Transparency In Ministry

The major tax deadlines for February are as follows:

1. February 28 - payors must file 2006 information returns (such as 1099s) with the IRS. (Electronic filers have until April 2 to file.)

2. February 28 - employers must send 2006 W-2 copies to the Social Security Administration. (Electronic filers have until April 2 to file.)

In December 2005 the Financial Accounting Standards Board (FASB) issued FAS #153: Exchanges of Nonmonetary Assets. This statement amended certain provisions of APB Opinion No. 29, Accounting for Nonmonetary Transactions.

This new standard is effective for organizations (churches/ministries) with years ending after June 15, 2006. The statement addresses how to calculate a gain/loss from a non-monetary exchange. FAS #153 defines an exchange (or exchange transaction) as a reciprocal transfer between an enterprise and another entity that results in the enterprise's acquiring assets or services or satisfying liabilities by surrendering other assets or services or incurring other obligations. One of the most common nonmonetary exchanges involves trade-in allowances on vehicles.

Under this new standard, a nonmonetary exchange shall be measured based on the recorded amount (after reduction, if appropriate, for an indicated impairment of value) of the nonmonetary asset(s) relinquished and not on the fair values of the exchanged assets, if any of the following conditions apply:
a. Fair value is not determinable
b. Exchange transaction to facilitate sales to customers
c. Exchange transaction that lacks commercial substance.

A nonmonetary exchange has commercial substance if the entity’s future cash flows are expected to significantly change as a result of the exchange. The entity’s future cash flows are expected to significantly change if either of the following criteria is met:
a. The configuration (risk, timing, and amount) of the future cash flows of the asset(s) received differs significantly from the configuration of the future cash flows of the asset(s) transferred.
b. The entity-specific value of the asset(s) received differs from the entity-specific value of the asset(s) transferred, and the difference is significant in relation to the fair values of the assets exchanged.

Remember application of this new standard applies to material items. Earlier application of the standard is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning January 2006 and shall be applied prospectively.

For an example of calculating a nonmonetary exchange based on this new standard, see post 2.

In the two previous posts we have discussed how the housing allowance should be reported by a minister and taxed. What kind of housing expenses are allowed? In an excerpt from the 2006 Church & Clergy Tax Guide, published by Christianity Today International, the following expenses are allowed in computing the housing allowance:

· down-payment on a home

· interest and principal payments on a mortgage loan to purchase or improve the home

· real estate taxes

· property insurance

· utilities (electricity, gas, water, trash pickup, local telephone charges)

· furnishings and appliances (purchase and repair)

· structural repairs and remodeling

· yard maintenance and improvements

· maintenance items (household cleansers, light bulbs, pest controls, etc)

· homeowners association dues

The actual costs incurred for the above items can be used in calculating any excess compensation that should be taxed. Remember, the amount reported for the housing allowance must be the lowest of one of the following:

1. church designated housing allowance
2. actual housing expenses paid by the pastor and properly supported
3. fair rental value of the home (furnished + utilities)

So if the actual housing expenses paid is the lowest amount, then the difference in what was received and the actual costs paid is included as taxable income.

A calculation of the fair rental value of the home should be made by consulting reliable sources. Estimating the actual costs that will be paid annually and determining the fair rental value will help the minister determine a proper housing allowance.

If a church hires a new minister during the year or if they need to make changes to a minister’s housing allowance, a board resolution is one of the methods used by churches to designate and approve the allowance.

For an example of a board resolution, see SAMPLE

Remember, the allowance should be approved (i.e., properly designated) before any payments are made to the minister.

Scenario: On a weekly basis love offering envelopes are available for congregants to fill out and include a donation for their pastor. The love offerings are received regularly and systematically and the church makes a payment to the pastor on a monthly basis.

Question: Are these offerings considered a gift to the pastor or taxable compensation?

Answer: IRC Section 102 stipulates that “gross income does not include the value of property acquired by gift, bequest, devise, or inheritance”. An employee who receives this type of gift, however, shall not exclude from gross income any amount transferred by or for an employer to, or for the benefit of, an employee.

So what exactly is a gift?

