50. Corporations sole. Some persons are promoting the use of "corporations sole" by churches and church members as a lawful way to avoid all government laws and regulations, including income taxes and payroll taxes. Church leaders are informed that by structuring their church as a corporation sole they will become an "ecclesiastical" entity beyond the jurisdiction of the government. Individuals are told that by becoming a corporation sole they can avoid income taxes. The promoters, who often use email and the Internet, make it all sound so believable with numerous references to legal dictionaries, judges, and ancient cases. Such claims are false. Any material you receive promoting the corporation sole scam should be immediately discarded. In fact, the IRS recently issued a warning to persons who promote or succumb to such scams. Revenue Ruling 2004-27. The IRS noted that participants in these scams are provided with a state identification number that can be used to open financial accounts. They claim that their income is exempt from federal and state taxation because this income belongs to the corporation sole, a tax-exempt organization. Participants may further claim that because their assets are held by the corporation sole, they are not subject to collection actions for the payment of federal or state income taxes or for the payment of other obligations, such as child support.
•

The IRS noted that promoters, including return preparers, are recommending that taxpayers take frivolous positions based on this argument. Some promoters are marketing a package, kit, or other materials that claim to show taxpayers how they can avoid paying income taxes based on this and other meritless arguments.

The IRS concluded, "A taxpayer cannot avoid income tax or other financial responsibilities by purporting to be a religious leader and forming a corporation sole for tax avoidance purposes. The claims that such a corporation sole is described in section 501(c)(3) and that assignment of income and transfer of assets to such an entity will exempt an individual from income tax are meritless. Courts repeatedly have rejected similar arguments as frivolous, imposed penalties for making such arguments, and upheld criminal tax evasion convictions against those making or promoting the use of such arguments."

51. Court finds board member of a church school liable for unpaid payroll taxes. A church operated a private school for primary and secondary students. The school is incorporated, and its board of directors includes parents of students and members of the affiliated church. The board has six directors.

The school suffered a substantial drop in enrollment. The loss of tuition made the school insolvent. The directors chose to pay some creditors while negotiating with others. The board's goal was to keep the school open as long as possible. The school's checks required two signatures. The board's chairman, treasurer, and the school administrator, were signatories. The chairman claimed that he rarely signed checks and only did so when the others were not available.

Because of its financial problems, the school did not deposit its employees' withheld taxes for three quarters. The treasurer informed the chairman about the tax liability from the beginning. The chairman discussed it with the board, and suggested cutbacks to free up cash to pay the taxes. He claimed that the board rejected his ideas. Nearly $120,000 in withheld payroll taxes were not deposited for the quarters in question.

A few years later, the IRS assessed the full amount of payroll taxes against the treasurer and chairman of the board pursuant to section 6672 of the tax code. Both of these individuals insisted that they were not liable and that the IRS had abused its discretion by not assessing other board members for the taxes. A federal district initially found the treasurer personally liable for the full amount of the payroll tax liability. In a subsequent proceeding, the personal liability of the board chairman was addressed by the court.

The court noted that "under federal law, a company's agent who is responsible for the collection and payment of employment taxes is liable to the government for the amount of the taxes unpaid," and that a responsible person "has some authority over the payment of the taxes, like paying them himself, ordering their payment, or having some control over the company's treasury." The chairman of the board "had enough responsibility to be personally liable for the unpaid taxes. He knew about the tax burden —he signed a return showing that no tax deposits were made for three months. Also, he signed several checks to some of the school's creditors instead of paying the withheld taxes. He could have seen that the taxes were paid but chose not to."

The court rejected the board chairman's argument that his concern over the use of the withheld taxes was ignored or rejected by the board. It observed, "As chairman, he could have protested the use of the funds or refused to follow the directive. Further, that the school required two signatures on its checks is not a defense; it simply shows that at least two people were jointly in control."

The court also ruled that the board chairman was not immune from liability because he was a volunteer for the school since "he had a real position, he was involved in the financial operations of the school, and he knew about the obligation to the government. His titles, positions, and jobs were not honorary."

The court concluded that along with the treasurer the government would "recover jointly from the board chairman the balance of the unpaid employment taxes because he actively participated in the diversion of the funds. Others may share in the responsibility." Holmes v. United States, 2004-2 USTC 50,301 (S.D. Tex. 2004).

52. The United States Tax Court ruled that the IRS can ignore a pastor's "tithes" as a "living expense" in evaluating an offer in compromise. An ordained pastor served as the pastor of a local church for several years. He then moved to another state and was employed as a medical technician in a hospital. The IRS sent the pastor a letter notifying him that it was going to seize his assets in an attempt to satisfy unpaid tax liabilities of $60,000. Seeking to avoid IRS collection efforts, the pastor submitted an "offer in compromise" to the IRS (on Form 656) in which he sought to have his tax liabilities compromised for a reduced amount. His offer listed his assets and liabilities, and included a monthly "tithe" of $520 to his church as a "necessary living expense." The IRS rejected the offer in compromise. On appeal, the Tax Court affirmed the IRS position. The court noted that the IRS Internal Revenue Manual concedes that if a minister is required "as a condition of employment" to "tithe" to a church, then this is a necessary living expense that can be considered in evaluating an offer in compromise submitted by the minister. The "only thing to consider is whether the amount being contributed equals the amount actually required and does not include a voluntary portion." In this case, the court concluded that there was no evidence that the pastor was employed as a pastor, and it rejected his argument that tithing was a "condition of employment" even with respect to earnings from a secular employer since he was required by church doctrine to "tithe" on such earnings. The court also rejected the pastor's claim that the IRS's disregard of tithing expenses in evaluating offers in compromise violates the first amendment guaranty of religious freedom since the effect of this policy was to reduce the funds that taxpayers have to support their religion and divert those funds to the U.S. Treasury. The court concluded, "It may well be true that paying their taxes will leave the pastor and his wife with less funds to support their religion. But this is a burden, common to all taxpayers, on their pocketbooks, rather than a recognizable burden on the free exercise of their religious beliefs." Pixley v. Commissioner, 123 T.C. 15 (2004).

