Transparency In Ministry

In a recent case ruling by the Oklahoma Court of Civil Appeals, a tax-exempt corporation

excludes any entity wherein any part of its net earnings goes to benefit any private shareholder or individual.

Can you spell "inurement?"

Little Debits are selected information obtained from various sources that provide “user friendly” information for churches and ministries. Enjoy!

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In March of 1982 the Financial Accounting Standards Board (FASB) issued Financial Accounting Standard 57 Related Party Disclosures and this standard became effective for financial statements ending after June 15, 1982.

Transactions incurred by compensation arrangements, expense allowances, and other similar items in the ordinary course of business are not considered to be a related party transactions and therefore not required to be disclosed in the organization’s financial statements.

For nearly 25 years all organizations (including churches/ministries) that issue financial statements with note disclosures are required to report related party transactions and there continues to be discussions between auditors and management regarding the requirements established by the FASB. During the next several posts we will define a related party and discuss the requirements for reporting material transactions.

What is a related party transaction? FAS 57 defines a related party as:
1.Parent company and its subsidiaries

2.Subsidiaries of a common parent

3.Affiliates of the enterprise;

4.Entities for which investments are accounted for by the equity method by the enterprise;

5.Trusts for the benefit of employees, such as pension and profit-sharing trusts that are
managed by or under the trusteeship of management;

6.Principal owners of the enterprise;

7.Management;

8.Members of the immediate families of principal owners of the enterprise and its management; and

9.Other parties with which the enterprise may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests.

10.Another party if it can significantly influence the management or operating policies of the transacting parties or if it has an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests.

Understanding who is a related party helps organizations report material transactions incurred during a reporting period. We will define some of the relationships in post #2.

In accordance with FAS 57, material related party transactions must be disclosed in the financial statements. In our post #1 we defined a related party. Let’s look closer at these parties to determine who is “related”:

1. Parent company and subsidiary - (under APB Opinion #16), one organization owning a majority of another organization’s voting stock.

2.Affiliate - a party that, directly or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with an enterprise.

3.Management - persons who are responsible for achieving the objectives of the enterprise and who have the authority to establish policies and make decisions by which those objectives are to be pursued. Management normally includes members of the board of directors, the chief executive officer, chief operating officer, vice presidents in charge of principal business functions (such as sales, administration, or finance), and other persons who perform similar policymaking functions. Persons without formal titles also may be members of management.

4.Principal owners - owners of record or known beneficial owners of more than 10 percent of the voting interests of the enterprise.

5.Immediate families - family members whom a principal owner or a member of management might control or influence or by whom they might be controlled or influenced because of the family relationship.

See post #3 to understand “common” related party transactions.

In our two previous posts on related parties organizations may incur material transactions with individuals or organizations that are required to be disclosed in the financial statements. In post #1 these related parties were classified as: parent company and its subsidiaries; subsidiaries of a common parent; affiliates of the enterprise; entities for which investments are accounted for by the equity method by the enterprise; trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management; principal owners of the enterprise; management; members of the immediate families of principal owners of the enterprise and its management; and other parties with which the enterprise may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests or another party if it can significantly influence the management or operating policies of the transacting parties or if it has an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests.

As explained in FAS 57 “Related Party Disclosures” some examples of common types of transactions with related parties are: sales, purchases, and transfers of realty and personal property; services received or furnished, (for example, accounting, management, engineering, and legal services); use of property and equipment by lease or otherwise; borrowings and lendings; guarantees; maintenance of bank balances as compensating balances for the benefit of another; intercompany billings based on allocations of common costs; and filings of consolidated tax returns.

Transactions between related parties are considered to be related party transactions even though they may not be given accounting recognition. For example, an enterprise may receive services from a related party without charge and not record receipt of the services.

See post #4 for disclosure requirements for related party transactions.

As we have discussed in the three previous blog postings, organizations are required to disclose material related party transactions in their financial statements. Transactions incurred by compensation arrangements, expense allowances, and other similar items in the ordinary course of business are not considered to be a related party transactions and therefore not required to be disclosed in the organization’s financial statements.

