IRS RELEASES DISCUSSION DRAFT OF TAX GUIDE FOR CHURCHES.

Announcement 94-111

The Internal Revenue Service is developing a publication designed to assist churches and clergy in complying with the requirement of the Internal Revenue Code. The publication is intended to be a user-friendly compilation of existing rules, set forth in question-and-answer format. As part of this effort, the IRS is releasing a draft of the publication and soliciting comments, in writing, from any interested party.

A copy of this unnumbered draft publication, tentatively titled "Tax Guide for Churches and Other Religious Organization," is available at no charge from the Internal Revenue Service by asking for it by name and sending your request in writing to:

           Freedom of Information Reading Room

           Internal Revenue Service

In view of the unique relationship between the United States Government and the religious community, Congress has provided special tax rules relating to certain religious organizations.

This booklet is designed to provide general information relating to Federal tax rules and Internal Revenue Service (IRS) procedures of particular interest to churches and other religious organizations. It is made available to help these organizations understand their privileges and responsibilities within the Federal tax system. It is intended only as a quick reference guide and should not be relied upon as a sole source of information. This booklet is not intended to substitute for a determination by the IRS that a church is, or is not, exempt from Federal taxation, nor that a particular activity will lead to a specific result for tax purposes.

This booklet contains NO NEW RULES OR REGULATIONS TO BE IMPOSED ON CHURCHES OR THEIR CLERGY BY THE INTERNAL REVENUE SERVICE. It is simply a convenient "one-stop" compilation of existing provisions of tax law that may relate to, or impact on, churches, certain other religious organizations, and clergy.

The IRS publishes a number of tax information publications covering a variety of topics. A list of those publications most likely to be of interest to churches and other religious organizations is included at the end of this publication. These and other tax-related publications and forms are available free at local IRS offices, or may be obtained by calling, toll-free, 1-800-TAX-FORM (829-3676). Direct assistance is provided by Taxpayer Assistance Representatives located at most local IRS offices. Taxpayer Assistors may be contacted by telephone, toll-free, at 1-800-TAX-1040 (829- 1040).

DEFINITIONS

The words "church" and "minister" are not used by all faiths. However, in an attempt to make this publication as easy to read as possible, the terms "Church" and "minister" are used because the terms are generally understood and because they are used in the Internal Revenue Code. The rules contained in this publication come from the Internal Revenue Code, the Income Tax Regulations, court decisions, and the IRS interpretation of the Code, regulations, and court decisions.

SECTION 501(c)(3): This section of the Internal Revenue Code describes charitable organizations, including churches and other religious organizations, that qualify for exemption from Federal income tax and are eligible to receive tax deductible contributions. Section 501(c)(3) provides that an organization must be organized and operated exclusively for religious or other charitable purposes, that net earnings may not inure to the benefit of any private individual or shareholder, that no substantial part of its activity may be the carrying on of propaganda or otherwise attempting to influence legislation, and that the organization may not intervene in political campaigns. These requirements are set forth in greater detail below.

SECTION 501(c)(3) ORGANIZATION: This term refers to any organization, including a church or other religious organization, that is tax exempt because it meets the requirements and thus is described in section 501(c)(3).

MINISTER: A minister is an individual who is duly ordained, commissioned, or licensed by a religious body constituting a church or church denomination. A minister has the authority to conduct religious worship, perform sacerdotal functions, and administer ordinances or sacraments according to the prescribed tenets and practices of that church or denomination. A minister is considered to be a religious leader by his or her church or denomination. Generally, an individual who is a minister of music or education is not considered to be a minister for Federal tax purposes. As used in this booklet, the term includes priests, rabbis, imams, and similar members of the clergy.

INTEGRATED AUXILIARY OF A CHURCH: This term refers to a class of organizations that are related to a church or convention or association of churches but are not such organizations themselves. In general, the IRS will treat as an integrated auxiliary of a church any organization that meets two tests: 1) affiliation with a church or convention or association of churches, and 2) financial support primarily from internal church sources as opposed to public or governmental sources. For more guidance as to what types of organizations the IRS will treat as integrated auxiliaries, please see Revenue Procedure 86-23, 1986-1 C.B. 564. [Revenue Procedures are published by the IRS in the Internal Revenue Bulletin and the Cumulative Bulletin, both of which are available in most legal libraries or from legal on-line computer services. If these resources are not available in your community, please contact your local IRS office for assistance in obtaining copies of revenue procedures.]

CHURCH: The term "church" is not specifically defined in the Internal Revenue Code. However, because special tax rules apply to churches, it is important to distinguish churches from other religious organizations.

Certain characteristics are generally attributed to churches. These attributes have been developed by the Service and by court decisions. They include:

           a) A distinct legal existence

RECOGNITION BY THE IRS THAT THE CHURCH IS TAX EXEMPT

DOES A CHURCH HAVE TO CONTACT THE INTERNAL REVENUE SERVICE IN ORDER TO BE EXEMPT FROM INCOME TAXATION?