53. The IRS issued a ruling in which it addressed a number of important issues including (1) the impact an accumulation of assets has on a church's tax-exempt status; (2) the prohibition of political campaign intervention by churches and church leaders; and (3) the definition of the term "church" for federal tax purposes. A church conducted three or four weekly worship services on its premises for a number of years. These services were attended by up to 350 persons. Over time, the church stopped conducting regular worship services and embarked upon radio and publishing activities and occasional regional seminars where the church's founder disseminated his religious views, counseled the audience, and raised funds. These ventures proved successful, and the church accumulated large sums of money and acquired substantial real estate properties. On a couple of its radio broadcasts the founder urged listeners not to vote for a particular candidate in a presidential election. The IRS reviewed the church's status, and its political activities, and reached the following conclusions:

accumulation of assets

The IRS noted that a tax-exempt organization can justify a significant accumulation of assets only if it can demonstrate that the assets are necessary for its reasonably anticipated needs. To do this, the organization "must demonstrate a need warranting such accumulation and the existence, as of the end of the relevant taxable year, of specific, definite and feasible plans to use the accumulation within a reasonable time to meet this need." The IRS concluded, "While this case is close, we think that the church has provided sufficient information as to its needs and reasonably anticipated needs for its accumulations." The IRS pointed out that for several years the church operated its tax-exempt programs at substantial deficits, and the income from the investment real estate was available to cover the deficits.

political activities

Section 501(c)(3) of the tax code exempts from federal income taxes a church or other religious organization that is organized and operated exclusively for exempt purposes, and which does not "participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of any candidate for public office.” During two of its radio broadcasts, the church's founder told the audience that they should not vote for a particular candidate for president in the general election. The IRS concluded that the church had violated the tax code's ban on campaign intervention. But, instead of revoking the church's tax-exempt status, it imposed excise taxes against the church and pastor under section 4955 of the tax code. This section gives the IRS the discretion to impose excise taxes in lieu of, or in addition to, revocation of exempt status as a result of "political expenditures." The court concluded that revocation of exempt status was not appropriate given the relatively brief and infrequent comments made by the founder regarding opposition to a presidential candidate.

definition of "church"

The IRS concluded that the church had ceased to qualify as a "church" for federal tax purposes. In reaching its decision, the IRS noted that the organization failed most of the 14 criteria used by the IRS in identifying churches. These 14 criteria are: (1) a distinct legal existence; (2) a recognized creed and form of worship; (3) a definite and distinct ecclesiastical government; (4) a formal code of doctrine and discipline; (5) a distinct religious history; (6) a membership not associated with any other church or denomination; (7) an organization of ordained ministers; (8) ordained ministers selected after completing prescribed studies; (9) a literature of its own; (10) established places of worship; (11) regular congregations; (12) regular religious services; (13) Sunday schools for religious instruction of the young; and (14) schools for the preparation of its ministers. The IRS concluded that "while some of these are relatively minor, others, e.g. the existence of an established congregation served by an ordained ministry, the provision of regular religious services and religious education for the young, and the dissemination of a doctrinal code, are of central importance."

Conceding that "both the courts and the IRS agree that there is no bright-line test as to whether an organization is a religious organization or a church," it concluded, based on an analysis of the 14 criteria that the organization in this case no longer qualified as a church. The IRS observed, "Most important, it no longer possesses the regular church services which have been held to be a prerequisite for church status. It no longer has the minimum for church status—a body of believers or communicants that assembles regularly in order to worship. It no longer has a defined congregation of worshipers, nor an established place of worship, nor regular religious services. Nor does it have other substantial church characteristics. Its ministers officiated at no more than [a few] weddings or other ministerial events or sacerdotal functions during the years. . . ." IRS Letter Ruling 200437040.

54. Holiday gifts to employees. Many churches provide employees and volunteers with "gifts" at Christmas. Common examples include hams, turkeys, fruit baskets, small amounts of cash, or gift certificates. Church treasurers may assume that these gifts are so small that they need not be reported as taxable income. A recent IRS ruling suggests that this assumption is incorrect. A charity provided employees with a ham, turkey or gift basket as an annual holiday gift. Over the years, several employees complained about the gifts because of religious or dietary restrictions, and requested a gift coupon of comparable value. In response, the charity began providing employees with a gift coupon having a face value of $35 instead of a ham, turkey, or gift basket. The coupons list food stores where the coupon is redeemable. The charity did not withhold or pay any employment taxes for any portion of the $35 gift coupons provided to employees.

The IRS ruled that these coupons represented taxable income that should have been added to the employees' W-2 forms. It rejected the charity's argument that the coupons were a "de minimis fringe benefit" that were so low in value that they could be ignored for tax purposes. The IRS conceded that taxable income does not include any fringe benefit that qualifies as a de minimis fringe benefit, which is defined by section 132 of the tax code as "any property or service the value of which is so small as to make accounting for it unreasonable or administratively impracticable." The IRS concluded that cash can never be a de minimis fringe benefit since it is not "unreasonable or administratively impracticable" to account for its value. The same conclusion applies to "cash equivalents," such as gift coupons, even though the property acquired with the coupon would be a nontaxable de minimis fringe benefit had it been provided by the employer. The IRS noted that the definition of de minimis fringe benefits in section 132 refers only to "property or services," and not cash.

The IRS concluded, "It is our view that the employer-provided gift coupon operates in essentially the same way as a cash equivalent fringe benefit such as a gift certificate. As with a gift certificate, it is simply not administratively impracticable to account for the employer-provided gift coupons; they have a face value of $35. Accordingly, we conclude that an employer-provided holiday gift coupon with a face value of $35 that is redeemable at several local grocery stores is not excludable from gross income as a de minimis fringe benefit." IRS Letter Ruling 200437030 (2004).

