1.) Salary. The most basic component of church staff compensation is salary. There are two important considerations to keep in mind with respect to staff salaries: the amount of the salary, and the use of “salary reduction agreements.”
If a church pays unreasonably high compensation to a pastor or other employee, it may lose its tax-exempt status or face intermediate sanctions, including tax on disqualified persons, additional tax on disqualified persons, and tax on organization matters.

Recommendation. Churches that pay a minister (or any staff member) significantly more than the highest 25 percent for comparable positions should obtain a legal opinion from an experienced tax attorney confirming that the amount paid is not “unreasonable” and will not expose the employee or the board to intermediate sanctions.

Many churches have established “salary reduction agreements” to handle certain staff expenses. The objective is to reduce an employee’s taxable income since only the income remaining after the various “reductions” is reported on the employee’s W-2 at the end of the year. It’s important for churches to understand that they cannot reduce an employee’s taxable income through salary reductions unless specifically allowed by law. There are three ways taxable income can be reduced through salary reduction agreements: (1) tax-sheltered annuity contributions, (2) “cafeteria plans” and (3) housing allowances.

2.) Housing and equity allowances. The most important tax benefit available to ministers who own or rent their homes is the housing allowance. Ministers who own or rent their home don’t pay federal income taxes on the amount of their compensation that their employing church designates in advance as a housing allowance, to the extent that the allowance represents compensation for ministerial services is used to pay housing expenses and doesn’t exceed the annual fair rental value of the home (furnished, plus utilities).

Housing-related expenses include mortgage payments, rental payments, utilities, repairs, furnishings, insurance, property taxes, additions and maintenance.

Ministers who live in a church-owned parsonage that’s provided “rent-free” as compensation for ministerial services don’t include the annual fair rental value of the parsonage as income in computing their federal income taxes. The annual fair rental value isn’t “deducted” from the minister’s income. Rather, it’s not reported as additional income anywhere on Form 1040 (as it generally would be by non-clergy workers).

Further, ministers who live in a church-provided parsonage don’t pay federal income taxes on the amount of their compensation that their employing church designates in advance as a parsonage allowance, to the extent that the allowance represents compensation for ministerial services and is used to pay parsonage-related expenses such as utilities, repairs and furnishings.

Note that the parsonage and housing allowance exclusions only apply in computing federal income taxes.

Ministers can’t exclude them when computing their self-employment (Social Security) taxes.

Recommendation. Be sure that the designation of a housing or parsonage allowance for the subsequent year is on the agenda of the church board for one of its final meetings of the current year. The designation should be an official action of the board or congregation, and it should be duly recorded in the minutes of the meeting. The IRS also recognizes designations included in employment contracts and budget line items — assuming in each case that the designation was duly adopted by the church board (or the congregation in a business meeting). Also, if the minister is a new hire, be sure the church designates a housing allowance prior to the date he or she begins working.

Ministers who live in church-owned parsonages are denied one very important benefit of home ownership: the opportunity to accumulate “equity” in a home over the course of many years. Many ministers who have lived in parsonages during much of their active ministry often face retirement without housing. To avoid the potential hardship of no equity and no housing, some churches increase their minister’s compensation as an “equity allowance” to provide the equivalent of equity in a home. This is an excellent idea that should be considered by any church having one or more ministers living in church-provided housing. The equity allowance shouldn’t be accessible by the minister until retirement, so it should be placed directly in a minister’s tax-sheltered retirement account.

Equity allowances also should be considered by a church whose minister rents a home.

Accountable Business Expense Reimbursement Policy. Under such an arrangement, a church (1) reimburses only those business expenses that are properly substantiated within a reasonable time as to date, amount, place and business purpose, and (2) requires any excess reimbursements (in excess of substantiated expenses) to be returned to the church. Churches should seriously consider adopting an accountable reimbursement policy for reimbursing staff business expenses. Such a policy has the following advantages:

• Church staff reports their business expenses to the church rather than to the IRS.
• Church staff who report their income taxes as employees, or who report as self-employed and who are reclassified as employees by the IRS in an audit, avoid the limitations on the deductibility of employee  business expenses. These limitations include (1) the elimination of any deduction if the employee cannot itemize deductions on Schedule A (most taxpayers can’t), and (2) the deductibility of business expenses on Schedule A as an itemized expense only to the extent that these expenses exceed 2 percent of the employee’s  adjusted gross income.
• The so-called Deason allocation rule is avoided. Under this rule, ministers must reduce their business expense deduction by the percentage of their total compensation that consists of a tax-exempt housing allowance.
• The “50 percent limitation” that applies to the deductibility of business meals and entertainment expenses is avoided.
• Unless these expenses are reimbursed by an employer under an accountable plan, only 50 percent of them are deductible by either employees or self-employed workers.
• Church staff who report their income taxes as self-employed avoid the risk of being reclassified as an employee by the IRS in an audit and assessed additional taxes.

This excerpt was adapted from the 2012-2013 Compensation Handbook for Church Staff (Christianity Today) available at YourChurchResources.com. Used with permission. The handbook provides reliable church employee compensation breakdowns for 13 part- and full-time positions all organized by a variety of factors, including church size, income budget and geographical setting. In addition, compensation levels based on personnel characteristics are provided, including years employed, denomination, region, gender and educational training. Worksheets with step-by-step directions are included for each position to help leaders establish ranges based on this data. With this information, leaders can compare their plans to other churches that have similar positions and demographics.

Richard R. Hammar is an attorney, CPA and best-selling author specializing in legal and tax issues for churches and clergy. He is senior editor of Christianity Today’s Church Law & Tax Group, which includes the Church Law & Tax Report and Church Finance Today newsletters, and ChurchLawAndTax.com.

Deciding whether an individual worker is an employee or independent contractor is an increasingly important decision and deserves every church and ministry’s full attention. It is often tempting for churches and ministries to classify workers as independent contractors so as to avoid paying employment and payroll taxes and providing employee benefits and otherwise minimize costs.