No. Churches, their integrated auxiliaries, and conventions or associations of churches are not required to apply for and obtain recognition of tax-exempt status from the IRS in order to be treated as tax exempt provided they meet the requirements of section 501(c)(3).

IS THERE ANY REASON WHY A CHURCH WOULD CONTACT THE IRS FOR FORMAL RECOGNITION OF THE CHURCH AS TAX EXEMPT?

Yes. Notwithstanding the fact that there is no requirement to do so, many churches seek recognition of exempt status from the IRS because such recognition provides certain benefits. An organization may find it useful to establish to the IRS that it is a church, integrated auxiliary or convention or association of churches so that the leaders of the church, as well as its parishioners and contributors, are certain that the church is eligible for exemption and the many tax-preferred provisions that Congress has created for such organizations. For example, establishing its exempt status under section 501(c)(3) provides the contributors of the church with advance assurance that their contributions are tax deductible. In order to receive this recognition and advance assurance, the organization must submit a Form 1023, Application for Recognition of Exemption, to the IRS and pay the applicable user fee. (User fees are discussed in greater detail below.)

A church may obtain recognition of exemption for any or all periods prior to the time it requests that the IRS make a determination as to its tax-exempt status.

WHAT IF THE CHURCH HAS A PARENT THAT IS TAX EXEMPT?

A church or other organization with a parent organization may wish to contact the parent to see if the parent has a "group exemption letter". An organization has a parent if, for example, another organization manages, financially or ecclesiastically, the first organization. If the parent holds a group exemption letter, then the organization seeking exemption may already be recognized as exempt by the IRS. Under the group exemption process, one organization, the parent organization, becomes the holder of a group exemption ruling naming other affiliated churches as included within the ruling. Under these rules, a church is recognized as exempt if it is included in the annual update of the parent organization. If the church is included on such a list, it need take no further action in order to obtain such recognition.

For general information on the group exemption process, please refer to Revenue Procedure 80-27, 1980-1 C.B. 677.

DOES A RELIGIOUS ORGANIZATION OTHER THAN A CHURCH HAVE TO APPLY FOR RECOGNITION THAT IT IS TAX EXEMPT?

Yes. Religious organizations other than churches, their integrated auxiliaries, and conventions or associations of churches that wish to be recognized as tax exempt must file Form 1023, Application for Recognition of Exemption, and pay the applicable user fee. (User fees are discussed in detail below.)

For organizations other than churches, their integrated auxiliaries, and conventions or associations of churches, in order for exemption and the ability to receive deductible contributions to be effective from the date the organization was formed, the application generally must be submitted within 15 months from the end of the month in which the organization was formed. However, an organization whose gross receipts do not normally exceed $5,000 annually is not subject to the 15-month rule for submitting an application.

WHAT NOTICE DOES THE SERVICE PROVIDE WHEN IT HAS FOUND AN ORGANIZATION TO BE TAX EXEMPT?

Organizations submitting Form 1023 and satisfying all requirements of section 501(c)(3) will be notified in writing of their status, any requirement to file an annual information return (see below), and of eligibility to receive deductible contributions. Generally, a letter from the IRS is the only evidence provided to the organization as to the organization's exempt status. No special number or other identification is assigned by the IRS as evidence of an organization's exempt status.

Organizations which, as a result of filing an application for exemption have been determined to be organizations qualified to receive tax-deductible contributions, are included in Publication 78, Cumulative List of Organizations Described in Section 170(c) of the Internal Revenue Code of 1986. This book is sold to the public by the Superintendent of Documents, U. S. Government Printing Office, Washington, D.C. Only the parent organization in a group ruling is included by name in Publication 78.

IS THERE A COST TO AN ORGANIZATION THAT APPLIES FOR EXEMPTION?

Yes. The IRS is required to collect a fee from any organization seeking a determination of its tax-exempt status under the Internal Revenue Code. The fact that churches are not required by law to file an application for exemption does not mean that if a church voluntarily applies it is excused from the user fee requirement.

The non-refundable fee must be submitted with the Form 1023 application for exemption. Otherwise, the application will be returned to the submitter. The fees imposed change periodically and are listed on Form 8718, User Fee for Exempt Organization Determination Letter Request, which is used to transmit both the appropriate fee and the application for exemption.

  RESTRICTIONS THAT APPLY IF A CHURCH IS TO REMAIN TAX EXEMPT UNDER

All organizations that are exempt under section 501(c)(3), including churches, must be engaged in activities that further exclusively public purposes, rather than private interests. The organization must not be operated for the benefit of designated individuals or the persons who created them.

WHAT IS PROHIBITED INUREMENT?