55. A federal appeals court ruled that a pastor whose "rabbi trust" retirement fund was substantially lost by an investment company due to securities law violations could not sue the investment company since he had no present interest in the trust assets. A pastor wished to save for his retirement. As a result, he entered into a "rabbi trust" arrangement with his church. A rabbi trust is a nonqualified deferred compensation arrangement that allows employers to set aside tax-deferred funds for an employee. The funds are taxable only upon distribution upon the employee's retirement or death. The trust funds, however, being the property of the employer until they are distributed, remain subject to the employer's general creditors. The church funded the pastor's rabbi trust by diverting a portion of his salary into the trust (salary reduction). The church contracted with a company that provided trustee services for rabbi trusts. The pastor claimed that the company lost a substantial amount of his retirement savings through questionable investments that violated securities laws. The court noted that "the money used to make these investments was not the pastor's, but instead belonged to the trust and was subject in its entirety to the claims of the church's creditors." This case illustrates an important feature of rabbi trusts. Rabbi trusts are commonly used by secular corporations, and are increasingly used by churches. A rabbi trust is a trust established by an employer to pay benefits to an employee upon retirement or some other event. The trust is generally irrevocable and does not permit the employer to use the assets for purposes other than payments to the employee. A rabbi trust is not taxable to the employee until the assets are distributed, so long as the trust is subject to a "substantial risk of forfeiture" which generally means that the trust is subject to the claims of the employer's general creditors. The IRS has published a "model" rabbi trust agreement that will provide the benefit of tax deferral if adopted. This model agreement was used by the pastor's church in this case. It contains language necessary to avoid having contributions taxed to the employee in the year they are made. However, as this case illustrates, such language, to achieve the benefit of tax deferral, deprives the employee of all rights in the trust fund. This can have consequences in addition to tax deferral. It also means that the employee will not be allowed to sue investment companies in the event that their trust fund is lost or depleted due to securities law violations. Smith v. Partington, 352 F.3d 884 (4th Cir. 2003).

57. Using an employer's checks for personal purchases. The Tax Court ruled that the owner of a small company who used company checks to pay for personal purchases should have reported the value of these checks as taxable income. Some churches have checkbooks requiring the signature of only one person. Persons with such authority may write checks for personal purposes without authorization, and justify their acts on the ground that their purchases were indirectly for church purposes, or in some cases to compensate for a "substandard salary." Whatever the reason, persons who write church checks for personal purposes not only will generate taxable income, but they may face criminal charges for embezzlement and tax fraud (assuming that the amount of the checks is not reported as taxable income). Thompson v. Commissioner, TC Memo. 2004-2.

58. IRS steps up scrutiny of highly-paid officers of tax-exempt organizations. In 2004 the IRS announced a new enforcement effort to identify and halt abuses by tax-exempt organizations that pay excessive compensation and benefits to their officers and other insiders. As part of the Tax Exempt Compensation Enforcement Project, the IRS will contact nearly 2,000 charities and foundations to seek more information about their compensation practices and procedures. The IRS said the enforcement project will consist of examinations as well as other contacts. Because part of the project's objective is to gather information regarding current practices, contact by the IRS should not necessarily imply improper activity by an organization. “We are concerned that some charities and private foundations are abusing their tax-exempt status by paying exorbitant compensation to their officers and others,” said Mark W. Everson, Commissioner of the IRS. “The IRS has an obligation to investigate questionable compensation practices and put a stop to abuses we find,” he said. “We won't let the misbehavior of a few organizations damage the credibility of the vast majority of law-abiding charities and foundations.” The initiative will focus on particular areas including the compensation of specific officers and various kinds of insider transactions, such as loans and the sale, exchange or leasing of property to officers and others. IRS News Release IR-2004-106.

59. Court addresses bankrupt debtors' church contributions. A married couple with over $65,000 of consumer debts filed a "chapter 7" bankruptcy petition seeking to have their debts discharged. The plan called for all of the couple's income to be assigned to the court over and above specified living expenses which included $615 in monthly contributions to their church. The court noted that bankruptcy plans can be rejected if they would promote a "substantial abuse" of bankruptcy law. The court concluded that allowing the couple to withhold $615 each month for payment to their church was abusive, and it would accept their bankruptcy plan only after reducing monthly charitable contributions to $400. The court conceded that the bankruptcy law bars the rejection of bankruptcy plans on the basis of charitable contributions that do not exceed 15% of a debtor's annual income (or a higher percentage if consistent with the debtor's regular practice in making charitable contributions). While the couple's proposed contributions were less then 15% of their income, the court noted that "this does not mean that the court must accept the amount of charitable contributions that a debtor lists where the evidence does not reflect that the debtor, in fact, has given or is giving the listed amount to charity." The court noted that the couple had only contributed $450 per month to their church over the previous two years, and therefore it reduced their proposed monthly contributions of $615 to $450 as a condition of accepting the plan. In re Hallstrom, 2002 WL 1784500 (M.D.N.C. 2003).

60. Tax court addresses substantiation of charitable contributions. The court ruled that a taxpayer was allowed to claim a charitable contribution deduction on his tax return for various items of property that he had donated to a religious organization, as well as a cash donation to another charity, but could claim a deduction for miles he allegedly drove for charitable activities.

(1) Donated property. The taxpayer claimed a contribution deduction of $3,700 for items of property he donated to a religious charity. None of the donated items were valued at more than $100, and so the more stringent substantiation rules that apply to donations of property valued at $250 or more did not apply. The IRS had disallowed a deduction because the taxpayer could not produce receipts documenting the price he paid for them. The court pointed out that he did keep a list of the items he donated, and the price he paid for each item, and also was issued a letter by the charity listing each donated item. The court pointed out that the charity's letter and the taxpayer's list identified the same donated items. It concluded, "The list provided by the taxpayer and the written acknowledgment from the charity meet the substantiation requirements, despite his failure to maintain the individual receipts."

(2) Cash donation. The court ruled that the taxpayer could deduct a $50 contribution he allegedly made to another religious charity, even though he had no cancelled check to substantiate it. The court noted that the charity had issued the taxpayer a written confirmation of the contribution, and this was sufficient to substantiate the gift.

(3) Charitable travel. The taxpayer claimed a contribution deduction for miles he drove his car for volunteer work on behalf of a charity. The court denied any deduction for these miles, since the taxpayer "did not provide substantiation of these expenses, other than his testimony that he drove approximately 600 miles; he did not provide a mileage log or even any corroboration that he participated in the program. We find that he has not substantiated the mileage expenses." Mudd v. Commissioner, T.C. Summary Opinion 2004-1.