However, this is a very short-sided view that may cause some very real financial harm and liability exposure to your church or ministry if care is not exercised.

Misclassifying a worker as an independent contractor can cause liability for failing to withhold and to pay the employer’s share of payroll taxes; exposure for failing to include the individuals in employee benefits plans; the tax disqualification of retirement plans; and back wages, add-on damages, and penalties for failing to comply with wage-hour requirements. Also, even tougher penalties are being contemplated by state and federal agencies.

Classify correctly
So, how can your church or ministry avoid misclassification? First, begin with the realization that there is a presumption by the Internal Revenue Service (IRS) and other agencies that everyone working for an employer (such as your church or ministry) is an employee. This presumption can be overcome by the right facts establishing a worker is not an employee; however, the default position is that a worker is an employee and the burden is on the church or ministry to overcome this presumption.

Unfortunately, a bright-line rule for making the fact-based determination of when someone becomes an independent contractor is not available. It just is not possible given the sometimes complicated nature of the analysis, including multi-tiered tests subject to differing interpretations and the fact that different agencies apply differing rules.

For instance, the Department of Labor (DOL) and Internal Revenue Service (IRS) apply slightly different criteria. But, there is a general framework of analysis that can greatly assist your church or ministry in making the correct classification. In addition to working through this general analysis, it is important to ultimately check with an experienced attorney who can not only help with the analysis, but also draft the appropriate legal agreement to document the classification and nature of the relationship depending on the context of the relationship.

Steps in classifying well
In regards to the general framework of analysis to follow when classifying workers, the first step is to follow the DOL’s analysis by considering the “economic realities test,” which encompasses several factors. Courts sometimes apply different factors or weigh similar factors differently in evaluating whether an individual has been properly classified as an independent contractor, but the “economics realities test” is probably the best general test we have at this time. The following factors are examined as part of this test:

Under the DOL “Economics Realities Test,” your church or ministry should consider:

1. The degree to which the person’s work is controlled by the organization;
2. The individual’s investment in facilities and equipment, if any;
3. The individual’s opportunities for profit or loss, if any;
4. The amount of any initiative, judgment or foresight the person uses in open-market competition;
5. The permanency of the relationship; and
6. Whether, and to what extent, the individual’s work is an integral part of the organization’s business or activities.

No one factor is necessarily determinative. The ultimate question is whether as a cumulative matter they demonstrate that, in reality, the workers are economically dependent upon the organization for their livelihoods and, if so, then they are employees; but, if the factors demonstrate a fair amount of independence from the organization, then it is more likely an independent contractor relationship exists.

Economic realities test
Second, as indicated above, the IRS does have its own analytical framework, which is thankfully not necessarily contrary to DOL’s analysis. The IRS framework can also be considered in concert with the DOL’s “economic realities test.” Before examining IRS’ current analytical framework, note that IRS used to advocate for a “Twenty Factor Test.”

However, Congress and the labor and business industries all pressed the IRS to simplify the test and make it more user-friendly. As a result, the “Twenty Factor Test” was transformed into an analytical framework that has 11 main tests organized into three main groups: (1) behavioral control, (2) financial control and (3) the type of relationship of the parties.

There are also separate Tax Court and Supreme Court tests that have been used, but such analysis is beyond the scope of this article. Fortunately, there is a lot of overlap and commonality among the various tests.

So what should your church or ministry do once it realizes that the organization has made a mistake in the classification of a worker and/or has been contacted by the IRS? Don’t panic. Contact experienced legal counsel.  Experienced legal counsel can guide the organization through a worker classification audit and help determine whether the IRS classification is correct and whether the organization qualifies for relief under what is known as IRS Section 530 Relief.

David Middlebrook is a partner with Anthony and Middlebrook of The Church Law Group, Grapevine, TX. www.ChurchLawGroup.com

By Ronald E. Keener

Asking questions often can be a first means to resolving church conflicts, say two authors of a new book, Redeeming Church Conflicts: Turning Crisis into Compassion and Care (Baker Books, 2012). “We begin by helping leaders and members learn what it means to ask not just the right questions but the ‘best’ questions so that the path followed to redeem and resolve conflicts avoids the pitfalls generated by the pursuit of non-essential controversies,” say authors Tara Klena Barthel and David V. Edling.

“Too often people involved in church conflicts fail to recognize that until everyone is on the page concerning what issues are at stake efforts to bring about resolution are wasted,” they say in respond to questions on the book from Church Executive. “The best way to get everyone on the same page is through a careful crafting of the best questions that capture the heart of the real conflicts and not just collateral matters. With some instruction the church member can certainly do this and become a peacemaker contributing to the unity of their church.”

Barthel is a former attorney and director of the Institute for Christian Conciliation, a division of Peacemaker Ministries. She lives in Billings, MT and is a mediator, arbitrator and conflict church intervention team member. Edling was a director of Peacemaker Ministries, and living in Colorado Springs, CO, and is in private practice of Christian conciliation through his church’s reconciliation ministry (see sidebar).

What is it about churches that seem to engender conflict?

First, many people have a misunderstanding about the nature of the church. The church of Jesus Christ is not just another volunteer organization that can be joined or left like people join or leave their local gym. The word translated “church” in the New Testament is a compound word literally meaning “the called out” and “the gathered assembly.”

If more people recognized that the church is to be a place for God’s called people gathered together by him for his purposes they would likely be more careful both about joining and leaving.

Second, many people in the church don’t recognize that the church is composed of a wide range of differing levels of spiritual maturity, including those who may not even be actual believers regenerated by grace through faith.

Third, because we live in a very “loud” majority secular culture many people bring into the church concepts of governance and tolerance from their secular experiences that they believe are also appropriate in the church.

