Church and Clergy Tax Developments in 1998: Tax Changes of Interest to Ministers

By Richard R. Hammar, J.D., LL.M., CPA

© Copyright 1998 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: m27 c0199

1. Tax rate adjustments. For 1998, the income tax rates for married couples filing jointly are 15% for the first $42,350 of taxable income, 28% for taxable income from $42,350 to $102,300, 31% for taxable income from $102,300 to $155,950, 36% on taxable income from $155,950 to $278,450, and 39.6% on taxable income in excess of $278,450. For 1998, the income tax rates for single individuals are 15% for the first $24,650 of taxable income, 28% for taxable income from $25,350 to $61,400, 31% for taxable income from $61,400 to $128,100, 36% on taxable income between $128,100 and $278,450, and 39.6% on taxable income in excess of $278,450. The new income tax rate structure is summarized in the following two tables.

TABLE 1 - 1998 INCOME TAX RATES

MARRIED PERSONS FILING JOINTLY

TABLE 2 - 1998 INCOME TAX RATES

SINGLE PERSONS

• Example. Rev. B is married and for 1998 he and his wife report gross income of $50,000 on their income tax return. Their taxable income, after deducting itemized deductions, personal exemptions, and a housing allowance, is $35,000. According to Table 1, they will pay an income tax rate of 15% on their entire taxable income, since it is below $42,350.
• Example. Same facts as the previous example, except that Rev. B and his wife report gross income of $75,000, and taxable income of $50,000. According to Table 1, some of this taxable income will be subject to the higher 28% tax rate. The couple computes their income taxes as follows: (1) $6,352 in taxes on the first $42,350 of taxable income (taxed at 15%); and (2) a 28% tax on taxable income above $42,350 (and below and $102,300), or $2,142 ($50,000 - $42,350 x 28%). The combination of these amounts is $8,494. This is in addition to Rev. B's self-employment tax, which is an additional 15.3% multiplied times his net earnings from self employment (note that this amount will include his housing allowance).

2. Increase in earnings subject to the self-employment tax. The self-employment tax rate (15.3%) did not change in 1998. However, the amount of earnings subject to tax increased. The 15.3% tax rate consists of two components: (1) a Medicare hospital insurance (HI) tax of 2.9%, and (2) an "old-age, survivor and disability" (OASDI) tax of 12.4%. There is no maximum amount of self-employment earnings subject to the Medicare hospital insurance (the 2.9% "HI" tax rate). The tax is imposed on all net earnings regardless of amount. For 1998, the maximum earnings subject to the "old-age, survivor and disability" (OASDI) portion of self-employment taxes (the 12.4% amount) increases to $68,400-up from $65,400 in 1997. Stated differently, persons who receive compensation in excess of $68,400 in 1998 will pay the 15.3% tax rate for net self-employment earnings up to $68,400, and the "HI" tax rate of 2.9% on all earnings above $68,400. These rules directly impact ministers, who always are considered self-employed for social security purposes with respect to their ministerial services. Ministers should take these rules into account in computing their quarterly estimated tax payments.

• Example. Rev. L has net earnings from self-employment for 1998 of $68,400 (the maximum amount subject to the self-employment tax). His self-employment tax will be $10,465. Note that the housing allowance is not excluded when computing this tax. If Rev. L earned $70,000, he would pay the 12.4% "old-age, survivor and disability" (OASDI) tax up to the limit of $68,400, and the 2.9% Medicare tax on his entire taxable earnings.

3. The standard mileage rate for business miles increased to 32.5 cents per mile in 1998 (up from 31.5 cents in 1997). The standard mileage rate can be used to compute the cost associated with the business use of a car, provided that it is used in the first year the car is used for business purposes. In addition, employers can use the standard mileage rate to reimburse clergy and church workers for their business use of a car. Of course, clergy are free to deduct the actual costs associated with the business use of a car. Most do not use the "actual cost method, since it is much more time-consuming and inconvenient. The new standard mileage rate applies to all business miles driven in 1998.

4. Inflation adjustments. For 1998, the following three "inflation adjustments" took effect:

Tax rates. The amounts of income you need to earn to boost you to a higher tax rate were adjusted for inflation. This means that additional income you earn due to inflation will not automatically put you in a higher tax rate bracket. To illustrate, married persons filing jointly do not move from the 15% to the 28% tax rate in computing their 1998 taxes until they have at least $42,350 of taxable income (up from $41,200 in 1997). Single persons do not move from the 15% to the 28% tax rate until they have $25,350 of taxable income (up from $24,650 in 1997). As noted elsewhere in this summary, additional tax rates apply to higher income taxpayers in 1998.

Personal exemptions. The "personal exemption amount" (the amount you can deduct for yourself, your spouse, and each dependent) was adjusted for inflation. For 1998, the amount increased to $2,700 per person (up from $2,650 in 1997).

Standard deduction. The "standard deduction" (the amount you can deduct if you cannot itemize your deductions) was adjusted for inflation. The standard deduction increases to $7,100 for married couples filing jointly (up from $6,900 in 1997). It increases to $4,250 for single taxpayers (up from $4,150 in 1997). Single taxpayers who are 65 years of age or older, or blind, get a $1,050 increase in their standard deduction for 1998 (up from $1,000 in 1997). Married taxpayers who are 65 years of age or older, or blind, get an $850 increase in their standard deduction for 1998 (up from $800 in 1997).

5. Increase in standard deduction of dependents. Beginning in 1998, the standard deduction for a taxpayer who is claimed as a dependent on another's tax return is increased to the lesser of (1) the standard deduction for individuals, or (2) the greater of (a) $500 (indexed for inflation), or (b) the individual's earned income plus $250. The $250 amount will be indexed for inflation after 1998.

6. A recently released confidential IRS memo dating back to 1992 concluded that the so-called Deason rule must be applied in the computation of self-employment taxes as well as income taxes. The Deason rule requires ministers to reduce their business expense deductions by the amount of their total compensation that consists of a nontaxable housing allowance (or fair rental value of a parsonage). Since the housing allowance is fully taxable in computing a minister's self-employment taxes, the Deason rule has no application. Not so, said the IRS in its 1992 memorandum. However, its reasoning was so dubious that it conceded that "litigation hazards" were associated with its conclusion. In fact, it even acknowledged that "an argument can be made" that the Deason rule does not apply in computing self-employment taxes. Fortunately, the flawed reasoning in the internal memo was rejected by the IRS itself a few years later. In 1995 the IRS issued "audit guidelines" for ministers that its agents are to follow when auditing ministers' tax returns. These guidelines state that the Deason rule is not to be applied in computing a minister's self-employment tax.

7. The tax consequences of tuition discounts. A recent IRS ruling suggests that clergy and church staff members may be able to exclude tuition reductions from their income. Many churches operate preschools and private schools, and grant tuition reductions to employees of both the church and school. The tax code makes these "tuition reductions" nontaxable benefits for school employees, but there is some doubt as to their tax status for church employees. The IRS ruled that a part-time teacher in a public school who worked only a few hours each week was an employee rather than a self-employed worker. It concluded that the facts demonstrated sufficient control to render the teacher an employee. It noted that less control is needed to find that a professional worker is an employee, since such workers generally work with very little control or supervision. This IRS ruling can be used to support the availability of a qualified tuition reduction exclusion to pastors and other church employees who teach one or more classes each semester at a church-operated school. After all, this ruling leaves little doubt that the IRS considers part-time teachers who work only a few hours each week to be employees. The same logic should apply to the definition of a "school employee" for purposes of determining eligibility for the qualified tuition reduction exclusion. IRS Letter Ruling 9821053.

