LITTLE-KNOWN TAX LEGALITIES - Christianity Today

Just when we think we’ve gotten a handle on the regulations, they’re reworked. At this time of year when taxes inevitably enter our thoughts, here are six considerations to keep in mind.

Business expense deductions

A recent Tax Court ruling (Dalan v. Commissioner, T.C. Memo. 1988-106) may limit how much of business and professional expenses clergy can deduct. In essence, it says you cannot deduct the percentage of business and professional expenses attributable to the housing allowance portion of your income. The IRS in recent years had instructed its agents not to raise the issue enforced in an earlier Tax Court ruling, Deason v. Commissioner, 41 T.C. 465 (1964), but Dalan appears to be reversing the position. Let’s look at the history.

Section 265 of the Internal Revenue Code states basically that when a percentage of your income isn’t taxable (such as a housing allowance), an equal percentage of your deductions aren’t allowable. Therefore, if a pastor’s $30,000 pay package is composed of $20,000 in salary and $10,000 in housing allowance, the pastor could deduct only two-thirds of his expenses, the part allocable to his salary.

This application of Section 265 was upheld in Deason in 1964, which kept Pastor Deason from deducting the full amount of his unreimbursed automobile expenses since part of his income-his housing allowance-was tax-exempt. But this ruling was disregarded by the IRS. For several years, pastors were allowed to deduct their full expenses from their taxable income.

Then came Dalan in 1988, reversing the leniency and causing pastors to reduce their deductible expenses. If the Dalan case indeed reflects a change in the IRS’s longstanding position, then pastors seeking deductions for unreimbursed business and professional expenses need to figure a ratio of salary to total compensation and then deduct only that portion of expenses.

For example, if S equals salary (less housing allowance), H equals housing allowance, and E equals expenses you want to deduct, then the formula for allowable deductions is E x S ö (S + H). To use the example above, if the pastor’s expenses are $500, the formula would be: $500 x $20,000 ö ($20,000 + $10,000) = $333.33, what he can deduct as expenses.

Two notes: First, pastors living in a parsonage likewise may be affected if the IRS begins to consider the fair rental value of the parsonage part of the pastor’s tax-exempt income, as is housing allowance for home-owning pastors. This is yet to be seen.

Second, the adverse impact of Dalan can be eliminated if clergy work under a church policy in which they are reimbursed fully on a periodic basis for expenses for which they adequately account with receipts or other documentary evidence. Those pastors currently receiving an expense allowance probably will find tax advantages in converting to a reimbursement system.

Church-owned vehicles

Many churches are acquiring an automobile for their pastors’ church-related travel. Here’s one reason why. If a church owns or leases a car and the board adopts a resolution restricting use of the car to church-related activities, the pastor need report no income or deductions related to it. And better yet, there are no accountings, reimbursements, allowances, or record-keeping requirements, a relief for most pastors.

The following conditions must be satisfied, however: (1) The vehicle is owned or leased by the church and is provided for use in connection with church business; (2) when the vehicle is not being used for church business, it is kept on the church’s premises (unless it is temporarily located elsewhere, such as a repair shop); (3) no employee using the vehicle lives on the church’s premises; (4) under a written policy statement adopted by the church board, no employee of the church can use the vehicle for personal purposes, except for “de minimis” (minimal) personal use (such as a stop for lunch between two business trips); (5) the church reasonably believes no church employee uses the vehicle for personal purposes; and (6) the church can prove to the IRS that the preceding five conditions have been met (Reg. 1.274-6T(a)(2)).

Commuting is always considered to be personal use of a car. Thus this simplified setup wouldn’t be available if a church allowed its minister to commute to work in a church-owned vehicle. A pastor always has the option of keeping a log of personal-use miles and reimbursing the church at the standard 24 cents per-mile rate. The record keeping may well be worth the convenience of using the car for the commute to church.

Loans to clergy

Churches occasionally make loans to clergy to enable them to purchase housing or make another major purchase. Typically, the church charges no interest or a rate far below the prevailing market rate. These loans can create problems for a number of reasons.

First, many state nonprofit corporation laws prohibit loans to officers and directors. Churches considering a loan to a minister (even at a reasonable interest rate) are wise to determine first that such loans are permissible under state law.

Second, no-interest or low-interest loans to clergy may be viewed as “inurement” of the church’s income to a minister. This can potentially jeopardize the church’s tax-exempt status.

Third, for loans of $10,000 or more (or for lesser loans in which an intent to avoid taxes exists), a church must figure the benefit to a minister of receiving the loan and add this amount to the minister’s reportable income-a complex calculation I won’t begin to touch here.

The point is: Even if loans to clergy are allowed under a state’s nonprofit corporation law, no-interest and low-interest loans of $10,000 or more will result in income to a minister that must be valued and reported. Failure to do so could result in prohibited inurement of the church’s income to a private individual, a potentially disastrous prospect.

Special-occasion gifts

Clergy often receive gifts for special occasions. Are these considered compensation? The general rule for federal tax purposes is this: If the gifts are in any way processed through the church’s books or paid out of church funds, then the distribution to the minister should be reported as taxable compensation and included on his or her W-2 or 1099 and Form 1040. Members who contribute to special-occasion offerings processed through the church’s books can deduct their contributions as a charitable contribution if they itemize deductions.

Of course, members are free to make personal gifts to clergy, such as a card at Christmas accompanied by a check or cash. Such payments may be tax-free gifts to the minister, although they are not deductible by the donor.

Bargain sales

Some churches “sell” a parsonage to a retiring minister at a price well below the property’s fair market value. Other churches may sell a car or other church-owned vehicle to their pastor at a below market price. The important consideration with such bargain sales is this: The “bargain” element (the difference between the sales price charged by the church and the property’s market value) must be reported as income to the minister.

Churches should consider thoroughly the tax consequences of such sales before approving them. In some cases, pastors have had to sell the property to pay the taxes.

Works made for hire

Ministers who are authors or composers are often shocked to learn that their employing church may be the copyright owner of works they create. Section 201 of the Copyright Act specifies that “the employer . . . is considered the author” of a “work made for hire” and “owns all of the rights comprised in the copyright” unless the employer and employee “have expressly agreed otherwise in a written instrument signed by them.” The Act defines a work made for hire as “a work prepared by an employee within the scope of his or her employment.”

To illustrate, if a minister of music composes a hymn at church during regular working hours and using church equipment or secretarial help, the work almost certainly will be considered a work made for hire. The church, and not the minister, is the copyright owner. This means the minister has no legal right in the work and no authority to enter into a contract with a publishing company.

The same conclusion would apply to clergy who write articles or books. Clergy who produce articles, books, or musical works as part of their ministry may want to consider entering into a written agreement with their church regarding copyright ownership of such works. Unless the minister and church specifically agree otherwise in a signed writing, the copyright in such works probably will vest in the church

-Richard R. Hammar

Attorney-at-law and CPA

Springfield, Missouri