Church Tax and Accounting Questions

Church's Tax

 

Is a church required to file an annual report or income tax return with the IRS?
No. As an affiliated church with the Association of Unity Churches, your ministry is automatically tax-exempt from federal income tax under the provisions of section 501(c)(3) of I. R. C. and, therefore, your church is not required to file federal income tax returns (Form 990) so long as your church retains a tax-exempt status. However, your church needs to send an annual report including a financial statement to the Association of Unity Churches International so that your Association can file an annual report to IRS. Your church is not liable for federal unemployment taxes. The following outline illustrates the concept:

• Church: Tax Exemption Status
  • Are churches required to apply for tax-exempt status under IRS Code 501(c)3?
  • Churches are not required to file application for exemption number (Form 1023) or Annual report (Form 990) (Tres. Reg. 1.6033-2)
  • Key concept: Churches do not have to apply for tax-exempt status to qualify as tax-exempt organizations. Churches are exempt from paying income tax simply by operating as a church (Treas. Reg 1.511-2a)
• Church: Tax-Exempt Number
  • Churches affiliated with the Association are not required to file a separate application for exemption number for IRS Code 503(c)3 (Form 1023)
  • Member churches can use the Association's group tax-exempt number, also called an umbrella number. Please contact the CFO's office (young@unity.org) for this number.
  • The Association is responsible for evaluating the tax status of its affiliated churches.
• Our Tax-Exempt Number
  • The Association has applied for a tax-exempt number by filing Form 1023 and has received IRS approval.
  • The Association is not listed in Pub 78, Cumulative List of Organizations because the Association has not filed Form 990. We are exempt from the filing requirement.
  • The Association is required to file an annual report on behalf of all affiliated churches. Therefore, all member churches need to send an annual report to the Association.

Does a church need an Employer Identification Number (EIN) even if the church has no employee? How can we get an EIN?
Yes, your church needs an EIN regardless of the number of employees.
You need to fill out Form SS-4 and submit it to the IRS.

Can we use the Association of Unity Churches EIN (44-0668175) for opening a bank account or to issue W-2 or Form 1099-Misc? When can we use the Association?s EIN?
No. You need to have your own EIN for the purpose of W-2 or Form 1099-Misc. The only time you can use the Association's EIN is as follows: 

1.  
   1. When you want to apply for a sales tax exemption to your state.
   2. When you apply for a nonprofit postal bulk permission.
   3. When your minister applies for an exemption from social security tax (Form 4361).

Is a church liable for tax on dividend, interest, annuities, royalties and rents from real property?
Generally, those forms of income are exempted from tax on unrelated business taxable income (IRC Sec 512(b). However, if the rental income is from Debt-Financed Property (not Mortgage-free) and less than 85 percent of the property is used for church's exempt purpose, then it constitutes unrelated business taxable income.

How does a church make a report to IRS for unrelated business income?
Unrelated business taxes are reported on IRS Form 990-T. Unrelated business income is income from a trade or business regularly carried on, which is not substantially related to the charitable purpose of the church. If your church has $1,000 or more gross income (less allowable deduction) from unrelated business, you must file Form 990-T.

Our church bookstore carries many unrelated items. What shall we do?
You need to either eliminate any unrelated items from your bookstore, or you need to form a separate entity as a bookstore (for-profit subsidiary).

What are the major factors to consider to form a separate for-profit bookstore subsidiary?
1. When your bookstore carries many unrelated items
2. Income from the bookstore is too extensive to be conducted within the tax-exempt status of the church
3. When your church board does not want to report the receipts of any unrelated income and is enamored with the idea of having a for-profit subsidiary

*See IRS private letter Ruling 8706012 and Reg &1.501(c)(3)...1(e)

Is a church required to send an annual giving record to the donors at the end of each year?
Per IRS, your church should issue a statement of receipt either when a daily contribution exceeds $250, or Quid Pro Quo contribution exceeds $75.