And, fourth, religious beliefs for many people go to the core of their personal identity and whenever those treasured beliefs and practices (even if inconsistent with the Scriptures) come under attack they respond with deep emotion and anger. All of these factors make churches places ripe for conflict.

You write that “leaders must lead” but when does that begin to look autocratic and nonproductive?

Whenever church leadership becomes anything but shepherd-leadership the authority granted by Christ to lead in the church is lost. True shepherd-leaders champion humility and all of the other spiritual character traits that qualify a person for a position of church leadership.

God’s Word condemns the “hired-hand” as a church leader as well as any who would prey on God’s eternal children. True leaders lead through the compelling nature of God’s Word being applied in a manner that people following intuitively know that it is Christ’s faithful under-shepherd promoting God’s agenda for the church and never his own.

Further, faithful church leaders know their leadership will not be productive whenever it strays from God’s model of gentle shepherding because it will not be based in his revealed truth. God’s under-shepherds are called to be examples of holiness so that those they lead will grow in their own holiness. Such models of holiness are never, of course, autocratic.

You write that “Christ enlists us as his co-laborers in the process of peacemaking.” But you say we are “saturated with worldly ideas of what personal relationships are to be,” that “church members don’t read or understand their Bibles,” and “many of us make our church conflicts worse.” How so?

Christians become meaningful co-laborers with Christ when they study God’s Word and follow the principles, precepts and rules that govern life in the faith. Because we have been so crafted into the pattern of this world in our thinking and acting we need first and foremost the correction of Scripture to transform our thinking by the renewing of our minds so that we may be useful and effective co-laborers with Christ as we redeem conflicts for God’s glory and our spiritual growth.

The evidence of such usefulness and effectiveness becomes apparent when our goals and desires align with the goals and desires of Christ for His people. People who inhabit the church who fail first to understand God’s process for the redemption and reconciliation of conflicts only contribute to deepening and extending conflicts that destroy the witness we are to have to one another and to the watching world.

Many church members do read and understand their Bibles; however, unless consistent application of those truths is practiced such knowledge becomes ineffective and unproductive.

How does governance structure help or hinder a church in the midst of a conflict?

A church’s polity (governance practices) will often set the boundaries within which efforts to respond to conflicts in a biblically faithful manner can be undertaken. Clear expectations for governance are an important aspect of doing everything decently and in good order. The opposite is also true. When there is confusion over governance practices there will usually be little order and lack of progress in the quest to redeem and resolve conflicts.

Of course, polity structures must be consistent with God’s Word so that both church leaders and members have confidence that more than merely man’s wisdom is being followed. Frequently, a church’s rules of order become seen as merely human wisdom used to manipulate and control. That will undermine the efforts being taken to redeem conflicts and bring about the kinds of change needed to satisfy the legitimate concerns of those who rightly desire a more Christ-centered church environment.

You note that churches, despite having a system of church governance in the bylaws, over time deviate substantially from its own documents. So does the conflicted church then turn to its practices in real life?

The point we are making is that when conflicts come to the church there will frequently be those who will use official written policy as a weapon against those who have been following an unwritten practice that has taken on the apparent force and effect of policy.

In such cases the written policy will be upheld by the courts of both the church and the state, so, no, actual practices as governing policy usually fail. While some in the church may argue that unwritten practices should triumph, the usual pattern is that people will feel that they have been misled by leaders and wrong expectations have been established. This dynamic usually brings about mistrust of leaders and is another important reason why leaders and members alike know their written bylaws and other governing documents and follow them with consistency.

How does a pastor deal with factions in his conflicted church and get beyond that?

Factions in the church reflect a level of spiritual immaturity that should be seen and used by the pastor as an opportunity to teach and model God’s call for unity among his eternal children. Pastors should, in our opinion, never ignore the fact that factions may exist in the church and then tackle the issue head-on. That is what the apostle Paul did.

Failure to face the issue with the force of Scripture will only feed the notion that factions in the church are acceptable. The appropriate use of redemptive, corrective church discipline may be required to hold accountable those who perpetuate the idea that factions can continue. Unless God’s own methods for curtailing factions are employed the church will never be free of divisions that will undermine the mission of the church. Dealing with factions can be a pastor’s golden opportunity to help people grow in their maturity if addressed biblically with confidence in God’s Word.

The last five pages of the book deal with “the illusion of a conflict-free church,” that churches alternate from keeping the peace to denying obvious problems. What are early warning signals for conflict and heading it off at the pass?

One early warning sign is when factions begin to appear and people associated with those factions begin advocating favored outcomes over God’s priority for meaningful relationships. Whenever evidence emerges that relationships are being placed in a secondary position behind favored agendas then the need for biblical peacemaking efforts are in order.

Also, when people stop having a passion to honestly pray for one another — prayer that is other-centered and not self-centered, then the danger signs should go up. In the church, if people aren’t honestly praying for one another there is a need for a serious discussion related to what is at the center of any conflicts that may be emerging.

Usually, “heading it off at the pass” means getting back to the basics of the Gospel and all of its implications. God expects us to have a bigger heart and passion for His priorities than our own and that means renewing our commitment to His call for “making every effort to maintain the unity of the Spirit through the bonds of peace” that unite us in His church.

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Congregations have reconciliation ministries

Village Seven Presbyterian Church (PCA), a congregation in Colorado Springs, CO, of about 2,000 members, has a ministry called Peacemakers of Village Seven. As a church-based reconciliation ministry, it provides conflict coaching, mediation and arbitration services to members of the church as a benefit of their church membership. There is no charge for this service.

The church has a team of peacemakers staffed by church members who have been trained by Peacemaker Ministries, Billings, MT www.peacemaker.net and they stay busy assisting church members in resolving marital disputes, family conflicts, business and employment issues, and church conflicts involving members and church leaders.