8. The Tax Court addressed gifts of stock and the "assignment of income" doctrine in a case that will be instructive to both ministers and church treasurers. A donor owned several shares of stock in Company A. Company B offered to purchase all shares of Company A at a huge premium over book value. The donor contributed several shares to his church, and claimed a charitable contribution deduction for the inflated amount. The IRS conceded that a gift of stock had been made to the church. It insisted, however, that the donor should have reported the "gain" in the value of his stock that was transferred to the church. Not so, said the donor. After all, he never realized or "enjoyed" the gain, but rather transferred the shares to the church to enjoy. The IRS asserted that the donor had a legal right to redeem his shares at the inflated amount at the time he transferred the shares to the church. As a result, he had "assigned income" to the church, and could not avoid being taxed on it. The Tax Court agreed. It observed: "It is a well-established principle of the tax law that the person who earns or otherwise creates the right to receive income is taxed. When the right to income has matured at the time of a transfer of property, the transferor will be taxed despite the technical transfer of that property. . . . An examination of the cases that discuss the anticipatory assignment of income doctrine reveals settled principles. A transfer of property that is a fixed right to income does not shift the incidence of taxation to the transferee. . . . [T]he ultimate question is whether the transferor, considering the reality and substance of all the circumstances, had a fixed right to income in the property at the time of transfer." The court concluded that the donor had a "fixed right to income" at the time he donated the 30,000 shares to his church. Ferguson v. Commissioner, 108 T.C. 244 (1997).

9. The Tax Court addressed the deductibility of a minister's "writing" and car expenses. An ordained minister served as a full-time government employee. In addition, he had part-time jobs as a Navy chaplain and a college professor. He also was an author, publishing three reference books prior to 1983. Since 1983, he has written several manuscripts on philosophy, religion, logic, and politics, but only submitted one for publication (it was not accepted). The minister claimed a "depreciation deduction" of $8,000 for depreciation on his professional library of 6,400 books (with an alleged purchase price of $160,000), plus an additional $1,320 for depreciation on various office equipment, such as desks, bookcases, filing cabinets, furniture, and computers. These expenses all related to his writing activities. The minister used his car to commute from home to his various places of employment and other locations. He submitted a handwritten mileage log reflecting the dates he drove, where he drove, and the exact odometer reading at the beginning of each trip. He prepared this log at the time he was audited, using a spiral calendar and a small notebook in which he had logged his mileage information. The log shows that the minister traveled to his chaplain's duties, bookstores, church meetings, his government office, and the library. The log indicates that the minister drove 20,617 miles during the year in question, of which he claimed that 12,157 (about 59 percent) were business use miles. He claimed a "car expense" deduction for these "business miles" using the standard mileage rate. The IRS disallowed the minister's depreciation and car expenses, and the minister appealed. He insisted that he was engaged in the trade or business of writing on the topics of religion and philosophy, and so  he was entitled to deduct the depreciation on his library and home office equipment. The Tax Court disagreed. It observed that for the minister to be able to deduct writing expenses "he must prove that profit was the primary or dominant purpose for engaging in the activity." The court referred to the income tax regulation's list of factors to consider in deciding whether or not a taxpayer is engaged in an activity with a profit objective: "(1) the manner in which the taxpayer carried on the activity; (2) the expertise of the taxpayer or his advisers; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that the assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer's history of income or loss with respect to the activity; (7) the amount of occasional profits that are earned; (8) the financial status of the taxpayer; and (9) whether elements of personal pleasure or recreation are involved. No single factor is controlling, and we do not reach our decision by merely counting the factors that support each party's position." Treas. Reg. 1.183-2(b). The court concluded that the minister's writing activity was not motivated by profit according to these considerations, and as a result he could not deduct depreciation expenses associated with this activity: "[He] did not carry on this activity in a businesslike manner, as he did not maintain any books and records. Moreover, since 1983, [he] submitted only one manuscript for publication and earned no income from his writing activity. In addition, he did not demonstrate that he changed his operation to improve profitability, had a business plan, or investigated the basic factors that affect profitability." The court also rejected any deduction for the minister's car expenses, since "they represent travel between his home and places of employment. The cost of commuting to work, regardless of distance traveled, is a nondeductible personal expense." Nauman v. Commissioner, T.C. Memo. 1998-217.  

10. The IRS ruled that a minister who served as a denominational official was an employee for federal income tax reporting purposes. The minister was ordained in 1969, and has served as minister to several congregations. In the early 1990s, he was appointed as a presiding elder of his church. As a presiding elder, the minister supervises 27 churches; conducts quarterly conferences and preaches at churches within his district, and advises congregations as needed; oversees the collection of assessments from each church; presides over district conferences and Sunday School Conventions; licenses ministry candidates; and confirms stewards, Sunday school superintendents, and Christian education directors. Denominational rules establish salary guidelines for each salaried worker. A presiding elder is guaranteed a minimum salary annually and additional allowances from each church. Fringe benefits provided to a presiding elder, as part of his compensation package, include an annual housing allowance, pension benefits, payment of the minister's self-employment tax, and insurance (health, disability, and malpractice). Denominational rules specify that a presiding elder may be expelled or suspended from all official standing in the church if charged with any one or more of various offenses. The minister insisted that he was self-employed for income tax reporting purposes, but the IRS concluded that he was an employee. The IRS conceded that "for federal income tax purposes, an ordained minister may be an employee or an independent contractor." It concluded that the minister in this case was an employee, on the basis of the Tax Court's decision in the Weber case (finding that a Methodist minister was an employee). It noted that a minister's correct reporting status will be based largely on "church structure," and that the minister in this case was much closer to the facts in the Weber case than to those cases in which ministers were found to be self-employed. The Weber case is addressed fully in chapter 2 of Richard Hammar's 1999 Church and Clergy Tax Guide. IRS Letter Ruling 9825002.

11. Computer expenses. A taxpayer purchased an Apple Macintosh computer for $2,013 and deducted the entire cost as a business expense in the year of purchase. The IRS audited the taxpayer and disallowed the deduction. It pointed out that the taxpayer failed to make any "section 179 election" in the year the computer was purchased, and so he could not deduct the full cost of the computer in that year. The Tax Court agreed. It noted that section 179 of the tax code permits a taxpayer to deduct the entire cost of many kinds of business equipment in the year of purchase-but only if a "section 179 election" is made on the taxpayer's tax return. This is done on Form 4562, the depreciation schedule that accompanies Form 1040. If this election is not made, then a taxpayer has no choice but to claim annual depreciation deductions over the useful life of the computer or other business equipment. Fors v. Commissioner, T.C. Memo. 1998-158 (1998).  

12. A bill introduced in Congress would have permitted ministers who have opted out of social security to revoke their exemption. Representative English of Pennsylvania introduced House Bill 939, which provides, in part:

[A]ny exemption which has been received . . . by a duly ordained, commissioned, or licensed minister of a church . . . and which is effective for the taxable year in which this Act is enacted, may be revoked by filing an application therefor (in such form and manner, and with such official, as may be prescribed in regulations . . . ), if such application is filed no later than the due date of the federal income tax return (including any extension thereof) for the applicant's second taxable year beginning after December 31, 1997. Any such revocation shall be effective . . . as specified in the application, either with respect to the applicant's first taxable year beginning after December 31, 1997, or with respect to the applicant's second taxable year beginning after such date, and for all succeeding taxable years; and the applicant for any such revocation may not thereafter again file application for an exemption  . . . . If the application is filed after the due date of the applicant's federal income tax return for a taxable year and is effective with respect to that taxable year, it shall include or be accompanied by payment in full of an amount equal to the total of the taxes that would have been imposed by . . . the Internal Revenue Code of 1986 with respect to all of the applicant's income derived in that taxable year which would have constituted net earnings from self-employment . . . except for the exemption . . . .

This bill only attracted a few sponsors in 1998, and is now considered dead.   

