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Ministers, churches get advice for complying with IRS rules

NEW ORLEANS (BP)–Most ministers and churches don’t realize how perilously close they may be to a painful lawsuit or IRS-imposed tax penalties, a CPA told students at New Orleans Baptist Theological Seminary.

But both lawyers and the IRS are looking at churches and ministers much more closely than before because of a careless lack of proper oversight to church operations and noncompliance to governmental rules and regulations, said Rex Frieze, former assistant pastor of administration and chief business and financial officer for First Baptist Church, Orlando, Fla., and now a church management consultant based in Orlando.

Frieze was on the NOBTS main campus Jan. 10-11 and at the NOBTS North Georgia Campus Jan. 9 presenting a second annual continuing education conference on topics of extreme interest to all ministers and churches for up-to-date information, if not for sheer defense: evaluating areas of risk within the church and properly structuring the minister’s compensation plan.

In a day when lawyers think they can make some easy money by suing churches, church leaders must take time to evaluate possible areas of risk within their church operations, Frieze said.

“It used to be unheard of for a church to be sued,” he said. “Now our litigating society sees churches as easy targets with deep pockets.”

But a sadder situation, he said, is embezzlement of church funds is at an all-time high. “Recent studies have revealed that 15 percent of churches have been, are being or will be victims of embezzlement,” he said. The number in actuality is much higher, he said, because church embezzlement is so easy to cover up with the sloppy way some churches keep their financial records.

“To effectively minister within such a litigating society,” Frieze said, “church leaders are being required to be much more prudent in the management of church affairs. They must manage with prevention in mind, instead of waiting for a risk (such as a lawsuit or IRS inquiry) to occur.”

Congress is seeking to hold churches and other tax-exempt organizations more accountable regarding compensation and benefits issues, Frieze said. Last August, Congress gave the IRS the right to impose penalty excise taxes (called intermediate sanctions) on leaders of churches and other tax-exempt organizations if such organizations give “excess benefit transactions” to anyone in the organization in a position to exercise substantial influence over the organization’s affairs, such as ministers.

For a church to maintain its tax-exempt status, no part of its funds can “inure” to the private benefit of an individual. Inurement is the improper diversion of church funds to people with substantial influence over the affairs of the church for their private benefit or that of related parties, such as family members.

Examples could include excess salaries, interest-free loans, forgiveness of debt, significant cash or non-cash love gifts and paying a predetermined percentage of tithes and offerings to those with control over the affairs of the church.

An “excess benefit transaction” is one in which the economic benefit an organization provides is greater than the value of the consideration it receives, including performance of services. The penalty excise taxes, as mentioned above, can be levied on any person in a position to exercise substantial influence over the church’s affairs and on church leaders, such as board or personnel committee members, who participate in the transactions knowing they are improper.

Whether a transaction results in private inurement depends on a measure of reasonableness or fair market value. According to the Congressional Joint Tax Committee report on the new law, a minister’s compensation arrangement is presumed to be reasonable if it meets three requirements:

1) The compensation and benefit arrangement must be approved by a board or authorized committee “composed entirely of individuals who are unrelated to and not subject to the control” of the minister(s) involved in the arrangement.

2) The board or committee “shall obtain, review and rely upon objective ‘comparability’ information to substantiate their independent decisions regarding reasonable levels of compensation paid and benefits granted,” i.e., compensation arrangements of similar churches for comparable positions, independent compensation surveys of nationally recognized organizations, etc.

3) The board or committee “shall adequately document the basis for all of its decisions and actions.” That means no more little notes torn off the corner of a church bulletin or verbal OKs over the phone, Frieze said.

Church leaders must take heed to these new tax provisions, Frieze said, noting the congressional committee report on the new law estimates revenues from intermediate sanctions of $33 million over the next five years.

“The fact that revenues are expected to be collected indicates the IRS is intent on imposing the sanctions aggressively,” Frieze said.

Besides tax problems that may result from an improperly structured minister’s compensation plan, there are significant ethical problems, Frieze said, from “a misrepresentation to the congregation as to what the minister is truly receiving in the form of compensation,” to church leaders and staff members being “viewed as unwise stewards of the tithes and offerings which have been entrusted to them.”

Two “historical mind-sets” prevalent in church settings that “must be changed,” according to Frieze, are:

1) the payment of a minister’s compensation, benefits and ministry-related expenses through a “package arrangement” and

2) the payment of “expense allowances” to the minister for “ministry-related expenses” and “protection coverage reimbursements.”

Frieze gave six guidelines for “the ideal minister tax reporting arrangement:”

1) Report as an employee for federal income tax purposes, meaning the minister will receive a Form W-2 and not a Form 1099.

2) Develop a church personnel budget “which addresses separately,” Frieze emphasized, each of the following three categories:

A. Ministry-related expense reimbursements (funds needed for “doing the work of ministry”).

B. Protection coverages, such as insurance, retirement, etc.

C. personal (take-home) pay.

3) Operate under a church-approved “Accountable Expense Reimbursement Arrangement.” To do so requires specific IRS guidelines. If these guidelines are not met, expense reimbursements will be taxable to the minister.

4) Consistently review adequacy of insurance coverages and retirement contributions.

5) Properly designate a housing or parsonage allowance through the church board or authorized committee before each new year begins.

6) Consider voluntary withholding of federal income and self-employment taxes through the church (withhold both only as “federal income taxes”).

To continue to handle church money “the same old way” simply because “that’s just the way we’ve always done it” is setting up the church and minister for a disastrous situation, Frieze said.

“The church must be the pacesetter in demonstrating to its members and to a lost world the highest levels of integrity in organizing and operating its ministry affairs,” Frieze said.

“Many church leaders feel that all these rules and regulations are nothing more than ‘a pain in the neck,'” he said. “Yes, we must take pains to do what is right, not only in the eyes of the Lord, but also in the eyes of man,” he said, quoting from 2 Corinthians 8:21.

“And yes, churches must also submit to governing authorities, not only because of possible punishment (such as IRS penalties and fines), but more importantly, as stated in Romans 13:5, because of our testimony.”

    About the Author

  • Debbie Moore