However, for donor's convenience, it may be good for your church to issue an annual giving statement at year-end. It may be helpful for your financial planning and internal auditing purposes too.

To satisfy the IRS substantiation requirement, your church needs to include the following paragraph at the end of the statement:

"No benefits were provided to you in return for your contribution other than intangible religious benefits. Please retain this letter for your tax records, since it fulfills the substantiation requirements that must be met in order to deduct your contribution." (Title XIII of OBRA '93 P.L. 103-66)

What other IRS Forms does a church need to issue?

• Form 8282: This is to be completed by the church only if noncash donated items are sold within two years
• Form 8283: This form is submitted to the IRS for donations of noncash items in excess of $500.
• Form 8300: If a church receives $10,000 or more in cash (lump sum), it would need to be reported.

Is our church required to provide Workers Compensation for our ministers and lay employees?
Most states require churches to provide Workers Compensation for their ministers and lay employees. However, a few states exempt churches from it. Please check with your state.

Church Accounting and Finance

Are there any national statistics or recommended amounts available regarding a proper percentage of a minister's salary compared to a church's income?
Setting a fair salary is the most difficult part of establishing an equitable payrate.

Minister compensation is based on the combination of church income, church attendance, church's geographical setting, years of service, and minister's educational achievement. To say that the size of church's budget or attendance determines compensation is wrong and misleading. Hence, it must be determined in the context of all the factors, including theology.

*However, many congregations today make a big mistake in committing funds to building and programs rather than to people. Resources should be directed at people first, then programs and facilities. (i.e.) For a service organization, total salary represents from 50 percent to 90 percent of the total budget.

Is it okay for a minister to be a church check signer?
As long as a church provides for an adequate separation of duties in order to ensure the accuracy of financial information and to protect the assets, it is acceptable for a minister to be a check signer. For adequate separation, no one person is allowed to perform more than one of these duties: authorization of transactions, recording of transactions and custody of assets. It is recommended that two signatures are required on every check.

Our church has a building fund and the balance is $50,000 now. Our building plan is not yet determined, while our general fund has a deficit of $10,000. Is it okay to use some of the building fund to make payments on the past due operating expenses?
If the building fund of $50,000 is from funds earmarked by donors for a church building, it should be recorded as a temporary restricted fund until the building project is completed (per SFAS 117). It should be separated from unrestricted funds from which the annual operating expenses are paid.

However, if the building fund resulted from a decision of your church board or members when your annual fund had a surplus and your church wanted to set it aside for a future building project, then your church can use it if your board or membership meeting approves it. This is possible because these funds are not in a temporary restricted fund but rather an unrestricted fund (per SFAS 117).

(Legal aspect: The Connecticut Supreme Court ruled that donors who give money and place restrictions on its use might not force institutions to comply with the restrictions. The court noted that while under the Uniform Management of Institutional Funds Act, the attorney general may bring a suit against an organization for violating grant restriction, the grant makers themselves may not. The court also suggested that Treasury regulations provide that a donor may either place restrictions on the use of donated money, or take a tax deduction, but not both.)

Are there any guidelines for a balanced budget system for a church? We are under a deficit budget and we have some outstanding bills to pay now. What shall we do?
There are many different church budget systems such as a program budget system, a zero-base budget system, a traditionally known incremental budget system, a functional budget system, etc. Ideal budget systems vary, depending upon factors such as the congregation size, the budget amount, number of programs, etc.