13. Child tax credit. If you have one or more children under 17 years of age (at the end of 1998), and you earn less than a specified amount of income, then you will be able to claim a $400 credit on your 1998 tax return for each child. The credit increases to $500 in 1999 and thereafter. To qualify for the credit, you must have a child who (1) is under 17 years of age; (2) is your child, descendent, stepson or stepdaughter, or foster child; and (3) is claimed by you as a dependent on your tax return. The child care credit is reduced by $50 for each $1,000 of adjusted gross income in excess of $110,000 for married couples filing jointly. For single persons, the credit is reduced by $50 for each $1,000 of adjusted gross income in excess of $75,000. These amounts are not adjusted for inflation. The child tax credit is in addition to the personal exemption amount ($2,700 for 1998) that can be claimed for each dependent child. In the case of a taxpayer with three or more qualifying children, if the amount of the allowable child credit exceeds the taxpayer's regular tax liability before the computation, then the excess is a refundable tax credit.  

14. Health insurance deduction for the self-employed. Self-employed persons can deduct health insurance costs for themselves (and their spouse and children) as follows: 45 percent in 1998; 60 percent in 1999 through 2001; 70 percent in 2002; and 100 percent in 2003 and thereafter. This deduction is not allowed in any year in which the self-employed person is eligible to participate in a subsidized health plan maintained by an employer of either the self-employed person or his or her spouse.  

15. Foreign earned income credit. United States citizens generally are subject to federal income tax on all their income, whether derived in the United States or in a foreign country. However, citizens working in foreign countries may be eligible to exclude from their income for federal income tax purposes certain foreign earned income and housing costs. To qualify for these exclusions, the individual must either (1) be a resident of the foreign country for an uninterrupted period that includes the entire tax year, or (2) be present overseas for 330 days out of any 12 consecutive month period. The maximum exclusion for foreign earned income under current law is $70,000 per year. Congress enacted legislation in 1997 that increases the $70,000 annual foreign earned income exclusion by $2,000 per year beginning in 1998, until it reaches a maximum of $80,000 in the year 2002. In addition, the credit will be indexed for inflation beginning in 2008. This credit is claimed by many American missionaries serving in foreign countries.   

16. Estimated tax penalties. Taxpayers are subject to an "addition to tax" for any underpayment of estimated taxes. This penalty is not assessed if the total tax liability for the year (reduced by any withheld tax and estimated tax payments) is less than $500. Beginning in 1998, this amount is increased to $1,000. This provision is relevant to ministers, who always pay estimated taxes because their wages are exempt from tax withholding (unless they elect voluntary tax withholding).

17. Estimated tax requirements. A taxpayer is subject to a penalty for underpayments of estimated taxes. For 1998, the penalty is avoided if a taxpayer made timely estimated tax payments at least equal to (1) 100 percent of the previous year's tax liability, or (2) 90 percent of the current year's tax liability. The 100 percent of last year's tax liability rule is changed to 105 percent of the previous year's tax liability in 1999, 2000, and 2001; and 112 percent of the previous year's tax liability in 2002. The 100 percent of last year's tax liability exception is increased to 110 percent for individuals with adjusted gross income of more than $150,000 for the previous year.

18. HOPE scholarship tax credit. Beginning in 1998, taxpayers can claim a "HOPE" credit against federal income taxes of up to $1,500 per student per year for 50 percent of qualified tuition and related expenses (not including room, board, and books) paid during the first two years of the student's postsecondary, undergraduate education in a degree or certificate program.

19. Lifetime learning credit. Taxpayers can claim a "lifetime learning credit" against federal income taxes equal to 20 percent of tuition and academic fees incurred during a year on behalf of the taxpayer, or the taxpayer's spouse or dependent child. This credit applies to tuition expenses incurred after June 30, 1998, for education furnished in academic periods beginning after such date. The credit is available for tuition expenses incurred by a taxpayer, or the taxpayer's spouse or dependent child. The credit is 20 percent of the first $5,000 of tuition and academic fees This means that the maximum credit will be $1,000 per year. However, for expenses paid after December 31, 2002, up to $10,000 of tuition and academic fees will be eligible for the 20 percent lifetime learning credit. This means that the maximum credit will increase to $2,000 per year. Unlike HOPE credits, the lifetime learning credit is not limited to the first two years of postsecondary, undergraduate education. It can be claimed for an unlimited number of years. The lifetime learning credit can be claimed in any one year on behalf of any number of eligible students. The lifetime learning credit is available to students at both undergraduate and graduate educational institutions (and postsecondary vocational schools). In addition, students need not be enrolled half-time or full-time. If a taxpayer claims a HOPE credit with respect to a student then the lifetime learning credit will not be available with respect to that same student for the year, although the lifetime learning credit may be available with respect to that student for other years.

20. Education IRAs. Beginning in 1998, taxpayers can contribute up to $500 each year to an "education IRA." Here is how it works. A taxpayer establishes an education IRA and designates a "beneficiary" (usually, the taxpayer's child). The taxpayer contributes up to $500 each year into the account, up until the beneficiary's 18th birthday. Earnings on an education IRA generally accumulate tax-free-provided they are distributed for the post-secondary educational expenses of the beneficiary. In any year in which an exclusion is claimed for a distribution from an education IRA, neither a HOPE credit nor a lifetime learning credit may be claimed with respect to educational expenses incurred during that year on behalf of the same student. The HOPE credit and lifetime learning credit may be available in other years with respect to that beneficiary.

The IRS Restructuring and Reform Act of 1998 provides the following clarifications, beginning in 1998: (1) Any balance remaining in an education IRA will be deemed to be distributed within 30 days after the date that the designated beneficiary reaches age 30 (or, if earlier, within 30 days of the date that the beneficiary dies). (2) In the event of the death of the designated beneficiary, the balance remaining in an education IRA may be distributed (without imposition of the additional 10-percent tax) to a contingent beneficiary or to the estate of the deceased designated beneficiary. If any member of the family of the deceased beneficiary becomes the new designated beneficiary of an education IRA, then no tax will be imposed on such redesignation and the account will continue to be treated as an education IRA. However, the new beneficiary must be under 30 years of age for the "rollover," or change of beneficiary, to be nontaxable. (3) In order for taxpayers to establish an education IRA, the designated beneficiary must be a life-in-being. (4) If any qualified higher education expenses are considered in determining the amount of a distribution from an education IRA that is nontaxable, then no business expense deduction will be allowed with respect to those same education expenses. Education IRAs are explained in chapter 10 of Richard Hammar's 1999 Church and Clergy Tax Guide.  

21. Penalty-free withdrawals from an existing IRA to pay for educational expenses. Beginning in 1998, taxpayers can make early withdrawals from an IRA to pay for qualified higher education expenses of the taxpayer or the taxpayer's spouse, child, or grandchild-without triggering the 10 percent penalty that applies to early distributions from an IRA.

22. Increase IRA phaseout limits. Prior to 1998, if an individual (or his or her spouse) was an active participant in an employer-sponsored retirement plan, the $2,000 IRA deduction limit was phased out over the following levels of adjusted gross income: (1) $25,000 to $35,000 for single persons; and (2) $40,000 to $50,000 for married persons filing jointly. Two important changes to these rules took effect in 1998. First, an individual will not be considered to be an active participant in an employer-sponsored retirement plan merely because his or her spouse is an active participant in such a plan. And second, the deductible IRA phaseout ranges are increased. These changes are explained in chapter 10 of Richard Hammar's1999 Church and Clergy Tax Guide.

23. "Roth" ("backloaded") IRAs. Beginning in 1998, taxpayers can make annual nondeductible contributions of up to $2,000 to a Roth IRA, and distributions from such an IRA are not taxed if they are made after a five year holding period, and are made as a result of the account holder's attaining age 59 and 1/2 or older, death, disability, or purchase of a first home. Further, earnings on Roth IRAs accumulate tax-free. Roth IRAs are explained further in chapter 10 of Richard Hammar's1999 Church and Clergy Tax Guide.

