Let the IRS answer this in their own words:“The following organizations may be considered tax-exempt under section 501(c)(3) even if they do not file Form 1023: (a) churches, integrated auxilliaries of churches, and conventions or associations of churches” –Ibid, Purpose of Form, 2. Organizations not required to file Form 1023, paragraphs 1 and 2. [underlining added].
“Although a church, its integrated auxillaries, or a convention or association of churches is not required to file Form 1023 to be exempt from Federal Income tax or to receive tax-deductible contributions, such an organization may find it advantageous to obtain recognition of exemption” –IRS Form 1023 (Rev. 9-98) Instructions, Schedule A, Churches, Instructions, Page 13. [underlining added]
You read that correctly… the IRS does not require any ‘church’, church auxillary, or group of associated churches to file Form 1023 in order to be exempt from “Federal Income tax”. They also say that a church can receive tax-deductible contributions even if they have not filed a Form 1023.
The catch here is whether or not a ‘church’ requests the IRS to issue their own internal “recognition of exemption”. This is not to say that a church is not exempt, but rather to explicitly inform the church that if they want a special recognition of exemption from the IRS, then they need to incorporate, then file a Form 1023 and its accompanying Schedule A.
Since no ‘church’ is required to do this, then why do they? How many Pastors and Deacons have filled out an IRS Form 1023 and never read the instructions? If they are not required to apply for this non-required IRS exemption, then why do they do it? Perhaps you should ask your Pastor and Deacons these questions. Who are they serving: the Body of Christ or the IRS? It’s one or the other, so what is their choice?
Church Defined – IRS Church Definition
Because of First Amendment religious freedom concerns, Congress has never passed any statute anywhere which defines what a church is (beyond saying “a church or convention or association of churches”, which is like saying that the definition of a duck is “one or more ducks”). The IRS, which apparently is unconstrained by the First Amendment, has nonetheless ventured where angels fear to tread, and has established criteria which, in its view, define a church as follows:
2. A recognized creed and form of worship
3. A definite and distinct ecclesiastical government
4. A formal code of doctrine and discipline
5. A distinct religious history
6. A membership not associated with any other church or denomination
7. An organization of ordained ministers
8. Ordained ministers selected after completing prescribed studies
9. A literature of its own
10. Established places of worship
11. Regular congregations
12. Regular religious services
13. Sunday schools for religious instruction of the young
14. Schools for the preparation of its ministers.
There are several appropriate steps to take before the IRS comes to call:
- Review your activities. Does the church have documentation to establish the relationship between the various church programs and your exempt purpose as a church? Today, churches launch a wide variety of ministries. Documenting the relationship of each ministry to the mission of the church is a fundamental principle.
- Review your records. Are the basic records of the church (legal, financial, donor, personnel) stored on the church premises and labeled accurately? Many of the church records may be stored electronically on the church network. Does the church have a records retention policy and follow the policy?
- Recognize all employees as employees. Does the church have clear policies to determine which workers are employees v. independent contractors? Does the church err on the side of classifying workers as employees? This topic is a hot-button with the IRS. They will tend to classify all workers as employees. If the church has classified workers as independent contractors and the IRS views them as employees, the IRS will assess FICA taxes (both halves—15.3%) and federal income tax withholding, plus penalties and interest—often going back three years.
- Stay current on employment tax filings. Are payroll tax returns (Forms 941) timely filed each quarter and payroll tax deposits made when due? If the church is running close on cash, never borrow from the funds that are due to the IRS for payroll tax.
- Consider any unrelated business income (UBI) filing responsibilities. Many churches have an obligation to file a UBI return but are unaware of this duty. This is an easy problem for the IRS to find. What triggers UBI filings? Just $1,000 of gross unrelated business income requires the filing of Form 990-T. There is generally no tax to pay but the filing is still required. What is one of the most common types of UBI? Rental income from mortgaged property. There are many other kinds of UBI but this is a frequent issue for churches.
- Keep your information filings up-to-date. There are a myriad of other filings that may be required with the IRS. Some common examples are: Form 5578 that must be annually filed if the church operates a private school. Form 1099-MISC that must be filed for independent contractors (be sure your files contain justification for independent contractor status). Form 1099-INT must generally be provided to recipients of $10 or more of interest income. All payments to nonresident aliens, other than expense reimbursements and amounts reported on Form W-2, must be reported on Form 1042 and 1042-S (these filing are often overlooked and the IRS has this problem on the top of their list).
- Carefully document the status of ministers. If a church treats an individual as a qualified minister, has the church clearly documented ministerial status? Is a copy of the ordination, licensing or commissioning document in each minister’s personnel file? Has the church documented the position description of each minister?
- Properly document the personal use of church-owned or leased vehicles. While not much tax money is involved, this issue is low-hanging fruit for the IRS. Church staff members are obligated to track any personal mileage, including commuting miles, on any church owned or leased vehicles they drive. The personal use mileage must then be taxed to the staff member using one of the methods approved by the IRS. If the church takes the position that a church-owned or leased vehicle is never used for personal purposes, this will rarely fly with the IRS unless we are talking about a Sunday school bus!
- Identify the personal use of cell phones. The personal use of cell phones is another hot item with the IRS. The IRS Regulations in this area are very strict—almost beyond the point of possible compliance. At a minimum, however, a church must make a reasonable effort to identify the personal use portion of cell phone usage from a compliance and risk management standpoint. It isn’t enough to say the church bought so many minutes and didn’t go over the limit. While neither option literally complies with Regulations, most churches that pay for church staff cell phone time either gross up the employee’s Form W-2 or require a reimbursement for the personal use portion.
- Properly handle spousal travel expenses. The spousal travel expenses of church staff members do not qualify for reimbursement by the church unless the spousal travel qualifies as business expense. Even if it appears there is a business purpose for the spousal travel, the key is documentation, e.g., documenting the purpose for spousal travel on a trip-by-trip basis.