61. Court addresses designated gifts to charity. Most churches have established funds for specific purposes. Common examples include building funds and vehicle funds. Members are encouraged to donate funds for such projects, and donations are accumulated until the project is funded. Occasionally, donors will ask to have their contributions returned, often because the fund's purpose has not been implemented. Is a church required to return contributions to donors who request them under such circumstances? Very few courts have addressed this question, and so definitive guidance is lacking. A California court addressed this issue in a recent case. While the case involved a public university, the court's ruling is directly relevant to churches and any other charity.

A private university asked a wealthy individual (the "donor") if he would donate $1.5 million to the university to "endow" a professorship in his name to support young, untenured researchers in the field of gerontology. The donor agreed, and donated $1.5 million. A short time later the university named the first holder of the professorship. However, it did not inform the donor that it had not used his donation to fund the position. Three years later, the university selected the second holder of the professorship. Unknown to the donor, this individual was ineligible because she was not a young researcher just beginning her career, but instead was an existing faculty member due to receive tenure within six months.

The donor eventually discovered how his donation had been mishandled, and he sued the school for breach of contract. He claimed that the university had made promises in connection with the gift that it never intended to honor. It also alleged that the university had breached its contract with the donor by not funding the professorship as promised. The university claimed that it could not be liable for breach of contract since the donor had made a gift, and not entered into a contract. A trial court dismissed the case, and the donor appealed.

The appeals court began its opinion by noting that "the donor alleges he performed under the contract when he transferred $1.5 million to the university. He alleges the university breached the contract by not funding the professorship and by selecting an ineligible recipient. Finally, he alleges the university's breach damaged him because he could have put his money to uses other than giving it to the school." The court concluded that the donor could sue the university on the following two grounds:

(1) Promissory fraud. The court noted that promissory fraud occurs when someone "promises to do something without intending to do it." The elements of promissory fraud are "(1) a knowing misrepresentation, (2) made with the intent to induce another's reliance, (3) the other's justifiable reliance, and (4) damages." The court noted that "the donor alleges that the university promised to fund the professorship immediately without intending to do so. He alleges the university made the promise to encourage him to endow the position, and in giving $1.5 million to the university he justifiably relied on that promise. Based on these allegations, the donor has pleaded a cause of action for promissory fraud."

(2) Breach of contract. The court rejected the university's claim that it could not be sued for breach of contract based on its failure to honor the specific conditions set forth both orally and in writing between the parties.

While this case has no precedential value outside of California, it is one of the few cases to address the question of a donor's remedies when a charity diverts a designated contribution to some other use and so the court's opinion may be given greater weight in other jurisdictions. The court concluded that the donor could sue the university on the basis of "promissory fraud" and breach of contract as a result of the university's failure to honor the express terms of the donation. Glenn v. University of Southern California, 2002 WL 31022068 (Cal. App. 2003).

62. Can bankrupt debtors continue making tuition payments to church schools? A federal court ruled that tuition payments made to a church-operated school are not "charitable contributions," and so a married couple's bankruptcy plan could be rejected because of their insistence on continuing to make such payments. A married couple (the debtors) filed for bankruptcy protection. They had net monthly income of $5,770, expenses of $4,194, and $1,576 in disposable income. The bankruptcy plan provides for 36 monthly payments of $1,576 (total $56,736), which will pay $123,714 of unsecured creditors 25% of their claims. The debtors are devout Catholics, and asked the court to allow them to continue making monthly tuition expenses of $750 to send their children to a parochial school. They pointed out that the tuition was less than 15% of their gross annual income, and that the bankruptcy code permits debtors to make charitable contributions of up to 15% of their annual income. The bankruptcy trustee claimed that parochial school tuition does not qualify as a charitable donation, and that if the tuition payments were applied to creditors the total payments to creditors would more than double to 62% over three years.

A federal bankruptcy court noted that for a debtor's bankruptcy plan to be approved, it must provide "that all of the debtor's projected disposable income to be received in the three-year period beginning on the date that the first payment is due under the plan will be applied to make payments under the plan." Disposable income is defined as "income which is received by the debtor and which is not reasonably necessary to be expended (A) for the maintenance or support of the debtor or a dependent of the debtor, including charitable contributions."

The court noted that "in the absence of some compelling circumstance a private school education is not reasonably necessary." Further, "these debtors have given no reason why their children need to attend parochial school, i.e., they have not shown that the public schools in their area are not adequate, and neither have they suggested any other special need to do so. The only reason advanced by them is preferential, i.e., their children have always attended parochial school because of the family's strong religious ties. This argument addresses none of the compelling circumstances typically cited for finding private school tuition a reasonably necessary expense, and mere preference does not bring it within the meaning of the Act. Allowing these debtors to pay parochial school tuition which over the life of the plan will exceed the amount distributed to creditors, is to require general creditors to fund the private education of the debtors' kids."

The court also rejected the debtors' argument that parochial school tuition payments should be allowed because they constitute a charitable contribution. The court acknowledged that the bankruptcy code prohibits trustees from rejecting a bankruptcy plan on the basis of charitable contributions (so long as the contributions do not exceed 15% of the debtor's annual income), but it concluded that this provision did not apply to tuition payments even if motivated by religious beliefs: "Charitable or religious donations are just that, and in making such contributions the donor is not bargaining for a tangible quid pro quo, but is making a gift to support the religion of his/her choice. Here the debtors propose to purchase, under the guise of a so-called religious donation, a substantial asset--the private education of their children. Based upon the record and the applicable law, I conclude as a matter of law that parochial school tuition payments are not charitable donations within the meaning of the Act, and that the money proposed to be used by the debtors to make said payments is disposable income required to be distributed under the chapter 13 plan."