An organization exempt under section 501(c)(3) is prohibited from engaging in activities that result in inurement of the organization's net earnings. In its simplest terms, the prohibition against inurement means that the persons who created or who now control an exempt organization, including its members, ("insiders") may not use their control to acquire any of its funds or assets (other than for the payment of reasonable compensation for services rendered or in return for the payment of fair market value). Examples of inurement include the payment of dividends or unreasonable compensation. The prohibition against inurement is absolute; therefore, any amount of inurement is grounds for loss of exempt status.

WHAT IS PROHIBITED PRIVATE BENEFIT?

In addition to the prohibition on inurement to "insiders," there is the requirement that a section 501(c)(3) organization's activities may not serve private interests. In general, an organization's activities must be directed toward exclusively charitable, educational or religious purposes. The beneficiaries of the organization's activities must be recognized objects of charity (such as the poor or the distressed) or the primary benefit of the activity must flow to the community at large (for example, through the conduct of religious services or the promotion of religion).

WHAT ARE THE RESTRICTIONS ON LEGISLATIVE ACTIVITY THAT MAY BE ENGAGED IN BY CHURCHES?

In general, no organization, including a church, may qualify for tax-exempt status as a charitable organization if a substantial part of its activities is attempting to influence legislation.

Whether an organization's legislative activity constitutes a "substantial part" of its overall activities is determined on the basis of all the pertinent facts and circumstances in each case. Consideration is given to a variety of factors including the time devoted by the organization to the activity (by both compensated and volunteer workers), assets devoted to the activity (such as office space, machinery, etc.), as well as expenditures.

WHAT CONSTITUTES "ATTEMPTING TO INFLUENCE LEGISLATION"?

An organization will be regarded as "attempting to influence legislation" (commonly known as "lobbying") if it contacts, or urges the public to contact, members of a legislative body for the purpose of proposing, supporting, or opposing legislation, or if the organization advocates the adoption or rejection of legislation.

Organizations may, however, involve themselves in issues of public policy so long as the involvement does not result in attempts to influence legislation that constitute a substantial part of their activities. For example, churches may conduct educational meetings, prepare and distribute educational materials, or otherwise consider public policy issues in an educational manner without jeopardizing their exempt status.

WHAT CONSTITUTES "LEGISLATION"?

"Legislation" includes action by the Congress, any state legislature, any local council or similar governing body, or by the public in a referendum, initiative, constitutional amendment, or similar procedure.

MAY A CHURCH USE OTHER THAN THE "SUBSTANTIAL PART" TEST?

No. However, tax-exempt religious organizations OTHER THAN CHURCHES, THEIR INTEGRATED AUXILIARIES, AND CONVENTIONS OR ASSOCIATIONS OF CHURCHES may avoid application of the subjective "substantial part" test, by electing an alternative "expenditure" test. Under the "expenditure" test, the extent of an organization's legislative activity will not jeopardize its exempt status provided its expenditures related to such activity do not normally exceed an amount specified in the tax code. This limit is based generally upon the size of the organization. Should the organization exceed its lobbying expenditure dollar limit in a particular year, it must pay an excise tax equal to 25% of the excess. Continued excessive lobbying expenditures can result in loss of exempt status.

The election to use the "expenditure" test is made by filing Form 5768, Election/Revocation of Election by an Eligible Section 501(c)(3) Organization to Make Expenditures to Influence Legislation, during the tax year for which it is to be effective. The election remains in effect for succeeding years until it is revoked by the organization. By law, churches may not make this election and thus are covered under the substantial part test.

WHAT ARE THE CONSEQUENCES THAT RESULT FROM EXCESSIVE LEGISLATIVE ACTIVITY?

An organization that continues to lobby on an excessive basis may lose its tax exemption under section 501(c)(3). If an organization loses its status as a tax-exempt charitable organization because it engages in excessive legislative activity, it may not thereafter qualify for exemption as a social welfare organization under section 501(c)(4).

WHAT ARE THE RESTRICTIONS ON POLITICAL ACTIVITY THAT MAY BE ENGAGED IN BY CHURCHES?

All section 501(c)(3) organizations, including churches, their integrated auxiliaries, conventions or associations of churches, are prohibited from participating in, or intervening in (including the publication or distribution of statements), any political campaign on behalf of (or in opposition to) any candidate for public office. Violation of this prohibition results in denial or revocation of exempt status and the imposition of certain excise taxes.

WHAT CONSTITUTES PROHIBITED POLITICAL ACTIVITY?

Whether a particular activity, action, or expenditure constitutes the conduct of prohibited political activity depends on all the facts and circumstances. For example, certain voter education activities (including the presentation of public forums and the publication of voter education guides) conducted in a non-partisan manner may not constitute prohibited political activity, while other so-called voter education activities may. Contributions to political campaign funds, public statements of position (verbal and written) in favor of or in opposition to candidates for office, or provision of a forum for expression of candidates' views on a partisan basis, however, would clearly violate the prohibition against political activity.