24. No penalty for early IRA withdrawals by first-time homebuyers. Prior to 1998, a 10 percent "additional tax" applied to distributions from an IRA prior to age 59 and 1/2. Beginning in 1998, taxpayers may withdraw up to $10,000 from their IRA prior to age 59 and 1/2 for "first-time homebuyer expenses" without triggering the 10 percent penalty. The expenses must be incurred to buy or build a principal residence for yourself, or a child or grandchild. This new rule takes effect in 1998.

25. Estate tax relief. Some people unexpectedly find themselves subject to federal estate taxes because of insurance proceeds, successful investments, and inheritances. The estate tax is substantial-it begins at a 37 percent rate. Prior to 1998, estates of less than $600,000 were exempt from tax (unchanged since 1987). In 1998, the exempt amount increases to $625,000. It increases to $1 million by the year 2006. Some estates that include a family-owned business are eligible for a $1.3 million exemption amount beginning in 1998.

26. Increase in charitable mileage rate. Taxpayers can deduct out-of-pocket expenses incurred in performing services on behalf of a church or other charity. Prior to 1998, taxpayers could value the use of a car while performing charitable services at a "standard charitable mileage rate" of 12 cents per mile. This standard mileage rate increased to 14 cents per mile in 1998. The new rate is not indexed for inflation.

27. Contributions on behalf of self-employed ministers to church retirement plans. Congress enacted legislation in 1997 clarifying that in the case of contributions made on behalf of a minister who is self-employed to a church plan, the contribution is nontaxable to the extent that it would be if the minister were an employee of a church and the contribution were made to the plan. This provision takes effect in 1998.

28. IRS announces moving expense changes for 1998. Churches often reimburse moving expenses incurred by new staff. Church leaders should be familiar with the following changes in moving expense reporting that took effect in 1998: (1) Form 4782, which was used by employers to report moving expense reimbursements made to employees, has been eliminated; (2) qualified moving expenses an employer pays to a third party on behalf of the employee (e.g. to a moving company) are not reported on Form W-2; (3) qualified moving expenses reimbursements an employer pays directly to an employee will be reported in Box 13 of Form W-2 and will be identified using Code P (currently, all qualified moving expense reimbursements are identified with Code P, regardless of whether or not they were paid directly to the employee); (4) other moving expense reimbursements (nonqualified expenses) will continue to be included in wages (Form W-2, box 1) and are subject to income tax withholding and social security and Medicare taxes.

29. No change in IRS audit rate. The IRS audited the same percentage of tax returns in 1996 as it did in 1995, according to IRS statistics. The audit rate for 1996 was 1.67% of individual income tax returns-the same rate as 1995.

30. Projected inflation adjustments for 1999. The "personal exemption amount" (the amount you can deduct for yourself, your spouse, and each dependent) is projected to increase to $2,750 in 1999-up from $2,700 in 1998. The "standard deduction" (the amount you can deduct if you cannot itemize your deductions) is expected to increase to $7,200 for married couples filing jointly-up from $7,100 in 1998. It increases to $4,300 for single taxpayers-up from $4,250 in 1998. For married persons filing jointly, the 28% income tax bracket will start at $43,050 in 1999. For single persons, the 28% income tax bracket will start at $25,750.

31. IRS releases intermediate sanctions regulations. The IRS issued regulations in 1998 that address intermediate sanctions. The regulations provide a number of clarifications, including the following: (1) The regulations confirm that intermediate sanctions apply to churches, but they specify that the protections of the "Church Audit Procedures Act" apply. (2) Disqualified persons can avoid an excise tax equal to 200% of the amount of an excess benefit if they "correct" the transaction. The regulations clarify that a correction occurs if the disqualified person repays the excess benefit to the tax-exempt organization, plus any additional amount needed to compensate the organization for the loss of the use of the money. (3) "Managers" who approve an excess benefit transaction are subject to an excise tax equal to 10% of the amount of the excess benefit-up to a maximum of $10,000. This is the maximum liability for the board as a whole, and not for each manager individually. (4) Since intermediate sanctions apply only to disqualified persons (and in some cases managers), it is important for church leaders to be familiar with this term. The new regulations provide helpful guidance. They define a disqualified person as any person who was in a position to exercise substantial influence over the affairs of the tax-exempt organization, or any family member of such a person. The regulations specify that board members, presidents, and treasurers are presumed to exercise substantial influence. On the other hand, persons who do not meet the definition of a "highly compensated employee" (one whose annual compensation exceeds $80,000) will not be deemed to exercise substantial influence over a charity and therefore will not meet the definition of a disqualified person-unless they are a board member, president, treasurer, or family member of a disqualified person. (5) Compensation in excess of what is "reasonable" constitutes an excess benefit that will expose a disqualified person to intermediate sanctions. The regulations note that "compensation for the performance of services is reasonable if it is only such amount as would ordinarily be paid for like services by like enterprises under like circumstances." The regulations clarify that compensation includes all items of compensation provided by a church or charity in exchange for the performance of services, including but not limited to cash and noncash compensation, fees, bonuses, severance payments, deferred compensation whether or not paid under a plan that is a qualified plan under federal tax law, the amount of premiums paid for liability or any other insurance coverage, any payment or reimbursement of expenses, fees, or taxes not covered by any insurance policy, and "all other benefits" whether or not included in income for tax purposes (including payments to plans providing medical, dental, life insurance, severance pay, and disability benefits, and both taxable and nontaxable fringe benefits including expense allowances or reimbursements or foregone interest on loans). (6) The regulations specify that whether a compensation arrangement based on a percentage of a tax-exempt organization's revenue constitutes an excess benefit transaction will depend on all of the facts and circumstances, including the "relationship between the size of the benefit provided and the quality and quantity of the services provided," and "the ability of the person receiving the compensation to control the activities generating the revenues on which the compensation is based." The regulations clarify that a revenue-sharing transaction may constitute an excess benefit transaction "regardless of whether the economic benefit provided to the disqualified person exceeds the fair market value of the consideration provided in return if, at any point, it permits a disqualified person to receive additional compensation without providing proportional benefits that contribute to the organization's accomplishment of its exempt purpose." (7) The regulations caution that churches and other charities are still exposed to loss of their tax-exempt status if they pay excessive compensation. The fact that such compensation arrangements may trigger intermediate sanctions does not necessarily protect the organization's tax-exempt status from attack.

32. Simplified definition of "highly compensated employee." A number of tax-favored rules do not apply if there is discrimination in favor of "highly compensated employees." These include (1) simplified employee pensions (SEPs); (2) 403(b) tax-sheltered annuities (churches and qualified church-controlled organizations are exempt from this nondiscrimination rule); (3) qualified employee discounts; (4) cafeteria plans; (5) flexible spending arrangements; (6) qualified tuition reductions; (7) employer-provided educational assistance; and (8) dependent care assistance. Unfortunately, the definition of a "highly compensated employee" has been complex, and has often led to absurd results. Congress enacted legislation in 1996 making the definition of the term "highly compensated employee" much simpler and fairer. Beginning in 1997, a highly compensated employee is one who (1) was a 5 percent owner of the employer at any time during the current or prior year (this definition will not apply to churches), or (2) had compensation for the previous year in excess of $80,000, and, if an employer elects, was in the top 20 percent of employees by compensation. The new definition repeals the previous rule requiring the highest paid officer to be treated as highly compensated, no matter how little he or she was paid. The $80,000 amount is adjusted annually for inflation. However, the amount was not increased in 1998. IRS News Release IR-97-41.