Peacemaker Ministries encourages churches to develop Peacemaking Teams and provides helpful support services. They also have group discount rates for team training and team attendance at the annual Peacemakers Conference (this year in Denver, Sept. 13-16).

David Edling notes, “As a conservative Presbyterian church our members take their faith seriously and desire to live consistently with the commitments they have made. We are not an especially contentious or conflicted congregation, just one where members know that the peacemaking responses to conflict are to be pursued over the escape and attack responses that so many others seem to follow. Having a ministry of the church available to quickly assist and equip members to respond to conflicts biblically has been a great benefit and spiritual blessing as marriages have been reconciled and relationships healed.”

Tara Barthel is a member of Rocky Mountain Community Church (PCA), Billings, MT, and a participant in the congregation’s peacemaking team. On their website, they explain: “We have adopted the Peacemaker’s Pledge as a practical guideline for how Christians should resolve their differences, and we are committed to assisting our members in living out these principles in the midst of life’s conflicts.”

The extensive use of social media, including Facebook, Twitter, streaming sermon videos, podcasts and blogging, has placed many churches into a public arena with potential legal and public relations consequences. Social media has been a good thing for the spreading of the Gospel, allowing churches to have an immediate and global impact for Christ as well as the opportunity to create a sense of community within the church. However, as with all human endeavors, problems can and do occur.

One example involves First Baptist Church of Jacksonville, FL, that recently settled a defamation lawsuit against a formerly anonymous blogger who filed a complaint in 2009 after having been labeled by the pastor from the pulpit as “obsessive compulsive” and a “sociopath.” The pastor was reacting to statements made on a blog deemed to be critical of the church.

Another example of defamation involves a lawsuit filed in 2012 against a former church member of Beaverton Grace Bible Church, OR, who was apparently blogging about her experience and allegedly making negative online reviews of the pastor and the church.

Neither of these examples involved a church employee using social media to make allegedly defamatory remarks, but there have been instances where church blogs have resulted in legal trouble for the church and its leadership, whether culminating in a judgment from a lawsuit or an expensive legal settlement of a pending lawsuit.

Common sense can go a long way
Be careful what you say and what you type. Since most people are more likely to “hide behind the keyboard” and type something they wouldn’t say in person, ask yourself: “If the recipient of the e-mail was standing next to me, would I say or type the same words?”

Church defamation lawsuits seem to be increasing, and churches need to address this issue with all staff and volunteers, especially those whose job description (employee) or position description (volunteer) entails interacting with social media on behalf of the church.
Libel is written defamation and slander is spoken defamation. Context does matter practically though and while it is true that truth is always a possible defense, keep in mind that proving something is true can be a time-consuming and expensive legal and public relations process.

Develop a social media policy
Generally, you want to establish guidelines and rules for social media use, including the various roles and responsibilities of key employees and/or volunteers. A key point is recognizing that social media sites are never really private and information can and does become public. When responding to church critics via social media, it is a good idea to run it by legal counsel for the church before “returning volley” or placing a “warning shot across the bow” of critics.

It is best to have the social media policy and Christian code of conduct within the employee handbook or otherwise signed by the responsible employee or volunteer. If you adopt an appropriate and comprehensive written policy and train staff and volunteers about the legal environment, including the need to avoid making defamatory remarks or any kind of knee-jerk response to a situation or criticism in the use of social media, you will likely avoid defamation lawsuits and other forms of liability from your church’s use of social media.

David Middlebrook is a partner with Anthony and Middlebrook of The Church Law Group, Grapevine, TX. www.churchlawgroup.com

The Supreme Court decision on the Obama health care reform legislation has come and gone, and employers are now wondering: What do we do now? There are a few issues that need to be addressed in 2012: employees need to be provided with the new “summary of benefits and coverage” during the open enrollment period for the upcoming plan year.

Furthermore, unless your health care plan is a “grandfathered” plan or you (as an employer) are entitled to a religious employer exemption or special temporary enforcement safe harbor, your plan must cover contraceptive services without deductibles, co-pays or cost-sharing; and if you provide your employees with a flexible spending account, the limit on annual contributions to that account cannot exceed $2,500 beginning with the 2013 plan year.  (The cost of health care coverage is also required to be included on employee W-2s for the 2012 tax year).

However, under transition relief, small employers (employers that filed fewer than 250 Forms W-2 for the preceding calendar year) and churches and church-related employers are exempt from this requirement. This transition relief could change in the future.

Looking ahead
But what about 2014? What should employers be doing now to prepare for the new world of health insurance exchanges, premium assistance tax credits and employer “pay or play” excise taxes, which all become effective in 2014? The difficulty with planning for 2014 is that the information that is needed for an employer to decide whether to continue to provide its own health care plan in 2014 and following years is not now available.

Pricing of and a description of benefits provided under health care exchange plans will not be available until the spring of 2013, and an employer will not be able to compare benefits provided under its plan with those provided by exchange plans until next year. That said, a couple of points about what will happen beginning in 2014 can be made now.

First, it’s important to remember that the employer “pay or play” excise tax (i.e., the penalty an employer will pay if it does not provide a health care plan or provides a plan that is not “affordable” or does not provide “minimum value”)  does not apply to any employer with fewer than 50 “full-time equivalent employees.” (For purposes of this determination, part-time employees—those working fewer than 30 hours per week — are turned into a number of FTEEs by dividing the aggregate number of monthly hours of service for all part-time employees by 120.)

For purposes of the pay or play penalty, coverage is not “affordable” if its cost requires an employee to pay more than 9.5 percent of the employee’s W-2 income. (The ability of an employer to use W-2 income instead of “household income” for purposes of the “affordability” test is contained in a proposed rule.) A health care plan does not provide “minimum value” unless the employer pays for 60 percent or more of its total cost.

Making choices
The point: If an employer employs fewer than 50 FTEEs, it is free to make its decisions about whether to have a plan or the level and cost of coverage it will provide without having to be concerned that its decision will cause it to have to pay the excise tax/penalty.