The political activity prohibition is not intended to restrict free expression on political matters by leaders of religious organizations speaking for themselves as individuals. Ministers and others who commonly speak or write on behalf of religious organizations should clearly indicate, at the time they do so, that public comments made by them in connection with political campaigns are strictly personal and are not intended to represent their organization. Partisan comments by the employees or other representatives of an organization regarding political candidates must be avoided in official organization publications and at official church functions.

WHAT ARE THE CONSEQUENCES THAT RESULT FROM POLITICAL ACTIVITY?

An organization will lose its tax exemption under section 501(c)(3) for engaging in political activities. In addition to loss of exempt status, an organization that engages in political activity is subject to an excise tax on its political expenditures and is required to correct the violation.

Excise tax

An initial tax is imposed on the organization at the rate of 10% of the political expenditures. Also, a tax at the rate of 2.5% of the expenditures is imposed against the organization's managers (jointly and severally) who, without reasonable cause, agreed to the expenditures knowing they were political expenditures. The tax on management may not exceed $5,000.

In any case in which an initial tax is imposed against an organization, and the expenditures are not corrected within the period allowed by law, an additional tax equal to 100% of the expenditures is imposed against the organization. In that case, an additional tax is also imposed against the organization's managers (jointly and severally) who refused to agree to make the correction. The additional tax on management is equal to 50% of the expenditures and may not exceed $10,000 with respect to any one expenditure.

Correction

Correction of a political expenditure requires the recovery of the expenditure, to the extent possible, and establishment of safeguards to prevent future political expenditures. Possible injunction

Where a section 501(c)(3) organization has flagrantly participated in a political campaign, the IRS may go to court for an injunction to prevent further abuse and to ensure that the organization's funds are preserved for charitable purposes.

Status after revocation

A section 501(c)(3) organization that loses its tax-exempt status because of having engaged in prohibited political activity may not subsequently qualify for exemption as a social welfare organization under section 501(c)(4).

  IS A CHURCH SUBJECT TO TAX ON ANY INCOME FROM AN ACTIVITY THAT IS

WHEN IS INCOME SUBJECT TO THE UNRELATED BUSINESS INCOME TAX?

Income from an activity will be subject to the unrelated business income tax if the following three conditions are met: (1) the activity constitutes a trade or business; (2) the trade or business is regularly carried on; and (3) the trade or business is not substantially related to the organization's exempt purpose. (The fact that the organization uses the income to further its charitable or religious purposes does not make the activity substantially related to its exempt purposes.)

WHAT ARE SOME EXCEPTIONS TO THE TAXATION OF UNRELATED TRADE OR BUSINESS INCOME?

There are certain exceptions and exclusions to the unrelated business income tax. Therefore, even if an activity meets the above three criteria, the income may not be subject to the unrelated business income tax if, for example (1) substantially all of the work in operating the trade or business is performed by volunteers; or (2) the trade or business involves the selling of merchandise substantially all of which was donated. If either of these exceptions applies, the income from the activity is not treated as unrelated trade or business income. Further, in general, rents, royalties and interest are not subject to the unrelated business income tax.

WHAT ARE SOME EXAMPLES OF UNRELATED TRADES OR BUSINESSES?

Unrelated trade or business activities take many forms. Some of the more common types of activities that may be considered unrelated trade or business activities are summarized below:

* Advertising -- Many tax-exempt organizations sell advertising in their publications or other communication vehicles. Generally, income from the sale of advertising is unrelated trade or business income. This may include the sale of advertising space in weekly bulletins and other publications.

* Gambling Activities -- Most forms of gambling, if regularly conducted, may be considered the conduct of an unrelated trade or business. This can include the sale of pull-tabs and raffles. Income derived from the conduct of bingo games may be eligible for a special exception to unrelated business income tax (in addition to the volunteer labor exception discussed above) if the following conditions are met: (1) The bingo game is the traditional type of bingo (as opposed to "Instant Bingo," a variation of pull-tabs); (2) the conduct of the bingo game is not an activity carried out by for-profit organizations in the local area; and (3) the conduct of the bingo game does not violate any State or local law.

* Sale of Merchandise and Publications -- The sale of merchandise and publications (including the actual publication of materials) can be considered the conduct of an unrelated trade or business if the items involved do not have a substantial relationship to the exempt purposes of the organization.

* Rental Income -- Generally, the income derived from the rental of real property or certain personal property is excluded from unrelated trade or business income. However, there are certain situations in which rental income may be unrelated business taxable income. For example, if a church rents out property on which there is debt outstanding (for example, a mortgage note), the rental income may constitute unrelated debt-financed income subject to unrelated business income tax. Also, if personal services are rendered in connection with the rental, then the income may be unrelated business taxable income (for example, if church facilities are rented out for wedding receptions and catering services are provided by the church).