The Religious Liberty and Charitable Donation Protection Act of 1998 provides important protections to churches and church members. One of the key protections of the Act prevents bankruptcy trustees from recovering a bankrupt debtor's charitable contributions from a church if the amount of the contributions does not exceed (1) 15 percent of the debtor's income or (2) more than 15% of the debtor's income if the contributions were "consistent with the practices of the debtor in making charitable contributions." When a bankruptcy trustee seeks to recover donations to a church that exceed 15% of the debtor's annual income, the question becomes whether the higher donation is consistent with the practices of the debtor in making contributions. This case clarifies that the term "charitable contribution" under the bankruptcy code does not include tuition payments made to a church school since a debtor receives something of substantial value in exchange for the tuition payments. In re Watson, 299 B.R. 56 (D.R.I. 2003).

63. Tax Court ruled that a married couple could not use cancelled checks to substantiate charitable contributions of $250 or more. The couple made charitable contributions of $21,000 to various charities, and claimed that they could use their personal testimony and cancelled checks to substantiate all of these contributions, including those of $250 or more. The IRS disagreed, noting that the tax code requires contributions of $250 or more to be substantiated with a "written acknowledgement" from the charity that meets various requirements. The Tax Court agreed with the IRS. It concluded, "We agree with the IRS that the disputed amounts are not deductible given the absence of a written acknowledgment. Under section 170(f)(8)(A) of the tax code an individual taxpayer may deduct a contribution of $250 or more only if he or she substantiates the deduction with a contemporaneous written acknowledgment by the donee that meets the requirements of that section. That acknowledgment, which must be furnished by the donee organization, must state the amount of cash and describe other property contributed, indicate whether the donee organization provided any goods or services in consideration for the contribution, and provide a description and good faith estimate of the value of any goods or services provided by the donee organization. Given that the taxpayers in this case do not have such a written acknowledgment from any of the recipients of the disputed amounts . . . we conclude that they are precluded by the statute from deducting the disputed amounts as charitable contributions." Hill v. Commissioner, T.C. Memo. 2004-156 (2004).

64. IRS addresses donations of cars to charity. Many churches have had cars donated to them. Often, the donor is a member of the congregation who wants the car to be transferred by the church to a designated individual (such as a staff member, or needy person). The donor's objectives in many cases are (1) to claim a charitable contribution deduction for the value of the car, and (2) to specify the recipient of the car. Whenever a car is donated to a church, there are three issues that church leaders should understand:

1. Can the donation be treated as a charitable contribution (and receipted by the church)?
   
2. What substantiation requirements must be met for the donor to claim a charitable contribution?
   
3. Should title to the car be transferred to the church?
   

Each of these issues is addressed in a new publication released by the IRS (Publication 4302, A Charity's Guide to Car Donations). Here is how the publication addresses the three questions mentioned above:

charitable contribution

Publication 4302 cautions that "in order to be deductible, a donation must be made to a charity that has full control and discretion over the disposition or use of the donation." This suggests that persons who donate a car to their church with the stipulation that it be transferred to a designated individual are not making a charitable contribution. On the other hand, the donation of a car can be treated as a charitable contribution if the donor makes no designation regarding its intended use, or stipulates that it be used in furtherance of one of the exempt purposes of the church (such as assisting the needy).

Some prior IRS rulings and court decisions have suggested that designated donations can be treated as charitable contributions so long as the designation is a mere "expression of interest" in a particular individual rather than a "commitment or understanding" that the donation will be used for the specified individual. This is an aggressive position, however, that should not be followed without the advice of a tax professional.

Can a church transfer a donated car to the senior pastor or some other staff member? Publication 4301 answers this question as follows: "A charity must operate exclusively to further the charity’s exempt purposes. A charity must not operate a car donation program in a manner that improperly benefits private parties. For example, a charity should not sell cars on favorable terms to individuals such as board members."

substantiating the contribution

Publication 4302 provides the following information on substantiating the donation of a car:

A donor must file Form 8283, Noncash Charitable Contributions, to report information about noncash charitable contributions if deductions for all noncash gifts during the year exceed $500. For most property donations for which the deduction claimed is greater than $5,000, the donor must obtain an appraisal. A qualified appraiser must complete and sign Section B of Form 8283, called the appraisal summary; and an authorized official of the charity must also complete a portion of the form and sign it. The donor must give the charity a copy of Section B. A charity required to sign Form 8283 for receipt of a car must file Form 8282, Donee Information Return, if it sells or otherwise disposes of the car within two years after the date it received the car. This form must be filed within 125 days after the charity disposes of the car. This form requires the charity to identify the donor, the charity, and the amount the charity received upon disposition of the car. The charity must give the donor a copy of the completed Form 8282. . . .

A donor cannot deduct any single charitable contribution valued at $250 or more unless the donor obtains a contemporaneous written acknowledgment of the contribution from the charity.

Some church treasurers who are unfamiliar with these substantiation requirements erroneously assume that they can simply use a donated car's "blue book" value to determine the true valuation of the car. Publication 4302 warns that this is not acceptable: "Some fundraisers mistakenly claim that donors can, in all cases, deduct the full value of their cars as found in a used car guide (such as blue book value). A used car guide may be a good starting point to value a car, but donors and charities should exercise caution. The IRS will only allow a deduction for the fair market value of the car, which may be substantially less than the blue book value."

Publication 4302 also warns charities that they may be subject to a penalty if they help a donor overstate the value of a charitable contribution deduction.

title requirements under state law

Publication 4302 makes the following comments about titling of donated cars: (1) Charities must comply with state law requirements relating to titling of vehicles and transfers of title. (2) Generally, state charity officials ask the donor to transfer the car title to the charity, to make a copy of the title transfer, and to notify the state motor vehicle administration by updating the information on the donor’s car registration about any sale or transfer. (3) The donor should remove the license plates, unless state law requires otherwise. This will help avoid liability problems after the car is transferred.

65. Taxpayer's church contributions properly substantiated with church receipts. A taxpayer attended church regularly. Sometimes he would attend his father's church and other times his grandfather's, but he contributed to both churches. He made weekly payments using offering envelopes provided by the churches. He put both cash and checks into these envelopes. He also made a contribution by cash or check to the Salvation Army. The taxpayer claimed a deduction of $6,000 for these contributions. The IRS audited his tax return and disallowed any deduction for these contributions on the ground that the taxpayer lacked adequate substantiation. The Tax Court conceded that the taxpayer had no canceled checks or credit card receipts proving his charitable contributions. However, "he did produce letters from the two churches he attended acknowledging contributions of $3,750 and $4,500. These contributions total $8,250, and exceed the $6,000 claimed on the taxpayer's return. The court is satisfied with the credibility of the taxpayer's testimony as verified by his documentation under the cited legal standards and, therefore, allows a charitable contribution deduction of $8,201 for the year at issue." Jones v. United States, T.C. Summary Opinion 2004-76.