Even if an employer does have 50 or more FTEES, it still will not have to pay the penalty if it has 30 or fewer full-time employees because of the way the penalties are calculated – and, even if it is subject to the penalty, the economic analysis that will have to be done in the future may still demonstrate that it will be less costly to pay the employer penalty and send its employees to the exchanges for health care coverage.  (If you participate in a denominational health care plan, note that efforts are underway to secure premium assistance tax credits for pastors and lay workers without having to go to the state exchanges.)

Tax credits
The premium assistance tax credits can be significant. These tax credits are only available to individuals whose household income is between 100 percent and 400 percent of the Federal Poverty Level. (In 2012, 400 percent of the FPL for a family of four is $92,200 – and clergy housing allowance reduces household income for purposes of determining premium assistance tax credit availability.

Those credits will thus be available to some degree for individuals who are considered to have high compensation in the church community.)  For example, based on calculations made on a calculator available on the Kaiser Family Foundation’s website, a family of four living in a high-cost health care area whose household income is $45,000 could expect to pay $14,556 per year for “silver” level health care coverage in 2014.

However, if the family purchases such “silver” level coverage on an exchange, its out-of-pocket premium cost would only be $2,672 per year – its premium assistance tax credit would be $11,885.

Doing the math
So, once the exchange plan information becomes available, get out your calculators, sharpen your pencils and get ready to “do the math.” Doing that math can be daunting, but some enterprising soul will no doubt develop software to use in making the necessary calculations. And one final thought: There is much to be done, both by states and the federal government, before the exchanges can officially come online.

If the current 2014 effective date holds – and most seem to think it will – then you may want to keep your current coverage in 2014 and give the new exchange world a chance to settle down a bit before making a decision on what to do about your workers’ health care coverage.

Danny Miller is a partner attorney in the law firm of Conner & Winters LLP, Washington, DC. [www.cwlaw.com]

Benevolence is identifying and meeting the needs of individuals that they cannot meet themselves. Individuals often call upon churches when they are broke. The most common requests include food, utilities, rent, medical expenses and transportation. But they can range from the compelling to the absurd. For example, one individual asked the church to provide school supplies so their children could attend school, while another asked the church to provide a Lexus automobile so he could land an outside sales job. From a stewardship perspective, the church should separate the reasonable from the unreasonable.

Here I will restrict benevolence to financial needs, since the IRS is most concerned about the money. Financial need may be met with cash or in-kind helps. This definition is broken into two requirements: needs and recipient resources. The church must document in writing that all benevolent expenditures meet both requirements.

The issue of need
The term “need” remains undefined in the tax authorities. So, churches usually resort to the dictionary when they must define “need.” Webster’s dictionary says that “need” equals “necessity.” Necessity usually includes food, shelter, clothing, transportation and health care expenses. For example, assume a single mom approaches the church about her need — her unpaid electric bill. Since electricity is needed in most residences, the church may consider this a need.

Of course, need is subjective. A church should not consider a request for $200 sneakers a need, though it fits the clothing category. On the other hand, providing modestly priced shoes would clearly fit within the definition of a “need.”

Needs get more complicated because some needs do not fit neatly into any category. For example, a child “needs” to participate in sports, but the family lacks the resources to buy the equipment. Another example: a welfare mom “needs” childcare to work. The church may adopt a written policy that gives guidance to the staff administering the programs.

The church should document that the request represents an unmet need. For example, the church could call the landlord and verify that last month’s rent is still unpaid. The church’s employee should prepare a memo to the file to reflect the conversation.

Benevolence gets more complicated when talking about a business need. The IRS has opined that a business can never receive church benevolence. Regardless whether this is confirmed later in court, every church should consult with competent legal counsel before giving a business any benevolence payment.

The issue of resources
The recipient of benevolence must lack the resources to meet the need. This test is related to the type of need being considered. For example, if a tornado destroyed an individual’s house today, the test would be whether that individual had the resources to find a room for the night. On the other hand, if the individual’s house was destroyed weeks ago, then the test is whether that individual can afford substitute housing until his home is rebuilt. In the first instance, the availability of insurance is not relevant, while in the second instance, the availability of insurance is very important.

Most churches accept a tax return or paycheck stub as proof of resources. Sometimes a copy of a bank statement is required. Again, many times the church will also require the recipient to sign a statement where the recipient represents that they lack the resources to pay the need.

Discretionary accounts. Many churches maintain a minister’s discretionary fund for benevolence. If the minister does not account for this fund or is the sole signer on the account, then all amounts placed in the account are taxable income to the minister. To prevent the minister being taxed on this account, the account should require at least two signatures and the minister should account for the expenditures just like the church’s other benevolence expenditures.

Repeat requests. Nearly every church has at least one person who is continually in need, or at least continually requests assistance. The IRS grows concerned when the benevolence assistance is regular and continuous. If the person also volunteers at the church, the IRS will likely claim that the payments were wages. If the payment is substantial, the IRS will likely claim that the person is receiving a private benefit, jeopardizing the church’s tax-exempt status.

Every church should use extreme caution when the benevolence payment is substantial or regular. In one case that I handled, the IRS claimed that the church’s monthly payments to a widow for the last three years constituted taxable compensation due her deceased minister/husband. In another case, the IRS claimed that $20,000 exceeded any possible needs. The IRS takes a very hard line in these circumstances, so the church should consult with competent legal counsel if either circumstance arises.

Employee benevolence. For better or worse, churches seem to attract needy employees. They may need their car repaired or have serious uninsured medical expenses. The Internal Revenue Code requires all benevolence payments provided to employees be taxed. The church must add the amount of the benevolent payments to the employee’s Form W-2, and if nonclergy, withhold all payroll taxes like the payment was wages. It makes no difference if the payment is direct or indirect, like to the employee’s doctor.