Over the past 47 years, several cases have highlighted similar scenarios.

In the Commissioner v. Duberstein, 363 U.S. 278, 285 (1960) case, the courts concluded that whether money or property transferred by an employer to an employee is an excludable gift is based on the reason for the employer’s action. If the employer’s reason for giving is based on a detached or disinterested generosity, affection, respect, admiration, charity or like impulses, the transaction is a gift and excludible from compensation.

However in Borgadus v. Commissioner, 302 U.S. 34, 45 (1936) if the gifts are made or intended to be made for any services rendered or to be rendered, then the gifts would be taxable.

So a donor can give based on a detached or disinterested generosity and it cannot be perceived to be based on services rendered or to be rendered. These gifts are not taxable tothe pastor and the donor does not receive a charitable deduction for income tax purposes.

Gift = detached generosity.

Are the love offerings a detached generous gift?

See the next post as we define special or love offerings?

As discussed in our earlier post, the FASB issued a new standard for nonmonetary asset exchanges. One of the most common nonmonetary exchanges is purchasing a new vehicle with a trade in. The nonmonetary asset that is exchanged is the old vehicle. This new standard requires calculating the gain/loss differently.

For example, if your trade a vehicle which initially cost you $20,000 and you have recognized $16,000 of book depreciation, for a vehicle with a sticker price of $30,000 with a $9,000 trade-in allowance. You would calculate the gain on the relinquished asset as follows:

Initial cost of vehicle $20,000 less accumulated depreciation(16,000) = Net book value of $4,000 less trade in allowance of (9,000) = gain on exchange of $ 5,000.

The transaction would be recorded as follows:

Debit New vehicle $30,000
Debit Accumulated depreciation. 16,000
Credit Gain on new vehicle $ 5,000
Credit Old vehicle 20,000
Credit Cash (paid for vehicle) 21,000

If the church financed the vehicle with a new note, instead of crediting cash you would credit notes payable for $21,000.

Further questions? Contact us.

In December 2005, the AICPA (American Institute of Certified Public Accountants) issued SAS (Statement on Auditing Standards) #103, Audit Documentation. This statement addresses certain audit practices incorporated during fieldwork. One of the significant changes provided by this new standard is the dating of the audit opinion. Prior to years ending before December 31, 2006, the last day of audit fieldwork was the date the auditors used for the opinion. SAS #103 changes the date of the auditor’s report.

In accordance with U.S. Auditing section 339, paragraph 23 the auditor’s report should not be dated earlier than the date on which the auditor has obtained sufficient appropriate audit evidence to support the opinion. Among other things, sufficient appropriate audit evidence includes evidence that the audit documentation has been reviewed and that the entity’s financial statements, including disclosures, have been prepared and that management has asserted that it has taken responsibility for them.

For examples of sufficient appropriate audit evidence, read on

So instead of having the audit report dated on the last day the auditors are in “the field”, the auditors will date the opinion when:

1. the last piece of significant evidential matter is obtained and

2. management has accepted responsibility for the financials including the disclosures.

This date will typically be closer to the auditor’s release of the statements.

This standard is effective for audits of financial statements for periods ending on or after December 15, 2006 and earlier application is permitted.

In the previous post on love offerings, we discussed the definition of a gift. A gift = detached generosity. The following is a common church scenario:

On a weekly basis love offerings envelopes are available for congregants to fill out and include a donation for their pastor. The love offerings are received regularly and systematically and the church makes a payment to the pastor on a monthly basis.

Question: Are these offerings considered a gift to the pastor or taxable compensation?

What are special offerings?

In Banks v. Commissioner, 62 T.C.M. 1611 (1991) special offerings were given to a minister on four separate occasions during the year. The offerings were in addition to the minister’s salary and amounted to more than $40,000 annually. The members of the church who gave the offerings did not take a tax deduction for their contribution because their intent was to give a true gift. However, the Commissioner was able to use the Duberstein case and show that the gifts were in fact for services rendered.