66. Donor's "valuation" of property donated to a church did not qualify as a charitable contribution. The Tax Court ruled that a donor who filled in the "value" of items he donated to a church on a printed form provided by the church was not entitled to deduct the full value as a charitable contribution. The court noted that the amount of a charitable contribution of property (other than money) is the fair market value of the donated property at the time of the contribution. To be eligible for a charitable contribution deduction for property, a donor must, among other requirements, establish the fair market value of the property at the time of the contribution and show the method they used to estimate the value. The donor in this case simply attached a form provided by the church upon which he had inserted a value. He presented no detailed information regarding the property, its cost, or the manner in which the value was determined. Under these circumstances, the donor was not entitled to a deduction for the full value of the donated property. McCarron v. Commissioner, T.C. Summary Opinion 2004-13.

67. Year 2004 Social Security changes. Full retirement age (the age at which you are entitled to full retirement benefits) for persons born in 1938 is 65 years and 2 months. Full retirement age for persons born in 1939 is 65 years and 4 months. There is no reduction in Social Security benefits for income earned in the month full retirement age is attained (and all future months). For months prior to full retirement age, Social Security retirement benefits are reduced by $1 for every $1 of earned income above $11,640 (for 2004). In the year an individual reaches full retirement age, Social Security benefits are reduced by $1 for every $3 of income earned above $2,590 for each month prior to the month that full retirement age is attained.

68. IRS to scrutinize retirement plans with 2,500 or more participants. IRS research has revealed a major market segment of pension plans with very little audit activity. This segment consists of plans with 2,500 or more participants. While these plans (about 4,400 in total) represent only 1% of the total plan universe they include some 48 million participants and have an asset value of $2 trillion dollars. As a market segment, these plans have remained relatively untouched by IRS audits. The few audits that have been performed revealed significant issues, including excess contributions. The IRS is deploying additional agents to beef up its examination of these plans. Targeted plans include 403(b) annuities having 2,500 or more participants.

69. Federal appeals court addresses rabbi trusts. A "rabbi trust" is a retirement plan used by some churches to set aside funds for an employee's retirement. Rabbi trusts typically are created for a senior pastor who is approaching retirement. One of the advantages of a rabbi trust is that the annual contribution limits that apply to tax-sheltered annuities and qualified pension plans do not apply. This allows churches to set aside more substantial amounts for a minister's retirement.

The IRS has ruled that amounts set aside by employers in a rabbi trust on behalf of an employee are not currently taxable to the employee so long as certain requirements are met. One requirement is that the trust is subject to a "substantial risk of forfeiture." A "substantial risk of forfeiture" includes making the funds set aside in a rabbi trust subject to the employer's general creditors. A federal appeals court addressed this aspect of rabbi trusts in a recent case.

A company filed for bankruptcy protection, listing among its assets a substantial amount set aside in a rabbi trust for one of its officers. The company's secured creditors insisted that the entire trust was an asset of the bankruptcy court that should be distributed to them since their security agreement included all "intangible personal property of every kind and nature." The court agreed that this language was broad enough to include a rabbi trust, but it concluded that the creditors had no right to the trust fund. It noted that the company had based its rabbi trust on "model trust" language adopted by the IRS which only makes trust funds subject to general creditors of the employer. As a result, the court ruled that the company's secured creditors had no right to funds in the rabbi trust, even though their security interest extended to all "intangible personal property of every kind and nature."

In summary, according to this court, funds set aside in a rabbi trust based on the IRS "Model Rabbi Trust Agreement" are subject to the general or unsecured creditors of the church, but not the secured creditors. This is true even if a secured creditor's security interest applies to "intangible personal property of every kind and nature." The court noted that there is no reason, in principle, why a creditor could not secure a loan to a church with a security interest in funds set aside in a rabbi trust. But, this would require a modification in the model trust language drafted by the IRS. Bank of America v. Moglia, 330 F.3d 942 (7th Cir. 2003).

70. The IRS ruled that a "rabbi trust" established by a church for some of its employees, and that conformed to the "model" rabbi trust published by the IRS in 1992, was "owned" by the church and therefore the church's periodic contributions to the trust and trust earnings did not result in current taxable income to the trust beneficiaries. The IRS stressed that (1) the trust was revocable; (2) the trust document did not contain any language inconsistent with the language of the model IRS rabbi trust agreement; (3) the trust was a valid trust under state law and that all of the material terms and provisions of the trust, including the creditors' rights clause, were enforceable under state law; (4) an employee's rights to benefits under the trust were not subject in any manner to attachment or garnishment by his or her creditors; (5) the trust did not provide for any distributions to an employee prior to retirement or voluntary termination. Under the terms of the church's rabbi trust, employees forfeited any rights under the trust if they were terminated for cause or resigned without the church's consent. IRS Letter Ruling 200434008 (2004).

71. Retaining W-2 forms. It is a good practice for employees to keep copies of all W-2 forms issued to them by their employer until they confirm that the earnings reported on their W-2s correspond to the earnings credited to them on the Social Security Statement that is automatically issued each year to all Americans aged 25 and over. One of the main purposes of the Social Security Statement is to encourage taxpayers to check the accuracy of Social Security records and to make corrections. If earnings reflected on an employee’s Social Security Statement are underreported, the easiest way to correct the record is for the employee to present a copy of his or her W-2 for the year in question to the nearest Social Security office. While proof of earnings is possible without a W-2 form, it is much more difficult and time-consuming.

72. Change in 2004 W-2 forms. The IRS has announced that it is modifying Form W-2 for 2004 to add an additional code to box 12. The new code is "Code W," which will be used by employers to report their contribution to an employee's health savings account.