33. Increase in "section 179" deduction. It is a basic principle of tax law that if a product is purchased for business use and has a useful life of more than one year, the full cost may not be deducted in the year of purchase but rather must be allocated over the useful life of the product and an annual "depreciation" deduction claimed each year. Section 179 of the Code, however, permits taxpayers to elect to deduct most if not all of the cost of business property in the year of purchase if certain conditions are satisfied. In 1998 and future years the deduction is limited to the following amounts:

34. Extend the phaseout of the luxury tax on automobiles. An excise tax is imposed on the sale of a "luxury automobile" whose price exceeds a threshold amount ($36,000 in 1998). The excise tax for 1998 is 7 percent of the purchase price in excess of this threshold amount.

35. Senior Citizens' Right to Work Act. The amount of annual income that retired persons (from age 65 to 70) may earn without losing some of their social security benefits was increased as a result of the Senior Citizens' Right to Work Act, enacted by Congress in 1996. This is good news for those churches that employ retired persons and would like to compensate them adequately without reducing their social security benefits. Under this law, workers from age 65 to 70 could earn up to $14,500 in 1998 without a reduction in their social security benefits. Workers can earn $15,500 in 1999 without a reduction in benefits; $17,000 in 2000; $25,000 in 2001; and $30,000 in 2002 and later years. These tests apply only to workers who are 65 to 70 years old. Social security benefits are reduced by $1 for every $3 of income above these limits.

Workers 62 to 65 years of age could earn only $9,120 in 1998 without a reduction in social security benefits (a $1 reduction for every $2 of income in excess of the limit). This amount is indexed for inflation in future years. There is no earnings limit for workers who have reached age 70.

36. "Luxury car" limits adjusted for inflation. Ministers who use the "actual expense" method of computing their car expenses can claim a deduction for depreciation. There are limits on the amount of depreciation that you can claim in any given year. These limits are known as the "luxury car" limits. The 1998 limits are summarized in the table below, along with the limits for 1997 (for comparison purposes).

"Luxury car" depreciation limits

37. The IRS continues to target "self-employed" taxpayers. The IRS continues to target self-employed taxpayers for audits. Particularly vulnerable are persons who receive only one or two 1099 forms each year. Why all the attention on self-employed persons? A joint IRS and General Accounting Office study concluded that most taxpayers who report as self-employed, but who receive only one or two 1099 forms each year, are actually employees. Reclassifying self-employed persons as employees results in higher tax revenues for the IRS, since employees are subject to tax withholding and they often are not allowed to deduct their business expenses (unless their employer has adopted an accountable reimbursement plan). Also, the employer of a self-employed person who is reclassified as an employee by the IRS is subject to a special penalty under the tax code. Clergy who report their income taxes as self-employed are "prime targets" for IRS examination, since most of them will "fit the profile" of receiving only one or two 1099 forms. Our recommendation-most clergy should report their income taxes as employees, not self-employed. This is one very good reason.

38. Phase-out of personal exemption for high-income taxpayers. As noted elsewhere in this summary, the personal exemption deduction (that you can claim for yourself and each dependent) increased to $2,700 in 1998 (up from $2,650 in 1997). In 1998, the personal exemption amounts are phased out for certain high-income taxpayers. For married taxpayers filing jointly, the phase-out begins when adjusted gross income exceeds $186,800. For single taxpayers, the phase-out begins when adjusted gross income exceeds $124,500.

39. New per diem rates for substantiating the amount of travel expenses incurred in 1998. The IRS allows taxpayers to substantiate the amount of their business expenses by using "per diem" (daily) rates. Taxpayers still must have records substantiating the date, place, and business purpose of each expense. There are separate rates for meals and lodging, and separate rates for "high-cost localities" and all other communities. The rates for 1998 are summarized in the table below.

Per Diem Rates

1998

In some cases using the per diem rates will simplify the substantiation of meals and lodging expenses incurred while engaged in business travel. However, a number of restrictions apply, and these are explained in chapter 7 of Richard Hammar's1999 Church and Clergy Tax Guide.

40. Electronic signatures. Federal tax law requires that tax forms be signed. The IRS will not accept an electronically filed return unless it has also received a Form 8453, which is a paper form that contains signature information on the filer. Obviously, this requirement greatly reduces the convenience and efficiency of electronic filing. Congress enacted legislation in 1998 requiring the IRS to develop procedures that would eliminate the need to file a paper form (Form 8453) relating to signature information. Until the procedures are in place, the provision authorizes the IRS to provide for alternative methods of signing all returns and other documents. An alternative method of signature would be treated identically, for both civil and criminal purposes, as a signature on a paper form.  

41. Filing dates for electronically filed returns. Generally, a return is considered timely filed when it is received by the IRS on or before the due date of the return. If the return is mailed by registered mail, the dated registration statement is evidence of delivery. But what about electronically filed returns? When are they filed? Congress enacted legislation in 1998 requiring the IRS to develop rules for determining when electronic returns are deemed filed.   

42. Access to account information. Under current law, taxpayers who file their returns electronically cannot review their accounts electronically. The new law requires the IRS to develop procedures under which taxpayers filing returns electronically can review their accounts electronically not later than December 31, 2006-if all necessary privacy safeguards are in place by that date.  

43. Sale of a home owned and occupied for less than two years. Congress enacted legislation in 1998 that contains a big break for taxpayers. It allows taxpayers who own and occupy their home for less than two years to claim a partial exclusion of gain on the sale of their home-based on the fraction of $250,000 ($500,000 if married filing jointly) corresponding to the fraction of two years that they owned and occupied the home as their principal residence. To illustrate, assume that Rev. B and his wife purchased a home on July 1, 1997 for $150,000, and sold it on July 1, 1998 for $200,000 because of a change in place of employment. Under the old rules, since they owned and occupied the home for only half of the minimum requirement of two years, they could exclude only half of the gain on the sale of their home. This meant that they could exclude only $25,000 of their $50,000 gain. But under the new rules, they can exclude up to half of $500,000-which means that their entire gain is nontaxable. This provision is effective retroactive to sales occurring after May 6, 1997.

44. Roth IRAs. Beginning in 1998, taxpayers can make annual nondeductible contributions of up to $2,000 to a "Roth IRA". Distributions from such IRAs are not taxed if they are made after a five year "holding period," and are made as a result of the taxpayer attaining age 59 and 1/2 or older, death, disability, or purchase of a first home. Earnings on Roth IRAs accumulate tax-free. Eligibility for Roth IRAs is phased out for single taxpayers with adjusted gross income of $95,000 to $110,000, and for married taxpayers filing jointly with adjusted gross income of $150,000 to $160,000. A regular IRA may be rolled over to a Roth IRA. Only taxpayers with adjusted gross income of less than $100,000 are eligible for this provision. If you roll over your regular IRA into a Roth IRA prior to 1999, the amount that would have been included in taxable income had the funds been withdrawn (any gain or income in excess of annual contributions) are included in your taxable income over a four-year period. The ten percent penalty on early withdrawals from an IRA does not apply. In summary, the advantage of a Roth IRA is that it is "backloaded." This means that annual contributions to the IRA are not tax-deductible, but earnings and distributions are nontaxable if they meet the requirements mentioned above. This is a major tax break for many taxpayers, and will make Roth IRAs preferable in some cases to ordinary IRAs. Congress enacted legislation in 1998 that made a few technical modifications to Roth IRAs. These changes are summarized in chapter 10 of Richard Hammar's1999 Church and Clergy Tax Guide.  