As a result, “love offerings,” pastoral appreciation gifts, Christmas gifts, anniversary gifts and birthday gifts that flow from the church to the church employee are always taxable. Even retirement gifts are taxable to the recipient. No exceptions to this rule exist.

If the church pays a benevolence payment to a “control person,” then the tax consequences get more complicated. If the IRS decides that the payment did not represent a true “need,” then the payment may represent an excess benefit transaction, subjecting the control person and the board or committee to an excise tax that can range from 10 percent to 200 percent, plus requiring the control person to repay the benevolent payment. A control person is generally someone having substantial authority within the church. It’s clear that the senior minister, the treasurer, the business administrator or executive minister is treated as a control party. The ministers on staff that have substantial authority over a significant part of the church are likely to be control parties. Volunteer board members, finance committee members, benevolence committee members and personnel committee members may become control parties subject to the excise taxes.

Suggested procedures
I suggest that the church adopt a written policy spelling out limits of the church’s benevolence. The policy should require a written application from the proposed recipient. The application should require a copy of an identifying document, such as a driver’s license.

The application should also include a copy of the unpaid bill, if the bill is the source of the need. At least two unrelated individuals should make all decisions regarding the request. The church should retain the application and related documents, plus the decision document at least three calendar years after the decision was made.

Also, the policy should require a separate application for each need. The church should have its policy reviewed by competent legal counsel. Finally, when faced with borderline requests, the church should consult with competent legal counsel before making the gift. By following this procedure, the church can fearlessly face any IRS inquiry about its benevolence.

Frank Sommerville, JD, CPA, is a partner in the law firm of Weycer, Kaplan, Pulaski & Zuber, P.C., Dallas and Houston, TX.  www.wkpz.org

Churches are automatically considered tax-exempt organizations by the Internal Revenue Code, and also exempted from the requirement to file the annual Form 990 (Return of Organization Exempt From Income Tax). But while churches are tax-exempt organizations by law, local congregations are still affected by many tax issues. These include unrelated business income tax (UBIT), the correct classification of independent contractors, ministerial compensation and other common tax concerns.

Unrelated business income tax
Although churches are exempted from filing Form 990 annually, they may be required to file Form 990-T (Exempt Organization Business Income Tax Return) if their activities generate gross unrelated business income of more than $1,000. “Gross income” is defined as “gross receipts minus cost of goods sold.”

Churches may generate unrelated business income from a parking lot, cell phone tower and office rentals, bookstores, rental of equipment in conjunction with events, and advertising in event programs or sports venues. In many cases these activities are specifically excluded because they are conducted for the convenience of members, meet the “corporate sponsorship” exclusion, or are substantially staffed by volunteers. The governing principle for UBIT is that it’s not how the funds are spent, but how they are generated. Just because a church uses the “profits” from an unrelated business activity to fund its exempt purpose activities does not mean that those “profits” will not be subject to UBIT.

Employee classification
Recently, the IRS has been conducting a “compliance project” on employment tax issues.

One of the focuses of this compliance project has been whether organizations are correctly classifying workers. The delineation between employee and independent contractor is important to the IRS. Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding) provides a good framework for helping churches discern the proper classification. I would caution against filing Form SS-8 without conferring with your tax advisor, but the form and its instructions can provide good guidance in this area.

If a church finds that it has improperly classified employees as outside contractors, there are several remedies. The IRS is currently conducting a “voluntary classification settlement program” where organizations may seek to reclassify misclassified workers. The program may dramatically reduce penalties that would normally be imposed in a reclassification of this nature.

The application is made on Form 8952, and you should seek the advice of your tax advisor before proceeding. In many cases, the “Section 530” relief described in IRS Publication 1976 may be a better option than the voluntary program.

Ministerial housing allowance
A minister may generally exclude a designated housing allowance from income. The allowance must be the lesser of:

• Amount approved in advance by the church,
• Actual expenses incurred, or
• Fair rental value of the house.

Finally, although churches are currently exempt from filing Form 990, this may not continue to be the case for all churches. There’s much discussion in Washington about which types of organizations may have to file in the future. Church financial leaders, especially those at larger churches, should familiarize themselves with Form 990 – just in case.

Dave Moja is a partner with CapinCrouse LLP, in Melbourne, FL, and national director of not-for-profit tax services. www.capincrouse.com

Many churches, ministries and charities are increasingly using volunteers and unpaid interns partly because of the economic benefits from not having to pay wages, benefits and taxes to traditional employees. But have you considered how to legally structure an internship program? One of the primary legal issues that may arise in this area is worker classification. Federal and state agencies are investigating organizations for possible misclassification of labor. Failure to properly classify a worker can result in serious consequences.

Who is an intern?
According to the Department of Labor (DOL), if all of the following “Unpaid Intern Positive Factors” apply, the workers are not “employees” within the meaning of the FLSA and do not need to be paid:

• The training, even though it includes actual operation of the facilities of the employer, is similar to that which would be given in a vocational school.
• The training is for the benefit of the interns.
• The interns do not displace regular employees, but they do work under regular employees’ close supervision.
• The employer that provides the training derives no immediate advantage from the activities of the interns and, on occasion, the employer’s operations may actually be impeded (it predominantly benefits the intern).
• The interns are not necessarily entitled to a job at the conclusion of the training period.
• The employer and the interns understand that the interns are not entitled to wages for the time spent training. (Tuition assistance and nominal stipends for students are not considered wages.)

While this six-part test was originally developed and applied to a for-profit corporation, it is still a helpful guidance for determining if a worker is properly an unpaid intern. Furthermore, most courts have determined that it is not necessary for all six of the above factors to be satisfied in order for a worker to be classified as an unpaid intern.