73. Tax withholding on severance agreements. Many churches have entered into severance agreements with terminating employees. These agreements usually provide for the payment of a specified amount, plus a continuation of certain fringe benefits. The Tax Court has issued a ruling that reminds employers that payments made to a former employee pursuant to a severance agreement ordinarily constitute taxable income and therefore payroll taxes need to be withheld (unless the person is a minister who was employed to perform ministerial services, and did not elect voluntary withholding). The court relied on the following tax regulation: “Any payments made by an employer to an employee on account of dismissal, that is, involuntary separation from the service of the employer, constitute wages regardless of whether the employer is legally bound by contract, statute, or otherwise to make such payments.” Meehan v. Commissioner, CCH Dec. 55,662 (2nd Cir. 2004).

74. Property tax exemption determined by status of property on "tax date." A church purchased a parcel of land in March of 1997. A local tax assessor later sued the church for unpaid property taxes. A court ruled that under state law the exempt status of property is determined on January 1 of each year, and since on January 1, 1997 the church did not own the property in question it was not entitled to exemption. Many states have similar laws specifying that the tax status of property is determined on a specified date each year. It is for this reason that churches may have to pay property taxes for at least a portion of a year on newly acquired property, even if the property is immediately used for church purposes. St. Joseph Orthodox Christian Church v. Spring Branch Independent School District, 2003 WL 1922580 (Tex. App. Houston 2003).

75. Sales tax on Internet sales. The question of sales taxes on Internet purchases continues to create controversy. Most states have enacted "use taxes" that require residents to pay a tax on the purchase of items from out-of-state vendors who do not collect sales taxes. Use taxes generally are the same rate as the sales tax. Residents are expected to report and pay use taxes on special tax forms, though very few ever do. Historically, the use tax was not enforced or policed. But this is changing in recent years due to the extraordinary growth in online purchases for which sales taxes are rarely collected. Some experts believe that tens of billions of dollars in tax revenue is being denied to state governments because online vendors are not collecting sales taxes, and consumers are not paying use taxes. This is causing several states to take renewed interest in the use tax, especially those that are facing budgetary crises. One strategy that is being adopted in several states (including California and New York) is to add a line on the state income tax return requiring taxpayers to report purchases from out-of-state vendors and pay use taxes. This likely will end up being a voluntary system, since it is doubtful that states will actually "audit" taxpayers' estimates of their out-of-state purchases (even if they report nothing).

76. Failure to use the EFTPS system to remit payroll taxes may lead to penalties. The IRS assessed a 10% "failure-to-deposit" penalty against an employer because it did not use the EFTPS system to deposit its payroll taxes electronically. The IRS conceded that the employer paid the correct amount of payroll taxes by depositing them with a bank by the due date. But, since the employer failed to remit the taxes electronically as required by law, the IRS imposed the 10% penalty (amounting to $90,000). On appeal, a federal court upheld the penalty. It rejected the employer's argument that it "complied" with the EFTPS requirement by remitting the payroll taxes to a bank which in turn electronically forwarded them to the government. It also rejected the employer's argument that it could not be liable for the penalty because there was no "underpayment" of tax. Schumacher Company v. United States, 2004-1 USTC 50,166 (N.D. Ohio 2004).

Few churches are required to use EFTPS. But, this ruling is still relevant for two reasons: (1) some churches are large enough to be required to use EFTPS; and (2) many churches that are not required to use EFTPS have voluntarily chosen to do so, and these churches are subject to the EFTPS requirements unless they voluntarily cancel their participation.

77. Employee leasing company and employer both liable for payroll taxes. A growing number of employers are turning to "employee leasing companies" to provide employees. The idea is that this will relieve the employer of the hassle of recruiting and training employees. It also enables smaller employers to obtain health insurance, workers compensation insurance, and other fringe benefits at a much lower cost because of volume discounts. Employee leasing companies also pay wages and payroll taxes on behalf of the leased employees using funds advanced by the client company. But what happens if the client company fails to advance sufficient funds to meet payroll tax obligations? Is the leasing company jointly liable for the payment of these taxes? Yes, said a federal appeals court in a recent case. The court stressed that an organization that uses an employee leasing company to provide employees remains the "common law" employer of the workers and as such is liable for all payroll taxes since "the common law employer has a non-delegateable duty to timely perform its federal income tax obligations and cannot avoid its tax liability by contracting away the responsibility for the payment of wages." However, the court also concluded that an employee leasing company is also liable for the payment of payroll taxes if for any reason a client company is unable to advance sufficient funds. United States v. Total Employment Company, 2004-1 USTC 50,177 (M.D. Fla. 2004).

78. The IRS warns churches to stay out of politics. The tax code prohibits churches from participating or intervening in any political campaign on behalf of any candidate for public office. This is often called the "campaign" limitation. A church that violates this limitation “could lose its tax-exempt status,” the IRS cautioned in a recent news release. The news release lists the following activities that could jeopardize a church’s tax-exempt status: Endorsement of any candidates; making donations to a candidate’s campaign; fundraising on behalf of a candidate; distribution of statements or becoming involved in any other activities that may be beneficial or detrimental to any candidate; or “partisan” voter education activities. Internal Revenue News Release IR-2004-59.

79. An Illinois court ruled that a church-owned home used primarily as a residence for a teacher in the church's school did not qualify for exemption from property taxation. The church applied for exemption of the property from taxation, but its application was denied. A state appeals court agreed that the property was not tax-exempt even though it was occupied by a teacher employed by the church to teach a second grade class from a Christian perspective. A state law exempts property "used exclusively for religious purposes, or used exclusively for school and religious purposes." The court concluded that the house did not satisfy the requirements for exemption. It observed, "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." In summary, "the residential use of the property was primary; the educational use was secondary. As a result, the property was not exempt." Du Page County Board of Review v. Department of Revenue, 790 N.E.2d 918 (Ill. App. 2003).

