable remainder trust, a pooled income fund, or a charitable gift annuity ("split interest distributions"). Direct distributions are eligible for the exclusion only if made on or after the date the IRA owner attains age 70 1/2. Distributions to a split interest entity are eligible for the exclusion only if made on or after the date the IRA owner attains age 59 1/2. This provision would take effect in 2004.
(3) Contributions of food inventory. Taxpayers are eligible to claim an enhanced deduction for donations of food inventory to charity.
(4) Charitable mileage rate. The bill would make reimbursements by a church or other charity to a volunteer for the costs of using an automobile in connection with providing donated services excludable from the gross income of the volunteer, provided that (1) the reimbursement does not exceed the business standard mileage rate prescribed for business use (36 cents per mile in 2003), and (2) recordkeeping requirements applicable to deductible business expenses are satisfied.
(5) Annual IRS notices. Most charities are required to file an annual information return with the IRS (Form 990). This form, which is subject to public inspection, contains detailed information about a charity's finances and operation (including disclosure of compensation paid to officers). Some charities are exempt from filing this form, including churches, some other religious organizations, and charities that normally have gross annual income of not more than $25,000. The CARE bill would require charities that are exempt from filing Form 990 because they normally have annual income of less than $25,000 to provide the IRS with a "notice" each year containing specified information. Failure to file the notice for three years would result in revocation of a charity's tax exemption. This notice requirement would not apply to churches. It would be effective beginning in 2004.
(6) IRS audits of churches. Under present law, the IRS may begin a church tax inquiry only if an appropriate high level Treasury official reasonably believes, on the basis of the facts and circumstances recorded in writing, that an organization (1) may not qualify for tax exemption as a church, (2) may be carrying on an unrelated trade or business, or (3) otherwise may be engaged in taxable activities. A church tax inquiry is any IRS inquiry to a church to determine if it qualifies for tax exemption as a church or whether it is carrying on an unrelated trade or business or otherwise is engaged in taxable activities. An inquiry is initiated when the IRS requests information or materials from a church contained in church records, other than routine requests for information or inquiries regarding matters that do not primarily concern the tax status or liability of the church itself. The CARE bill clarifies that the church tax inquiry procedures do not apply to contacts made by the IRS for the purpose of educating churches with respect to the federal income tax law governing tax-exempt organizations. For example, the IRS does not violate the church tax inquiry procedures when written materials are provided to churches for the purpose of educating them with respect to the types of activities that are not permissible under section 501(c)(3) of the tax code.
(7) Conventions and associations of churches. Under present law, an organization that qualifies as a "convention or association of churches" is not required to file an annual return (Form 990); is protected by the Church Audit Procedures Act; and is subject to certain other provisions generally applicable to churches. The tax code does not define the term "convention or association of churches." The CARE bill specifies that an organization that otherwise is a convention or association of churches does not fail to be so merely because the membership of the organization includes individuals as well as churches, or because individuals have voting rights in the organization.
Key point. Some leaders in the House of Representatives are opposing the Senate version of the CARE bill because it does not contain a provision specifically allowing religious organizations to make hiring decisions on the basis of religious belief or affiliation.
20. Form 941 may now be filed electronically. For more information, visit the IRS website at www.irs.gov or call 1-800-829-1040.
21. 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 2003 Forms W-2 with the Social Security Administration electronically (not by magnetic media), the due date is extended to March 31, 2004. 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.
22. An Illinois court ruled that a church-owned home that was used as a residence by a teacher in a private school operated by the church was not exempt from property tax. The church agreed to pay the teacher a salary and provide her with housing in return for her services as a teacher. The teacher used the home primarily as a residence, although she did use a bedroom as an office where she graded papers and did teaching-related work. However, the house was never used for meetings or other school activities. State law exempts "all property used exclusively for religious purposes, or used exclusively for school and religious purposes" from property taxes. The statute further specifies that "a parsonage . . . shall be considered to be exclusively used for religious purposes when the church requires that [minister] who performs religious related activities shall, as a condition of employment, reside in the facility.” The court concluded that the home was not exempt from tax because it was not used exclusively for religious purposes or school and religious purposes. It concluded, "The five-room house is primarily a place for the teacher to live. Only one room, the bedroom that serves as her office, is used for school or religious purposes. No school or religious functions take place on the property. Although her contract (her call) requires her to live in the house, the evidence does not establish that the nature of her duties requires her to reside there. The other teachers and the principal live in private housing. . . . The property is used primarily as a residence and only secondarily for school or religious purposes. Although the teacher's employment agreement requires her to live in the house, her job duties do not make it reasonably necessary for her to do so. Other teachers live in private housing, and the church could have made the same arrangement with her. It was not reasonably necessary to the church’s function to provide her with church-owned housing. Therefore, the house is not tax exempt." DuPage County Board of Review v. Department of Revenue, (Ill. App. 2003).
23. Indiana repeals property tax exemption acreage limit. For many years the Indiana property tax exemption statute limited the exemption of church property to 15 acres. This acreage limitation was eliminated by the state legislature in 2003 (effective March 8, 2003). The 15-acre limit continues to apply to property on which a parsonage is located. Ind. Stat. 6-1.1-10-21 (2003).