Although the DOL has set forth a six-part test, this method of determining whether a worker is an unpaid intern has been met with criticism by various courts that prefer to evaluate the totality of the circumstances, where no one factor is determinative. In such cases, the courts have instead tended to analyze the economic reality of the training, as well as the circumstances surrounding the training, focusing mainly on whether the worker had an expectation of compensation and whether the employer received an immediate or direct advantage from the work.

Further – and of positive note for churches, ministries and charities – the DOL’s fact sheet on this issue states the following:

DOL also recognizes an exception for individuals who volunteer their time, freely and without anticipation of compensation for religious, charitable, civic or humanitarian purposes to non-profit organizations. Unpaid internships in the public sector and for non-profit charitable organizations, where the intern volunteers without expectation of compensation, are genera lly permissible. DOL is reviewing the need for additional guidance on internships in the public and non-profit sectors.

Although we are still awaiting this more specific guidance from DOL with respect to religious and charitable nonprofit internships, the foregoing statement from the DOL is encouraging as it demonstrates that the DOL recognizes and generally allows uncompensated internships.

When is an intern not an intern?
In addition to providing a six-part test that indicates when an individual is an intern, the DOL has also provided some common examples of when an intern will not be considered an intern (and therefore is an employee). Please note that the presence of any one of these “Unpaid Intern Prohibited Factors” probably means the intern needs to be classified as an employee, especially when the unpaid internship program is not part of a formal academic experience:

• The employer uses the intern as a substitute for regular workers or as a supplement to its current workforce; or
• But for the intern, the employer would have hired additional employees or asked its existing staff to work additional hours; or
• The intern is engaged in the employer’s routine operations and/or the employer is dependent upon the intern’s work.

How to know whether to classify a worker as an unpaid intern or an employee? We wish there was a bright-line legal rule that would be a specific answer to the situation. However, until we get more specific guidance from DOL, the best practice is that you endeavor to ensure your internship program meets as many of the DOL’s six unpaid intern positive factors as possible and does not contain an unpaid intern prohibited factor.

The more your internship program looks like a formal academic internship program, the more likely it will meet the requirements. Make certain you have the appropriate contracts in place with your interns. If you follow this advice, you are in the best possible situation given the available judicial and governmental guidance we have available at this time.

David Middlebrook is a founding shareholder with Anthony & Middlebrook, P.C., The Church Law Group, Grapevine, TX. www.ChurchLawGroup.com

From the founding of our country until 1953, churches and their ministers enjoyed complete freedom to address social, moral, Biblical and political issues. Churches have enjoyed exemptions from federal income tax in every income tax law enacted since 1861 without any restrictions on the political activities of the church. But in 1954 all that changed.

As part of the Internal Revenue Code of 1954, then Senator Lyndon B. Johnson added a new condition to the tax exemption for all nonprofit organizations: no political activity. This amendment to the Code prohibited all nonprofits from doing anything that would support or hinder a candidate for elective office. (For purposes of this article, I will use the prior sentence as the definition of “political activity.”)  This amendment was added at the last minute without any discussion or hearings.

Since 1954, the Internal Revenue Service has struggled with enforcing this provision. The courts only report a single case where a church lost its tax exemption due to political activity. Yet many professionals have advised churches to avoid any activity that could be interpreted as prohibited political activity. After the 2004 elections, the IRS attempted to open exams of several churches and other nonprofit organizations that allegedly engaged in political activity.  When those organizations strongly resisted any attempts to examine their alleged political activity, the IRS quietly closed their inquiries rather than engage in a very public fight over those activities.

Evaluating with Scripture
In recent years, ministers and their churches believe that political issues and candidates for elected office need to evaluated in light of scriptural truth and historical church teachings. However, if the minister offered such a biblical evaluation to his church, the church could lose its tax exempt status.

Some ministers claim that this amounts to government censorship of the Gospel.

In 2008 the Alliance Defense Fund started the Pulpit Initiative to encourage pastors to speak freely from their pulpit about social, moral, Biblical and political issues. The Pulpit Initiative ministers received training regarding the application of the political activity restriction in their church and their rights of free speech under the First Amendment to the Constitution.

The Alliance Defense Fund believes that the restriction on political activity is unconstitutional because it violates the free speech clause of the First Amendment of the United States Constitution.  On a Sunday chosen in October, the ministers will address social, moral, biblical and political issues as part of their sermons. They record those sermons to preserve their “free speech.” The Pulpit Initiative highlights the issue of whether the political activity restriction is constitutional.

The IRS has remained silent despite the fact that the Alliance Defense Fund heavily publicizes the number of churches that have chosen to participate in the Pulpit Initiative. Though the IRS started the examination of one church that was part of the Pulpit Initiative, it quietly closed the file without explanation.

Basis for selection
In general, the IRS will not select a church for examination simply because the church asked to be examined. The IRS will not select the church for examination simply because the apparent violation of the law is blatant and flagrant. The IRS will select nonprofit organizations for examination solely on its internal, secret criteria. No amount of publicity by the Alliance Defense Fund will cause the IRS to openly challenge the Pulpit Initiative.

The IRS has an additional problem. In 2009 a United States District Court in Minnesota ruled that the IRS was violating the Church Audit Act when it changed its internal procedures in approving the opening of church examinations. The Church Audit Act, codified at section 7611 of the Internal Revenue Code, requires that all church examinations be approved by the Regional Commissioner of Internal Revenue Service. When the IRS reorganized in 1998, it eliminated the position of Regional Commissioner.

At that time, the IRS selected the Chief of Examinations, Exempt Organizations Division, as its official to approve church examinations. Living Word Christian Center, Minneapolis, MN, challenged the IRS saying that the Chief of Examinations was not a high enough IRS official to approve the examination. United States District Court agreed with the church and dismissed the attempted examination.

Since that court decision, IRS has not opened a single church examination. Later in 2009, the IRS proposed new regulations authorizing the Commissioner of Exempt Organizations to approve church examinations. However, many criticized the proposed regulation because it was still not a high enough official. The Regional Commissioner was one organizational level below the Commissioner of Internal Revenue.