In accordance with FAS 57 Related Party Disclosures financial statements shall include disclosures of material related party transactions, other than compensation arrangements, expense allowances, and other similar items in the ordinary course of business. However, disclosure of transactions that are eliminated in the preparation of consolidated or combined financial statements is not required in those statements. The disclosures shall include:
a. The nature of the relationship(s) involved

b. A description of the transactions, including transactions to which no amounts or nominal amounts were ascribed, for each of the periods for which income statements are presented, and such other information deemed necessary to an understanding of the effects of the transactions on the financial statements

c. The dollar amounts of transactions for each of the periods for which income statements are presented and the effects of any change in the method of establishing the terms from that used in the preceding period

d. Amounts due from or to related parties as of the date of each balance sheet presented and, if not otherwise apparent, the terms and manner of settlement

e. The information required by paragraph 49 of FASB Statement No. 109, Accounting for Income Taxes.

Transactions involving related parties cannot be presumed to be carried out on an arm's-length basis, as the requisite conditions of competitive, free-market dealings may not exist. Representations about transactions with related parties, if made, shall not imply that the related party transactions were consummated on terms equivalent to those that prevail in arm's-length transactions unless such representations can be substantiated.

If the reporting enterprise and one or more other enterprises are under common ownership or management control and the existence of that control could result in operating results or financial position of the reporting enterprise significantly different from those that would have been obtained if the enterprises were autonomous, the nature of the control relationship shall be disclosed even though there are no transactions between the enterprises.

For more information about related party transactions, contact us.

The following is an excerpt from an e-mail from a client who is in the middle of an IRS examination:

Yesterday our auditor was in a talkative mood. He told us that he had just returned from meeting in Washington, D.C. where he was told that the IRS was going to audit "televangelists" this year. He indicated that the target will be those living in expensive homes owned by the ministry and they'd also be looking for other ministry expenses that benefit the minister.

We are posting this "unsubstantiated third party quote" only because it is an IRS initiative that we have expected to occur for several years since Congress passed the Intermediate Sanctions Law. We have speculated that excess compensation could be defined in terms of "excessiveness" or benefits not detailed in the minister's compensation plan --- although the Service may not be successful in their claim.

For all non-profits, we recommend an annual review of transactions between a "control person" and the tax-exempt organization.

Need further clarification of control persons, contact us.

Are you still waiting for your tax refund? If so, you may be one of the 95,746 taxpayers to whom the IRS has been unable to deliver a refund check. The refunds total $92.2 million.

Every year there are taxpayers who don’t update the IRS or the U.S. Postal Service when they move or change their mailing address. Checks are mailed to the last known address for taxpayers, and when the address isn’t current, the checks are returned as undeliverable.

To check on a missing refund, you can go to the IRS Web site and type “Where’s My Refund?” in the search box. To check on a refund by phone, call 1-800-829-1954.

For January 2007

January 16 - Final 2006 individual estimated tax payment is due, unless 2006 tax return is filed and taxes are paid in full by January 31, 2007.

January 31- Employers must provide 2006 W-2 statements to employees.

January 31- Payors must provide 2006 Form 1099s to payees.

January 31 - Employers must generally file Form 941 for the fourth quarter of 2006 and pay any tax due.

January 31 - Employers must generally file 2006 federal unemployment tax returns and pay any tax due.

NOTE: Businesses are required to make federal tax deposits on dates determined by various factors that differ from business to business.

Payroll tax deposits: Employers generally must deposit Form 941 payroll taxes (income tax withheld from employees' pay and both the employer's and employees' share of social security taxes) on either a monthly or semiweekly deposit schedule. There are exceptions if you owe $100,000 or more on any day during a deposit period, if you owe $2,500 or less for the calendar quarter, or if your estimated annual liability is $1,000 or less.

Monthly depositors are required to deposit payroll taxes accumulated within a calendar month by the fifteenth of the following month.

Semiweekly depositors generally must deposit payroll taxes on Wednesdays or Fridays, depending on when wages are paid.

For more information on tax deadlines that apply to your business, contact us.

After losing several court challenges to charging an excise tax on long-distance telephone service, the IRS is no longer assessing the tax. In May of 2006, the IRS announced that it will refund the tax paid by individuals, businesses, and tax-exempt organizations during the 41 months from March 2003 through July 2006.

Individuals can claim their refunds by calculating the actual tax they paid, or they can take a standard refund amount based on the number of personal exemptions they claim on their 2006 tax returns.

The IRS has also provided businesses and tax-exempt organizations with a formula to estimate the amount of refund to which they’re entitled. The formula can be used by those who don’t want the bother of going through 41 months of phone bills to calculate the exact taxes paid.