24. The Minnesota tax court ruled that a building owned by a church and used for various youth activities (including a weight room, tanning salon, and video arcade) was exempt from property tax. A church owned a separate building (located two miles from the sanctuary) consisting of two stories and 12,000 square feet of space that contained a gymnasium, auditorium, tanning salon, weight room, prayer room, bookstore, offices, and video arcade. The building was used primarily as the location of the church's youth ministry, and it was used for Sunday youth activities, religious services, special events, athletic events, prayer meetings, and concerts. The church claimed that it used the building to fulfill its mission to "win souls for Christ" through religious activities and events. It noted that the building was constructed to attract youth, and that it provides a place both for the youth to gather in a family environment and for the gospel to be preached to the users of the building's various facilities. Christian music plays over the loudspeakers at all times. The church's youth and staff are trained to approach others to share their religious message. Proselytizing takes place in the weight room and with people waiting to use the tanning room. In addition, the rooms contain Christian messages and pictures on posters lining the walls. The court concluded that the entire building was exempt from property tax on the ground that it was being used for church purposes. Country Bible Church v. County of Grant, (Minn. Tax Court 2003).
25. The New Jersey tax court ruled that a home owned by a synagogue and used as a residence of visiting rabbis did not qualify for exemption from property tax as a parsonage, but did qualify as property used exclusively for religious purposes. The court noted that the exemption of parsonages only pertained to property "actually occupied by the officiating clergymen of any religious corporation." It concluded that while the visiting clergy who occupied the parsonage "enjoy positions of great prestige and status with the members of the congregation and may be officiating clergymen at their congregations . . . none of the visitors are the settled or incumbent pastor or minister of the congregation" in this case. Rather, "the visiting clergy are just that--visitors--and, for much of the year, they are not available to teach, lead, or participate in religious services, to give sermons, or to officiate at the congregation's weddings, funerals, and bar mitzvahs. The duties of seasonal clergy simply do not sound like those customarily performed by congregational leaders." However, the court concluded that the property was exempt from tax under another law exempting "all buildings actually used in the work of" religious organizations. The court concluded, "I find that the congregation has demonstrated that the subject property is reasonably necessary for its operation. . . . Because of religious restrictions as to how and when the clergy may travel on the Sabbath and on religious holidays, it is necessary for the congregation to supply housing in close proximity to the synagogue in order to obtain the services of the visiting clergy. In other words, the subject building used for the housing of the visiting clergy is necessary for the proper and efficient operation of the congregation during the summer months, and is not a mere convenience for the visiting clergy or for the congregation. Further, the visiting clergy make it possible for the congregation to serve the enlarged membership during the summer months, and it is that membership which provides much of the financial support for the year-round operation of the congregation." City of Long Branch v. Ohel Yaacob Congregation, 20 N.J.Tax 511 (N.J. Tax Court 2003).
26. The Ohio board of tax appeals ruled that a church-owned parsonage was not exempt from state property taxes. Ohio law exempts "houses used exclusively for public worship . . . and the ground attached to them that is not leased or otherwise used with a view to profit" from state property taxes. The board of tax appeals noted that property "must be used in a principal, primary, and essential way to facilitate the public worship" in order to be exempt. This test was not met even though the pastor "counsels, studies and uses the portion of the parsonage in question as a prayer area and as an area where he counsels members of the congregation," since the church "failed to submit any evidence showing that the primary use of the area is for worship and not for residential purposes." Eastern Star Baptist Church v. Zaino, Case No. 2002-J-1264 (Ohio Bd. Tax Appeals 2003).
27. An Ohio court ruled that an undeveloped tract of land owned by a church was not exempt from taxation even though it was occasionally used for religious purposes. A church purchased property with the intent of building a church and related facilities. The church eventually constructed a new sanctuary, a play area, two parking lots, and a football field on a portion of the property. A tax assessor determined that the remainder of the church's property (which was being held for future expansion) was not exempt from property tax. The church insisted that the unimproved land was exempt from tax because it was occasionally being used for outdoor worship, neighborhood block parties, recreational activities, and overflow parking. A state appeals court noted that the state property tax law exempts "houses used exclusively for public worship . . . and the ground attached to them that is not leased or otherwise used with a view to profit and that is necessary for their proper occupancy, use, and enjoyment." The court concluded, "The church did present evidence that the unimproved area was occasionally used for outdoor worship, recreation, and neighborhood block parties, [but] presented absolutely no evidence that area was ever used for church retreats or church camping, much less primarily used for either of those purposes." The court rejected the church's claim that the property was exempt because it was needed for overflow parking, noting that the church "failed to provide any indication of how often the overflow parking area was needed, whether the need arose in connection with worship services, or what portion of the unimproved area . . . is actually needed for overflow parking. This lack of evidence [leaves us] with no choice but to deny the tax exemption to the entire unimproved portion of the property." Columbus Christian Center v. Zaino, 2002 WL 31839175 (Ohio App. 2002).
28. The Washington board of tax appeals ruled that a parsonage that was occupied by a church's music director and her roommate did not qualify for property tax exemption. The church could not afford to pay its music director a salary, but did let her occupy the parsonage without charge. The state property tax law exempted parsonages from taxation, and defined a parsonage as "a residence occupied by a member of the clergy who has been designated for a particular congregation and who holds regular services therefor." The state department of revenue construed the definition of "clergy" very narrowly as one who holds regular services, preaches, and is responsible for the covenants of the church. The minister that is designated for this particular congregation chooses to live in her own home, rather than in the parsonage. While it considers the music minister a very important lay person in the church, the department contends she does not meet the requirements of a member of the clergy. The board of tax appeals concluded, "The church acknowledges the parsonage is not occupied by the appointed, ordained minister assigned to the church. The music leader will not qualify the parsonage for exemption as she is an ancillary member of the church staff." Liberty Park United Methodist Church v. State of Washington, Wash. Board of Tax Appeals (docket no. 58399, April 11, 2003).