Testimony of congregation members indicated that transfers were designed to compensate the minister for the excellent work the minister had done and to encourage them to remain with the congregation. The court also found that the amounts transferred to the minister were part of a highly structured program for transferring money to the minister on a regular basis. The regularity of the payments from church members to the minister also “suggests that the transfers did not emanate from a detached and disinterested generosity but, instead, were designed to compensate for service as a minister”.

The same type of ruling was upheld in Goodwin v. United States, 67 F.3d 149 (8th Cir. 1995). The court held that the gifts to the pastor and his wife were taxable income based on evaluating the donor’s intent. Although the gifts were anonymous and not coerced, payments were made on a regular basis; were systematically organized and collected by church personnel; were substantial compared to pastor’s salary; and were made to retain the pastor’s services.

So are love offerings, collected regularly and systematically by the church and paid to the pastor, taxable compensation?

YES.

These payments should be included in the pastor’s W-2 and considered as part of the minister’s annual compensation.

Classify this as a Taxable Valentine.

Just before adjourning for 2006, Congress passed the Tax Relief and Health Care Act of 2006. President Bush signed the bill into law on December 20, 2006. The law retroactively reinstates a number of tax breaks that had expired at the end of 2005, making them effective for 2006 and 2007. Here’s a brief overview of what was extended:

1. The itemized deduction for state and local sales tax was reinstated for 2006 and 2007. This is a boon for taxpayers in states without a state income tax, but taxpayers who pay both state sales and income taxes can deduct whichever is higher.

2. Middle-income taxpayers can claim a deduction for up to $4,000 of qualifying higher education expenses for 2006 and 2007. This is an above-the-line deduction so you don’t need to itemize to claim it. However, income limits apply.

3. Teachers can claim a deduction for classroom supplies that they pay for out of their own pocket. This is also an above-the-line deduction, with a limit of $250.

4. The law also extends a number of business tax credits and deductions, including the research credit, the work opportunity and welfare-to-work credits, and the 15-year recovery period for certain leasehold and restaurant improvements.

5. The Energy Tax Incentives Act of 2005 provided several tax credits and deductions intended to promote energy conservation. Though these tax breaks generally were not scheduled to expire until the end of 2007, the new law further extended certain ones through 2008.

The new law makes other miscellaneous changes to the tax code. For additional information and guidance in your tax planning, call us.

If you’ve given up itemizing deductions, you’re not alone. These days over half of all taxpayers find they’re better off using the standard deduction. But even if you take the standard deduction, you can also deduct some individual expenses. Consider the following.

1. IRA and HSA contributions - you can deduct up to $4,000 in contributions to a traditional IRA this year. That increases to $5,000 if you’re age 50 or older. Income limitations may apply in some cases. You can’t deduct contributions to Roth IRAs.

2. Health Savings Accounts (HSAs) are IRA-like accounts set up in conjunction with a high-deductible health insurance policy. You make annual deductible contributions to your HSA. Contributions are invested and grow tax-free, and you're allowed to withdraw money in the account tax-free to pay for your unreimbursed medical expenses.

3.Student loan interest and tuition fees - deduct up to $2,500 interest on student loans for yourself, your spouse, and your dependents. You can also deduct up to $4,000 of tuition and fees for qualified higher education courses. Income limitations apply, and you must coordinate these deductions with other education tax breaks.

4.Self-employment deductions - if you’re self employed, you can generally deduct the cost of health insurance premiums, retirement plan contributions, and one-half of self-employment taxes.

5.Other deductions - don’t overlook deductions for alimony you pay, certain moving expenses, and early withdrawal penalties. Teachers can deduct up to $250 for classroom supplies that they buy themselves.

Contact us for more information on these and other deductions that could cut your tax bill.

Many financial statements disclose subsequent events for a church or ministry. What is a subsequent event and why are they important?

A material event that occurs after the balance-sheet date (say December 31, 2006) but prior to the auditor issuing the financial statements (say March 15, 2007) is a subsequent event. This event may require an adjustment to the financial statements or may require disclosure.

How do you determine if you adjust or disclose?

The first type of a subsequent event provides additional audit evidence that a transaction existed at the date of the balance sheet and usually affect estimates. For example:

A church has registered its pastors for a conference event and owes $10,000 in fees to another church. Subsequent to year-end, the registering church is hit by a tornado and is unable to pay the outstanding fees.