To claim their refunds, businesses (including sole proprietors, corporations, and partnerships) and tax-exempts are to complete Form 8913 (Credit for Federal Telephone Excise Tax Paid) and attach the form to their regular 2006 income tax return or, in the case of tax-exempt organizations, to Form 990-T. The form allows taxpayers to either claim the actual amount of refundable long-distance telephone excise taxes paid during the 41-month period or to use the IRS simplified formula to figure the refund.

In the last several fraud postings we have discussed ways that ministries and churches may be vulnerable for fraud. Fraud is defined as an intentional act to misrepresent financial information or misappropriate resources.

Management has a responsibility to set "ethical standards" within the organization. They must establish the "tone at the top" promoting ethical behavior. In post #4 we discussed that management has the opportunity to create a culture of honesty and high ethics.

By creating a positive workplace environment, poor employee moral can be reduced, thus affecting the employee's rationalization for committing fraud.

Hiring and Promoting Appropriate Employees - each employee has a unique set of values and personal code of ethics. When faced with sufficient pressure and a perceived opportunity, some employees will behave dishonestly rather than face the negative consequences of honest behavior. Hiring and promoting appropriate employees who promote ethical values may improve the workplace environment the decreasing the perceived opportunity to commit fraud.

In our final post in this fraud series, we will discuss employee discipline and evaluating controls to detect fraud.

·Discipline
The way an entity reacts to incidents of alleged or suspected fraud will send a strong deterrent message throughout the entity, helping to reduce the number of future occurrences. The following actions should be taken in response to an alleged incident of fraud:

• A thorough investigation of the incident should be conducted.

• Appropriate and consistent actions should be taken against violators.

• Relevant controls should be assessed and improved.

• Communication and training should occur to reinforce the entity's values, code of conduct, and expectations.

·Evaluating Antifraud Processes and Controls
Neither fraudulent financial reporting nor misappropriation of assets can occur without a perceived opportunity to commit and conceal the act. Organizations should be proactive in reducing fraud opportunities by (1) identifying and measuring fraud risks, (2) taking steps to mitigate identified risks, and (3) implementing and monitoring appropriate preventive and detective internal controls and other deterrent measures.

It must be stated if a group of people are working together to perform the fraud it makes it very hard to detect the act in a timely manner, but it will be exposed, for what is done in the dark will be exposed to the light.

If you have additional questions, please do not hesitate to contact us.

Question: How are housing allowances reported to the taxing authorities?

By January 31st churches are required to file the W-2s with their employees. By February 28th the W-2s and W-3s are filed with the Social Security Administration.

The amount of a minister’s taxable compensation is reported in box 1 wages, tips and other compensation on the W2. The housing allowance is not reported on form W-2 or on the form 1099.

As a courtesy to the ministers, the church accountant may provide a letter that communicates the amount of housing allowance paid during the year. It is the minister’s responsibility to report excess housing allowance in Form 1040.

How to report and calculate the excess housing allowance coming up in post 2 of this series.

Ministers may receive fees to perform marriages, funerals or baptismals directly from congregants or other individuals. These fees are typically incurred in the performance of their ministerial duties and represent taxable income under Treas. Reg. 1.61-2(a)(1). These fees are reported on schedule C of the minister’s tax return.

Little Debits are selected information obtained from various sources that provide “user friendly” information for churches and ministries. Short and sweet like Little Debbies.

Once a minister has been hired, it is management’s responsibility to designate a portion of his salary as a housing allowance. This designation should occur before the first paycheck. This designation may be documented in an employment contract, minutes of the church or compensation board or in the annual budget. This designation establishes that a component of the minister’s compensation is considered to be a housing allowance, and therefore not taxable for federal income tax purposes.

The allowance should be designated and approved before being paid to the minister. If the designation is not made on a timely basis, then the allowance is basically forfeited until designated.

Ministers may designate a portion of their compensation as a housing allowance. Ministers do not pay federal income taxes on the housing allowances. However each year the minister is responsible for calculating any excess housing benefits and paying and reporting the federal income tax.

What is an excess housing benefit? An excess housing benefit is the difference between the housing allowance received and the amount allowed for reporting purposes. The amount allowed is the lowest of the following three:
1. Church designated housing allowance

2. Actual housing expenses paid by the pastor and properly supported

3. Fair rent value of the home (furnished + utilities)

So to calculate any excess housing benefits the minister should compare the amount received from the church for the housing allowance to the lowest amount allowed and report the difference either on line 7 of Form 1040 or schedule C.

What types of housing costs are allowable? See post 3 of this series.