Whether an income-producing activity is an unrelated trade or business activity depends on all the facts and circumstances. The Internal Revenue Service publishes Publication 598, Tax on Unrelated Business Income of Exempt Organizations, which provides more in- depth information on unrelated trade or business income. Questions regarding the tax on unrelated business income should be addressed to the IRS key district office in which the church is located. See Publication 557 for a list of key districts.

Tax forms or publications can be ordered by calling 1-800-TAX- FORM.

                 SPECIAL RULES THAT LIMIT THE ABILITY

Yes. There are special limitations on how and when the IRS may conduct civil tax inquiries and examinations of churches. Under these rules, the IRS may initiate a so-called "church tax inquiry" only if a high ranking official (e.g., a regional commissioner) reasonably believes that the organization either may not qualify for exemption or may not be paying tax on an unrelated business or other taxable activity.

If the "reasonable belief" requirement is met, the IRS must begin the inquiry by providing the church a written notice containing an explanation of its concerns. A church is allowed a reasonable period in which to respond by furnishing a written explanation to alleviate the IRS's concerns. If the organization fails to respond within the required time, or if its response is not sufficient to alleviate the IRS's concerns, the IRS may issue a second notice notifying the organization of the need to examine its books and records. The inquiry period (the time between the first and second notices) may generally not exceed 90 days. After issuance of the second letter, but before commencement of an examination of its books and records, the organization is entitled to a conference with an IRS official to discuss the concerns of the IRS.

If at any time during the inquiry process the organization supplies information sufficient to alleviate the concerns of the IRS, the matter will be closed without examination of the organization's books and records. Additional safeguards for the protection of churches (requiring more detailed explanation than appropriate for this booklet) are also provided.

WHAT ORGANIZATIONS ARE COVERED UNDER THESE SPECIAL RULES?

The restrictions on church inquiries and examinations apply only to churches (including organizations claiming to be churches) and conventions or associations of churches. They do not apply to related persons or organizations. Thus, for example, the rules do not apply to schools that, although operated by a church, are organized as separate legal entities. Similarly, the rules do not apply to integrated auxiliaries.

DO THE RESTRICTIONS APPLY TO ALL IRS INQUIRIES TO A CHURCH?

No. The restrictions on church inquiries and examinations do not apply to all church inquiries by the IRS. The most common exception relates to routine requests for information. For example, IRS contacts with churches about filing of returns, compliance with income or FICA withholding requirements, supplemental information needed to process returns or applications, and other similar inquiries are excepted.

MUST A CHURCH MAINTAIN BOOKS AND RECORDS?

Yes. All tax-exempt organizations, including churches (regardless of whether exempt status has been officially recognized by the IRS), are required to maintain the books of account and other records necessary to justify their claim for exemption in the event of an audit. Tax-exempt organizations are also required to maintain books and records that are necessary to accurately file any Federal tax and information returns that may be required.

There are no specific requirements as to the form of the records required. However, the types of required records frequently include charter and bylaws, minute book, property records, general ledgers, receipts and disbursements journals, payroll records, banking records, invoices, etc. The extent of the records necessary generally varies according to the type, size, and complexity of the organization's activities.

The law does not specify the length of time that records must be retained other than that they should be kept for so long as they may be material to the administration of any internal revenue law. Generally, records of revenue and expenses, including payroll records, should be retained for at least four years after filing the return(s) to which they relate. Records relating to acquisition and disposition of property (real and personal, including investments) should be retained for at least four years after the filing of the return for the year in which disposition occurs.

SPECIAL RULES APPLICABLE TO THE COMPENSATION OF CLERGY

WHAT RULES APPLY TO A PARSONAGE OR RENTAL ALLOWANCE?

A minister's gross income does not include the rental value of a home (a parsonage) provided, or the rental allowance paid, as part of his or her compensation for services performed that are ordinarily the duties of a minister.

A minister who is furnished a parsonage may exclude the fair rental value of a parsonage. A minister who receives a rental allowance may exclude the allowance to the extent it is used for expenses in providing a home. Generally, those expenses include rent, mortgage payments, utilities, repairs, and other expenses directly relating to providing a home.

Only one parsonage or rental allowance may be provided to a minister, and the parsonage or rental allowance must be reasonable in amount.

The exclusion of the fair rental value of the parsonage or the rental allowance provided is for income tax purposes only. The amounts may not be excluded in calculating the minister's social security (self-employment) tax.

The minister's employing organization must designate the rental allowance pursuant to official action taken in advance of the payment. If a minister is employed and paid by a local congregation, a resolution by a national church agency of the denomination will not be an effective designation. The designation must be made by the local congregation. A national church agency can make an effective designation for ministers it directly employs.

ARE THERE LIMITATIONS ON THE AMOUNT THAT IS DEDUCTIBLE BY A MINISTER AS TO EXPENSES ALLOCABLE TO TAX FREE INCOME?