The Commissioner of Exempt Organizations is four organizational levels below the Commissioner of Internal Revenue. Until final regulations are effective, the initiation of any church examination can be challenged unless it was approved by the Commissioner of Internal Revenue. To date, he has declined to approve any church examinations.

Frank Sommerville, JD, CPA is a shareholder with the law firm of Weycer, Kaplan, Pulaski & Zuber, P.C., Arlington, TX. www.wkpz.com

There is a blockbuster religious freedom case that is currently pending before the United States Supreme Court. Courts have generally believed that federal employment discrimination statutes do not apply to church employees performing religious functions.

However, in Hosanna-Tabor Evangelical Lutheran Church and School v. EEOC, the question has been raised as to whether the “ministerial exception” applies not simply to religious leaders, but also to teachers at religious schools – particularly someone who teaches the full secular curriculum, but also teaches daily religion classes, is a commissioned minister and regularly leads students in prayer and worship.

Specifically, the case revolves around a teacher in a religious elementary school in Michigan who was diagnosed with narcolepsy and eventually fired.

The religious tenants of the school’s sponsoring denomination – the Lutheran Church-Missouri Synod (LCMS) – required any disputes be handled by the church tribunal; however, the teacher did not abide with the policies of the denomination regarding dispute resolution, but rather sued the church and school in secular court under the Americans with Disabilities Act (ADA), claiming her termination was due to her disability (which, of course, is not a permissible action by employers under the ADA).

Religious reasons
The church and school insist that the terminated employee was a “commissioned minister” and that her termination was for religious reasons; therefore, that the case is subject to the ministerial exception (i.e., dismissal from the secular courts).

As described in the petition for certiorari filed with the Supreme Court:

“The ‘ministerial exception’ bars lawsuits that interfere in the relationship between a religious organization and employees who perform religious functions — most obviously, lawsuits seeking to compel a religious organization to reinstate such an employee or seeking to impose monetary liability for the selection of such employees. As the first court adopting the ministerial exception explained: ‘The relationship between an organized church and its ministers is its lifeblood’; allowing the state to interfere in that relationship — effectively allowing judges and juries to pick ministers — would produce ‘the very opposite of that separation of church and State contemplated by the First Amendment.’ McClure v. Salvation Army, 460 F.2d 553, 558, 560 (5th Cir. 1972).

“Based on this principle, every circuit has agreed that the ministerial exception bars most lawsuits between a religious organization and its leaders. Every circuit has also agreed that the ministerial exception extends beyond formally designated ‘ministers’ to include other employees who play an important religious role in the organization.”

Tenets of faith
The ministerial exception to employment law was established to give religious groups the freedom to hire and fire people performing religious functions, in order to uphold the tenets of their particular faith. The rationale is that the ministerial exception lets religious organizations practice their religion and convey their beliefs without being subject to employment discrimination laws.

For example, the Catholic Church does not permit women to serve as priests; however, the church is free from a discrimination claim due to the ministerial exception to federal employment laws.

In a common employment claim scenario, a church employs a minister and then that minister sues the church alleging some violation of either Title VII (such as retaliation, racial discrimination, gender discrimination, or sexual harassment), the Age Discrimination in Employment Act (ADEA), or the ADA. In such a scenario, the majority of courts will apply the ministerial exception, which results in the case being dismissed.

However, in the Hosanna-Tabor case, the issue at hand is whether the ministerial exception can be extended to an employee who, though a commissioned minister who taught religious studies and lead children in prayer, mostly taught secular subjects such as math and English. In this case, the teacher filed a discrimination claim, and the church filed a motion to dismiss based on the ministerial exception. The U.S. Court of Appeals for the Sixth Circuit sided with the teacher, and the church appealed to the U.S. Supreme Court.

Freedom of religion
Generally, courts feel that they cannot get involved in such issues without coming into conflict with the freedom of religion clauses in the First Amendment. Many commentators argue that the ministerial exception is wrong and should not be applicable based on the fact that it does not matter whether the church had a religious basis for making its decision; rather, the mere fact that a church and a minister are involved are enough to warrant dismissal of the case.

These same commentators argue that, instead of being applied as a blanket rule, the ministerial exception should only be applied when the employees claim is grounded in a religious context (rather than a strictly employment-related context, such as sexual harassment for example).

Some who argue in favor of doing away with the ministerial exception concede (albeit grudgingly) that there may be instances of exception for certain employees who perform “exclusively” religious function.

However, this “exception” would be fairly difficult to implement considering that most church employees, including the ministers, perform at least some nonreligious administrative duties on a regular, if not daily, basis.

Religious enough?
If the government’s argument is accepted, the courts would be involved in disputes about the selection and termination of clergy at all levels and in every denomination. Basically, this would mean that, in every future case, a court – and not the church itself – could decide whether the church’s reasons for firing or not hiring a minister were good (i.e., religious) enough.

As you can see, based on the facts alone, this is a case about whether a teacher in a faith-based school who teaches a non-religious subject but who has some religious duties should be considered a “ministerial” employee, such that the school is largely free to make decisions about her employment without running afoul of employment laws.

However, for many this is a vitally important case dealing with the separation of church and state.

Supporting the school’s decision to invoke the ministerial exception are multiple and various groups, including Roman Catholics, Mormons, Presbyterians, United Methodists, Seventh-day Adventists, Hindus, United Sikhs, Muslims, Episcopalians, Reform Jews and Orthodox Jews.

These groups hope the high court will hold that the ministerial exception applies not only to religious leaders but also to others within a religious organization, which would provide religious organizations with a broad-based protection from discrimination lawsuits. A ruling is not expected until next spring or summer.

David Middlebrook is a partner and Wendi L. Hodges is an attorney of Anthony and Middlebrook, The Church Law Group, Grapeville, TX. www.churchlawgroup.com