45. Traditional IRAs. Congress enacted legislation in 1998 that modifies traditional IRAs in a couple of important ways. First, the new law confirms that an individual is not considered an "active participant" in an employer-sponsored retirement plan merely because his or her spouse is an active participant. This means that persons who are not "active participants" in an employer-sponsored retirement plan will have their annual IRA deduction (up to $2,000) "phased out" at a much higher level of income-even if their spouse is an active participant in an employer plan. Second, the new law addresses distributions from employer-sponsored retirement plans (including 403(b) annuities) made on account of hardship of the employee. Under current law, the 10-percent "early withdrawal" tax does not apply to distributions from an IRA if the distribution is for first-time homebuyer expenses (subject to a $10,000 life-time cap), or for higher education expenses. These exceptions do not apply to distributions from employer-sponsored retirement plans. A distribution from an employer-sponsored retirement plan that is an "eligible rollover distribution" may be rolled over to an IRA. An eligible rollover distribution that is not transferred directly to another retirement plan or an IRA is subject to 20-percent withholding on the distribution. Participants in employer-sponsored retirement plans, including section 403(b) tax-sheltered annuities, have been able to avoid the early withdrawal tax by rolling over "hardship distributions" to an IRA and then withdrawing the funds from the IRA. The new law modifies the rules relating to the ability to roll over hardship distributions from employer-sponsored retirement plans (including section 403(b) annuities) in order to prevent such avoidance of the 10-percent early withdrawal tax. The law provides that distributions from employer-sponsored retirement plans made on account of hardship of the employee are not eligible rollover distributions. However, the new law further clarifies that such distributions will not be subject to the 20-percent withholding rule applicable to eligible rollover distributions. This provision is effective for tax years beginning after 1998.  

46. Capital gains-elimination of 18-month holding period. The Taxpayer Relief Act of 1997 provided lower capital gains rates for individuals. Generally, the 1997 Act reduced the maximum rate on the net capital gain from 28 percent to 20 percent and reduced the 15-percent rate to 10 percent. However, to qualify for these reduced rates, a taxpayer had to hold an asset for more than 18 months prior to sale. This was a major change in the law, since in the past lower capital gains rates were available if an asset had been held for only one year. Beginning in 2001, lower rates of 18 and 8 percent will apply to the gain from certain property held more than five years. The IRS Restructuring and Reform Act of 1998 reduces the 18-month holding period to qualify for the reduced capital gains rates to one year. This provision takes effect for any tax year beginning after 1997.

47. Meals provided for the convenience of the employer. The value of meals furnished to an employee by his employer is excluded from the employee's gross income if the meals are furnished on the business premises of the employer and they are furnished for the convenience of the employer. Under what circumstances meals provided on an employer's premises meet this test has proven to be a difficult question. Congress enacted legislation in 1998 that provides some clarification by providing that all meals furnished to employees on an employer's premises are for the convenience of the employer if the meals furnished to at least half of the employees are for the convenience of the employer. Generally, meals are for the convenience of the employer if the employer has a "noncompensatory" business reason for furnishing the meals (for example, there are few if any restaurants nearby, and the employer would have to provide employees with longer lunch breaks if they were not furnished meals at work).  

48. Donations of computer equipment. In computing taxable income, a taxpayer who itemizes deductions generally is allowed to deduct the fair market value of property contributed to a charitable organization. However, in the case of a charitable contribution of inventory, short-term capital gain property, and certain other gifts, the amount of the deduction is limited to the taxpayer's basis (cost) in the property. The Taxpayer Relief Act of 1997 provided that certain contributions of computers by corporations to educational institutions for use by elementary and secondary school children qualify for an increased deduction. Under this special rule, the amount of the increased deduction generally is equal to the donor's basis in the donated property plus one-half of the amount of ordinary income that would have been realized if the property had been sold. However, the increased deduction cannot exceed twice the basis of the donated property. To qualify for the increased deduction, the contribution must satisfy various requirements. This special provision expires after the year 2000. Congress enacted legislation in 1998 clarifying that the increased charitable contribution deduction applies regardless of whether the recipient is an educational organization or some other tax-exempt charitable entity. This provision is effective as of August 5, 1997.  

49. IRS structure and functions. The main focus of the IRS Restructuring and Reform Act of 1998 was to make the IRS more responsive to taxpayers and less vulnerable to abuse. Here are some of the ways the new law accomplishes this objective:

lIRS reorganization plan. During extensive public hearings, Congress found that a key reason for taxpayer frustration with the IRS is the lack of attention to taxpayer needs. At a minimum, taxpayers should be able to receive from the IRS the same level of service expected from the private sector. For example, taxpayer inquiries should be answered promptly and accurately; taxpayers should be able to obtain timely resolutions of problems and information regarding activity on their accounts; and taxpayers should be treated fairly and courteously at all times. In order to make the IRS more "customer" oriented, the IRS is being reorganized. The old 3-tier geographic structure (including a National Office, Regional Offices, and District Offices) is being replaced by a structure that focuses on four groups of taxpayers with similar needs-individual taxpayers, small businesses, large businesses, and the tax-exempt sector. Under this structure, each unit will be charged with end-to-end responsibility for serving its group of taxpayers.

lIRS mission statement. The current "mission statement" of the IRS begins by declaring that the purpose of the IRS is "to collect the proper amount of tax revenue at the least cost." The new law requires the IRS to revise its mission statement to provide greater emphasis on serving the public and meeting the needs of taxpayers.

lIRS oversight board. The new law provides for the establishment within the Treasury Department of the "Internal Revenue Service Oversight Board". The general responsibilities of the new Board are to "oversee the IRS in the administration, management, conduct, direction, and supervision of the execution and application of the internal revenue laws." The Board will be composed of nine members, six of whom must be from the private sector.

50. Study of tax law complexity. Congress noted "a clear connection between the complexity of the Internal Revenue Code and the difficulty of tax law administration and taxpayer frustration." It further noted that "complexity and frequent changes in the tax laws create burdens for both the IRS and taxpayers. Failure to address complexity may ultimately reduce voluntary compliance." As a result, the new law requires the congressional Joint Committee on Taxation to provide an analysis of complexity concerns raised by tax provisions of widespread application to individuals and small businesses. The analysis is to include: (1) an estimate of the number and type of taxpayers affected; and (2) if applicable, the income level of affected individual taxpayers.

51. Disclosure of income tax returns. The confidentiality of personal income tax returns has become a growing issue in recent years. In 1997 alone, the number of "federal income tax return disclosures" exceeded 3.2 billion! That works out to an average of 32 "disclosures" for the year for each individual tax return. The Act as originally worded would have required the IRS to place "plain English" notices on all tax forms informing taxpayers of the many different ways in which tax return information is disclosed by the IRS. However, a House-Senate conference committee dropped this provision on the ground that language in the current instruction booklets to the main tax forms provides sufficient "notice" to taxpayers. Even though the proposal for more effective disclosure to taxpayers of the nonconfidentiality of their tax returns did not pass, it has raised the issue. More and more taxpayers will now be aware of how common it is for the IRS to disclose personal tax information to others. This in turn will affect the inaccurate public perception that personal tax return data is confidential.

52. Removal of the "scarlet letter." For many years, the IRS has placed a special code letter ("P") in its computer systems and tax files to identify tax "protestors". This letter has been associated with several tax protestor schemes, including the following: (1) contributions to "mail order" or other "sham" churches; (2) "constitutional" exemptions from tax; (3) reducing taxes because of the declining value of the dollar; and (4) reliance on the gold standard. While such schemes have been universally rejected by the courts, many in Congress felt that it was wrong to stigmatize a person for life as a tax protestor. After all, some of these persons eventually abandon their tax protestor position, and why should they continue to be stigmatized with the letter "P"? The new law forbids the IRS to use this designation any more.

53. Payment of taxes. The new law allows taxpayers to pay their taxes with checks payable to the "United States Treasury" instead of the IRS. The idea here is to reinforce the fact that the IRS merely collects taxes on behalf of the federal government.  

54. Electronic filing. Each year the IRS publishes a list of forms and schedules that may be electronically filed. During the 1997 tax filing season, the IRS received approximately 20 million individual income tax returns electronically. Under the new law, the stated policy of Congress is to promote "paperless" filing of tax returns, with a long-range goal of providing for the filing of at least 80 percent of all tax returns in electronic form by the year 2007.  