Yes. A minister may be able to itemize deductions for ministerial trade or business expenses incurred while working as an employee. However, when a minister receives a tax free parsonage or rental allowance, the portion of expenses that are allocable to that tax free amount is not deductible. (Note however that this limitation does not apply to home mortgage interest or real estate taxes.)

DOES THE PARSONAGE ALLOWANCE APPLY TO HOME OWNERSHIP?

Yes. A minister who owns or is purchasing a home may exclude the parsonage allowance from gross income to the extent it is used for the down payment, mortgage payments, interest, real estate taxes, utilities, and repairs.

HOW DO YOU GET FURTHER INFORMATION?

For further information, see Publication 517, Social Security for Members of the Clergy and Religious Workers, which includes a comprehensive example of the tax treatment of the parsonage allowance and the related limitations on deductions, and Publication 525, Taxable and Nontaxable Income.

WHAT IS THE TREATMENT OF REIMBURSEMENT PAYMENTS TO MINISTERS AND OTHER CHURCH EMPLOYEES?

A church is treated like any other organization for these purposes. If a church or other religious organization is reimbursing its minister(s) and/or church employees for expenses while conducting church business certain rules apply.

Reimbursements for business expenses are (1) not includible in the minister's gross income and (2) not includible in the employee's wages subject to FICA and income tax withholding if the church's reimbursing arrangement is considered an "accountable plan." Alternatively, if the church reimburses business expenses under a "nonaccountable plan," then the reimbursements are includible in the minister's gross income and the employees' wages. What is an accountable plan?

An "accountable plan" is one that has a business connection, requires the individual to substantiate expenses, and requires the return of any excess reimbursement. The substantiation of expenses and return of excess amounts must occur within a reasonable period of time.

The substantiation requirement is met by having the reimbursed individual submit sufficient information to the church that identifies the specific business nature of each expense. Each element of an expenditure must be substantiated. It is not sufficient to have the reimbursed individual merely aggregate expenses into broad categories such as "travel" or to report individual expenses through the use of vague, nondescriptive terms such as "miscellaneous business expenses."

HOW ARE AUTOMOBILE EXPENSE REIMBURSEMENTS TREATED?

Probably the most common business expense that a church may be reimbursing for is automobile business mileage. Generally, the amount of a mileage allowance that a church pays at a rate that is less than or equal to the Federal standard rate is treated as being substantiated and is treated as paid under an accountable plan with no employment tax consequences to the reimbursed individual providing that the employee documents the time, place, and business purpose of the reimbursement. Each year, the Federal government establishes a standard mileage reimbursement rate.

If a church reimburses business miles at a rate exceeding the standard mileage rate, the excess reimbursement is treated as being paid under a nonaccountable plan and is therefore includible in the individual's income.

In addition, any mileage reimbursement that is paid without requiring the individual to document the time, place, and business purpose of each trip is includible in the individual's income, regardless of the rate at which the church reimburses.

If a church is paying a monthly automobile expense allowance that requires no substantiation of the time, place, business purpose and/or amount, and which does not require a return of any excess amounts, then the entire amount of the allowance is required to be reported in the worker's income. For example, if a church pays its church secretary a $200 per month allowance to reimburse his or her monthly business expenses incurred while conducting church business, and the secretary does not substantiate that he or she incurred $200 of expenses, then the entire $200 is required to be reported on Form W-2 as part of his or her wages subject to FICA and income tax withholding. Similarly, if a church is paying its minister a monthly $200 expense allowance without requiring that he or she substantiate the actual expenses incurred, then the entire amount is includible in the minister's compensation.

CHURCH RESPONSIBILITIES FOR EMPLOYMENT TAXES

ARE CHURCHES LIABLE FOR EMPLOYMENT TAXES?

Except as provided below, the answer is yes. While qualifying religious organizations, in general, are exempt from Federal income tax, they are not exempt from the requirement to withhold and pay over to the government payroll taxes for their employees, as well as to pay the employer's share of social security and Medicare taxes. However, churches and other religious organizations exempt under section 501(c)(3) are not liable for Federal unemployment tax (FUTA) and there are special rules for social security (FICA) and Medicare taxes.

WHEN ARE CHURCHES AND OTHER RELIGIOUS ORGANIZATIONS NOT LIABLE FOR SOCIAL SECURITY AND MEDICARE TAXES?

Wages paid to employees of churches or other religious organizations exempt under section 501(c)(3) are subject to social security and Medicare taxes unless (1) or (2) apply:

(1) The section 501(c)(3) organization pays the employee wages of less than $100 in a calendar year.