However, there are some basic components to consider for a balanced budget and the following is a step-by-step guideline to attain a balanced budget under a budgetary shortfall:  

1.  
   1. Are church's mission, goal, annual objectives clearly stated?
   2. Do budget committee members know what is the minimum/essential expense amount needed to operate the church? (tithing, pastoral expense, minimum music, basic building expenses, basic education expenses)
   3. What is the total variable expense amount? (pastoral raise, other salaries, outreach, other expenses over and above the basic expenses (music, building, education), new equipment and special program expenses.
   4. What is an annual realistic income amount?
   5. Is this projected income enough for the total amount of the expense items 2 and 3?
   6. If the projected income is not enough for the total expense, then always go back to item 1 and adjust the annual objectives and accordingly adjust item 3 variable expenses.
      1. NEVER jump to item 2 first and try to cut the pastoral expense!
      2. If necessary, plan a stewardship drive by reviewing the existing stewardship campaign and amending the project income budget at the same time.
      3. It is also ideal to consider that some expenses be reduced by means such as refinancing a loan, asking donation for office supplies and equipment, and a moratorium in hiring and purchasing.
   7. Now, celebrate a balanced budget!

Is it okay for a church to pay the minister on a percentage of revenue as a part of his/her compensation?
The use of contingent compensation arrangements should be discouraged because of IRS scrutiny. Instead, the church can award a year-end bonus based on performance if incentive is necessary. (GCM 39674, PLR 8807081)

However, the following are recommendations by our counsel, if a church really needs a contingent feature for minister compensation arrangement:

1.  
   1. Document negotiations between the minister and the board.
   2. Document the board's consideration of other alternative compensation arrangements.
   3. Document discussions and reasons why the contingent payments serve the church well.
   4. A cap should be inserted.
   5. Seek ways to link it to minister's performance.
   6. Document inquires directed towards other churches to review and compare.
   7. Document identification of any conflicts of interest.
   8. Document discussions to explore available methods by church members.
   9. Minister compensation should be both reasonable in amount and directly related to benefits by church members.
   10. Identify minister's specific responsibilities and duties.

The Financial Accounting Standards Board (FASB) issued two new accounting rules for nonprofit organizations including churches. What are the rules and how must churchs comply?
A new rule from FASB, known as SFAS-117, Financial Statements for Not-for-Profit Organizations, becomes effective for fiscal years beginning on or after 12/15/1995. This rule has had a profound impact on the presentation of the church financial statement.

SFAS-117 requires all nonprofits to include the following in their financial statements:  

1. Statement of Financial position. Formerly known as the balance sheet, this includes amounts for churches' total assets, liabilities, and net assets (a new term for fund balance). This net asset consists of permanently restricted, temporarily, and unrestricted net assets with donor?s stipulation.
2. Statement of Activities. Formerly the statement of revenues and expenses, this includes the change in churches' net assets. Church needs to indicate the change in permanently restricted, temporarily, and unrestricted net assets. This Statement of Activities also must include expense information reported by function (by major programs and major classes of supporting services).
   Alternatively, this functional report can be presented in the footnotes to the financial statements.

* Must your church comply?—No. Your church is not bound by federal law or by the IRS to comply with accounting standards issued by the FASB. However, if your church issues financial statements, your church will not be able to have them certified as "prepared in accordance with generally accepted accounting principles." This could have very negative consequences when using the statements in fund-raising efforts. Also, banks may require certified statement if your church applies for a loan.

 

* How to change?
Prior Fund Balance Description	New Net Asset Category
Current Unrestricted	Unrestricted
Current Unrestricted	Board Designated Unrestricted
Current Restricted	Temporarily Restricted
Endowment	Permanently Restricted
Term Endowment	Temporarily Restricted
Fund Functioning as Endowment	Unrestricted
Quasi-Endowment	Unrestricted
Annuity and Life Income Funds	Temporarily Restricted
Unexpended Capital Funds-Unrestricted	Unrestricted
Unexpended Capital Funds-Restricted	Temporarily Restricted
Renewal and Replacement Funds	Unrestricted
Retirement of Indebtedness Funds	Unrestricted
Net Investment in Plant	Unrestricted

*Your church can continue to maintain internally the existing fund accounting in order to report to donors and agencies concerning restricted gifts and grants and respective interest and earning allocations.

Download Young's presentation on Church Tax Issues (.pps)

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For answers to additional accounting or tax questions, please contact Young Bae, CFO/VP Administration & Finance

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