55. Civil damages against the IRS for negligence. Under current law, a taxpayer may sue the government for up to $1 million because of an IRS agent's reckless or intentional disregard of federal tax law in the course of any tax collection activity. The new law allows taxpayers to sue the government for up to $100,000 in civil damages caused by an IRS agent's negligent disregard of the law. The law clarifies that taxpayers cannot seek civil damages for negligence or reckless or intentional disregard of the law unless they first exhaust their administrative remedies within the IRS. This provision is effective immediately.  

56. Limitation on financial status audits. The IRS selects returns to be audited in a number of ways, including "financial status" audits. Under such an arrangement, IRS agents look for discrepancies between taxpayers' reported income and their "standard of living." If the standard of living seems excessive in light of reported income, then several financial questions can be raised in an effort to find unreported income. This technique has been criticized because of the potential for abuse. The new law prohibits the IRS from using financial status or economic reality examination techniques to determine the existence of unreported income of any taxpayer unless the IRS has independent and reasonable proof that there is a likelihood of unreported income. This provision is effective immediately.

57. Explanation of taxpayers' rights in interviews with the IRS. Prior to (or at) audit interviews, the IRS must explain to taxpayers the audit process and taxpayers' rights under that process. In addition, the IRS must explain the collection process and taxpayers' rights under that process. If a taxpayer clearly states during an interview with the IRS that he or she wishes to consult with a "representative," the interview must be suspended to allow the taxpayer a reasonable opportunity to consult with the representative. Congress enacted legislation in 1998 that requires that the IRS rewrite Publication 1 ("Your Rights as a Taxpayer") to more clearly inform taxpayers of their rights (1) to be represented by a representative and (2) if the taxpayer is so represented, that the interview may not proceed without the presence of the representative unless the taxpayer consents.

58.  Disclosure of IRS top-secret audit formula. Under current law, the IRS selects returns to be audited in a number of ways, such as through a computerized classification system (the discriminant function ("DIF") system). The DIF system accounts for about one-third of all audits, but the IRS has refused to disclose any of the details of this system to taxpayers. Congress enacted legislation in 1998 that requires the IRS to add to Publication 1 ("Your Rights as a Taxpayer") "a statement which sets forth in simple and nontechnical terms the criteria and procedures for selecting taxpayers for examination." The statement must specify the general procedures used by the IRS, including the extent to which taxpayers are selected for examination on the basis of information in the media or from informants.

59. Confidentiality privilege extended to some non-attorney tax professionals. Communications made between an attorney and client are "privileged," meaning that neither party can be compelled to disclose in court the substance of their confidential conversations. For the privilege to apply, the client must have been meeting with the attorney for legal advice. The IRS also recognizes the attorney-client privilege in tax proceedings. However, no equivalent privilege is provided for communications between taxpayers and other professionals authorized to practice before the IRS, such as CPAs or enrolled agents. Congress enacted legislation in 1998 that recognizes a new privilege of confidentiality for communications between taxpayers and individuals who are authorized to practice before the IRS. Enrolled agents and CPAs are the tax professionals contemplated by the new law. For the privilege to apply, the professional must be acting within the scope of his or her profession when the communication occurs. Further, the privilege will not apply to criminal proceedings before the IRS. This provision became effective on the date of the new law's enactment.

60. IRS employee contacts. The IRS sends many different notices to taxpayers. Many of these notices do not contain the name and telephone number of an IRS employee the taxpayer can call with questions. This failure has led to untold frustration. Congress enacted legislation in 1998 requiring all IRS notices and correspondence to contain a name and telephone number of an IRS employee whom the taxpayer may call. In addition, to the extent practicable and where it is advantageous to the taxpayer, the IRS should assign one employee to handle a matter with respect to a taxpayer until that matter is resolved. This provision is effective 60 days after the date of the law's enactment.

61. IRS telephone hotline. Congress enacted legislation in 1998 requiring all IRS telephone helplines to provide an option for any taxpayer to speak with a "live person" in addition to hearing recorded messages.  

62. IRS local office telephone numbers. Have you ever experienced the frustration of being unable to find the telephone number for your local IRS office in the telephone directory? Millions have. Congress enacted legislation in 1998 that requires each IRS office to list its office telephone number and address in the telephone directory.  

63. Approval of IRS levies. Under current law, IRS agents can impose liens, levies or seizures to collect taxes, without a supervisor's approval (except for the seizure of a taxpayer's home). The new law requires the IRS to implement an approval process under which any lien, levy or seizure would be approved by a supervisor, who would review the taxpayer's information, verify that a balance is due, and affirm that a lien, levy or seizure is appropriate under the circumstances. Circumstances to be considered include the amount due and the value of the asset. Failure to follow such procedures should result in disciplinary action against the supervisor or agent. This provision applies to all future tax collection actions.  

64. Changes in levy exemption amounts. The IRS can "levy" on all non-exempt property of a taxpayer. This means that the IRS can seize and sell a taxpayer's property to satisfy an unpaid tax bill. But some property is exempt from this process. In the past, exempt property has included up to $2,500 in value of fuel, provisions, furniture, and personal effects in the taxpayer's household, and up to $1,250 in value of books and tools necessary for the trade, business or profession of the taxpayer. Congress enacted legislation in 1998 that increases the value of personal effects exempt from levy to $6,250 and the value of books and tools exempt from levy to $3,125. These amounts are indexed for inflation. This provision is effective for all future collection actions.  

65. Seizure of personal residences. Congress enacted legislation in 1998 that prohibits the IRS from seizing real property that is used as a residence (by the taxpayer or another person) to satisfy an unpaid tax liability of $5,000 or less, including penalties and interest. The new law further requires the IRS to exhaust all other payment options before seizing the taxpayer's principal residence. This provision is effective immediately.  

66. "Due process" in IRS collection actions. The IRS may collect taxes by a "levy" upon a taxpayer's property (including accrued wages) if the taxpayer neglects or refuses to pay the tax within 10 days after notice and demand that the tax be paid. Congress enacted legislation in 1998 that establishes formal procedures designed to insure due process when the IRS seeks to collect taxes by levy.  

67. Application of fair debt collection practices. The Fair Debt Collection Practices Act provides a number of rules relating to debt collection practices. Among these are restrictions on communication with the consumer, such as a general prohibition on telephone calls outside the hours of 8:00 a.m. to 9:00 p.m. local time, and prohibitions on harassing or abusing the consumer. Congress enacted legislation in 1998 that makes the Fair Debt Collection Practices Act's restrictions relating to communication with the debtor and the prohibitions on harassing or abusing the debtor applicable to the IRS by incorporating these provisions into the Internal Revenue Code. The restrictions relating to communication with the taxpayer are not intended to hinder the ability of the IRS to respond to taxpayer inquiries (such as answering telephone calls from taxpayers). This provision is effective immediately.  

68. Offers in compromise. The tax code permits the IRS to compromise a taxpayer's tax liability. An offer in compromise is an offer by the taxpayer to settle an unpaid bill for less than the full amount of the assessed balance. Congress enacted legislation in 1998 that will make it easier for taxpayers to reduce tax liabilities through offers in compromise. Among other things, the IRS must implement procedures to review all rejections of taxpayer offers in compromise prior to the rejection being communicated to the taxpayer. The IRS must allow the taxpayer to appeal any rejection of such offer to the IRS Office of Appeals. The IRS must notify taxpayers of their right to have an appeals officer review a rejected offer in compromise on the application form for an offer in compromise. Further, Congress instructed the IRS to "adopt a liberal acceptance policy for offers in compromise to provide an incentive for taxpayers to continue to file tax returns and continue to pay their taxes."