(2) A church, its integrated auxiliaries, or a convention or association of churches that is opposed to the payment of social security and Medicare taxes for religious reasons files Form 8274, Certification by Churches and Qualified Church-Controlled Organizations Electing Exemption from Employer Social Security and Medicare Taxes, to elect exemption from social security and Medicare taxes. The organization must file for exemption before the first date on which a quarterly employment tax return would otherwise be due. This election does not relieve the organization of its requirements to withhold income tax on wages paid to its employees. Further, if such election is made, the employee of a church, its integrated auxiliaries, or a convention or association of churches that is exempt from social security and Medicare taxes must pay the self- employment tax, unless the employee qualifies for an exemption (see below). Certain self-employed religious practitioners or members of religious orders, and self- employed persons and their employees who are members of a recognized religious sect opposed to insurance can apply to the IRS for exemption from social security and Medicare taxes.

HOW DO YOU DETERMINE WHETHER A WORKER IS AN EMPLOYEE?

In general, an organization is only responsible for the employer portion of social security and Medicare tax with respect to its "employees". Thus, in determining the church's responsibilities for employment tax, the determination of whether a particular worker is an employee is important. The facts will determine whether there is an actual employer-employee relationship. For an in-depth discussion, and examples of the common-law employer-employee relationship, see Who Are Employees? in Publication 937. An organization or a worker that wants the IRS to determine whether a worker is an employee should file Form SS-8 with the District Director for the Internal Revenue Service district in which the organization is located.

WHAT IS THE TREATMENT OF COMPENSATION PAID TO MINISTERS FOR PURPOSES OF EMPLOYMENT TAX AND INCOME TAX WITHHOLDING?

The remuneration that a church pays to its duly ordained, commissioned, or licensed minister(s) for their services is not subject to mandatory Federal income tax withholding, nor is it subject to the Federal Insurance Contribution Act (FICA). However, a church is still required to report a minister's compensation to the IRS on a Form W-2. The earnings that a minister earns in the performance of his or her ministry are generally subject to self- employment taxes under the Self-Employment Contributions Act (SECA).

A minister may voluntarily request that a church withhold income taxes from the amounts paid him or her. This is accomplished by having the minister furnish the church with a completed Form W-4, Employee's Withholding Allowance Certificate. These withheld amounts would then be reflected on the minister's Form W-2.

WHERE CAN YOU GET MORE INFORMATION?

For further information on employment taxes, see Publication 334, Tax Guide for Small Business, and Circular E, Employers Tax Guide. For further information on statutory and nonstatutory employees, see Publication 937, Business Reporting (Employment Taxes, Information Returns).

For further information on the treatment of ministers for employment tax purposes, see Publication 517, Social Security for Members of the Clergy and Religious Workers.

FUNDRAISING RULES

ARE THERE SPECIAL RULES RELATING TO FUNDRAISING AND CHARITABLE CONTRIBUTIONS?

Yes. Recent legislation contains a number of significant provisions affecting tax-exempt charitable organizations described in section 501(c)(3) of the Internal Revenue Code. These provisions include: (1) new substantiation requirements, and (2) new public disclosure requirements imposed on the organizations (with potential penalties for failing to comply). The substantiation and disclosure provisions are effective with respect to contributions made after December 31, 1993.

WHAT ARE THE NEW SUBSTANTIATION RULES?

In general, the new tax law provides that no charitable deduction will be allowed for any charitable contribution of $250 or more unless the donor receives written substantiation from the organization receiving the donation. The substantiation must contain the donor's name and address and provide sufficient information to substantiate the amount of the deductible contribution. The substantiation must note the AMOUNT of any CASH contribution but need only describe the NATURE of any donated PROPERTY. In addition, the substantiation must include a statement as to whether any goods or services were provided in return for the contribution. If no goods or services were provided to the donor in return for the contribution, the substantiation must state that no goods or services were provided. If goods or services were provided to the donor, the substantiation must include a statement of the value of any goods or services received by the donor. If the only goods or services received by the donor were intangible religious benefits from a religious organization, the substantiation must state that the only benefit received by the donor in return for the contribution was an intangible religious benefit. The organization is not required to provide a value for the intangible religious benefit. The responsibility for obtaining this substantiation lies with the donor, who must request it from the charity.

WHAT ARE "QUID PRO QUO CONTRIBUTIONS" AND WHAT NEW RULES APPLY TO SUCH TRANSACTIONS?

Charitable organizations that receive a "quid pro quo contribution" of more than $75 must provide a written disclosure statement to the contributor regarding the deductibility of the contribution. A quid pro quo contribution is defined as a payment made to a charitable organization that is partly in consideration for goods or services furnished to the donor by the organization and partly as a contribution to the organization. For example, if a donor gives an organization a payment of $200 and in return receives a ticket to some event valued at $80, this is a quid pro quo contribution and only $120 is deductible by the donor ($200 - $80 = $120). If an organization receives a quid pro quo contribution in excess of $75, the organization must provide a written disclosure statement to the donor that includes the amount of the payment and the value of the goods and services received by the donor. The statement must also tell the donor that only the amount of the payment in excess of the value of the goods and services provided is tax deductible. A religious organization does not have to provide the written disclosure statement if the only benefit received by the donor is an intangible religious benefit.