This subsequent event results in the fees being uncollectible and therefore management determines the receivable should be written off. This event required the financial statements to be adjusted subsequent to year-end.

The second type of subsequent event provides evidence of conditions that did not exist at the date of the balance sheet, but arose subsequent to year-end and should be reported or disclosed in order to keep the financial statements from being misleading. For example:

In February, a church kicks off a new capital campaign to raise $10 million for a new facility.

Management may consider this event a material transaction and would disclose the event in order to update the reader on significant transactions that could affect the comparability of future financial statements.

How does an auditor find a subsequent event? See the subsequent post…

There are several procedures that help auditors find and evaluate subsequent events. These include:

1. Reading and comparing the most recent financial statements to the statements under audit. Obtain client explanations for significant fluctuations.

2. Discussing with executive management:
a. how contingent liabilities were estimated at year-end and if they have been paid subsequent to year-end.
b. if any significant events have occurred after year-end.
c. if any unusual adjustments were made after year-end.
d. if there were any significant changes in long-term debt or significant purchases after year-end.

3. Reading the minutes from board meetings held after year-end.

4. Reading any meeting agendas and summaries of actions for minutes that have not been approved.

5. Reviewing confirmations from legal counsel concerning litigation, claims and assessments.

6. Obtaining a written representation letter from management clarifying any unusual issues or transactions.

7. And when all else fails…perform any other procedures that the auditor considers necessary and appropriate to dispose of any unanswered questions.

So when the auditor asks the CFO for interim financial statements, this is one of the procedures for identifying a subsequent event that could impact the financial statements under audit.

Now you know!

For more information, see events.

Concerned about an event or how to evaluate items for potential disclosures? Post a comment.

Scenario: Pastor Brown is going to take a week of vacation to Florida. He wants one of the youth pastors who work part-time to accompany he and his family. The church paid for the airfare and the hotel rooms for both pastors.

Question: Are the travel costs paid by the church, taxable compensation to the minister?

Answer: YES. Under IRS Publication 463, if a trip is “personal” in nature, the travel costs represent a personal expense and not a business expense. Because the church paid for these personal costs, the travel costs for both pastors are included as taxable compensation in Pastor Brown’s W-2 at the end of the year.

Why Pastor Brown's W-2 and not the youth pastor? It was Pastor Brown's decision and authorization for the church to pay for the youth pastor's airfare. It was Pastor Brown's request that the youth pastor accompany his family. Even if a business purpose could be performed during the vacation, the trip was primarily personal in nature, therefore justifying these expenses as taxable compensation to Pastor Brown.

Do you have any questions about other types of personal expenses that may be taxable? Post a comment.

The start of a new year is a good time to take care of a few “housekeeping” details in your ministry. One of those details, and it’s a very important one, is making certain that your board minutes are complete, accurate, and up to date. As we have discussed previously, housing allowances should not be paid until they are designated and approved by the board.

To preserve the legal benefits of incorporation, church boards should hold regular meetings. By keeping clear and appropriate records of these meetings in the form of corporate minutes, churches avoid business problems.

These transactions include compensation arrangements, loans, leases, facility purchases, capital campaigns, or other transactions between the church and employees and related entities. The business intent or ministry purpose for the transaction should be documented.

Many times churches and ministries incurr transactions or operational issues that they need help in recording. Our blogs may not have previously addressed the issue, or your transaction was slightly different.

Do you have a question? Post a comment or e-mail us.

If you want your comment to remain anonymous, we can post a blog discussing the issue.

No question is dumb.

In past years, you could ask the IRS to deposit your income tax refund into your bank account. For your 2006 tax refund, you'll be able to have the IRS split your refund and make deposits in up to three accounts at different financial institutions.

Examples of accounts you can choose include checking, savings, IRAs, health savings accounts, Archer medical savings accounts, and Coverdell education savings accounts.

It will be up to you to verify that the institution will accept direct deposits, and in the case of IRAs, to verify the year the contribution is for and the fact that the contribution has been timely made.