69. Guaranteed availability of installment agreements. Congress enacted legislation in 1998 that requires the IRS to enter into an installment agreement, at the taxpayer's option, if (1) the liability is $10,000, or less (excluding penalties and interest); (2) within the previous 5 years, the taxpayer has not failed to file or to pay, nor entered an installment agreement; (3) when requested by the IRS, the taxpayer submits financial statements, and the IRS determines that the taxpayer is unable to pay the tax due in full; (4) the installment agreement provides for full payment of the liability within 3 years; and (5) the taxpayer agrees to continue to comply with the tax laws and the terms of the agreement for the period (up to 3 years) that the agreement is in place. This provision is effective immediately.

70. Statute of limitations. Congress enacted legislation in 1998 that eliminates a previous rule that allowed the statute of limitations on collections to be extended by agreement between the taxpayer and the IRS. The new law also requires that, on each occasion on which the taxpayer is requested by the IRS to extend the statute of limitations on an assessment of tax, the IRS must notify the taxpayer of the taxpayer's right to refuse to extend the statute of limitations or to limit the extension to particular issues.

71. Relief for innocent spouses. Each spouse who signs a joint tax return is fully responsible for the accuracy of the return and for the full tax liability. This is true even though only one spouse may have earned the income which is shown on the return. This is "joint and several" liability. Relief from liability for tax is available for "innocent spouses" in certain limited circumstances. Congress enacted legislation in 1998 that makes innocent spouse relief easier to obtain.

72. Burden of proof. In the past, there was a "rebuttable presumption" that any determination of tax liability by the IRS was correct. As a result, taxpayers who challenged IRS determinations have the "burden of proof". Congress enacted legislation in 1998 that provides that the IRS will have the burden of proof in any court proceeding with respect to a factual issue if the taxpayer introduces credible evidence relevant to ascertaining the taxpayer's income tax liability. Four conditions apply: (1) The taxpayer must comply with the requirements of the tax code and regulations to substantiate any item. (2) The taxpayer must maintain records required by the tax code and regulations. (3) The taxpayer must cooperate with reasonable requests by the IRS for meetings, interviews, witnesses, information, and documents. (4) Corporations, trusts, and partnerships whose net worth exceeds $7 million are not eligible for the benefits of the provision. No net worth limitations apply to individuals.  

73. Suspension of interest and certain penalties if the IRS fails to contact individual taxpayer. Under current law, interest and penalties accrue continuously while taxes are unpaid whether or not the taxpayer is aware there is tax due. In many cases, the interest and penalties eventually exceed the tax liability itself. Congress enacted legislation in 1998 that suspends the accrual of penalties and interest after 18 months if the IRS has not sent the taxpayer a notice of deficiency within 18 months following the date which is the later of (1) the original due date of the return or (2) the date on which the individual taxpayer timely filed the return. The suspension only applies to taxpayers who file a timely tax return. The provision applies only to individuals and does not apply to the "failure to pay" penalty, in the case of fraud, or with respect to criminal penalties. Interest and penalties resume 21 days after the IRS sends a notice and demand for payment to the taxpayer. This provision is effective immediately.

74. Employees who do not seek reimbursement of business expenses. The Tax Court issued a ruling recently that illustrates an important point. Employees are not able to claim a business expense deduction for an unreimbursed expense if they "had the right to, but failed to seek, reimbursement" from their employer. In other words, if your church has an accountable reimbursement arrangement and an employee fails to seek reimbursement for a business expense, then this expense cannot be deducted by the employee as an unreimbursed expense. The taxpayer in this case was denied a deduction for his unreimbursed business expenses because he "failed to establish that his employer would not have reimbursed" the expenses. It is important for churches to clearly identify those business expenses that will be reimbursed under an accountable arrangement. This will make it easier for an employee to claim a deduction for a business expense that is not reimbursed by the church under its policy. Appling v. Commissioner, T.C. Memo. 1998-43 (1998).  

75. IRS refusal to answer questions no defense. A taxpayer repeatedly called the IRS seeking assistance with a tax question. Several agents "would not or did not give him the information" he requested. As a result, the taxpayer incorrectly reported his taxes. The IRS audited him and assessed back taxes and penalties. The taxpayer asked a federal court for relief. His argument-the IRS had an "implied duty" to provide him with correct tax advice. Not so, ruled the court: "It is well-settled that a taxpayer may not rely on an IRS agent's misstatement of the law." Further, "those who deal with the government are expected to know the law and may not rely on the conduct of government agents contrary to the law." Hollow v. United States, 98-1USTC para. 50,271 (W.D. Tenn. 1998).

76. Senate Rejects Tax Relief for Children in Private Schools. The Senate rejected a proposal by Senator Coverdell (R-GA) to provide tax relief to families with children in private elementary and secondary schools. Coverdell's bill, called "The Parent and Student Savings Account PLUS Act" (S. 1133) would have increased the contribution limit on the new "education IRAs" from $500 per year to $2,000 per year. And it would have allowed for withdrawals from these IRAs to be used for elementary and secondary education expenses-at both public and private schools. The bill was opposed by the President and several senators who feared the impact on public education.  

77. Reclassifying self-employed workers as employees. When the IRS reclassifies a self-employed worker as an employee, there usually are tax consequences-an increase in income taxes and a decrease in social security taxes. Can the IRS "offset" a "refund" of excess social security taxes by the additional income tax liability? Or, must it refund the entire overpayment of social security taxes, and charge the taxpayer for the additional income tax liability? In a recently published internal IRS memorandum, the IRS said that will offset the refund by the additional income tax liability. FSA 1992-116.1.

78. The Tax Court addressed the common practice of treating staff lunches as a business expense. The facts of the case can be quickly stated. A medical technician and a physician shared office space. The two often met at lunchtime to discuss the treatment of their patients and the details of office administration and operations. The two met at other times as well, but they found that lunchtime was often the best opportunity to meet. They alternated paying for their meals together. On her federal income tax return for 1994, the technician deducted her share of these meal expenses (subject to the 50% reduction that applies to unreimbursed meal expenses). The IRS disallowed any deduction for the meals, on the ground that they were not a legitimate business expense. The Tax Court agreed. It began its opinion by noting that "daily meals are an inherently personal expense, and a taxpayer bears a heavy burden in proving they are deductible" as a business expense. The Court referred to a previous ruling involving attorneys. Members of the same law firm met daily at a local restaurant to discuss work-related matters. The noon hour was chosen as the most convenient and practical time for the firm to hold meetings. A federal appeals court conceded the business purpose for these lunch meetings, but concluded that the meals represented nondeductible personal expenses rather than business expenses. It observed: "We are convinced that [the attorneys] discussed business at lunch, that the meeting was a part of their working day, and that this time was the most convenient time at which to meet. We are also convinced that the [firm] benefited from the exchange of information and ideas that occurred. But this does not make [these lunches] deductible any more than riding to work together each morning to discuss [firm] affairs would make commuting costs deductible." Moss v. Commissioner, 758 F.2d 211 (7th Cir. 1985). The court drew a distinction between meals with "outsiders" (such as clients or customers) from meals with coworkers: "[Coworkers] know each other well already; they don't need the social lubrication that a meal with an outsider provides-at least don't need it daily. . . . The meal itself was not an organic part of the meeting . . . where the business objective, to be fully achieved, required sharing a meal." Like the attorneys' lunches, the lunches shared by the medical technician and the physician were not "integral to the technician's business objectives and have not been clearly linked to her production of income. They met at lunchtime because that was the most convenient and feasible time to meet. Their business relationship was well established and did not require 'social lubrication,' at least not as often as [she and the physician] dined together. Indeed, the frequency of their lunches together and the reciprocal nature of their meal arrangement belie the existence of any business purpose for the meals. . . . If taxpayers were permitted to deduct meal expenses in such circumstances then . . . only the unimaginative would dine at their own expense." Dugan v. Commissioner, T.C. Memo. 1998-373.