For a discussion of the new tax laws, please refer to Publication 1771, Substantiation and Disclosure Requirements.

FILING REQUIREMENTS

DOES A CHURCH HAVE TO FILE AN ANNUAL INCOME TAX RETURN WITH THE IRS?

No. Exempt churches, their integrated auxiliaries, and conventions or associations of churches are not required to file Federal income tax returns or for that matter the usual information return filed by tax-exempt entities, the Form 990, Return of Organization Exempt from Income Tax. However, the organization may have to file Form 990-T, Exempt Organizations Business Income Tax Return, if it is generating gross income from an unrelated business of $1,000 or more.

DOES A RELIGIOUS ORGANIZATION OTHER THAN A CHURCH HAVE TO FILE AN ANNUAL INCOME TAX RETURN WITH THE IRS?

Religious organizations other than exempt churches, their integrated auxiliaries, and conventions or associations of churches, must file the Form 990. An exception to this rule exists for organizations with annual gross receipts that do not normally exceed $25,000. Such organizations are not required to file the Form 990. It should also be noted that a simplified form is available to organizations that have annual gross receipts of less than $100,000 and have total assets of less than $250,000 at the end of the year. These organizations may file a Form 990-EZ, Short Form Return of Organization Exempt from Income Tax.

Religious organizations that are required to file the Form 990 (i.e., organizations other than churches, their integrated auxiliaries, and conventions or associations of churches) generally must file the form on or before the 15th day of the fifth month following the end of their annual accounting period (May 15 for a calendar year accounting period). Like churches, these entities also have to file the Form 990-T if they have gross income from an unrelated business of $1,000 or more.

WHAT OTHER REPORTING REQUIREMENTS MUST BE MET BY A CHURCH?

There are several reporting requirements that may apply.

EMPLOYER IDENTIFICATION NUMBER

Every tax-exempt organization, including a church, is required to have an employer identification number (EIN) whether or not it has any employees. If an organization does not have an EIN, it should file Form SS-4, Application for Employer Identification Number, in accordance with the related instructions (or, if the organization is submitting an application for recognition of exemption, Form SS-4 should be included with the application).

INFORMATION RETURN FILING REQUIREMENTS

INTRODUCTION

Within a church's or other religious organization's business operations, the organization may be making payments that are required to be reported to the IRS on an annual, calendar year basis. The following is a brief discussion of the information returns that are most likely to be required.

With the exception of the Form 8282 discussed below, the following forms should be filed with an accompanying Form 1096, Annual Summary and Transmittal of U.S. Information Returns. These returns should be filed with the IRS no later than February 28th in the year following the calendar year in which the payments were made; the payees' copy of these returns should be furnished to them no later than January 3lst.

FORM 1099-MISC: MISCELLANEOUS INCOME:

An organization is required to file a Form 1099-MISC for each unincorporated individual or entity to whom it pays an aggregate of $600 or more in any calendar year to report:

      (a) gross rents,

An organization should file a Form 1099-INT to report interest of $600 or more paid in the course of its operations to non- incorporated individuals or entities during any calendar year.

An organization that files a Form 1099-INT with the IRS must furnish a copy of the form to the taxpayer who received the income.

FORM W-2G: CERTAIN GAMBLING WINNINGS:

An organization that conducts gambling activities is required to report gambling winnings on Form W-2G if it pays out either of the following:

(a) $600 or more from a wagering transaction. If the winnings exceed $1,000, then they are also subject to regular gambling withholding, which is applied at a rate of 20% to the amount of the winnings less the amount wagered and not merely to the amount in excess of $1,000. For example, a church sells raffle tickets for $2 per ticket with a first place prize of a car that has a fair market value of $10,000 and a second place prize of $1,500 in cash. Because both of these prizes have a value exceeding $1,000, the church is required to report the total winnings on a Form W-2G to each winner and withhold 20% of $9,998 ($10,000 - $2) and 20% of $1,498 ($1,500 - $2), respectively.

(b) $1,200 or more of gambling winnings from bingo. If the winnings are of a noncash nature, the fair market value of the item won is to be considered the amount of the winnings. These winnings are not subject to regular gambling withholding, however.

FORM 8282: DONEE INFORMATION RETURN:

An organization is required to file this information return if it sells, exchanges, transfers, or otherwise disposes of certain noncash, donated property within two years after the date that it originally received the donation. This applies to noncash property that had an appraised value of $5,000 or more at the time of donation.

This form must be filed with the appropriate IRS Service Center within 125 days of the date of the donee organization's disposition of the property. The donee must also furnish a copy of the form to the original donor.

FOR MORE INFORMATION ON THE FILING REQUIREMENTS OF THESE AND OTHER FORMS, SEE: 1993 INSTRUCTIONS FOR FORMS 1099, 1098, 5498 AND W-2G.

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