80. A Tennessee court ruled that a church-owned home that was used solely as a residence for visiting missionaries did not qualify for exemption from property taxation. A deceased woman's estate left her home to her church to be used "for the temporary housing and convenience of the missionaries of said church." The church asked the tax assessor for a ruling that the home was exempt from property taxation because it was used purely and exclusively for carrying out the religious purposes of the church. The assessor denied the exemption, and the church appealed. Tennessee law exempts from property taxation "the real and personal property, or any part thereof, owned by any religious . . . institution which is occupied and used by such institution or its officers purely and exclusively for carrying out thereupon one (1) or more of the purposes for which the institution was created or exists . . . and provided further, that no church shall be granted an exemption on more than one (1) parsonage, which shall include not more than three (3) acres of land except as hereinafter provided; and provided further, that no property shall be totally exempted, nor shall any portion thereof be pro rata exempted, unless such property or portion thereof is actually used purely and exclusively for religious . . . purposes." The court concluded, "We do not believe using the house for overseas missionaries temporarily returning to the United States constitutes an exempt use under the statute. This is not a use which is directly incidental to or reasonably necessary for the church to accomplish its missionary work. . . . While the religious purpose of the church may be incidentally served by the temporary housing of missionaries, this incidental use and benefit does not bring the property within the statutory exemption." First Presbyterian Church v. Tennessee Board of Equalization, 2003 WL 21994804 (Tenn. 2003).

81. A Pennsylvania court ruled that a church's fellowship hall that was used for weekly Bible study classes constituted "religious worship" and therefore was exempt from property taxes. A church owned a 3-acre tract of land next to its sanctuary. The tract contained a two-story frame structure, originally constructed as a home, to which had been added a fellowship hall and an unfinished addition. In 2002, as part of a countywide reassessment, the county determined that this tract was not exempt from property tax. The church appealed the assessment, asserting that the building was used for religious purposes. The church treasurer testified that the building was used for the following religious purposes: (1) "lock-ins" and other overnight activities for the youth; (2) a weekly Bible study and other church meetings and dinners; (3) wedding receptions; and (4) a Boy Scout troop. The court concluded that the entire building plus one-half acre of the adjoining land were exempt from tax because "the primary purpose and use of the structure . . . is for religious worship and other activities in that building are merely incidental thereto." The county appealed, noting that state law limited the property tax exemption of church property to "places of regularly stated religious worship, with the ground thereto annexed necessary for the occupancy and enjoyment of the same." The county claimed that none of the "religious" uses described by the church constituted "religious worship," and therefore the building and surrounding land were taxable.

A state appeals court ruled that the "fellowship hall" portion of the property was exempt. It noted that "the treasurer testified that the fellowship hall was used weekly for the weekly Bible study. The regularity and constancy of this worship brings the primary use of this part of the building within the standards for a place of regularly stated worship. The fellowship hall, which is primarily used for religious worship is, therefore, exempt." The court added that an unfinished second floor above the fellowship hall also was exempt, since it was not being used at all. The court acknowledged that the hall was used occasionally for social uses, but this "did not change the fact that its primary purpose is regular worship in the form of Bible study."

However, the court ruled that the unfinished addition connected to the building was not entitled to exemption. It noted that the treasurer did not testify that it was being used for any religious worship. It quoted from a 19th century decision by the state supreme court: "If religious or public worship have not been held in the place, that place itself has not a character. At some day, distant or near, it may be intended to be used for stated public worship, but the fact that it is not now used strips it of its only title to exemption."

Several state property tax exemption laws limit the exemption of church property to property that is used for "religious worship." This is a far narrower exemption than more liberal state laws that exempt property used for "religious purposes." It is important for church leaders to know which kind of property tax exemption applies in their state. The court in this case was persuaded that a weekly Bible study constituted "religious worship" that rendered the fellowship hall exempt, but other portions of the property were not exempt because they did not meet the "religious worship" test. Connellsville Street Church of Christ v. Fayette County Board of Assessment, 838 A.2d 848 (Pa. App. 2003).

82. IRS issues guidance to charities. The Internal Revenue Service has published two new brochures to help charities understand the tax laws conferring tax-exempt status. One brochure (Publication 4220) is designed to help prospective charities apply for tax exemption under the tax law. The other (Publication 4221) is a compliance guide that explains the record keeping, return filing and disclosure rules for those organizations. Both are concise, easy-to-use brochures that contain information designed to assist charities in maintaining their tax-exempt status. Publications 4220 and 4221 are available now on the IRS website, www.irs.gov, and can be ordered by calling toll-free 1-800-829-3676.

83. 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 final regulations issued by the Department of Labor in 2004 the minimum compensation required to qualify for exemption from the minimum wage and overtime requirements as an executive, administrative, or professional employee were boosted from $155 per week to $455 per week, and the "duties tests" were modified slightly. It is important for church leaders to be familiar with the new definitions since some church employees who previously were exempt will now qualify for overtime pay.

84. IRS cannot deliver some refund checks. The Internal Revenue Service announced in 2004 that unclaimed tax refunds totaling $2.5 billion were awaiting 2 million taxpayers who failed to file a 2000 income tax return. However, in order to collect the money, a return had to be filed with an IRS office no later than April 15, 2004.

85. 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.

86. 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 2004. 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 2004, the maximum wages subject to the OASDI portion of self employment taxes (the 6.2% amount) increased to $87,900—up from $87,000 in 2003. Stated differently, employees who received wages in excess of $87,900 in 2004 paid the full 7.65% tax rate for wages up to $87,900, and the HI tax rate of 1.45% on all earnings above $87,900. Employers pay an identical amount.

87. Tax relief for disaster victims. The IRS may postpone for up to one year certain tax deadlines of taxpayers who are affected by a Presidentially declared disaster. The tax deadlines the IRS may postpone include those for filing income, estate, certain excise, and employment tax returns, paying taxes associated with those returns, and making contributions to an IRA. If the IRS postpones the due date for filing a return and for paying a tax, it may abate the interest on underpaid tax that would otherwise accrue for the period of the postponement. This extension to file and pay does not apply to information returns, or to employment tax deposits. However, the IRS may abate penalties on such deposits for affected taxpayers due to reasonable cause during the FTD Penalty Waiver Period, provided they make the payment by the last day of that Period. Taxpayers whose specific disaster-related circumstances prevent them from making tax deposits within that Period may seek penalty abatements on a case-by-case basis.